-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, D7rDLrNjFg5Tse47ZwC5o/oXrafK6jjG+IwELJ9ognVWRdZP9l5qHcr/jPzrCTnC zo8MbU4COaWPWtjBH9nnJQ== 0000950152-04-001503.txt : 20040301 0000950152-04-001503.hdr.sgml : 20040301 20040301113230 ACCESSION NUMBER: 0000950152-04-001503 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040301 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LUBRIZOL CORP CENTRAL INDEX KEY: 0000060751 STANDARD INDUSTRIAL CLASSIFICATION: INDUSTRIAL ORGANIC CHEMICALS [2860] IRS NUMBER: 340367600 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-05263 FILM NUMBER: 04637846 BUSINESS ADDRESS: STREET 1: 29400 LAKELAND BLVD CITY: WICKLIFFE STATE: OH ZIP: 44092 BUSINESS PHONE: 2169434200 MAIL ADDRESS: STREET 1: 29400 LAKELAND BLVD CITY: WICKLIFFE STATE: OH ZIP: 44092 10-K 1 l05101ae10vk.txt THE LUBRIZOL CORPORATION FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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 of incorporation) (I.R.S. Employer Identification No.) 29400 Lakeland Boulevard Wickliffe, Ohio 44092-2298 (Address of principal executive officers, including zip code) Registrant's telephone number, including area code: (440) 943-4200 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered - ------------------------------- ----------------------- Common Shares without par value New York Stock Exchange Common Share purchase rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes X No ------ ----- Aggregate market value (on basis of closing sale price) of voting stock held by nonaffiliates as of June 30, 2003: $1,586,154,693. Number of the registrant's Common Shares, without par value, outstanding as of February 1, 2004: 51,596,502. Documents Incorporated by Reference Portions of the registrant's 2003 Annual Report to its shareholders (Incorporated into Part I and II of this Form 10-K) Portions of the registrant's Proxy Statement dated March 17, 2004 (Incorporated into Part III of this Form 10-K) 1 PART I ITEM 1. BUSINESS The Lubrizol Corporation was organized under the laws of Ohio in 1928. We began business as a compounder of special-purpose lubricants, and in the early 1930's were among the first to commence research in the field of lubricant additives. Today, we are a global fluid technology company that develops, produces and sells high-performance chemicals, systems and services for transportation and industry. We create these products by applying advanced chemical and mechanical technologies to enhance the performance, quality and value and reduce the environmental impact of the customer products in which our products are used. Beginning in 2002, we reorganized our product lines into three principal reporting segments: fluid technologies for transportation, fluid technologies for industry and all other, which is comprised of the advanced fluid systems(AFS) and emulsified products operating segments. Principal Products. 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, this segment sells additive components and viscosity improvers within its lubricant and fuel additives product lines. Fluid technologies for industry includes additives for industrial fluids, such as additives for hydraulic, grease and metalworking fluids and compressor lubricants; and performance chemicals, such as additives for coatings and inks, defoamers, process chemicals and surfactants for personal care and industrial cleaners. Advanced fluid systems principally is comprised of fluid metering devices, particulate emission trap devices, and FluiPaKTM sensor systems. Emulsified products is comprised of PuriNOxTM low-emissions diesel fuel. Revenues within the fluid technologies for transportation (FTT) segment comprised 76%, 79% and 83% of consolidated revenues in 2003, 2002 and 2001, respectively. Within FTT, additives for lubricating engine oils comprised 51%, 54% and 55% of consolidated revenues in 2003, 2002 and 2001, respectively and additives for driveline oils comprised 20%, 21% and 22% of consolidated revenues for these same respective periods. Revenues within the fluid technologies for industry (FTI) segment comprised 23%, 19% and 16% of consolidated revenues in 2003, 2002 and 2001, respectively. Within FTI, additives for industrial fluids comprised 10% of consolidated revenues in 2003, 2002 and 2001 and performance chemicals comprised 13% of revenues in 2003. Prior to 2003, performance chemicals comprised less than 10% of revenues. Further financial information for the company's operating segments is contained in Note 13 to the Financial Statements, which is included in our 2003 Annual Report to shareholders and is incorporated herein by reference. Additives improve the lubricants and fuels used in cars, trucks, buses, off-highway equipment, marine engines and industrial applications. Additives in lubricants enable oil to withstand a broader range of temperatures, limit the buildup of sludge and varnish deposits, reduce wear, inhibit the formation of foam, rust and corrosion, and retard oxidation. Additives in fuels help maintain efficient operation of the fuel delivery system, help control deposits and corrosion, improve combustion and assist in preventing decomposition during storage. Coatings additives are used to enhance the appearance and durability of coatings in architectural and industrial uses, as well as to improve their processing and application characteristics. Inks additives improve the processing and performance of printing inks, pigment dispersions, and coatings to the printing ink industry by improving the abrasion resistance properties and film characteristics of printing ink and coatings. Defoamer and anti-foam additives are used in many industrial and food processing applications to control the quantity of foam that occurs in a process. Specialty surfactants enhance the performance of emulsion explosives by improving long term stability, imparting waterproofing characteristics, enabling viscosity control, and improving the 2 detonation properties of the formula by their versatility to a wide range of density control methods. Specialty monomers are used in acrylic fibers to improve incorporation of dyes, dishwashing detergents to reduce filming on glassware and utensils, skin creams to improve lubricity and feel, medical gels for defibrillator pads to enhance conductivity, coatings and adhesives to improve adhesion to glass and other substrates, and water treatment polymers to reduce corrosion in cooling towers. Personal care and industrial cleaner additives enhance the functional and aesthetic properties of personal care products and many household and industrial cleaners by improving characteristics such as foaming, cleansing and moisturizing, as well as imparting the elegant "feel" to lotions and creams. Our advanced fluid systems products principally involve products used in emission controls, such as catalyst, exhaust and filter systems and precision metering devices used in blending and additive injection operations. Competition. Our FTT and FTI segments are highly competitive in terms of price, technology development, product performance and customer service. Our principal competitors within FTT, both in the United States and overseas, are Infineum, a joint venture involving two major petroleum companies (Shell Oil Company and Exxon Mobil Corporation); Chevron Oronite Company, a subsidiary of ChevronTexaco Corporation, a major petroleum company; and one chemical company (Ethyl Corporation). The petroleum companies either directly or indirectly produce lubricant and fuel additives for their own use and also sell additives to others. These petroleum companies are also our customers and may also sell base oil to us. We believe, based on volume sold, that we are the largest supplier to the petroleum industry of performance additive packages for lubricants. In FTI, we primarily compete in the metalworking fluids, hydraulic fluids, synthetic refrigerant lubricants and additives for paints, coatings and inks and specialty surfactants markets, with numerous competitors within each market. Customers. We primarily market our FTT and FTI products worldwide through our own sales organization. In addition, we use sales agents and distributors where necessary. Our additive customers primarily consist of oil refiners and independent oil blenders and are located in more than 100 countries. In 2003, approximately 45% of our consolidated sales were made to customers in North America, 29% to customers in Europe and 26% to customers in Asia-Pacific, Middle East and Latin America. Our ten largest customers, most of which are international oil companies and a number of which are groups of affiliated entities, accounted for approximately 52% of consolidated sales in 2003. The loss of one or more of these customers could have a material adverse effect on our business, specifically in FTT. BP was our largest customer within FTT during 2003, comprising 11% of consolidated sales. FTI is not materially dependent on a single customer or on a few customers. Raw Materials. We use a broad variety of chemical raw materials in the manufacture of our additives and use oil in processing and blending additives. These materials are obtainable from several sources, and for the most part are derived from petroleum. Political and economic conditions in the Middle East have, in the past, caused and may continue to cause the cost of raw materials to fluctuate significantly; however, our access to raw materials has not been significantly affected when these conditions occurred. We expect raw materials to be available in adequate quantities during 2004. Research, Testing and Development. We historically have emphasized research and have developed a large percentage of the additives we manufacture and sell. Technological developments in the design of engines and other automotive equipment, combined with rising demands for environmental protection and fuel economy, require increasingly sophisticated chemical additives to meet industry performance standards. The frequency of changes in industry performance affects our technical spending patterns. Consolidated research and development expenditures were $93.9 million in 2003, $93.5 million in 2002 and $87.6 million in 2001. These amounts were equivalent to 4.6%, 4.7% and 4.7% of the respective revenues for those years. These amounts include expenditures for the performance evaluation of additive 3 developments in engines and other types of mechanical equipment as well as expenditures for the development of specialty chemicals for industrial applications. In addition, we spent $73.0 million, $74.8 million and $70.9 million in 2003, 2002 and 2001, respectively, for technical service (testing) activities, principally for evaluation in mechanical equipment of specific lubricant formulations designed for the needs of petroleum industry customers throughout the world. Research, testing and development expenditures by reporting segment were as follows (in thousands of dollars):
2003 2002 2001 -------- -------- -------- Research & development expenditures: Fluid technologies for transportation $ 77,503 $ 81,645 $ 73,875 Fluid technologies for industry 13,668 9,370 10,025 All Other 2,766 2,485 3,682 -------- -------- -------- Total $ 93,937 $ 93,501 $ 87,582 ======== ======== ======== Testing expenditures: Fluid technologies for transportation $ 59,740 $ 62,243 57,314 Fluid technologies for industry 10,561 10,263 10,607 All Other 2,704 2,296 2,970 -------- -------- -------- Total $ 73,005 $ 74,802 $ 70,891 ======== ======== ========
We have two research facilities at Wickliffe, Ohio, one of which is principally for lubricant additive research and the other for research in the field of other specialty chemicals. We also maintain a mechanical testing laboratory at Wickliffe, equipped with a variety of gasoline and diesel engines and other mechanical equipment to evaluate the performance of additives for lubricants and fuels. We have similar mechanical testing laboratories in England and Japan and, in addition, make extensive use of independent contract research firms. Extensive field testing is conducted through various arrangements with fleet operators and others. We also have laboratories that perform research and customer testing in Paso Robles, California; Spartanburg, South Carolina; Linden, New Jersey; Midland, Michigan; and Ritterhude, Germany for our fluid technologies for industry business and in Newmarket, Ontario for our advanced fluid systems business. Liaison offices in Detroit, Michigan; Hazelwood, England; Hamburg, Germany; Tokyo, Japan; and Paris, France, maintain close contact with the principal automotive and equipment manufacturers of the world and keep us abreast of the performance requirements for our products in the face of changing technologies. These liaison activities also serve as contacts for cooperative development and evaluation of products for future applications. Contacts with the automotive and equipment industry are important so that we may have the necessary direction and lead time to develop products for use in engines, transmissions, gear sets, and other areas of equipment that require lubricants of advanced design. Patents. We own a variety of United States and foreign patents relating to lubricant and fuel additives, lubricants, chemical compositions and processes, and protective coating materials and processes. While these domestic and foreign patents expire from time to time, we continue to apply for and obtain patent protection on an ongoing basis. Although we believe that, in the aggregate, our patents constitute an important asset, we do not regard our business as being materially dependent upon any single patent or any group of related patents. We use patents in all operating segments. 4 Environmental Matters. We are subject to federal, state and local laws and regulations designed to protect the environment and limit manufacturing wastes and emissions. We believe that as a general matter our policies, practices and procedures are properly designed to prevent unreasonable risk of environmental damage and the consequent financial liability to the company. Compliance with environmental laws and regulations requires continuing management effort and expenditures. Capital expenditures for environmental projects were $5.5 million in 2003, which represented 6.2% of 2003 capital expenditures. We believe that the cost of complying with environmental laws and regulations will not have a material affect on our earnings, liquidity or competitive position. We are engaged in the handling, manufacture, use, transportation and disposal of substances that are classified as hazardous or toxic by one or more regulatory agencies. We believe that our handling, manufacture, use, transportation and disposal of such substances generally have been in accord with environmental laws and regulations. Among other environmental laws, we are subject to the federal "Superfund" law, under which we have been designated as a "potentially responsible party" that may be liable for cleanup costs associated with various waste sites, some of which are on the U.S. Environmental Protection Agency Superfund priority list. Our experience, consistent with what we believe to be the experience of others in similar cases, is that Superfund site liability tends to be apportioned among parties based upon contribution of materials to the Superfund site. Accordingly, we measure our liability and carry out our financial reporting responsibilities with respect to Superfund sites based upon this standard, even though Superfund site liability is technically joint and several in nature. We view the expense of such remedial cleanups as a part of our product cost, and accrue for estimated environmental liabilities with charges to cost of sales. We consider our environmental accrual to be adequate to provide for our portion of costs for all such known environmental liabilities. Based upon consideration of currently available information, we believe liabilities for environmental matters will not have a material adverse affect on our financial position, operating results or liquidity. Employees. At December 31, 2003, we and our subsidiaries had 5,032 employees of which approximately 53% were in the U.S. Geographic Area Information. Financial information with respect to domestic and foreign operations is contained in Note 13 to the Financial Statements which is included in our 2003 Annual Report to shareholders, and is incorporated herein by reference. We supply additive customers abroad through export from the United States and from overseas manufacturing plants. We have sales and technical service offices in approximately 30 countries outside the United States. 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. Changes in the U.S. dollar value of foreign currencies will affect earnings from time to time. Our consolidated net income generally will benefit as foreign currencies increase in value compared to the U.S. dollar and generally will decline as foreign currencies decrease in value. Available Information. Our Internet address is www.lubrizol.com. We make available free of charge on our Internet website the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file the material with or furnish it to the SEC. ITEM 2. PROPERTIES 5 Our general offices are located in Wickliffe, Ohio. We have other offices and facilities around the world as indicated in the following chart.
Owned in Fee or Office, Laboratory (R&D/Testing) Reporting Location Leased or Manufacturing/Blending Segment - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Sydney, Australia Owned Office, Manufacturing/Blending FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Vilvoorde, Belgium Owned Office, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Rio de Janeiro, Brazil Owned Office, Manufacturing/Blending FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Niagara Falls, Ontario Owned Office, Manufacturing/Blending FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Newmarket and Owned Office, Laboratory, Manufacturing All Other London, Ontario - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Oakville, Ontario Leased Office FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Bromborough, England Owned Office, Manufacturing/Blending FTT, FTI, All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Fareham, England Owned Office, Manufacturing All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Hazelwood, England Owned Office, Laboratory FTT, FTI, All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- London, England Leased Office FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Le Havre, Mourenx Owned Office, Manufacturing/Blending FTT, FTI and Rouen, France - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Hamburg, Germany Leased Office, Laboratory, Manufacturing/Blending FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Ritterhude, Germany Owned Office, Laboratory, Manufacturing/Blending FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Kinuura, Japan Owned Office, Laboratory, Manufacturing/Blending FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Apodaca, Mexico Owned Office, Manufacturing/Blending FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Jurong, Singapore Plant is owned; Office, Manufacturing/Blending FTT, FTI land is leased - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Durban, South Africa Owned Office, Manufacturing/Blending FTT, FTI - ---------------------------------- ---------------------------- -------------------------------------------------------------------- Malmo, Sweden Owned Office, Manufacturing All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Paso Robles, CA Leased Office, Laboratory, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Rancho Santa, CA Leased Office FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Wilmington, DE Leased Office FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Atlanta, GA Owned Office, Manufacturing All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- McCook, IL Leased Office, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Countryside, IL Owned Office, Manufacturing/Blending FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Naperville, IL Leased Office FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Midland, MI Owned Office, Laboratory, FTI Manufacturing/Blending - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Southfield, MI Leased Office FTT, FTI, All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Reno, NV Leased Office, Manufacturing All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Linden, NJ Owned Office, Laboratory, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Bowling Green, OH Owned Office, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Painesville, OH Owned Office, Manufacturing FTT, FTI, All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Wickliffe, OH Owned Laboratory FTT, FTI, All Other - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Mountaintop, PA Owned Office, Manufacturing/Blending FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Spartanburg, SC Leased Office, Laboratory FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Spartanburg, SC Owned Office, Laboratory, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Bayport, TX Owned Office, Manufacturing FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Deer Park, TX Owned Office, Manufacturing FTT, FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Houston, TX Leased Office FTT - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Houston, TX Owned Office, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Vancouver, WA Leased Office FTI - ---------------------------------- ---------------------------- ----------------------------------------------- -------------------- Cheyenne, WY Owned Office, Manufacturing FTI - ---------------------------------- ---------------------------- ----------------------------------------------- --------------------
6 In some cases, the ownership or leasing of these facilities is through a subsidiary or affiliate. In addition, manufacturing/blending plants in India, Saudi Arabia and China are owned and operated by joint venture companies licensed by Lubrizol. Our ownership of each of these companies ranges from 49% to 50.05%. At both the Lanzhou, China plant and the Mumbai, India plant, the land on which the plants are located is leased. We have entered into long-term contracts for our exclusive use of major marine terminal facilities at the Port of Houston, Texas. In addition we have leases for storage facilities in Australia, Chile, Denmark, Ecuador, England, Finland, France, Holland, Singapore, Spain, South Africa, Sweden and Turkey; Paso Robles, Bakersfield and Los Angeles, California; St. Paul, Minnesota; Bayonne and Edison, New Jersey; Perrysburg, Ohio; Oklahoma City, Oklahoma; Odessa, Texas and Tacoma, Washington. We maintain a capital expenditure program to support our operations and believe our facilities are adequate for our present operations and for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS Lubrizol and our subsidiaries are participants in ordinary routine litigation incidental to the business but are not defendants in any material pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to the vote of the security holders during the three months ended December 31, 2003. 7 EXECUTIVE OFFICERS OF THE REGISTRANT The following sets forth the name, age, recent business experience and certain other information relative to each person who was an executive officer as of February 9, 2004.
Name Business Experience W. G. Bares Mr. Bares, age 62, became Chairman of the Board on April 22, 1996, and Chief Executive Officer on January 1, 1996. He was President from 1982 to January 10, 2003. J. R. Ahern Mr. Ahern, age 57, has been Controller - Accounting and Financial Reporting and Principal Accounting Officer since April 26, 1999. From 1993 to April 1999 he was Controller - Operations. J. W. Bauer Mr. Bauer, age 50, has been Vice President and General Counsel since April 1992. D. W. Bogus Mr. Bogus, age 56, joined the company and became Vice President in May, 2000. He is responsible for fluid technologies for industry. Prior to joining the company, he was with PPG Industries, Inc., where he was Vice President of Governmental Affairs from May 1999 to February 2000 and Vice President Coatings from October 1998 to May 1999. C. P. Cooley Mr. Cooley, age 48, has been Vice President and Chief Financial Officer since he joined the company in April 1998. In addition, he was Treasurer from April 1998 to September 2001. In June 1998 he also became responsible for corporate strategic planning. S. A. Di Biase Dr. Di Biase, age 51, has been Vice President since September 1993. He has been responsible for emulsified products since October 2001. Prior to that, he was responsible for research and development. J. L. Hambrick Mr. Hambrick, age 49, was elected President on January 10, 2003. From May 2000 to January 2003 he was Vice President responsible for managing corporate strategies in the Asia Pacific. From October 1998 to April 2000 he was global business manager - engine oils. G. R. Hill Dr. Hill, age 62, has been Senior Vice President since 1988. He has been responsible for research and development since October 2001 and has been responsible for business development since October 1993. J. E. Hodge Mr. Hodge, age 61, has been Vice President since September 1993. He is responsible for operations. S. F. Kirk Mr. Kirk, age 54, has been Vice President since September 1993. Since January 1999, he has been responsible for sales and marketing. From April 1996 to January 1999, he was responsible for sales. Y. Le Couedic Mr. Le Couedic, age 56, has been Vice President since September 1993. He is responsible for management information systems.
8
Name Business Experience G. R. Lewis Mr. Lewis, age 44, was elected Vice President responsible for managing Corporate strategies in the Asia Pacific region on January 10, 2003. He was Assistant Secretary from April 2001 to January 2003 and was Assistant to the General Counsel from October 1997 to January 2003. G. P. Lieb Mr. Lieb, age 51, has been Controller - Commercial Analysis and Support since April 26, 1999. From 1993 to April 1999 he was Controller - Accounting and Financial Reporting. From 1994 to April 1999 he was also Principal Accounting Officer. A.C. Marcus Ms. Marcus, age 41, was named Assistant Secretary in April 2003. In addition, she has been Manager of Tax Planning - International since October 1997. M. W. Meister Mr. Meister, age 49, has been Vice President since April 1993, and was named Chief Ethics Officer in April 1998. He is responsible for human resources. R. S. Potter Ms. Potter, age 44, joined the company and was named Treasurer in September 2001. Prior to joining the company, she was Vice President and Treasurer at Dexter Corporation from 1999 to 2000 and Leader of Facilities Integration at Hercules, Inc. from 1998 to 1999. L. M. Reynolds Ms. Reynolds, age 43, was named Corporate Secretary in April 2001, and has been Counsel since February 1991. From April 1995 until April 2001, she was Assistant Secretary. J. D. Stearns Mr. Stearns, age 56, was named Chief Tax Officer in September 1990. In addition, he has been Controller - Tax Administration since September 1986. J. Wanstreet Ms. Wanstreet, age 52, was elected Vice President on April 22, 2002. She is responsible for global communications and investor relations. From January 2001 to April 2002 she was Manager, Investor Relations. From January 1999 to December 2000 she was Finance Manager.
All executive officers serve at the pleasure of the Board. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Our common shares are listed on the New York Stock Exchange under the symbol LZ. The number of shareholders of record of common shares was 3,894 as of February 9, 2004. Information relating to the recent price and dividend history of our common shares follows:
Common Share Price History Dividends 2003 2002 Per Common Share ---- ---- ---------------- High Low High Low 2003 2002 ---- --- ---- --- ---- ---- 1st quarter $32.06 $26.54 $36.18 $31.75 $ .26 $ .26 2nd quarter 32.46 29.50 36.36 32.26 .26 .26 3rd quarter 34.40 30.50 33.55 27.01 .26 .26 4th quarter 34.31 29.23 31.60 26.20 .26 .26 ----- ----- $1.04 $1.04 ===== =====
On October 31, 2003, 292 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 one employee of one of our wholly-owned UK subsidiaries. ITEM 6. SELECTED FINANCIAL DATA. The summary of selected financial data for each of the last five years included in the Historical Summary contained on pages 48 of our 2003 Annual Report to shareholders is incorporated herein by reference. Total costs and expenses includes restructuring charges of $22.5 million in 2003 and $19.6 million in 1999 and a restructuring credit of $4.5 million in 2000. Total debt reported in the Historical Summary includes the following amounts classified as long-term at December 31: $386.7 in 2003, $384.8 million in 2002, $388.1 million in 2001, $378.8 million in 2000, and $365.4 million in 1999. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The Management's Discussion and Analysis of Financial Condition and Results of Operations, including the information appearing under the heading "Cautionary Factors That May Affect Future Results," contained on pages 11 through 25, inclusive, of our 2003 Annual Report to shareholders is incorporated herein by reference. 10 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information appearing under the heading "Quantitative and Qualitative Disclosures about Market Risk" contained on page 25 of our 2003 Annual Report to shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Our consolidated financial statements, together with the independent auditors' report relating thereto, contained on pages 26 through 47, inclusive, of our 2003 Annual Report to shareholders, and the Quarterly Financial Data (Unaudited) contained on page 26 of the 2003 Annual Report, are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. ITEM 9A. CONTROLS AND PROCEDURES We evaluated, under the supervision and with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of December 31, 2003. Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2003, our disclosure controls and procedures were effective in timely alerting them to material information relating to Lubrizol and our consolidated subsidiaries required to be included in our periodic SEC filings. There were no significant changes in our internal control over financial reporting that occurred during the fourth quarter of 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information contained under the headings "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" of our Proxy Statement dated March 17, 2004, is incorporated herein by reference. Information relative to executive officers is contained under "Executive Officers of the Registrant" in Part I of this Annual Report on Form 10-K. Information regarding the identification of a financial expert on the Audit Committee is contained under the heading "Audit Committee" of our Proxy Statement dated March 17, 2004, is incorporated herein by reference. We have a code of ethics, entitled the Ethical and Legal Conduct Guidelines, that applies to our directors and all employees, including our chief executive officer, chief financial officer, and controller. The Ethical and Legal Conduct Guidelines are posted at the company overview area of our website, www.lubrizol.com. ITEM 11. EXECUTIVE COMPENSATION. The information relating to executive compensation contained under the headings "Director Compensation," "Executive Compensation - Summary Compensation Table," "Executive Compensation - Stock Incentive Plans," "Executive Compensation - Long-Term Incentive Plans," "Employee and Executive Officer Benefit Plans - Pension Plans," "Employee and Executive Officer Benefit Plans - Supplemental Retirement Plan" and "Employee and Executive Officer Benefit Plans - - Executive Agreements" of our Proxy Statement dated March 17, 2004, is incorporated herein by reference. 11 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information relating to security ownership set forth under the heading "Share Ownership of Directors, Executive Officers and Large Beneficial Owners" of our Proxy Statement dated March 17, 2004, is incorporated herein by reference. The following table gives information about our common stock that may be issued under the company's equity compensation plans as of December 31, 2003. Equity Compensation Plan Information
Number of securities Number of remaining available securities to be Weighted-average for future issuance issued upon exercise exercise price of under equity Plan Category of outstanding outstanding compensation plans options, warrants options, warrants (excluding securities and rights and rights reflected in column (a)) ------------------------- -------------------------------- ------------------------------- --------------------------------- Equity compensation plans approved by security holders 5,393,042 $31.28 854,843(1) ------------------------- -------------------------------- ------------------------------- --------------------------------- Equity compensation plans not approved by security holders (2) n/a (2) ------------------------- -------------------------------- ------------------------------- --------------------------------- Total 5,393,042 $31.28 854,843 ------------------------- -------------------------------- ------------------------------- ---------------------------------
(1) The number of shares available under the 1991 Stock Incentive Plan during a calendar year is 1% of the outstanding shares on January 1 of that year, plus any unused shares from previous years. As of January 1, 2004, the number of shares available was 1,370,725. (2) Under a deferred compensation plan, certain executive officers may defer any amount of their variable pay under the performance pay plan. Deferred amounts are converted into share units based on the current market price of Lubrizol's shares. There is a 25% company match. Additional share units are credited for quarterly dividends paid on Lubrizol shares. At the end of the deferral period, which is at least three years, common shares are issued equal to the number of share units in the participant's account. Amounts attributable to the company match credited after January 1, 2004 will be paid in cash. As of December 31, 2002, there were 68,315 share units outstanding. Prior to January 1, 2004, under a deferred stock compensation plan for outside directors, each director who is not a Lubrizol employee received 500 share units on each October 1 and is credited with additional share units for quarterly dividends paid on Lubrizol shares. When a person is no longer a director, Lubrizol shares are issued equal to the number of share units in the person's account. As of December 31, 2003, there were 46,552 share units outstanding. No additional share units other than those credited for quarterly dividends will be granted after January 1, 2004. Under a deferred compensation plan for directors, each director who is not a Lubrizol employee may defer all or any portion of his or her yearly fee and meeting attendance fees and have these amounts credited to various cash investment accounts and/or a share unit account. The number of share units credited to the share unit account is based on the price of Lubrizol shares on the day the share units are credited to the account 12 and includes share units credited for quarterly dividends paid on Lubrizol shares. When a person is no longer a director, Lubrizol shares are issued equal to the number of share units in the person's share unit account. As of December 31, 2003, there were 42,227 share units outstanding. Under a deferred compensation plan for officers, each executive officer may defer all or any portion of his or her total annual pay and have these amounts credited to various cash investment accounts and/or a share unit account. The number of share units credited to the share unit account is based on the price of Lubrizol shares on the day the share units are credited to the account and includes share units credited for quarterly dividends paid on Lubrizol shares. Upon the distribution date, Lubrizol shares are issued equal to the number of share units in the person's share unit account. As of December 31, 2003, there were 61,430 share units outstanding. Under a supplemental retirement plan for Donald W. Bogus, 500 share units are credited each anniversary date of the officer's employment to an officer's account and includes shares units credited for quarterly dividends paid on Lubrizol shares. Upon retirement Mr. Bogus may elect to receive cash or Lubrizol shares equal to the number of share units in the account. As of December 31, 2003, there were 2,159 share units outstanding. For units credited after January 1, 2004, the payment will be made in cash only. Under a one-year renewable consulting agreement for a non-Lubrizol employee, 1,500 common shares are issued to the consultant each renewal date, if any, of the consulting agreement. No further shares will be issued under this agreement after January 1, 2004. Under agreements with Donald W. Bogus, Charles P. Cooley and Stephen F. Kirk, 15,000 shares each will be issued provided the officer remains an employee until January 1, 2008. Under an agreement with Stephen A. DiBiase, 5,000 shares will be issued provided the officer remains an employee until January 1, 2008. There are no voting or dividend rights associated with these shares unless and until they are issued. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information contained in footnotes (1) and (3) under the heading "Share Ownership of Directors, Executive Officers and Large Beneficial Owners - Five Percent Beneficial Owners" of our Proxy Statement dated March 17, 2004, is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES The information included under the heading entitled "Independent Accountant Fees" of our Proxy Statement dated March 17, 2004, is incorporated herein by reference. 13 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as part of this Annual Report: 1. The following consolidated financial statements of The Lubrizol Corporation and its subsidiaries, together with the independent auditors' report relating thereto, contained on pages 26 through 47, inclusive, of our 2003 Annual Report to its shareholders, and incorporated herein by reference: Independent Auditors' Report. Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001. Consolidated Balance Sheets at December 31, 2003 and 2002. Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001. Consolidated Statements of Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001. Notes to Financial Statements. Quarterly Financial Data (Unaudited). 2. Schedules No financial statement schedules are required to be filed as part of this Annual Report. 3. Exhibits (3)(a) Amended Articles of Incorporation of The Lubrizol Corporation, as adopted September 23, 1991. (Reference is made to Exhibit (3)(a) to The Lubrizol Corporation's Annual Report on Form 10-K for the year ended December 31, 1999, which Exhibit is incorporated herein by reference.) (3)(b) Regulations of The Lubrizol Corporation, as amended effective April 27, 1992. (Reference is made to Exhibit (3)(b) to The Lubrizol Corporation's Annual Report on Form 10-K for the year ended December 31, 1999, which Exhibit is incorporated herein by reference.) (4)(a) Amendment to Article Fourth of Amended Articles of Incorporation. (Reference is made to Exhibit (4)(a) to The Lubrizol Corporation's Annual Report on Form 10-K for the year ended December 31, 1999, which Exhibit is incorporated herein by reference.) (4)(b) Indenture dated as of November 25, 1998, between The Lubrizol Corporation and The First National Bank of Chicago as Trustee. (Reference is made to Exhibit (4)(b) to The Lubrizol Corporation's Annual Report on Form 10-K for the year ended December 31, 1998, which Exhibit is incorporated herein by reference.) The company agrees, upon request, to furnish to the Securities and Exchange Commission a copy of any instrument authorizing long-term debt that does not 14 authorize debt in excess of 10% of the total assets of the company and its subsidiaries on a consolidated basis. (4)(c) Amended and Restated Rights Agreement between The Lubrizol Corporation and American Stock Transfer & Trust Company dated as of July 26, 1999. (Reference is made to Exhibit 4.l to The Lubrizol Corporation's Registration Statement on Form 8-A/A dated August 17, 1999, which Exhibit is incorporated herein by reference.) (10)(a)* The Lubrizol Corporation 1985 Employee Stock Option Plan, as amended. (Reference is made to Exhibit (10)(a) to The Lubrizol Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, which Exhibit is incorporated herein by reference.) (10)(b)* The Lubrizol Corporation Amended Deferred Compensation Plan for Directors. (Reference is made to Exhibit (10)(b) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000, which Exhibit is incorporated herein by reference.) (10)(c)* Form of Employment Agreement between The Lubrizol Corporation and certain of its senior executive officers. (Reference is made to Exhibit (10)(c) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000, which Exhibit is incorporated herein by reference.) (10)(d)* The Lubrizol Corporation Excess Defined Benefit Plan, as amended. (Reference is made to Exhibit (10)(d) to the Lubrizol Corporation's Quarterly Report on Form 10-Q for the period ended September 30, 2002 which Exhibit is incorporated herein by reference.) (10)(e)* The Lubrizol Corporation Excess Defined Contribution Plan, as amended. (Reference is made to Exhibit (10)(e) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002, which Exhibit is incorporated herein by reference.) (10)(f)* The Lubrizol Corporation Performance Pay Plan, as amended. (Reference is made to Exhibit (10)(f) to The Lubrizol Corporation's Annual Report on Form 10-K for the year ended December 31, 1998, which Exhibit is incorporated herein by reference.) (10)(g)* The Lubrizol Corporation Executive Death Benefit Plan, as amended. (Reference is made to Exhibit (10)(g) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the period ended March 31,2003 which Exhibit is incorporated herein by reference.) (10)(h)* The Lubrizol Corporation 1991 Stock Incentive Plan, as amended. (10)(i)* The Lubrizol Corporation Deferred Stock Compensation Plan for Outside Directors, as amended. (10)(j)* The Lubrizol Corporation Officers' Supplemental Retirement Plan, as amended. (Reference is made to Exhibit (10)(j) to The Lubrizol Corporation's Quarterly 15 Report on Form 10-Q for the period ended March 31, 2003, which Exhibit is incorporated herein by reference.) (10)(k)* The Lubrizol Corporation Deferred Compensation Plan for Officers, as amended. (10)(l)* The Lubrizol Corporation Executive Council Deferred Compensation Plan, as amended. (10)(m)* Supplemental Retirement Plan for Donald W. Bogus. (10)(n)* The Lubrizol Corporation Executive Officer Long Term Incentive Plan. (10)(o)* Employment Agreement effective January 1, 2003, between The Lubrizol Corporation and Charles P. Cooley. (Reference is made to Exhibit (10)(o) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the period ended on March 31, 2003, which Exhibit is incorporated herein by reference.) (10)(p)* Employment Agreement effective January 1, 2003, between The Lubrizol Corporation and Stephen F. Kirk. (Reference is made to Exhibit (10)(o) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the period ended on March 31, 2003, which Exhibit is incorporated herein by reference.) (10)(q)* Employment Agreement effective January 1, 2003, between The Lubrizol Corporation and Stephen A. Di Biase. (Reference is made to Exhibit (10)(o) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the period ended on March 31, 2003, which Exhibit is incorporated herein by reference.) (10)(r)* Employment Agreement effective January 1, 2003, between The Lubrizol Corporation and Donald W. Bogus. (Reference is made to Exhibit (10)(o) to The Lubrizol Corporation's Quarterly Report on Form 10-Q for the period ended on March 31, 2003, which Exhibit is incorporated herein by reference.) (10)(s)* Relocation Agreement between The Lubrizol Corporation and Joe E. Hodge (12) Computation of Ratio of Earnings to Fixed Charges. (13) The following portions of The Lubrizol Corporation 2003 Annual Report to its shareholders (The 2003 annual report is available on our website at www.lubrizol.com as a separate pdf file): Pages 11-25 Management's Discussion and Analysis of Financial Condition and Results of Operations Page 26 Quarterly Financial Data (Unaudited). Page 26 Independent Auditors' Report. Page 27 Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001. 16 Page 28 Consolidated Balance Sheets at December 31, 2003 and 2002. Page 29 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001. Page 30 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001. Pages 31-47 Notes to Financial Statements. Page 48 Historical Summary. (21) List of Subsidiaries of The Lubrizol Corporation. (23) Consent of Independent Auditors. (31) Rule 13a-14(a) Certifications. (32) Certification of Chief Executive Officer and Chief Financial Officer of The Lubrizol Corporation Pursuant to 18 U.S.C. Section 1350. *Indicates management contract or compensatory plan or arrangement. (b) Reports on Form 8-K On October 14, 2003, we furnished a Form 8-K to the Securities and Exchange Commission with respect to our news release dated October 13, 2003, announcing updated earnings guidance for the year 2003. On October 21, 2003, we furnished a Form 8-K to the Securities and Exchange Commission with respect to our news release dated October 21, 2003, announcing the results for the three months ended September 30, 2003. On October 24, 2003, we furnished a Form 8-K to the Securities and Exchange Commission with respect to the transcript of our teleconference on October 21, 2003, relating to the results for the three months ended September 30, 2003. On November 4, 2003, we furnished a Form 8-K to the Securities and Exchange Commission with respect to our news release dated November 4, 2003, announcing workforce reductions. On November 6, 2003, we furnished Form 8-K/A to the Securities and Exchange Commission with respect to our news release dated October 21, 2003, announcing the results for the three months ended September 30, 2003. 17 SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on February 23, 2004, on its behalf by the undersigned, thereunto duly authorized. THE LUBRIZOL CORPORATION BY /s/W. G. Bares --------------------------------------- W. G. Bares, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on February 23, 2004, by the following persons on behalf of the Registrant and in the capacities indicated. /s/W. G. Bares Chairman of the Board and Chief Executive - ------------------------------- Officer W. G. Bares (Principal Executive Officer) /s/J. H. Hambrick President - ---------------------------------- J.H. Hambrick /s/C. P. Cooley Vice President and Chief Financial Officer - ------------------------------- (Principal Financial Officer) C. P. Cooley /s/J. R. Ahern Controller, Accounting and Financial - ------------------------------- Reporting J. R. Ahern (Chief Accounting Officer) /s/Jerald A. Blumberg Director - ------------------------------- Jerald A. Blumberg /s/Forest J. Farmer, Sr. Director - ------------------------------- Forest J. Farmer, Sr. /s/Gordon D. Harnett Director - ------------------------------- Gordon D. Harnett /s/Victoria F. Haynes Director - ------------------------------- Victoria F. Haynes /s/David H. Hoag Director - ------------------------------- David H. Hoag /s/William P. Madar Director - ------------------------------- William P. Madar /s/Peggy Gordon Miller Director Peggy Gordon Miller /s/Ronald A. Mitsch Director - ------------------------------- Ronald A. Mitsch /s/Daniel E. Somers Director - -------------------------------- Daniel E. Somers 18 EX-10.H 3 l05101aexv10wh.txt EX-10(H) 1991 STOCK INCENTIVE PLAN Exhibit (10(h) THE LUBRIZOL CORPORATION 1991 STOCK INCENTIVE PLAN (As Amended November 10, 2003) Section 1. Purpose. The purposes of The Lubrizol Corporation 1991 Stock Incentive Plan are to encourage selected employees of The Lubrizol Corporation and its Subsidiaries and directors of the Company to acquire a proprietary and vested interest in the growth and performance of the Company, to generate an increased incentive to contribute to the Company's future success and prosperity, thus enhancing the value of the Company for the benefit of shareholders, and to enhance the ability of the Company and its Subsidiaries to attract and retain individuals of exceptional talent upon whom, in large measure, the sustained progress, growth and profitability of the Company depends. Section 2. Definitions. As used in the Plan, the following terms shall have the meanings set forth below: (a) "Award" means any Option, Stock Appreciation Right, Restricted Stock Award, or Stock Award granted pursuant to the provisions of the Plan. (b) "Award Agreement" means a written document evidencing any Award granted hereunder, signed by the Company and delivered to the Participant or Outside Director, as the case may be. (c) "Board" means the Board of Directors of the Company. (d) "Code" means the Internal Revenue Code of 1986, as amended from time to time. (e) "Committee" means a committee of not less than three (3) Outside Directors of the Board, each of whom shall be a "disinterested person" within the meaning of Rule 16b-3(d)(3) promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or any successor rule or statute. (f) "Company" means The Lubrizol Corporation. (g) "Employee" means any employee of the Company or of any Subsidiary. (h) "Fair Market Value" means the average of the high and low price of a Share on the New York Stock Exchange on the Grant Date (in the case of a Grant), or any other relevant date. (i) "Grant Date" means the date on which the Board approves the grant of an Option, Stock Appreciation Right, Restricted Stock Award, or Stock Award, and, with respect to an Option granted to an Outside Director pursuant to Section 10, the date of the Shareholders' Meeting on which such Option is granted. THE LUBRIZOL CORPORATION Page 2 1991 STOCK INCENTIVE PLAN (j) "Incentive Stock Option" means an Option that is intended to meet the requirements of Section 422A of the Code or any successor provision thereto. (k) "Non-Statutory Stock Option" means an Option that is not intended to be an Incentive Stock Option. (l) "Option" means an option to purchase Shares granted hereunder. (m) "Option Price" means the purchase price of each Share under an Option. (n) "Outside Director" means a member of the Board who is not an employee of the Company or of any Subsidiary. (o) "Participant" means an Employee who is selected by the Committee to receive an Award under the Plan. (p) "Plan" means The Lubrizol Corporation 1991 Stock Incentive Plan. (q) "Restricted Stock Award" means an award of restricted Shares under Section 8 hereof. (r) "Restriction Period" means the period of time specified in an Award Agreement during which the following conditions remain in effect: (i) certain restrictions on the sale or other disposition of Shares awarded under the Plan, (ii) subject to the terms of the applicable Award Agreement, the continued employment of the Participant, and (iii) such other conditions as may be set forth in the applicable Award Agreement. (s) "Shareholders' Meeting" means the annual meeting of shareholders of the Company in each year. (t) "Shares" means common shares without par value of the Company. (u) "Stock Appreciation Right" means the right to receive a payment in cash or in Shares, or in any combination thereof, from the Company equal to the excess of the Fair Market Value of a stated number of Shares at the exercise date over a fixed price for such Shares. (v) "Stock Award" means the grant of unrestricted Shares under the Plan. (w) "Subsidiary" means a corporation which is at least 80% owned, directly or indirectly, by the Company. (x) "Voting Stock" means the then-outstanding securities entitled to vote generally in the election of directors of the Company. THE LUBRIZOL CORPORATION Page 3 1991 STOCK INCENTIVE PLAN Section 3. Administration. The Plan shall be administered by the Committee. Members of the Committee shall be appointed by and serve at the pleasure of the Board, and may resign by written notice filed with the Chairman of the Board or the Secretary of the Company. A vacancy on the Committee shall be filled by the appointment of a successor member by the Board. Subject to the express provisions of this Plan, the Committee shall have conclusive authority to select Employees to be Participants for Awards and determine the type and number of Awards to be granted, to construe and interpret the Plan, any Award granted hereunder, and any Award Agreement entered into hereunder, and to establish, amend, and rescind rules and regulations for the administration of this Plan and shall have such additional authority as the Board may from time to time determine to be necessary or desirable. Notwithstanding the foregoing, the Committee shall not have discretion with respect to Options granted to Outside Directors pursuant to Section 10 such as to prevent any Award granted under this Plan from meeting the requirements for exemption from Section 16(b) of the Exchange Act, as set forth in Rule 16b-3 thereunder or any successor rule or statute. Section 4. Shares Subject to the Plan. (a) Subject to adjustment as provided in the Plan, the total number of Shares available under the Plan in each calendar year shall be one percent (1%) of the total outstanding Shares as of the first day of any year for which the Plan is in effect; provided that such number shall be increased in any year by the number of Shares available for grant hereunder in previous years but not covered by Awards granted hereunder in such previous years; provided further, that a total of no more than two million (2,000,000) Shares shall be available for the grant of Incentive Stock Options under the Plan; and provided further, that no more than four hundred thousand (400,000) Shares shall be available for grant to any Participant during a calendar year. Settlement of an Award, whether by the issuance of Shares or the payment of cash, shall not be deemed to be the grant of an Award hereunder. In addition, any Shares issued by the Company through the assumption or substitution of outstanding grants from an acquired company shall not reduce the Shares available for grants under the Plan. Any Shares issued hereunder may consist, in whole or in part, of authorized and unissued Shares or treasury shares. If any Shares subject to any Award granted hereunder are forfeited or if such Award otherwise terminates without the issuance of such Shares or payment of other consideration in lieu of such Shares, the Shares subject to such Award, to the extent of any such forfeiture or termination, shall again be available for grant under the Plan as if such Shares had not been subject to an Award. (b) The number of Shares which remain available for grant pursuant to this Plan, together with Shares subject to outstanding Awards, at the time of any change in the Company's capitalization, including stock splits, stock dividends, mergers, reorganizations, consolidations, recapitalizations, or other changes in corporate structure, shall be appropriately and proportionately adjusted to reflect such change in capitalization. Section 5. Eligibility. Any Employee shall be eligible to be selected as a Participant. THE LUBRIZOL CORPORATION Page 4 1991 STOCK INCENTIVE PLAN Section 6. Stock Options. Non-Statutory Stock Options and Incentive Stock Options may be granted hereunder to Participants either separately or in conjunction with other Awards granted under the Plan. Any Option granted to a Participant under the Plan shall be evidenced by an Award Agreement in such form as the Committee may from time to time approve. Any such Option shall be subject to the following terms and conditions and to such additional terms and conditions, not inconsistent with the provisions of the Plan, as the Committee shall deem desirable. (a) Option Price. The purchase price per Share under an Option shall be fixed by the Committee in its sole discretion; provided that the purchase price shall not be less than one hundred percent (100%) of the Fair Market Value of the Share on the Grant Date of the Option. Payment of the Option Price may be made in cash, Shares, or a combination of cash and Shares, as provided in the Award Agreement relating thereto. (b) Option Period. The term of each Option shall be fixed by the Committee in its sole discretion; provided that no Incentive Stock Option shall be exercisable after the expiration of ten years from the Grant Date; and provided further, that no reload Option granted to a Participant pursuant to the terms of Section 6(e) shall be exercisable after the expiration of the term of the Option that gave rise to the grant of such reload Option. (c) Exercise of Option. Options shall be exercisable to the extent of fifty percent (50%) of the Shares subject thereto after one year from the Grant Date, seventy-five percent (75%) of such Shares after two years from the Grant Date, and one hundred percent (100%) of such Shares after three years from the Grant Date, subject to any provisions respecting the exercisability of Options that may be contained in an Award Agreement; provided that a reload Option granted to a Participant pursuant to the terms of Section 6(e) shall be exercisable to the extent of one hundred percent (100%) of such Shares from the Grant Date. (d) Incentive Stock Options. The aggregate Fair Market Value of the Shares with respect to which Incentive Stock Options held by any Participant which are exercisable for the first time by such Participant during any calendar year under the Plan (and under any other benefit plans of the Company, of any parent corporation, or Subsidiary) shall not exceed $100,000 or, if different, the maximum limitation in effect at the Grant Date under Section 422A of the Code, or any successor provision, and any regulations promulgated thereunder. The terms of any Incentive Stock Option granted hereunder shall comply in all respects with the provisions of Section 422A of the Code, or any successor provision, and any regulations promulgated thereunder. (e) Reload. In the event that a Participant or an Outside Director exercises an Option other than a reload Option granted pursuant to this Section 6(e), and pays some or all of the Option Price with Shares, the Committee in its discretion may grant to such Participant or Outside Director a reload Option to purchase the number of Shares equal to the number of Shares used as payment of the Option Price, subject to the limitations described below. Options granted to Participants pursuant to this Section 6(e) shall have terms and conditions as described in this Section 6 and Options granted to Outside Directors pursuant to this Section 6(e) shall have terms and conditions as described in THE LUBRIZOL CORPORATION Page 5 1991 STOCK INCENTIVE PLAN Section 10. Options granted pursuant to this Section 6(e) shall be of the same character (i.e., Non-Statutory Stock Options or Incentive Stock Options) as the Option that is exercised to give rise to the grant of the reload Option, provided that if an Incentive Stock Option cannot be granted under this Section 6(e) in compliance with Section 422A of the Code, then a Non-Statutory Stock Option shall be granted in lieu thereof. Options may be granted pursuant to this Section 6(e) only to the extent that the number of Shares covered by such Option grants does not, when added to the number of Shares covered by Awards previously granted during such calendar year, exceed the limitation set forth in Section 4(a). Shares received upon the exercise of an Option granted pursuant to this Section 6(e) may not be sold or otherwise transferred (i) by a Participant until such Participant has met the Share ownership guideline for such Participant, if any, set by the Company, and then only to the extent that the Participant continues to meet such ownership guideline immediately after such sale, or (ii) by an Outside Director until such Outside Director ceases to be an Outside Director, provided, however, that a Participant or Outside Director may use such Shares as payment of the Option Price of Options granted under this Plan to the extent permitted by the applicable Award Agreement, in which case a number of the Shares (equal to the number of Shares used for such payment) purchased by the exercise of such Options also shall be subject to the same restrictions upon transferability. Certificates for such Shares with a transferability restriction shall bear a legend referencing such restriction. Notwithstanding the foregoing, effective for grants of Options on or after November 11, 2002, this Section 6(e) is deleted. Section 7. Stock Appreciation Rights. Stock Appreciation Rights may be granted hereunder to Participants either separately or in conjunction with other Awards granted under the Plan and may, but need not, relate to a specific Option granted under Section 6. The provisions of Stock Appreciation Rights need not be the same with respect to each Participant. Any Stock Appreciation Right related to a Non-Statutory Stock Option may be granted at the same time such Option is granted or at any time thereafter before exercise or expiration of such Option. Any Stock Appreciation Right related to an Incentive Stock Option must be granted at the same time such Option is granted. Any Stock Appreciation Right related to an Option shall be exercisable only to the extent the related Option is exercisable. In the case of any Stock Appreciation Right related to any Option, the Stock Appreciation Right or applicable portion thereof shall terminate and no longer be exercisable upon the termination or exercise of the related Option. Similarly, upon exercise of a Stock Appreciation Right as to some or all of the Shares covered by a related Option, the related Option shall be canceled automatically to the extent of the Stock Appreciation Rights exercised, and such Shares shall not thereafter be eligible for grant under Section 4(a). The Committee may impose such conditions or restrictions on the exercise of any Stock Appreciation Right as it shall deem appropriate. Section 8. Restricted Stock Awards. (a) Issuance. Restricted Stock Awards may be issued hereunder to Participants, either separately or in conjunction with other Awards granted under the Plan. Each Award THE LUBRIZOL CORPORATION Page 6 1991 STOCK INCENTIVE PLAN under this Section 8 shall be evidenced by an Award Agreement between the Participant and the Company which shall specify the vesting schedule, any rights of acceleration and such other terms and conditions as the Board shall determine, which need not be the same with respect to each Participant. (b) Registration. Shares issued under this Section 8 shall be evidenced by issuance of a stock certificate or certificates registered in the name of the Participant bearing the following legend and any other legend required by, or deemed appropriate under, any federal or state securities laws: The sale or other transfer of the common shares represented by this certificate is subject to certain restrictions set forth in the Award Agreement between ___________________ (the registered owner) and The Lubrizol Corporation dated _______________, under The Lubrizol Corporation 1991 Stock Incentive Plan. A copy of the Plan and Award Agreement may be obtained from the Secretary of The Lubrizol Corporation. Unless otherwise provided in the Award Agreement between the Participant and the Company, such certificates shall be retained by the Company until the expiration of the Restriction Period. Upon the expiration of the Restriction Period, the Company shall (i) cause the removal of the legend from the certificates for such Shares as to which a Participant is entitled in accordance with the Award Agreement between the Participant and the Company and (ii) release such Shares to the custody of the Participant. (c) Forfeiture. Except as otherwise determined by the Committee at the Grant Date, upon termination of employment of the Participant for any reason during the Restriction Period, all Shares still subject to restriction shall be forfeited by the Participant and retained by the Company; provided that in the event of a Participant's retirement, permanent disability, death, or in cases of special circumstances, the Committee may, in its sole discretion, when it finds that a waiver would be in the best interests of the Company, waive in whole or in part any or all remaining restrictions with respect to such Participant's Shares. In such case, unrestricted Shares shall be issued to the Participant at such time as the Committee determines. (d) Rights as Shareholders. At all times during the Restriction Period, Participants shall be entitled to full voting rights with respect to all Shares awarded under this Section 8 and shall be entitled to dividends with respect to such Shares. Section 9. Stock Awards. Awards of Shares may be granted hereunder to Participants, either separately or in conjunction with other Awards granted under the Plan. Subject to the provisions of the Plan, the Committee shall have sole and complete authority to determine (i) the Employees to whom such Awards shall be granted, (ii) the time or times at which such Awards shall be granted, (iii) the number of Shares to be granted pursuant to such Awards, and (iv) all other conditions of the Awards. Such conditions may include issuance of Shares at the time of the Award is granted or issuance of Shares at a time or times subsequent to the time the Award is granted, which subsequent times may be specifically established by the Committee and/or may be determined by THE LUBRIZOL CORPORATION Page 7 1991 STOCK INCENTIVE PLAN reference to the satisfaction of one or more performance measures specified by the Committee. The provisions of stock awards need not be the same with respect to each Participant. Section 10. Outside Directors' Options. On the close of business on the date of each Shareholders' Meeting, each Outside Director shall automatically be granted an Option to purchase 2,500 Shares. In addition, on April 23, 2001, each Outside Director shall automatically be granted an Option to purchase 2,500 Shares. All Options granted under this Section 10 shall be Non-Statutory Stock Options and shall be subject to the following terms and conditions and to such additional terms and conditions, not inconsistent with the provisions of the Plan, as are contained in the applicable Award Agreement. (a) Option Price. The purchase price per Share shall be one hundred percent (100%) of the Fair Market Value of the Share on the Grant Date. Payment of the Option Price may be made in cash, Shares, or a combination of cash and Shares, as provided in the Award Agreement in effect from time to time. (b) Option Period. The term during which Options granted under this Section 10 shall be exercisable shall be ten (10) years from the Grant Date; provided that no reload Option granted to an Outside Director pursuant to the terms of Section 6(e) shall be exercisable after the expiration of the term of the Option that gave rise to the grant of such reload Option. (c) Exercise of Options. Subject to the provisions of this Section 10(c), Options shall be exercisable to the extent of fifty percent (50%) of the Shares subject thereto after one year from the Grant Date, seventy-five percent (75%) of such Shares after two years from the Grant Date, and one hundred percent (100%) of such Shares after three years from the Grant Date; provided that a reload Option granted to an Outside Director pursuant to the terms of Section 6(e) shall be exercisable to the extent of one hundred percent (100%) of such Shares from the Grant Date. Options may be exercised by an Outside Director during the period that the Outside Director remains a member of the Board and under the circumstances described below. (i) If an Outside Director retires under a retirement plan or policy of the Company, then Options held by such Outside Director may be exercised for a period of thirty-six (36) months following retirement, to the extent of 100% of the Shares covered by such Options (notwithstanding the extent to which the Outside Director otherwise would have been entitled to exercise such Options at the date of retirement), provided that in no event shall an Option be exercisable after the expiration of the Option period provided in Section 10(b). (ii) In the event of the death of an Outside Director while serving as a director, Options held by such Outside Director may be exercised for a period of twelve (12) months following the date of death, (A) to the extent of 100% of the Shares covered by such Options (notwithstanding the extent to which the Outside Director otherwise would have been entitled to exercise the Option at the date of death), and (B) only by the executor or administrator of the Outside Director's THE LUBRIZOL CORPORATION Page 8 1991 STOCK INCENTIVE PLAN estate or by the person or persons to whom the Outside Director's rights under the Options shall pass by the Outside Director's will or the laws of descent and distribution, provided that in no event shall an Option be exercisable after the expiration of the Option period provided in Section 10(b). (iii) If an Outside Director shall cease to be a director for any reason other than retirement under a retirement plan or policy of the Company or death, Options held by such Outside Director may be exercised for a period of three (3) months following such cessation, to the extent of 100% of the Shares covered by such Options (notwithstanding the extent to which the Outside Director otherwise would have been entitled to exercise such Options at the date of such cessation), provided that in no event shall an Option be exercisable after the expiration of the Option period provided in Section 10(b). (iv) In the event an Outside Director, after ceasing to be a director, dies during and subject to one of the periods described in Section 10(c)(i) or (iii), while possessed of unexercised Options, the executor or administrator of the Outside Director's estate, or the person entitled by will or the applicable laws of descent and distribution, may exercise such Options held by the Outside Director at the time of the Outside Director's death during the period that is applicable, as follows: (A) If Section 10(c)(i) was in effect, for one year after the Outside Director's death; (B) If Section 10(c)(iii) was in effect, for three months after the Outside Director's death; provided that, in no event shall the Option be exercisable after the expiration of the Option period provided in Section 10(b). Section 11. Change in Control. Notwithstanding the provisions of Sections 6(c) and 10(c), Options shall become exercisable with respect to 100% of the Shares upon the occurrence of any Change in Control (as hereafter defined) of the Company; except that no Options shall be exercised prior to the end of six months from the Grant Date. Notwithstanding the provisions of Section 8 and the applicable Award Agreement, any restricted Shares shall be 100% vested and without any restrictions upon the occurrence of any Change in Control of the Company. For all purposes of the Plan, a "Change in Control" shall have occurred if any of the following events shall occur: (a) The Company is merged, consolidated or reorganized into or with another corporation or other legal person, and immediately after such merger, consolidation or reorganization less than a majority of the combined voting power of the then-outstanding securities of such corporation or person immediately after such transaction are held in the THE LUBRIZOL CORPORATION Page 9 1991 STOCK INCENTIVE PLAN aggregate by the holders of Voting Stock of the Company immediately prior to such transaction; (b) The Company sells all or substantially all of its assets to any other corporation or other legal person, and less than a majority of the combined voting power of the then-outstanding securities of such corporation or person immediately after such sale are held in the aggregate by the holders of Voting Stock of the Company immediately prior to such sale; (c) There is a report filed on Schedule 13D or Schedule 14D-l (or any successor schedule, form or report), each as promulgated pursuant to the Exchange Act, disclosing that any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13(d)(3) or any successor rule or regulation promulgated under the Exchange Act) of securities representing 20% or more of the Voting Stock; (d) The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then-existing contract or transaction; or (e) If during any period of two consecutive years, individuals who at the beginning of any such period constitute the Directors of the Company cease for any reason to constitute at least a majority thereof, provided, however, that for purposes of this Section 11(e), each Director who is first elected, or first nominated for election by the Company's stockholders, by a vote of at least two thirds of the Directors of the Company (or a committee thereof) then still in office who were Directors of the Company at the beginning of any such period will be deemed to have been a Director of the Company at the beginning of such period. Notwithstanding the foregoing provisions of Section 11(c) or 11(d) hereof, unless otherwise determined in a specific case by majority vote of the Board, a "Change in Control" shall not be deemed to have occurred for purposes of the Plan solely because (i) the Company, (ii) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities, or (iii) any employee stock ownership plan or any other employee benefit plan sponsored by the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-l, Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) under the Exchange Act, disclosing beneficial ownership by it of shares of Voting Stock, whether in excess of 20% or otherwise, or because the Company reports that a change in control of the Company has or may have occurred or will or may occur in the future by reason of such beneficial ownership. Section 12. Amendments and Termination. The Board may, at any time, amend, alter or terminate the Plan, but no amendment, alteration, or termination shall be made that would impair the rights of an Outside Director or THE LUBRIZOL CORPORATION Page 10 1991 STOCK INCENTIVE PLAN Participant under an Award theretofore granted, without the Outside Director's or Participant's consent, or that without the approval of the shareholders would: (a) except as is provided in Sections 4(b) and 13(c) of the Plan, increase the total number of Shares which may be issued under the Plan; (b) change the class of employees eligible to participate in the Plan; or (c) materially increase the benefits accruing to Participants under the Plan; so long as such approval is required by law or regulation; provided that, as long as required by law or regulation, the provisions of Section 10 hereof may not be amended or altered more than once every six (6) months, other than to comport with changes in the Code, the Employee Retirement Income Security Act, or the rules thereunder. The Committee may amend the terms of any Award heretofore granted (except, with respect to Options granted pursuant to Section 10 hereof, only to the extent not inconsistent with Rule 16b-3 under the Exchange Act or any successor rule or statute), prospectively or retroactively, but no such amendment shall impair the rights of any Participant or Outside Director without his consent. Section 13. General Provisions. (a) No Option, Stock Appreciation Right, or Restricted Stock Award shall be assignable or transferable by a Participant or an Outside Director otherwise than by will or the laws of descent and distribution, and Options and Stock Appreciation Rights may be exercised during the Participant's or Outside Director's lifetime only by the Participant or the Outside Director or, if permissible under applicable law, by the guardian or legal representative of the Participant or Outside Director. (b) The term of each Award shall be for such period of months or years from its Grant Date as may be determined by the Committee or as set forth in the Plan; provided that in no event shall the term of any Incentive Stock Option or any Stock Appreciation Right related to any Incentive Stock Option exceed a period of ten (10) years from the Grant Date. (c) In the event of a merger, reorganization, consolidation, recapitalization, stock dividend or other change in corporate structure such that Shares are changed into or become exchangeable for a larger or smaller number of Shares, thereafter the number of Shares subject to outstanding Awards granted to Participants and to any Shares subject to Awards to be granted to Participants pursuant to this Plan shall be increased or decreased, as the case may be, in direct proportion to the increase or decrease in the number of Shares by reason of such change in corporate structure; provided, however, that the number of Shares shall always be a whole number, and the purchase price per Share of any outstanding Options shall, in the case of an increase in the number of Shares, be proportionately reduced, and, in the case of a decrease in the number of Shares, shall be proportionately increased. The above adjustment shall also apply to any THE LUBRIZOL CORPORATION Page 11 1991 STOCK INCENTIVE PLAN Shares subject to Options granted to Outside Directors pursuant to the provisions of Section 10. (d) No Employee shall have any claim to be granted any Award under the Plan and there is no obligation for uniformity of treatment of Employees or Participants under the Plan. (e) The prospective recipient of any Award under the Plan shall not, with respect to such Award, be deemed to have become a Participant, or to have any rights with respect to such Award, until and unless such recipient shall have executed an Award Agreement, and otherwise complied with the then applicable terms and conditions. (f) All certificates for Shares delivered under the Plan pursuant to any Award shall be subject to such stock-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations, and other requirements of the Securities and Exchange Commission, any stock exchange upon which the Shares are then listed, and any applicable federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. (g) Except as otherwise required in any applicable Award Agreement or by the terms of the Plan, Participants shall not be required, under the Plan, to make any payment other than the rendering of services. (h) The Company shall be authorized to withhold from any payment under the Plan, whether such payment is in Shares or cash, all withholding taxes due in respect of such payment hereunder and to take such other action as may be necessary in the opinion of the Company to satisfy all obligations for the payment of such taxes. (i) Nothing contained in this Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to shareholder approval if such approval is required; and such arrangements may be either generally applicable or applicable only in specific cases. (j) Nothing in the Plan shall interfere with or limit in any way the right of the Company or any Subsidiary to terminate any Participant's employment at any time, nor shall the Plan confer upon any Participant any right to continued employment with the Company or any Subsidiary. Section 14. Effective Date and Term of Plan. The Plan shall be effective as of April 22, 1991. Options may be granted after the effective date any time prior to April 22, 2006, on which date the Plan shall expire but without affecting any options then outstanding. EX-10.I 4 l05101aexv10wi.txt EX-10(I) DEFERRED STOCK COMPENSATION PLAN Exhibit (10)(i) THE LUBRIZOL CORPORATION DEFERRED STOCK COMPENSATION PLAN FOR OUTSIDE DIRECTORS (Amended as of December 15, 2003) 1. PURPOSE. The Lubrizol Corporation (the "Company") hereby establishes its Deferred Stock Compensation Plan for Outside Directors (the "Plan") in order to promote the interests of the Company and its shareholders by having a portion of the total compensation payable to its outside directors be deferred and paid in the form of common shares of the Company, thereby increasing each Director's beneficial ownership of Company common shares as well as each Director's proprietary interest in the Company. 2. EFFECTIVE DATE. The effective date of the plan is October 1, 1991. 3. COMMON SHARE UNITS. In addition to the cash compensation otherwise payable to each outside director of the Company, the Company shall establish and maintain a Deferred Stock Account for and in the name of each outside director. Subject to the provisions of Section 10, on the first day of October in each calendar year, the Company shall credit 500 common share units ("Units") to the Deferred Stock Account of each person who is an outside director of the Company on said date. 4. DIVIDEND EQUIVALENTS. As of each dividend payment date declared with respect to the Company's common shares, the Company shall credit the Deferred Stock Account of each director with an additional number of Units equal to: (a) the product of (i) the dividend per common share of the Company which is payable with respect to such dividend payment date, multiplied by (ii) the number of Units credited to the director's Deferred Stock Account as of such dividend payment date; divided by (b) the closing price of a common share of the Company on the dividend payment date (or if such stock was not traded on that date, on the next preceding date on which such common shares were traded), as reported by the New York Stock Exchange - Composite Transactions Reporting System. 5. DISTRIBUTION (a) Each director, or, in the event of death, his/her beneficiary, shall be entitled to receive one common shares of the Company (a "Share" or "Shares") for each Unit credited to his/her Deferred Stock Account, payable at such time or times as hereinafter provided. (b) Unless otherwise elected by the director in accordance with the provisions of Section 5(c), the Shares shall be distributed to the director or beneficiary, as the -1- case may be, on the first day of the month following the date on which the director ceases to be a director for any reason. (c) At any time prior to the first time that the Company credits Units to the director's Deferred Stock Account, the director may irrevocably elect to have all Shares to which the director will be entitled under this Plan distributed to him/her (or in the event of his/her death, the director's designated beneficiary) in ten or fewer annual installments commencing on the first day of the month following the date on which such director ceases to be a director of the Company for any reason. The number of Shares to be distributed with each installment shall be equal to the nearer whole number obtained by dividing the number of Units then credited to the director's Deferred Stock Account by the number of unpaid installments. (d) Units with respect to which no distribution of Shares has yet occurred shall continue to be held in the director's Deferred Stock Account and credited with dividend equivalents in accordance with Section 4. 6. BENEFICIARY DESIGNATION (a) Each director may, from time to time, by writing filed with the Company, designate any legal or natural person or persons (who may be designated contingently or successively) to whom Shares attributable to the director's Units are to be distributed if the director dies prior to having received all such Shares to which he/she is entitled under Section 5. A beneficiary designation will be effective only if the signed form is filed with the Company while the director is alive and will cancel all beneficiary designation forms filed earlier. (b) To the extent that a director fails to designate a beneficiary or beneficiaries as provided in this Section 6, or if all designated beneficiaries die before the director or before the distribution of all Shares attributable to the director's Units, all remaining Shares attributable to such Units shall be distributed to the estate of the director as soon as practicable after such death. 7. ACCELERATION OF DISTRIBUTIONS. The Company may accelerate the distribution of Shares with respect to Units credited to the Deferred Stock Account of any director for reasons of severe financial hardship. For purposes of this Plan, severe financial hardship shall be deemed to exist in the event the Company determines that a director needs a distribution to meet immediate and heavy financial needs resulting from a sudden or unexpected illness or accident of the director or a member of his/her family, loss of the director's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the director. A distribution based on financial hardship shall not exceed the amount required to meet the immediate financial need created by the hardship. 8. TRANSFERABILITY. The interests of any director or beneficiary under the Plan are not subject to the claims of the director's creditors and may not otherwise be voluntarily or involuntarily assigned, alienated or encumbered. -2- 9. INTEREST OF DIRECTOR. The Company shall be under no obligation to segregate or reserve any funds or other assets for purposes relating to the Plan and, except as set forth in this Plan, no director shall have any rights whatsoever in or with respect to any funds or other assets held by the Company for purposes of the Plan or otherwise. Each director's Deferred Stock Account maintained for purposes of the Plan merely constitutes a bookkeeping entry on records of the Company, constitutes the unsecured promise and obligation of the Company to make payments as provided herein, and shall not constitute any allocation whatsoever of any cash or other assets of the Company or be deemed to create any trust or special deposit with respect to any of the Company's assets. Notwithstanding the foregoing provisions, nothing in this Plan shall preclude the Company from setting aside Shares or funds in trust pursuant to one or more trust agreements between a trustee and the Company. However, no director shall have any secured interest or claim in any assets or property of the Company or any such trust and all Shares or funds contained in such trust shall remain subject to the claims of the Company's general creditors. 10. CHANGES IN SHARES. In the event of any change in the number of outstanding Shares by reason of any stock dividend, stock split up, recapitalization, merger, consolidation, exchange of shares or other similar corporate change, the number of Units to be credited in accordance with Section 3, the number of Units held in the director's Deferred Stock Account and the Shares to be distributed in accordance with this Plan shall be appropriately adjusted to take into account any such event. 11. SUCCESSORS. This Plan shall be binding upon any assignee or successor in interest to the Company whether by merger, consolidation or sale of all or substantially all of the Company's assets. 12. AMENDMENT AND TERMINATION. The Board of Directors of the Company may, from time to time, amend or terminate the Plan; provided, however, that no such amendment or termination shall adversely affect the rights of any director or beneficiary without his/her consent with respect to Units credited prior to such amendment or termination. Effective December 15, 2003, no further grants will be made under the Plan. Deferred Stock Accounts will continue to be credited with dividend equivalents in accordance with Section 4 until all Deferred Stock Accounts have been fully distributed in accordance with the terms of the Plan. -3- EX-10.K 5 l05101aexv10wk.txt EX-10(K) DEFERRED COMPENSATION PLAN FOR OFFICERS Exhibit (10)(k) THE LUBRIZOL CORPORATION Deferred Compensation Plan For Officers (Amended as of December 15, 2003) 1. Purpose. The purpose of this Deferred Compensation Plan For Officers (the "Plan") is to permit an officer (as identified by the Company for Section 16 purposes under the Securities Exchange Act of 1934) (sometimes hereinafter referred to as "officer" or as the "Participant") of The Lubrizol Corporation (the "Company"), who wishes, to defer a portion of such officer's compensation as provided in the Plan. 2. Administration. The Plan shall be administered by the Organization and Compensation Committee of the Board of Directors of the Company (the "Committee"). The Committee's interpretation and construction of all provisions of the Plan shall be binding and conclusive upon all Participants and their heirs and/or successors. 3. Right to Defer Compensation. (a) An officer of the Company may, at any time prior to January 1 of a given calendar year, elect, for one or more future successive calendar years, to defer under the Plan a pre-selected amount of such officer's cash compensation, including bonus, which such officer may thereafter be entitled to receive for services performed during such elected calendar year or years. (b) The election under this Section 3 shall take effect on the first day of the calendar year following the date on which the election is made and such election shall be irrevocable for any elected calendar year after such elected calendar year shall have commenced. (c) An officer may elect to defer all or part of one or more of the following: (i) a fixed dollar amount or percentage of the officer's bi-weekly base salary; (ii) a fixed dollar amount or percentage of the officer's quarterly pay; (iii) a fixed dollar amount or percentage of the officer's participation in the performance pay plan, if any. (iv) a fixed dollar amount or percentage of the officer's participation in the long term incentive plan, if any. 1 (v) a fixed number of shares or percentage of the officer's stock compensation in the performance share program. (vi) a fixed number of shares or percentage of the officer's stock compensation in the long term incentive program, if any. (vii) a fixed number of shares or percentage of the officer's stock compensation pursuant to an employment agreement dated as of January 1, 2003; provided, however, that the actual amount deferred will be the elected amount less any applicable withholding taxes. (d) Notwithstanding paragraphs (a), (b) and (c), where an officer first becomes eligible to participate in the Plan, the newly eligible officer may make the election under this Section 3 to defer the specified compensation for services to be performed subsequent to the election and for the remainder of the calendar year in which the election under this Section 3 is made provided such election is made within 30 days after the date the officer first becomes eligible. (e) Within such periods of time as the Committee shall designate, and in addition to the provisions of paragraphs (a) through (d), an officer may elect to defer that portion or all of the officer's cash and/or stock compensation (i) described in paragraph (c) and/or (ii) any other plan or program that provides for cash or stock compensation, to the extent that such amounts would otherwise be nondeductible by the Company pursuant to Section 162(m) of the Internal Revenue Code of 1986, as amended. For purposes of the preceding sentence, the amount to be deferred with respect to any compensation plans payable in Company shares shall be determined by taking into consideration any fixed cash compensation (including biweekly and quarterly pay) to be received subsequent to the date on which shares are distributable under such program. Notwithstanding any other provision of this Plan, deferrals under this paragraph (e) shall be distributable only upon termination of employment in accordance with Section 6. (f) All elections under this Plan shall be made by written notice delivered to the Vice President, Human Resources, of the Company specifying (i) the number of calendar years, one or more, during which the election shall apply, (ii) the portion, if any, determined under paragraph (c), of each category of the Participant's compensation to be deferred for such year or years, as described above, (iii) the time of distribution, and (iv) if, applicable, the payment option as provided in Section 6 for distributions upon termination of employment. (g) A Participant may designate that the deferral election under this Section 3 shall remain in effect until the Participant, on a prospective basis, withdraws the election or changes the amount to be deferred. Any notice of the withdrawal of the deferral election or change of amount to be deferred shall be effective on the first day of the calendar year following the date on which such notice is given to the Company's Vice President, Human Resources; provided 2 that, such notice shall not change, alter or terminate the deferral of the officer's participation in the performance pay plan for the year in which such notice of withdrawal is given which, except for the deferral, would be payable in the calendar year following the date on which such notice of withdrawal is given. (h) Notwithstanding paragraph (f) and the first sentence of paragraph (g), any compensation earned after the end of the first month in which a Participant under this Plan no longer is an officer of the Company, as defined in Section 1, but continues to be employed by the Company, shall not be deferred, provided however, the balance in the Participant's Deferral Accounts shall continue to be held and administered pursuant to the Plan. 4. Deferral of Cash Compensation. (a) On the date the cash compensation deferred under the Plan would have become payable to the Participant in the absence of an election under the Plan to defer payment thereof, the amount of such deferred compensation shall be credited to a Stock Deferral Account and/or any of the Cash Deferral Account investment portfolios designated as available by the Committee from time to time. All Deferral Accounts shall be established and maintained for each Participant in the Company's accounting books and records and the Company shall be under no obligation to purchase any investments designated by the Participant. To the extent that, at the time amounts are credited to a Participant's Deferral Accounts, any federal, state or local payroll withholding tax applies (e.g., Medicare withholding tax), the Participant shall be responsible for the payment of such amount to the Company and the Company shall promptly remit such amount to the proper taxing authority. Notwithstanding the foregoing, any cash compensation deferred under Section 3(c)(iv) shall be credited to the fixed income fund in the Cash Deferral Account and shall not be eligible for transfer to any other investments. (b) Participant's Cash Deferral Accounts shall be credited with any gains or losses equal to those generated as if the Participant's Cash Deferral Account balances had been invested in the applicable investment portfolio(s) selected by the Participant. (c) A Participant's deferred cash compensation credited to a Participant's Stock Deferral Account shall be used to determine the number of full and fractional units ("Units") representing Company Common Shares ("Shares") which the deferred amount would purchase at the closing price for the Shares on the New York Stock Exchange ("NYSE") composite transactions reporting system on the date that the deferred amount is credited pursuant to paragraph (a) and if Shares were not traded on that date on the NYSE, then such computation shall be made as of the first preceding day on which Shares were so traded. The Company shall credit the Participant's Stock Deferral Account with the number of full and fractional Units so determined. A Participant's Stock Deferral Account shall be administered in accordance with Section 5(b) through (e). 3 (d) A Participant may elect pursuant to rules established by the Committee to transfer a portion or all of the balance of any Deferral Account established under this Section 4 to any other such Deferral Account. (e) Notwithstanding the foregoing, and other than cash deferrals under Section 3(c)(iv), a Participant may elect to have any portion or all of the Participant's cash deferrals credited to any of the Deferral Accounts listed in paragraph (a) and may transfer balances in accordance with paragraph (d) provided that the Participant is considered, in the judgment of the Chief Executive Officer of the Company, to be on plan to meet the Participant's Company Share ownership guideline. Otherwise, a Participant must elect that at least 50% of any cash deferral hereunder (other than cash deferred under Section 3(c)(iv)) be credited to a Stock Deferral Account and may not transfer any portion of the balance of the Stock Deferral Account to another Deferral Account. 5. Deferral of Stock Compensation. (a) At the time that Shares are distributable to a Participant, who has elected to defer the receipt thereof under Section 3(c) or (e), in lieu of Shares being issued, there shall be credited to a separate Stock Deferral Account for the Participant, full stock equivalent units ("Units') which shall be established and maintained on the Company's records. One Unit shall be allocated to the Stock Deferral Account for each such Share. The balance of a Stock Deferral Account established under this Section 5(a) pursuant to deferrals under Section 3(c)(v), (vi) or (vii) may not be transferred to any other Deferral Account. (b) As of each dividend payment date established by the Company for the payment of cash dividends with respect to its Shares, the Company shall credit each separate Stock Deferral Account of a Participant with an additional number of whole and/or fractional Units equal to: (i) the product of (x) the dividend per Share which is payable with respect to such dividend payment date, multiplied by (y) the number of whole and fractional Units credited to the separate Stock Deferral Account of a Participant as of such payment date; divided by (ii) The closing price of a Share on the dividend payment date (or if Shares were not traded on that date, on the next preceding day on which Shares were so traded), as reported on the NYSE-composite tape. (c) At no time prior to actual delivery of Shares pursuant to the Plan, shall the Company be obligated to purchase or reserve Shares for delivery of a Participant and the Participant shall not be a shareholder nor have any of the 4 rights of a shareholder with respect to the Units credited to the Participant's Stock Deferral Accounts. (d) To the extent that, at the time Units are credited to a Stock Deferral Account of a Participant, any federal, state or local payroll withholding tax applies (e.g., Medicare withholding tax), the Participant shall be responsible for the payment of such amount to the Company and the Company shall promptly remit such amount to the proper taxing authority. (e) In the event of any change in the number of outstanding Shares by reason of any stock dividend, stock split up, recapitalization, merger, consolidation, exchange of shares or other similar corporate change, the number of Units in each separate Stock Deferral Account of a Participant shall be appropriately adjusted to take into account any such event. 6. Payment of Deferred Compensation upon Termination. (a) The total amount standing as a credit in a Participant's Cash Deferral Accounts shall, upon termination of employment, be payable to the Participant either in a lump sum or in periodic installments over such period, not exceeding ten years, as the Participant shall have selected pursuant to Section 3(f)(iv). Such periodic payments shall begin or the lump sum payment shall be made, as the case may be, from the Participant's Cash Deferral Accounts, at such time, not more than twelve (12) months after the Participant ceases to be an employee of the Company, as the Participant shall have selected pursuant to Section 3 (f)(iv). All amounts payable in accordance with this Section 6(a) shall be subject to applicable federal, state and/or local payroll withholding taxes then in effect. Notwithstanding the foregoing, a Participant may elect no later than thirty (30) days prior to the Participant's termination of employment, nor earlier than ninety (90) days prior thereto, to change the form of distribution of the Participant's Cash Deferral Accounts. (b) The amount of each installment payable to a Participant shall be determined by dividing the aggregate balance of such Participant's Cash Deferral Accounts by the number of periodic installments (including the current installment) remaining to be paid. Until a Participant's Cash Deferral Accounts has been completely distributed, the balance thereof remaining, from time to time, shall be credited with gains and losses on a monthly basis as provided in Section 4(b). (c) The total number of Units credited to the Participant's Stock Deferral Accounts shall upon termination of employment be payable to the Participant either in a lump sum or in periodic installments, over such period, not exceeding ten years, as the Participant shall have selected pursuant to Section 3(f)(iv). Such periodic payments shall begin or the lump sum payment shall be made, as the case may be, at such time, not more than twelve (12) months after the Participant ceased to be an employee of the Company, as the Participant shall have selected pursuant to Section 3(f)(iv). All amounts payable in 5 accordance with this Section 6(c) shall be subject to applicable federal, state and/or local payroll withholding taxes then in effect. Notwithstanding the foregoing, a Participant may elect no later than thirty (30) days prior to the Participant's termination of employment, no earlier than ninety (90) days prior thereto, to change the form of distribution of the Participant's Stock Deferral Accounts. (d) The amount of any installment payable from the Stock Deferral Accounts to a Participant shall be determined by dividing the balance of the aggregate number of Units in the Participant's Stock Deferral Accounts by the number of periodic installments (including the current installment) remaining to be paid and the quotient shall be the number of Shares that are payable. If the determination of the installment payable from the Participant's Stock Deferral Accounts results in a fractional Share being payable, the installment payment shall exclude any such fractional Share payment except that, in the final installment payment, any such fractional Share shall be paid in cash in an amount as determined by the Committee. Until the Participant's Stock Deferral Accounts have been completely distributed, the balance in the Stock Deferral Accounts shall continue to be credited with the dividend equivalents on such balances as provided in Section 5(b). (e) If the Participant elects to satisfy tax withholding under paragraph (c) with Shares, then such withholding shall be from those Shares otherwise issuable pursuant to paragraph (c) above, and shall be such number of Shares that will provide for the federal, state and/or local income tax at the rates then applicable for supplemental wages, unless otherwise requested by the Participant, but in no event less than the statutory minimums for tax withholding. (f) For purposes under paragraph (e) of determining the number of Shares that are to be withheld to provide for the tax withholding, Shares shall be valued at the closing price on the New York Stock Exchange of a Share on the date the Shares are distributable (or if the Shares were not traded on that date, on the next preceding day on which the Shares were so traded). If the determination of the tax withholding would require the withholding of a fractional Share, the Participant shall remit cash to the Company in lieu of such fractional Share. (g) In the event a Participant dies prior to receiving payment of the entire amount in that Participant's Cash Deferral Accounts and/or Stock Deferral Accounts, as the case may be, the unpaid balance shall be paid to such beneficiary as the Participant may have designated in writing to the Vice President, Human Resources, of the Company as the beneficiary to receive any such post-death distribution under the Plan or, in the absence of such written designation, to the Participant's legal representative or to the beneficiary designated in the Participant's last will as the one to receive such distributions. Distributions subsequent to the death of a Participant may be made either in a lump sum or in periodic installments in such amounts and over such period, not exceeding ten years from the date of death, as the Committee may direct and 6 the amount of each installment shall be computed as provided in Section 6(b), and (d) as the case may be. (h) Payments from the Cash Deferral Accounts shall be made in cash and payments from the Stock Deferral Accounts shall be made in Shares. The amount of any distribution pursuant to Sections 6 through 9 shall reduce the balance held in the Participant's corresponding Deferral Accounts as of the date of such distribution. Installment payments shall be made pro-rata from a Participant's Deferral Accounts. 7. In-Service Distributions. Pursuant to Section 3 and other than for deferrals pursuant to Sections 3(c)(v), (vi), (vii) and 3(e), a Participant may elect to receive an in-service distribution of all or any specified percentage of the Participant's deferral for any calendar year commencing not earlier than the first calendar year following the year that such compensation would have been payable. In-service distributions shall be made in a lump sum payment. A Participant may elect once for any calendar year of deferral for which the Participant has elected an in-service distribution, to change the date of distribution to another in-service year or upon termination; provided, however, that any such modification must be made in writing at least twelve (12) months prior to the date originally elected for the in-service distribution. Notwithstanding the foregoing, any distribution hereunder shall be subject to further deferral pursuant to an election under Section 3(e). 8. Special Distributions. Notwithstanding any other provision of this Plan, a Participant may elect to receive distribution of part or all of the total of Participant's eligible Deferral Accounts, other than from deferrals pursuant to Sections 3(c)(v), (vi), (vii) and 3(e), in one or more distributions if (and only if) the amount of the distribution is reduced by ten (10) percent. The ten (10) percent reduction shall be forfeited. Distributions shall be made pro-rata among Participant's eligible Deferral Accounts. Any distribution made pursuant to such an election shall be made within sixty (60) days of the date such election is submitted to Vice President - Human Resources. Notwithstanding the foregoing, any distribution hereunder shall be limited to an amount that would not be subject to further deferral pursuant to an election under Section 3(e). 9. Hardship Distributions. The Committee may accelerate the distribution of part or all, in any or all, of a Participant's Deferral Accounts for reasons of severe financial hardship. For purposes of the Plan, severe financial hardship shall be deemed to exist in the event the Committee determines that a Participant needs a distribution to meet immediate and heavy financial needs resulting from a sudden or unexpected illness or accident of the Participant or a member of the Participant's family, loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstance arising as a result of events beyond the control of the Participant. A distribution based on financial hardship shall not exceed the amount required to meet the immediate financial need created by the hardship. 7 10. Non-assignability. None of the rights or interests in any of the Participant's Deferral Accounts shall, at any time prior to actual payment or distribution pursuant to the Plan, be assignable or transferable in whole or in part, either voluntarily or by operation of law or otherwise, and such rights and interest shall not be subject to payment of debts by execution, levy, garnishment, attachment, pledge, bankruptcy or in any other manner; provided that, upon the occurrence of any such assignment or transfer or the attempted assignment or transfer, all payments hereunder shall be payable in the sole and unrestricted judgment and discretion of the Committee, as to time and amount (including a lump sum amount), and shall be distributable to the person who would have received the payment but for this Section 10 only at such time or times and in such amounts as the Committee, from time to time, and in its sole and unrestricted judgment and discretion, shall determine. Should an event covered by this Section 10 occur prior to the death of a Participant, the balance, if any, in the Participant's accounts shall, after such death, be thereafter distributed as provided in Section 6 subject to the provisions of this Section 10. 11. Interest of Participant. The Company shall be under no obligation to segregate or reserve any funds or other assets for purposes relating to the Plan and, except as set forth in this Plan, no Participant shall have any rights whatsoever in or with respect to any funds or other assets held by the Company for purposes of the Plan or otherwise. Each Participant's accounts maintained for purposes of the Plan merely constitute bookkeeping entries on records of the Company, constitute the unsecured promise and obligation of the Company to make payments as provided herein, and shall not constitute any allocation whatsoever of any cash, shares or other assets of the Company or be deemed to create any trust or special deposit with respect to any of the Company's assets. Notwithstanding the foregoing provisions, nothing in this Plan shall preclude the Company from setting aside Shares or funds in trust pursuant to one or more trust agreements between a trustee and the Company. However, no Participant shall have any secured interest or claim in any assets or property of the Company or any such trust and all Shares or funds contained in such trust shall remain subject to the claims of the Company's general creditors. 12. Amendment. The Board of Directors of the Company, or the Organization and Compensation Committee may, from time to time, amend or terminate the Plan, provided that no such amendment or termination of the Plan shall adversely affect a Participant's accounts as they existed immediately before such amendment or termination or the manner of distribution thereof, unless such Participant shall have consented thereto in writing. Notice of any amendment or termination of the Plan shall be given promptly to all Participants. 13. Plan Implementation. This Plan is adopted and effective on the 25th day of July, 1994, as amended on June 17, 1995, as further amended September 25, 1995, effective as of January 1, 1995, further amended on September 22, 1997 and further amended on September 27, 1999, effective as of January 1, 2000; provided, however that any deferrals made hereunder into a Stock Deferral Account prior to January 1, 2000, shall be governed by the provisions of the Plan in effect prior to January 1, 2000, further amended on February 28, 2000, 8 effective as of January 1, 2000, further amended on March 11, 2000, further amended on November 12, 2001, further amended on November 11, 2002, further amended on February 24, 2003 and further amended on December 15, 2003. 9 EX-10.L 6 l05101aexv10wl.txt EX-10(L) EXE. COUNCIL DEFERRED COMPENSATION PLAN Exhibit (10)(l) THE LUBRIZOL CORPORATION EXECUTIVE COUNCIL DEFERRED COMPENSATION PLAN As Amended 1. Purpose. The purpose of this Executive Council Deferred Compensation Plan (the "Plan") is to permit a member of the Executive Council (sometimes hereinafter referred to as the "Member" or as the "Participant") who is employed by The Lubrizol Corporation (the "Company"), to defer a portion of such Member's compensation as provided in this Plan. 2. Administration. The Plan shall be administered by the Organization and Compensation Committee of the Board of Directors of the Company (the "Committee"). The Committee's interpretation and construction of all provisions of the Plan shall be binding and conclusive upon all Participants and their heirs and/or successors. 3. Right to Defer Compensation. (a) A Member may, at any time prior to January 1 of a given calendar year, elect, for one or more future successive calendar years commencing with the calendar year immediately following the election (each a "Participation Year"), to defer under the Plan a pre-selected fixed dollar amount or percentage of such Member's variable compensation, if any (the "deferred compensation"), under The Lubrizol Corporation Performance Pay Plan ("Performance Pay Plan"), which such Participant may thereafter be entitled to receive for services performed during each elected Participation Year; provided, however that the actual amount deferred will be the elected amount less any applicable withholding taxes. (b) The election under this Section 3 shall take effect on the first day of the first elected Participation Year and such election shall be irrevocable for any elected Participation Year once such Participation Year shall have commenced. (c) Notwithstanding paragraphs (a) and (b), when an individual Member first becomes eligible to participate in the Plan, the newly eligible Member may make the election under this Section 3 to defer the specified compensation for services to be performed subsequent to the date specified in the election and for the remainder of the calendar year in which the election under this Section 3 is made, provided that such election is made within 30 days after the date that the Member is notified of the Member's eligibility. (d) All elections under this Plan shall be made by written notice (on a form provided by the Company) specifying (i) the number of calendar years, one or more, during which the election shall apply, and (ii) the deferred compensation, if any, determined under paragraph (a). (e) A Participant may designate that the election under this Section 3 shall remain in effect until the Participant, on a prospective basis, withdraws the election or changes the amount to be deferred. Any notice of the withdrawal or change in the amount of the election shall be effective on the first day of the calendar year next 1 following the year on which such notice is given; provided that, such notice shall not change, alter or terminate the deferral of the Member's participation in the Performance Pay Plan for the year in which such notice of withdrawal or change is given which, except for the deferral, would be payable in the calendar year next following the year in which such notice of withdrawal or change is given. Notwithstanding paragraph (b) and the first sentence of this paragraph (e), any variable compensation earned after the end of the first month in which a Participant under this Plan ceases to be a Member, as defined in Section 1, but continues to be employed by the Company, shall not be deferred, provided however, the balance in the Participant's Stock Deferral Accounts shall continue to be held and administered pursuant to the Plan. (f) All notices by a Participant under the Plan shall be in writing and shall be given to the Company's Vice President, Human Resources. 4. Stock Deferral Accounts and Stock Matching Accounts. (a) At the close of business of the day on which the Performance Pay Plan deferred compensation would have been payable to the Participant in the absence of the election under the Plan to defer payment thereof, there shall be credited to a separate Stock Deferral Account and Stock Matching Account for each Participant full and fractional stock equivalent units ("Units") which shall be established as hereinafter provided and shall be maintained for each Participant on the Company's records. (b) The number of full and fractional Units that shall be credited to a separate Stock Deferral Account for a Participant shall be equal to an amount determined by dividing the Participant's deferred compensation for the applicable Participation Year by the average of the closing price for Lubrizol Common Shares ("Shares") on the New York Stock Exchange ("NYSE") composite transactions reporting system ("composite tape") for each of the ten (10) consecutive trading days commencing on the fourth business day following the release of earnings for such Participation Year. (c) The number of full and fractional Units that shall be credited to a separate Stock Matching Account for a Participant shall be equal to an amount determined by multiplying the number of Units determined in paragraph (b) by ..25. (d) To the extent that, at the time Units are credited to a Stock Deferral Account Stock Matching Account of a Participant, any federal, state or local payroll withholding tax applies (e.g., Medicare withholding tax), the Participant shall be responsible for the payment of such amount to the Company and the Company shall promptly remit such amount to the proper taxing authority. (e) The amount of deferred compensation used in the formulae set forth in paragraphs (b) and (c) shall not constitute sums due and owing to Participant. Such amounts shall be used solely as part of the formulae to determine the number of full and fractional Units. (f) As of each dividend payment date established by the Company for the payment of cash dividends with respect to its Shares, the Company shall credit each separate Stock Deferral Account and Stock Matching Account of a Participant with an additional number of whole and/or fractional Units equal to: 2 (i) the product of (x) the dividend per Share which is payable with respect to such dividend payment date, multiplied by (y) the number of whole and fractional Units credited to the separate Stock Deferral Account and Stock Matching Account, respectively, of the Participant as of such payment date; divided by (ii) the closing price of a Share on the dividend payment date (or if Shares were not traded on that date, on the next preceding day on which Shares were so traded), as reported on the NYSE- composite tape. (g) At no time prior to actual delivery of Shares pursuant to the Plan shall the Company be obligated to purchase or reserve Shares for delivery to any Participant and a Participant shall not be a shareholder or have any of the rights of a shareholder with respect to the Units credited to each separate Stock Deferral Account Stock Matching Account of a Participant. 5. Payment of Deferred Compensation. (a) All Units credited to a separate Stock Deferral Account and Stock Matching Account of Participant, including dividend equivalents thereon, shall be payable to the Participant at the end of three years from the first date Units were credited to such separate Stock Deferral Account and Stock Matching Account of the Participant under Section 4(a); provided, however, that a Participant may elect once for any calendar year of deferral, to change the date of distribution to another in-service year or upon retirement; provided further, that any such modification must be made in writing at least twelve (12) months prior to the original date of distribution; provided further, that if a Participant's employment is terminated for any reason other than retirement or death, the Units credited to each separate Stock Deferral Account and Stock Matching Account of a Participant as of the Participant's termination of employment date, including all dividend equivalents thereon, shall be payable to the Participant within 30 days of such termination of employment. (b) All distributions or payments of Units to a Participant in the Participant's Stock Deferral Account shall be made in Shares equal to the number of whole Units credited to the separate Stock Deferral Account(s) of the Participant which become payable in accordance with Section 5(a). Any fractional number of Units shall be paid in cash in lieu of Shares. (c) All distributions or payments of Units to a Participant in the Participant's Stock Matching Account shall be made in cash equal to the number of whole Units credited to the separate Stock Matching Account(s) of the Participant, which become payable in accordance with Section 5(a) multiplied by the closing price for Share on the NYSE composite tape on the date the Stock Matching Account(s) become payable. (d) To the extent that, at the time Shares are distributed to a Participant, any federal, state or local payroll withholding tax applies, the Participant shall be responsible 3 for the payment of such amount to the Company and the Company shall promptly remit such amount to the proper taxing authority. Such payment may be made in cash, in Shares, or in any combination of cash and Shares, at the election of the Participant. All elections must be made in writing and be submitted to the Vice President - Human Resources. If the Participant elects to satisfy tax withholding with Shares, then such withholding shall be from those Shares otherwise issuable pursuant to paragraph (b) above, and shall be such number of Shares that will provide for the federal, state and/or local income tax at the rates then applicable for supplemental wages, unless otherwise requested by the Participant, but in no event less than the statutory minimums for tax withholding. If no election is made prior to the first distribution of Shares, the Company shall withhold a sufficient number of Shares to pay the withholding taxes at the highest marginal tax rate in effect for such Participant. In no event shall the withholding be less than the statutory minimum for tax withholding. (e) In the event a Participant dies prior to receiving payment of the entire amount in each separate Stock Deferral Account and Stock Matching Account of the Participant, the unpaid balance shall be paid to such beneficiary as the Participant may have designated in writing to the Vice President, Human Resources, of the Company as the beneficiary to receive any such post-death distribution under the Plan or, in the absence of such written designation, to the Participant's legal representative or to the beneficiary designated in the Participant's last will as the one to receive such distributions. Distributions subsequent to the death of a Participant may be made either in accordance with Section 5(a) or earlier, as determined by the Committee. (f) To the extent the Committee deems necessary, the Shares distributed to a Participant pursuant to Section 5(a) or 6(a) or to a successor pursuant to Section 5(e) may contain such restrictions on the right of immediate transfer as the Committee may reasonably determine. 6. Acceleration of Payments. (a) The Committee may accelerate the distribution of part or all of one or more of a Participant's separate Stock Deferral Accounts and Stock Matching Accounts for reasons of severe financial hardship. For purposes of the Plan, severe financial hardship shall be deemed to exist in the event the Committee determines that a Participant needs a distribution to meet immediate and heavy financial needs resulting from a sudden or unexpected illness or accident of the Participant or a member of the Participant's family, loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstance arising as a result of events beyond the control of the Participant. A distribution based on financial hardship shall not exceed the amount required to meet the immediate financial need created by the hardship. 7. Non-assignability. None of the rights or interests in any of the Participant's separate Stock Deferral Accounts and Stock Matching Accounts shall, at any time prior to actual payment or distribution pursuant to the Plan, be assignable or transferable in whole or in part, either voluntarily or by operation of law or otherwise, and such rights and interest shall not be subject to payment of debts by execution, levy, garnishment, attachment, pledge, bankruptcy or in any other manner; provided that, upon the occurrence of any such assignment or transfer or the attempted assignment or transfer, all payments under Section 5 shall be payable in the sole and unrestricted judgment and discretion of 4 the Committee, as to time and amount, and shall be distributable to the person who would have received the payment but for this Section 7 only at such time or times and in such amounts as the Committee, from time to time, and in its sole and unrestricted judgment and discretion, shall determine. Should an event covered by this Section 7 occur prior to the death of a Participant, the balance, if any, in each of the Participant's Stock Deferral Accounts and Stock Matching Accounts shall, after such death, be thereafter distributed as provided in Section 5(e) subject to the provisions of this Section 7. 8. Interest of Participant. The Company shall be under no obligation to segregate or reserve any funds or other assets for purposes relating to the Plan and, except as set forth in this Plan, no Participant shall have any rights whatsoever in or with respect to any funds or other assets held by the Company for purposes of the Plan or otherwise. Each Participant's separate Stock Deferral Accounts and Stock Matching Accounts maintained for purposes of the Plan merely constitutes a bookkeeping entry on records of the Company, constitutes the unsecured promise and obligation of the Company to make payments as provided herein, and shall not constitute any allocation whatsoever of any cash or other assets of the Company or be deemed to create any trust or special deposit with respect to any of the Company's assets. Notwithstanding the foregoing provisions, nothing in this Plan shall preclude the Company from setting aside Shares or funds in trust pursuant to one or more trust agreements between a trustee and the Company. However, no Participant shall have any secured interest or claim in any assets or property of the Company or any such trust and all Shares or funds contained in such trust shall remain subject to the claims of the Company's general creditors. 9. Miscellaneous. In the event of any change in the number of outstanding Shares by reason of any stock dividend, stock split up, recapitalization, merger, consolidation, exchange of shares or other similar corporate change, the number of Units credited to each separate Stock Deferral Account and Stock Matching Account of a Participant shall be appropriately adjusted to take into account any such event. 10. Amendment. The Board of Directors of the Company, or the Organization and Compensation Committee, may, from time to time, amend or terminate the Plan, provided that no such amendment or termination of the Plan shall adversely affect any Stock Deferral Account or Stock Matching Account of a Participant as it existed immediately before such amendment or termination or the manner of distribution thereof, unless such Participant shall have consented thereto in writing. Notice of any amendment or termination of the Plan shall be given promptly to all Participants. 11. Plan Implementation. This Plan is adopted and effective as of the 1st day of January, 1997, amended effective November 23, 1998, amended effective September 27, 1999, amended effective February 29, 2000, amended effective March 11, 2000, amended effective February 26, 2001 and amended effective January 1, 2004. 5 EX-10.M 7 l05101aexv10wm.txt EX-10(M) SUPLMNT RETIREMENT PLN DONALD W. BOGUS Exhibit (10)(m) Supplemental Retirement Plan ---------------------------- for Donald W. Bogus ------------------- In addition to the benefits accrued under The Lubrizol Corporation Pension Plan and Employees' Profit Sharing and Savings Plan, and any accrued benefits under the associated excess plans, Lubrizol will also establish a supplemental retirement plan on behalf of Donald W. Bogus with the following terms and conditions: 1) On Mr. Bogus' first day of employment, and on each anniversary of that date thereafter, 500 phantom shares of Lubrizol stock will be credited to a supplemental retirement account on Mr. Bogus' behalf. 2) If Mr. Bogus works until age 65, over the 12 year period a total of 6,000 phantom shares would be credited to the account. 3) Dividends on accumulated phantom shares will be posted throughout the year and will be used as the basis for purchasing additional phantom shares under the plan. 4) In the event of a change in control, as defined in the Executive Employment Agreement, or at the time of Mr. Bogus' death, Lubrizol would fully credit the account with the remaining balance of the 6,000 phantom shares. In the event of employment termination for other than the above reasons, the account balances as of the date of termination would be distributable under the plan. 5) Phantom shares accumulated under the plan will be included when considering share ownership objectives under the Executive Council Ownership Guidelines. 6) Amounts may be withheld at the time of distribution for tax purposes. Mr. Bogus, or his estate, may elect distribution in the form of shares or cash at the time of distribution for phantom shares that are attributable to deferrals prior April 1, 2004. For phantom shares that are attributable to deferrals on or after April 1, 2004, the distribution will be a cash amount equal to the number of phantom shares multiplied by the closing price per common share of The Lubrizol Corporation on the New York Stock Exchange Composite Transactions Reporting System on the date retirement or other termination. 7) As the shares are unregistered, certain restrictions on selling/trading may apply at the time of distribution. 8) The Medicare tax on the increase in the value of the account year over year will be entered into Mr. Bogus' pay on an annual basis. EX-10.N 8 l05101aexv10wn.txt EX-10(N) EXE. COUNCIL LONG TERM INCENTIVE PAY PLAN Exhibit (10)(n) THE LUBRIZOL COMPANY EXECUTIVE COUNCIL LONG TERM INCENTIVE PAY PLAN (Amended As of 11/10/03) INTRODUCTION The Lubrizol Company ("Company") hereby establishes, effective as of January 1, 2003, The Lubrizol Company Executive Council Long Term Incentive Pay Plan ("Plan") in order to provide an award for executive officers, which reflects the pursuit of superior performance, increased customer satisfaction and enhancement of shareholder value. Awards for participating officers under the Plan will depend upon corporate operating earnings performance over a three-year period ("Plan Period), as determined by the Organization and Compensation Committee of the Board of Directors of the Company ("Committee") for the Plan Period. Except as otherwise provided, the Plan is administered by the Committee. The Committee has the conclusive authority to construe and interpret the Plan and any agreements entered into under the Plan and to establish, amend, and rescind rules and regulations for its administration. The Committee also has any additional authority as the Board may determine to be necessary or desirable. 1. Definitions. The following terms shall have the indicated meanings for purposes of the Plan: (a) "Board" means the Board of Directors of the Company. (b) "Chief Executive Officer" means the chief executive officer of the Company. (c) "Committee" means the Organization and Compensation Committee of the Board, or other designated committee of the Board, consisting of persons who are not employees of the Company. (d) "Company" means The Lubrizol Company, a Company organized under the laws of the State of Ohio. (e) "Director" means a member of the Board. (f) "Individual Award" means an Individual Cash Award or Individual Share Award. (g) "Individual Cash Award" means the amount paid (or to be paid) to a Participant by the Company pursuant to the Plan that relates to the Individual LTIP Cash Target. (h) "Individual Share Award" means the amount paid (or to be paid) to a Participant by the Company pursuant to the plan that relates to the Individual LTIP Share Target. (i) "Individual LTIP Cash Target" means 70% of a percentage of the Participant's Pay that would be paid at the end of the Plan Period if 100% of the Operating Earnings Target were met. 1 (j) "Individual LTIP Share Target" means 30% of a percentage of the Participant's Pay that would be paid at the end of the Plan Period if 100% of the Operating Earnings Target were met, divided by the closing price of a Share on the date the Operating Earnings Target is approved by the Committee. (k) "Officer" means an employee of the Company who is a member of the Executive Council of the Company. (l) "Operating Earnings" means total earnings for the calendar year less special items other than gains from patent litigation. (m) "Operating Earnings Target" means the Operating Earnings per Share growth rate target set by the Committee for the Plan Period. (n) "Participant" means all Officers who have been selected by the Committee pursuant to Section III to participate in the Plan, and have not for any reason become ineligible to participate in the Plan. (o) "Pay" for any Plan Period will be determined at the time of calculating the Operating Earnings Target for that Plan Period and will be the annual guaranteed pay. (p) "Plan" means The Lubrizol Company Executive Council Long Term Incentive Pay Plan. (q) "Plan Period" means each three-year period commencing January 1 and ending December 31. (r) "Share" means a share of outstanding common stock of The Lubrizol Corporation. 2. Construction. Where necessary or appropriate to the meaning of a word, the singular is deemed to include the plural, the plural to include the singular, the masculine to include the feminine, and the feminine to include the masculine. 3. Participation. All Officers at the beginning of each Plan Period will participate in the Plan. The Committee may also determine which Officers hired during a Plan Period will participate in the Plan for that Plan Period. The Committee's selection of Participants will be made after considering recommendations presented to it by the Chief Executive Officer. 4. Determination of Operating Earnings Target. Prior to the beginning of each Plan Period, the Committee will, after consideration of the recommendations of the Chief Executive Officer, establish, for each Plan Period, the Operating Earnings Target for that Plan Period. 5. Determination of Individual LTIP Cash Targets and Individual LTIP Share Targets. Prior to the beginning of the each Plan Period, the Committee will, after consideration of the recommendations of the Chief Executive Officer, establish for each Participant an Individual LTIP Cash Target and an Individual LTIP Share Target, as well as a range of potential payouts depending on actual Operating Earnings per Share growth for the Plan Period. The Operating Earnings Target, Individual LTIP Cash Target, Individual LTIP Share Target and range of potential payouts will be communicated to each Participant promptly after their establishment by the Committee. 2 Individual LTIP Cash Targets and Individual LTIP Share Targets may be increased or decreased at any time prior to the determination of the Individual Award for any Participant at the sole discretion of the Committee. 6. Determination of Individual Awards. In February following the close of the Plan Period each Participant's Individual Cash Award and Individual Share Award for a Plan Period will be calculated by multiplying Pay for that Plan Period by a percentage of the Individual LTIP Cash Target and Individual LTIP Share Target, respectively, determined in accordance with range of potential payouts established by the Committee as described in Section 5. Notwithstanding the foregoing, the Committee in its sole and unrestricted discretion may increase or decrease the amount of any Individual Award determined under this Section 6. The adjustment of any Individual Award will not cause an automatic adjustment of another Individual Award. No Participant has any vested interest in, or is entitled to, any Individual Award unless and until payment is authorized by the Committee. 7. Time and Method of Payment of Individual Awards. If the Committee determines that a Participant is entitled to an Individual Award, the Company will pay the Individual Cash Award to the Participant in cash as soon after the close of the Plan Period as may be administratively feasible, and will pay the Individual Share Award to the Participant in cash or, if an applicable shareholder approved stock plan is available and in the Committee's sole discretion, in Shares as soon after the close of the Plan Period as may be administratively feasible. If the Individual Share Award is paid in cash, the amount to be paid shall be determined by multiplying the Individual Share Award by the closing price of a Share on the date the Individual Share Award is approved by the Committee, as provided in Section 6. If the Individual Share Award is paid in Shares, the number of Shares paid to the Participant will be equal to the Individual Share Award. 8. Retirement, Death and Termination. If the Participant retires, separates from service or dies prior to the receipt of any Individual Award, the Participant or his beneficiary will receive a pro-rata Individual Award upon the end of the Plan Period based on the calculation in Section 6 and the number of months during the Plan Period prior to the Participant's retirement, separation from service or death. 9. Designation of Beneficiary. A Participant may at any time specify in writing a beneficiary to receive the Participant's Individual Award if the Participant dies before the receipt of an Individual Award. If the Company does not have a beneficiary election on file at the time of the Participant's death, the Individual Award will be paid to his spouse or if there is no spouse living at the time of payment, his children who are living at the time of payment, or if there are no children who are living at the time of payment, then to his estate. 10. Effect of Change in Control. In the event a Change in Control of the Company (as defined in Section 11) occurs prior to final determination by the Committee of the amounts of Individual Awards to be paid under the Plan with respect to any Plan Period, the Committee will calculate such Individual Awards as soon as practicable after the Change in Control. If 12 months have elapsed for any Plan Period, the Individual Awards for that Plan Period will determined based on the cumulative performance results as of the most recent year end and as if the end of the full Plan Period had occurred concurrently with the date of the Change of Control, but pro-rated for the number of months that have actually elapsed in the Plan Period as of the date of the Change of Control. Individual Awards shall be calculated in accordance with Section 6. 3 Payment of such Individual Awards will be made within 30 days of the date on which the determination is made to compute the payments according to the terms of this Section 10. 11. Change of Control Defined. For all purposes of the Plan, a "Change in Control of the Company" will have occurred if any of the following events occur: (a) The Company is merged, consolidated or reorganized into or with another Company or other legal person, and, as a result of such merger, consolidation or reorganization, less than a majority of the combined voting power of the then-outstanding securities of such surviving Company or person entitled to vote, immediately after such transaction, is held in the aggregate by the holders of Voting Stock (as hereinafter defined) of the Company immediately prior to such transaction; (b) The Company sells all or substantially all of its assets to any other Company or other legal person, and less than a majority of the combined voting power of the then-outstanding securities of such Company or person, immediately after such sale, is held in the aggregate by the holders of Voting Stock of the Company immediately prior to such sale; (c) There is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as promulgated pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act"), disclosing that any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13(d)(3) or any successor rule or regulation promulgated under the Exchange Act) of securities representing 20% or more of the combined voting power of the then-outstanding securities entitled to vote generally in the election of directors of the Company ("Voting Stock"); (d) The Company files a report or proxy statement with the Securities and Exchange Commission pursuant to the Exchange Act disclosing in response to Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) that a change in control of the Company has or may have occurred or will or may occur in the future pursuant to any then-existing contract or transaction; or (e) If during any period of two consecutive years, individuals who, at the beginning of any such period constitute the Directors of the Company, cease for any reason to constitute at least a majority thereof, unless the election, or the nomination for election by the Company's stockholders, of each Director of the Company first elected during such period was approved by a vote of at least two-thirds of the Directors of the Company then still in office who were Directors of the Company at the beginning of any such period. Notwithstanding the foregoing provisions, a "Change in Control" shall not be deemed to have occurred for purposes of the Plan solely because (i) the Company, (ii) an entity in which the Company directly or indirectly beneficially owns 50% or more of the voting securities or (iii) any Company-sponsored employee stock ownership plan or any other employee benefit plan of the Company, either files or becomes obligated to file a report or a proxy statement under or in response to Schedule 13D, Schedule 14D-1, Form 8-K or Schedule 14A (or any successor schedule, form or report or item therein) under the Exchange Act, disclosing beneficial ownership by it of shares of Voting Stock, whether in excess of 20% or otherwise, or because the Company reports that a change in control of the Company has or may have occurred or will or may occur in the future by reason of such beneficial ownership. 4 12. Changes in Capital Structure. If there is a stock split, reverse stock split or stock dividend, the Individual LTIP Share Target specified in Section 5, above will be increased or decreased in direct proportion to the increase or decrease in the number of Shares by reason of the stock split, reverse stock split or stock dividend. 13. Limitations on Share Distributions. Shares will not be distributed under this Plan if the issuance of the Shares would violate: (a) any applicable state securities law; (b) any applicable registration or other requirements under the Securities Act of 1933, as amended (the "Securities Act"), the Securities Exchange Act of 1934, as amended, or the listing requirements of any stock exchange on which the Company's Shares are listed; or (c) any similar legal requirement of any governmental authority regulating the issuance of shares by the Company. Further, if a Registration Statement with respect to the Shares to be issued is not in effect or if counsel for the Company deems it necessary or desirable in order to avoid possible violation of the Securities Act, the Company may require, as a condition to its issuance and delivery of certificates for the Shares, that the Participant deliver to the Company a statement in writing that the Participant understands the Shares may be "restricted securities" as defined in Rule 144 of the Securities and Exchange Commission and that any resale, transfer or other disposition of the Shares will be accomplished only in compliance with Rule 144, the Securities Act, or other or subsequent applicable Rules and Regulations thereunder. Further still, the Company may place on the certificates evidencing the Shares an appropriate legend under Rule 144. 14. Taxes. If Shares are distributable pursuant to Section 7, the Company will withhold a sufficient number of Shares to cover the Participant's withholding tax obligation. 15. Plan Administrator. The Committee is the Plan Administrator. 16. Duties of Plan Administrator. (a) The Committee will administer the Plan in accordance with its terms and has all powers necessary to carry out the provisions of the Plan including, but not limited to, the following: (1) Determination of Officers who are eligible for Plan participation; (2) Determination of Operating Earnings Targets; (3) Determination of Individual LTIP Cash Targets; (4) Determination of Individual LTIP Share Targets; and (5) Determination of Individual Awards. (b) The Committee will interpret the Plan and resolve all questions arising in the administration, interpretation, and application of the Plan. Any determination of the Committee will be conclusive and binding on all persons. 5 (c) The Committee will establish such procedures and keep such records or other data as the Committee in its discretion determines necessary or proper for the administration of the Plan. (d) The Committee may delegate administrative responsibilities to such person or persons as the Committee deems necessary or desirable in connection with the administration of the Plan. 17. Unfunded Plan. The Company is under no obligation to segregate or reserve any funds or other assets for purposes relating to this Plan and no Participant has any rights whatsoever in or with respect to any funds or assets of the Company. 18. Non-Alienation. Since a Participant does not have any rights to any Individual Award under the Plan until the time that payment of the Individual Award is made, no anticipated payment of any Individual Award will be subject in any manner to alienation, sale, transfer, assignment, pledge, attachment, garnishment or encumbrance of any kind. If a Participant attempts to alienate, sell, transfer, assign, pledge or otherwise encumber any anticipated Individual Award, or if he has filed or will be filing for bankruptcy, the Committee in its discretion may cause the amounts as would otherwise become payable to the Participant at various times to be paid to or applied for the benefit of such one or more of the following as the Committee in its sole and unrestricted judgment and discretion may designate: the Participant, his spouse, child or children, or other dependents. 19. Actions or Decisions with Respect to the Plan. Any decision or action of the Company, the Board, or the Committee, arising out of or in connection with the administration and operation of this Plan, may be made or taken in their sole and unrestricted judgment and discretion, and such decision or action shall be conclusive and binding upon all Participants. 20. No Employment Rights. Nothing in this Plan will be construed as a commitment or agreement upon the part of any Participant to continue his employment with the Company, and nothing in this Plan will be construed as a commitment on the part of the Company to continue the employment or rate of compensation of any Participant for any period. 21. Amendment of the Plan. The Company reserves the right, to be exercised by instruction from the Committee, to amend or terminate this Plan at any time. 6 EX-10.S 9 l05101aexv10ws.txt EX-10(S) RELOCATION AGREEMENT Exhibit(10)(s) Relocation Agreement between The Lubrizol Corporation and Joe E. Hodge The Lubrizol Corporation agreed to pay the relocation expenses for Joe E. Hodge, Vice President, to move from Ohio back to his home state of Texas, at the time of his assignment to Ohio in 1993. His relocation back to Texas occurred December 2003. The expenses, including tax gross-ups, were approximately $107,000 and were paid using Lubrizol's relocation policy as a guide. EX-12 10 l05101aexv12.txt EX-12 COMPUTATION OF RATIO OF EARNINGS TO FXD CHRG EXHIBIT 12 THE LUBRIZOL CORPORATION AND SUBSIDIARIES Computation of Ratio of Earnings to Fixed Charges (all amounts except ratios are shown in thousands)
2003 2002 2001 2000 1999 --------- --------- --------- --------- --------- Pretax income $ 129,071 $ 180,388 $ 139,949 $ 170,348 $ 195,350 Add (deduct) earnings of less than 50% owned affiliates (net of distributed earnings) included in pretax income 773 1,676 (558) 1,135 (3,195) Add losses of less than 50% owned affiliates included in pretax income 140 -- 2,162 1,818 18 Add fixed charges net of capitalized interest 25,114 23,298 25,041 26,869 29,696 Add previously capitalized interest amortized during period 1,312 1,159 1,634 1,255 1,446 --------- --------- --------- --------- --------- "Earnings" $ 156,410 $ 206,521 $ 168,228 $ 201,425 $ 223,315 ========= ========= ========= ========= ========= Gross interest expense including capitalized interest ("Fixed Charges") $ 25,272 $ 22,239 $ 24,142 $ 26,282 $ 28,953 Ratio of earnings to fixed charges 6.19 9.29 6.97 7.66 7.71
EX-13 11 l05101aexv13.txt EXHIBIT 13 Exhibit 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW GENERAL The Lubrizol Corporation is a global fluid technology company that develops, produces and sells high-performance chemicals, systems and services for transportation and industry. We create these products by applying advanced chemical and mechanical technologies to enhance the performance, quality and value and reduce the environmental impact of the customer products in which our products are used. We are a geographically diverse company operating manufacturing and blending facilities, laboratories and offices in approximately 30 countries through the efforts of approximately 5,000 employees. We group our product lines into three reportable segments: fluid technologies for transportation (FTT), which comprised 76% of 2003 consolidated revenues; fluid technologies for industry (FTI), which comprised 23% of revenues; and all other, which is comprised of the advanced fluid systems (AFS) and emulsified products operating segments. Note 13 to the financial statements contains a further description of the nature of our operations, the product lines within each of the operating segments, segment contribution and related financial disclosures for the reportable segments. FLUID TECHNOLOGIES FOR TRANSPORTATION A variety of industry market forces and conditions continues to influence the transportation lubricant additives business. A key factor is the low global growth rate for this business, which we believe is in the range of approximately 0% to 1% per year. Additional characteristics of this market are: - - Consolidation of the customer base in recent years, which has increased the competitiveness of the transportation lubricant additives market. Our 2003 volume was impacted by the loss of a large piece of business as a result of a major oil company merger. - - Frequent product specification changes driven primarily by original equipment manufacturers (OEMs) and the impact of environmental and fuel economy regulations on the OEMs. The specification changes require us to incur product development and testing costs, but also enable us to apply our technological know-how to create products and solve problems. We believe our technology, and our expertise in applying it, are key strengths. - - Improved engine design, which can result in longer lubricant drain intervals. Longer drain intervals lessen demand for lubricants. We believe we are the market leader in transportation lubricant additives and intend to remain the leader by continuing to invest in this business. FTT represents the preponderance of our assets, revenues, earnings and cash flow. FLUID TECHNOLOGIES FOR INDUSTRY We are expanding beyond our FTT business by using our strengths, including our technology, formulating skills and broad geographic infrastructure, to develop and invest in new fluid technology applications in higher-growth industrial markets. FTI revenues have grown from $259.1 million in 1998 to $464.1 million in 2003. Key factors to FTI's success continue to be introduction of new products, development of new applications for existing products, cross-selling of products, geographic expansion and acquisitions. In 2002, we completed four FTI acquisitions having aggregate annualized revenues of $85 million, including Chemron Corporation, a supplier of specialty surfactants principally for the personal care market. In 2003, we acquired a personal care ingredients business from Amerchol Corporation, a subsidiary of The Dow Chemical Company. In addition, we expanded our foam control additives business with the acquisition of silicones product lines. The 2003 acquisitions expanded our foam control additives business to approximately $40 million in annual revenues. In late January 2004, we acquired the additives business of Avecia, with annual revenues of approximately $50 million. The business develops, manufactures and markets high value additives used in coatings and inks. PRIMARY FACTORS AFFECTING 2003 RESULTS In addition to lower shipment volume in our FTT business along with acquisitions and ongoing business growth in FTI, the factors that most affected our 2003 results were: - - currency effects; - - increased raw material and energy costs; and - - cost control activities, including restructuring programs. In 2003, currency had an overall favorable effect on our operating results. We conduct a significant amount of our business outside the United States and are subject to business risks inherent in non-U.S. activities, including currency exchange rate fluctuations. As the U.S. dollar strengthens or weakens against other international currencies in which we transact business, our financial results will be affected. Raw material costs are significantly influenced by the price of crude oil and natural gas. Our results are affected by how quickly and the extent to which we are able to change our product selling prices in reaction to raw material cost and operating cost changes. Our operating cost structure has been pressured by higher energy, insurance, pension and health care expenses. Additionally, a large portion of our manufacturing expenses are fixed in the short term. As a result of these cost pressures and to achieve a more competitive cost structure, primarily in FTT, we implemented several restructuring programs in 2003. THE LUBRIZOL CORPORATION 11 2003 RESULTS OF OPERATIONS COMPARED WITH 2002 ANALYSIS OF REVENUES
Excluding Acquisitions ---------------------- (Millions of Dollars) 2003 2002 $ Change % Change $ Change % Change - --------------------- -------- -------- -------- -------- -------- -------- Net sales $2,049.1 $1,980.3 $68.8 3% $25.8 1% Royalties and other revenues 3.0 3.6 (0.6) (15%) (0.6) (17%) -------- -------- ----- ----- Total revenues $2,052.1 $1,983.9 $68.2 3% $25.2 1% ======== ======== ===== =====
We had record consolidated revenues for 2003. However, income per share before cumulative effect of a change in accounting principle declined 28% in 2003 to $1.76 per share, from $2.45 per share in 2002. The primary operating drivers of the lower earnings were lower shipment volume and higher raw material costs and manufacturing expenses, which more than offset higher selling price/mix, favorable currency, a lower effective tax rate and acquisitions that were accretive to earnings. In addition, a restructuring charge reduced 2003 earnings by $.29 per share. In 2003, the increase in consolidated revenues was due to a 9% increase in average selling price, partially offset by a 6% decline in shipment volume. Changes in our shipment volume vary by geographic area. The following table shows our 2003 shipment volume by geographic zone as well as the changes compared with 2002: ANALYSIS OF VOLUME - 2003 VS. 2002
Excluding 2003 Acquisitions Volume % Change % Change ------ -------- ------------ North America 45% (5%) (9%) Europe 28% (8%) (8%) Asia-Pacific / Middle East 20% (5%) (5%) Latin America 7% (2%) (2%) ---- Total 100% (6%) (8%)
Excluding acquisitions, approximately half of the decline in shipment volume was due to the loss of a portion of the business associated with a major international customer and 16% of the decline was due to a shift in our viscosity modifier product line from liquids to higher-value concentrated solid form. All geographic zones were affected by the loss of business with this customer and the viscosity modifier shift, though the effects were mostly seen in North America and Europe. In addition, weak worldwide demand for lubricants negatively impacted volume for the year. We believe that the economic and political conditions within certain countries of the Asia-Pacific / Middle East region contributed to the volume decline in this zone. See the "Segment Analysis" section for additional explanations of shipment volume changes by business segment and geographic zone in 2003 compared with 2002. We are seeing indications that customer demand is firming and we believe customer demand will strengthen in 2004. The 9% increase in average selling price was due to a 5% increase in the combination of price and product mix and 4% favorable currency effects. We combine the impact of price and product mix, as frequent product changes in our fluid technologies for transportation segment have made it difficult to distinguish between the two components. Sequentially, the fourth quarter 2003 average selling price was 3% higher than the third quarter of 2003, due to favorable currency effects, and 6% higher than the first quarter of 2003, due to favorable currency effects and price increases implemented in the first half of the year. In February 2004, we announced an additional price increase in the fluid technologies for transportation segment. ANALYSIS OF COSTS AND EXPENSES
Excluding Acquisitions ----------------------- (Millions of Dollars) 2003 2002 $ Change % Change $ Change % Change - --------- -- -------- -------- -------- -------- -------- -------- -------- Cost of sales $1,507.8 $1,416.3 $ 91.5 6% $61.7 4% Selling and administrative expenses 202.9 196.9 6.0 3% 2.2 1% Research, testing and development expenses 167.0 168.3 (1.3) (1%) (2.9) (2%) Restructuring charge 22.5 -- 22.5 * 22.5 * -------- -------- ------ ----- Total costs and expenses $1,900.2 $1,781.5 $118.7 7% $83.5 5% ======== ======== ====== =====
* Calculation not meaningful 12 THE LUBRIZOL CORPORATION Cost of sales increased due to higher average raw material cost and higher manufacturing expenses, partially offset by lower shipment volume. Average raw material cost increased 9% in 2003 compared with 2002, primarily due to 6% higher raw material prices and, to a lesser extent, unfavorable currency effects. Raw material prices started to increase in the second half of 2002 and continued to increase in the first and third quarters of 2003. Sequentially, the fourth quarter 2003 average raw material cost increased 2% compared with the third quarter and 7% compared with the first quarter, primarily due to higher raw material prices driven by higher prices of crude oil and natural gas and unfavorable currency effects. We believe raw material costs will continue to increase during the first half of 2004. Manufacturing expenses, which are included in cost of sales, increased 14% (12% excluding acquisitions) in 2003 compared with 2002. The increase was due to unfavorable currency effects, acquisitions, higher utility expenses and higher salary and benefit expenses, partially offset by a reduction in variable pay expense. In addition, total manufacturing expenses in 2003 included a $2.6 million reclassification of expenses at certain subsidiaries of our FTI and AFS operating segments that were charged in 2002 to selling and administrative expenses or material costs. We expect natural gas utility costs to remain high in 2004, which will continue to affect our manufacturing expenses. Cost of sales in 2003 also included approximately $3.4 million in manufacturing expenses to cover costs associated with two fires that occurred during the second quarter of 2003. In April 2003, an after-working-hours fire destroyed a metalworking additive blending facility we leased in Detroit. There were no injuries, nor any damage to a near-by warehouse where we stored finished goods. We were able to supply customers from this warehouse and have permanently shifted production to our Painesville, Ohio, plant. In April 2003, a fire associated with a maintenance shutdown occurred in a dispersant production unit at our plant in Le Havre, France. Again, there were no injuries and we were able to continue to supply customers from other facilities. Excluding currency effects, acquisitions and the cost associated with the fires, consolidated manufacturing expense increased 5% over 2002. Gross profit (net sales less cost of sales) decreased $22.7 million, or 4% ($35.8 million, or 6%, excluding acquisitions), in 2003 compared with 2002. Our gross profit percentage (gross profit divided by net sales) decreased to 26.4% in 2003 compared with 28.5% in 2002. Excluding the impact of acquisitions, our gross profit percentage was 26.3% in 2003. These decreases primarily were due to lower shipment volume, higher average raw material cost and higher manufacturing expenses, partially offset by higher average selling price and favorable net currency effects. The selling and administrative expenses increase, excluding acquisitions, was due to higher salary and benefit expenses and unfavorable currency effects, partially offset by lower variable pay expense and the reclassification to manufacturing expense of approximately $1.1 million of FTI and AFS costs that were classified as selling and administrative expenses in 2002. The timing and amount of research, testing and development expenses (technology expenses) are affected by FTT product standards, which change periodically to meet new emissions, efficiency, durability and other performance factors as engine and transmission designs are improved by original equipment manufacturers (OEMs). The decrease in technology expenses was due to lower testing activity at outside laboratories and a reduction in our variable pay expense, partially offset by unfavorable currency effects and higher salary and benefit expenses. In addition, technology expenses in 2003 included a write-down of $1.1 million related to a former technical facility in Japan that we sold during the third quarter of 2003. During 2003, approximately 82% of our technology cost was incurred in company-owned facilities and 18% was incurred at third-party testing facilities, compared with 78% and 22%, respectively, in 2002. In 2003, we completed a development program for GF-4, the U.S. passenger car motor oil technical standard that is scheduled for commercial introduction in 2004. We do not expect a major shift by our customers to GF-4 before the fourth quarter of 2004. In 2003, we recorded a restructuring charge of $22.5 million, or $.29 per share, related to the separation of approximately 250 employees in the United States, Europe and India, comprising 5% of our worldwide workforce. The components of the restructuring charge are shown in the table below: COMPONENTS OF THE RESTRUCTURING CHARGE
(Millions of Dollars) U.S. Europe India Total Employee severance $11.2 $4.6 $1.5 $17.3 Asset impairments 3.3 3.3 Other* 1.6 .3 1.9 ----- ---- ---- ----- Total restructuring charge $12.8 $8.2 $1.5 $22.5 ===== ==== ==== =====
* Other costs primarily include outplacement costs In November 2003, we announced workforce reductions of approximately 150 employees primarily at our headquarters in Wickliffe, Ohio, at our Deer Park and Bayport, Texas manufacturing facilities and at our Hazelwood, England, technical facility. This resulted in a restructuring charge primarily for employee severance costs in both the United States and England. The workforce reductions were completed prior to the end of 2003. The charge for Europe also included costs associated with the restructuring program announced in February 2003, for our Bromborough, England, intermediate production and blending facility. We have eliminated some capacity at this facility and substantially completed workforce reductions of 45 positions. An asset impairment charge of $3.3 million was recorded at Bromborough for production units taken out of service. The charge for Europe also included some severance-related costs for the closing of a sales office in Scandinavia. The charge for India pertains to a voluntary separation program of approximately 55 employees at our joint venture in India. The 2003 restructuring programs were undertaken to achieve a more competitive cost structure, primarily within FTT, and to help mitigate cost pressures from higher energy, pension, health care and insurance expenses. Annual savings are projected to be approximately $20 million, of which approximately $5 million were realized in 2003. Excluding the effects of currency and acquisitions, we estimate 2004 operating expenses, which consist of manufacturing, selling, administrative and technology expenses, will be approximately the same as 2003. THE LUBRIZOL CORPORATION 13 ANALYSIS OF OTHER ITEMS AND NET INCOME
Excluding Acquisitions ---------------------- (Millions of Dollars) 2003 2002 $ Change % Change $ Change % Change - --------------------- ---- ---- -------- -------- -------- -------- Other expense - net $ (1.6) $ (5.4) $ 3.8 * $ 4.5 * Interest expense - net (21.3) (16.6) (4.7) * (4.7) * Income before income taxes and cumulative effect of change in accounting principle 129.1 180.4 (51.3) (28%) (58.5) (32%) Provision for income taxes 38.3 54.1 (15.8) (29%) (17.9) (33%) Income before cumulative effect of change in accounting principle 90.8 126.3 (35.5) (28%) (40.6) (32%) Cumulative effect of change in accounting principle -- (7.8) 7.8 * 7.8 * Net income $ 90.8 $118.5 $(27.7) (23%) $(32.8) (28%)
* Calculation not meaningful The favorable change in other income (expense) primarily was due to increased currency exchange translation gains. Interest income decreased $2.9 million in 2003 compared with 2002 as a result of lower interest rates. Interest expense increased $1.8 million in 2003 compared with 2002, due to the absence of the interest rate swap agreements that we utilized in 2002. In 2002, we had swap agreements that reduced interest expense by approximately $4.2 million ($3.1 million impact from outstanding swap and $1.1 million amortization of deferred gain). We terminated the interest rate swap agreements in 2002 and recorded an unrecognized gain, which is being amortized as a reduction of interest expense through December 1, 2008. Amortization of the unrealized gain reduced interest expense in 2003 by approximately $2.7 million. During 2003, the U.S. dollar weakened against most currencies, especially the euro. We believe the change in currency exchange rates in 2003, as compared with 2002 exchange rates, had a favorable effect on 2003 net income. We had an effective tax rate of 29.7% in 2003 as compared with 30.0% in 2002. The 2003 effective tax rate was lower than the U.S. federal and state statutory rate of 35%, primarily due to significant nontaxable translation gains at foreign subsidiaries utilizing a U.S. dollar functional currency. The low effective tax rate in 2002 was due primarily to a non-recurring U.S. tax benefit resulting from the charitable contribution of technology, partially offset by nontaxable translation losses. We believe our effective tax rate for 2004 will be approximately 34%. As a result of the factors described above, income per share before the cumulative effect of a change in accounting principle was $1.76 in 2003 compared with $2.45 in 2002. The restructuring charge reduced earnings in 2003 by $.29 per share. During the first half of 2002, we completed the impairment analysis required for Statement of Financial Accounting Standards 142 (SFAS 142), "Goodwill and Other Intangible Assets," which we adopted on January 1, 2002. There was no impairment in either the FTT or FTI operating segments; however, for the AFS operating segment, which is included in the all other reporting segment, we recorded an impairment of $7.8 million, which eliminated all the goodwill for the all other reporting segment. The charge was recorded as a cumulative effect of a change in accounting principle as of January 1, 2002. There was no tax benefit associated with this charge. After adjustment of 2002 for the cumulative effect of a change in accounting principle from the implementation of SFAS 142, net income per share was $1.76 in 2003 compared with $2.30 for 2002. 14 THE LUBRIZOL CORPORATION 2002 RESULTS OF OPERATIONS COMPARED WITH 2001 ANALYSIS OF REVENUES
Excluding Acquisitions & LZ India ----------------------- (Millions of Dollars) 2002 2001 $ Change % Change $ Change % Change - --------------------- ---- ---- -------- -------- -------- -------- Net sales $ 1,980.3 $ 1,839.2 $ 141.1 8% $ 33.1 2% Royalties and other revenues 3.6 5.4 (1.8) (34%) 0.7 12% ---------- ---------- -------- ------- Total revenues $ 1,983.9 $ 1,844.6 $ 139.3 8% $ 33.8 2% ========== ========== ======== =======
We achieved higher revenues in 2002, primarily due to higher shipment volume resulting from the consolidation of Lubrizol India Private Limited and the favorable impact of acquisitions. Higher gross profit margins were realized in 2002 compared with 2001, driven by lower average raw material cost combined with lower unit manufacturing cost (manufacturing costs per metric ton sold) and ongoing volume growth. The increased margin, elimination of goodwill amortization and a lower effective tax rate, partially offset by higher STAR (selling, testing, administrative and research) expenses, resulted in increased net income in 2002 compared with 2001. Beginning January 1, 2002, we consolidated 100% of the revenues, costs, expenses, assets and liabilities of our joint venture, Lubrizol India Private Limited, with an offset for our partner's minority interest. Before 2002, we recorded our ownership in the joint venture as equity earnings, which was included in other income on the income statement. The change from equity to consolidation accounting resulted from an amendment to the joint venture agreement with our partner, Indian Oil Corporation Limited, which gave us operating control of Lubrizol India. We continue to own 50 percent of the voting shares. This change had no effect on our net income, but it did affect the line item comparisons for the income statement, the balance sheet and the statement of cash flows. The increase in 2002 revenues was due to 12% higher shipment volume, partially offset by a 4% decline in average selling price. The consolidation of Lubrizol India contributed 3% to the higher volume, acquisitions in our fluid technologies for industry segment added 5.5% to volume and increases in ongoing shipment levels provided the remaining 3.5% of the total shipment volume increase. Changes in our shipment volume vary by geographic area. The following table shows our 2002 shipment volume by geographic zone as well as the changes compared with 2001: ANALYSIS OF VOLUME - 2002 VS. 2001
Excluding Acquisitions 2002 & LZ India Volume % Change % Change ------ -------- ------------ North America 45% 20% 7% Europe 29% 6% 6% Asia-Pacific / Middle East 20% 9% (6%) Latin America 6% (3%) (3%) ---- Total 100% 12% 3.5%
The increases in North America and Europe were due to acquisitions and the strengthening of our business with major fluid technologies for transportation customer accounts for engine oils and specialty driveline additives, along with the strengthening of our fluid technologies for industry markets, including coatings and inks and metalworking. The decrease in Asia-Pacific volume, excluding the consolidation of Lubrizol India, primarily was the result of business lost in Japan in mid-2001 and the weak business environment and competitive intensity in Asia. Latin America, our smallest zone, experienced volume declines as the result of economic conditions, timing of orders and some business losses after the first quarter of 2001 due to price increases. The decrease in average selling price in 2002 compared with 2001 was due to the combination of lower prices and product mix changes. Currency had a negligible effect on average selling price for the year. Approximately half of the decline in average selling price was the result of the Chemron acquisition made in April 2002, due to its lower-priced product mix. The decrease in royalties and other revenues in 2002 compared with 2001 primarily was due to the consolidation of Lubrizol India, effective January 1, 2002, as royalties from India were eliminated when reporting consolidated results. THE LUBRIZOL CORPORATION 15 ANALYSIS OF COSTS AND EXPENSES
Excluding Acquisitions & LZ India ----------------------- (Millions of Dollars) 2002 2001 $ Change % Change $ Change % Change - --------------------- ---- ---- -------- -------- -------- -------- Cost of sales $ 1,416.3 $ 1,335.5 $ 80.8 6% $ (4.3) 0% Selling and administrative expenses 196.9 177.4 19.5 11% 15.0 8% Research, testing and development expenses 168.3 158.5 9.8 6% 8.9 6% ---------- ---------- -------- ------- Total costs and expenses $ 1,781.5 $ 1,671.4 $ 110.1 7% $ 19.6 1% ========== ========== ======== =======
The 2002 increase in cost of sales was due to higher shipment levels and higher manufacturing expenses, partially offset by a decline in average raw material cost. Average raw material cost decreased 6% in 2002 compared with 2001, due to both lower raw material prices and product mix changes. Although average raw material cost decreased in 2002 compared with 2001 on an annual basis, raw material prices started to increase in the second half of 2002. Sequentially in 2002, average raw material cost increased 1% in the third quarter compared with the second quarter, and 4% in the fourth quarter compared with the third quarter, due to the combination of higher raw material prices and higher-cost product mix. There were five price increases in base oil, our highest-volume raw material, between the end of April 2002 and the middle of October 2002, along with increases in other raw material prices. To recover the rapidly rising raw material prices that were affecting our business, we implemented an additive price increase in our fluid technologies for transportation segment in December 2002 for the North America zone and in January 2003 for the rest of the world. Manufacturing expenses, which are included in cost of sales, increased 9% (2% excluding acquisitions and the consolidation of Lubrizol India), in 2002 compared with 2001. The increase in manufacturing expenses was due to higher volume and higher compensation costs, consisting of variable pay, salary and employee benefit expenses, partially offset by lower utility expenses. Even though total manufacturing expenses increased, unit manufacturing cost was down 3% in 2002 compared with the prior year, primarily due to higher throughput and productivity improvements. Gross profit (net sales less cost of sales) increased $60.3 million, or 12% ($37.4 million, or 7%, excluding acquisitions and the consolidation of Lubrizol India), in 2002 compared with 2001. The increase primarily was the result of higher volume and lower raw material costs, partially offset by higher manufacturing expenses and lower selling prices. Our gross profit percentage (gross profit divided by net sales) increased to 28.5% in 2002 compared with 27.4% in 2001, due to the reasons explained previously. Excluding the impact of the consolidation of Lubrizol India and acquisitions, our gross profit per- centage was 28.9% in 2002. The 2002 increase in selling and administrative expenses, excluding acquisitions, primarily was due to higher compensation costs for existing businesses and incremental staffing and other costs associated with our strategy to expand into new markets. In addition, we recorded a $2.0 million charge for a contract claim related to an employee offsite personal injury. The 2002 increase in research, testing and development expenses primarily was a result of four engine oil programs. The first program pertained to the U.S. passenger car motor oil technical standard, GF-4, which is slated for commercial introduction at the end of 2004. The second program pertained to the European program for reduced emission targets for both diesel and passenger car applications (Euro IV). Commercial introduction was originally anticipated for 2005, when Euro IV becomes mandatory. However, plans to offer road tax incentives in Europe pushed commercial introduction to mid-2003. This resulted in increased technology and commercial product development expense in the fourth quarter of 2002 that had not been anticipated. The third program pertained to the introduction in early 2003 of new European passenger car standards, which significantly increase performance requirements. The change in the baseline performance required by OEMs for their specifications resulted in the redevelopment of several products. The fourth program pertained to the current U.S. diesel engine oil specification, PC-9, which was formally introduced in the third quarter of 2002. 16 THE LUBRIZOL CORPORATION ANALYSIS OF OTHER ITEMS AND NET INCOME
Excluding Acquisitions & LZ India ----------------------- (Millions of Dollars) 2002 2001 $ Change % Change $ Change % Change - --------------------- ---- ---- -------- -------- -------- -------- Other expense - net $ (5.4) $ (15.1) $ 9.7 * $ 12.3 * Interest expense - net (16.6) (18.3) 1.7 * 1.5 * Income before income taxes and cumulative effect of change in accounting principle 180.4 139.9 40.5 29% 28.0 20% Provision for income taxes 54.1 45.8 8.3 18% 1.0 (2%) Income before cumulative effect of change in accounting principle 126.3 94.1 32.2 34% 29.0 31% Cumulative effect of change in accounting principle (7.8) -- (7.8) * (7.8) * Net income $ 118.5 $ 94.1 $ 24.4 26% $ 21.2 23%
* Calculation not meaningful Beginning in 2002, the other income (expense) line item no longer included amortization of goodwill, due to a change in accounting standards, or equity income from Lubrizol India. Goodwill amortization expense was approximately $11.0 million in 2001. Equity income for Lubrizol India was $2.9 million in 2001. The remaining variance primarily was due to lower currency exchange translation losses. Interest income was about even in 2002 compared with 2001. Interest expense decreased $1.6 million in 2002 compared with 2001, partially due to lower interest rates. In addition, we terminated our interest rate swap agreements, which had converted the fixed interest rate on $100 million of 5.875% debentures to a variable rate. In terminating the swaps, we received cash of $18.1 million and recorded a $17.3 million unrealized gain, which is being amortized as a reduction of interest expense through December 1, 2008, the due date of the underlying debt. Amortization of the unrealized gain reduced interest expense in 2002 by $1.1 million. During 2002, the U.S. dollar weakened against most currencies, especially the euro and the yen, and we believe the change in currency exchange rates had a slightly favorable effect on net income as compared with the impact during 2001. We had an effective tax rate of 30.0% in 2002, compared with 32.7% for 2001, which increased 2002 earnings by $.09 per share. The lower effective tax rate in 2002 was primarily due to the U.S. tax benefit resulting from a charitable contribution of technology made in 2002 that did not occur in 2001, along with the elimination of goodwill amortization pursuant to the new accounting standard. As a result of the factors described above, income per share before the cumulative effect of a change in accounting principle was $2.45 in 2002 compared with $1.84 in 2001. After adjusting net income for the cumulative effect of a change in accounting principle due to the implementation of SFAS 142, net income per share was $2.30 in 2002 compared with $1.84 for 2001. SEGMENT ANALYSIS A description of the company's operating segments along with the products, services and markets for each of the operating segments is included in Note 13 to the financial statements. Prior year amounts have been restated to reflect reclassifications of products among the reportable segments. OPERATING RESULTS BY SEGMENT - ----------------------------
(Millions of Dollars) 2003 2002 2001 - --------------------- ---- ---- ---- Revenues: FTT $1,554.7 $1,576.0 $1,520.8 FTI 464.1 382.5 300.2 All other 33.3 25.4 23.7 -------- -------- -------- Total $2,052.1 $1,983.9 $1,844.7 ======== ======== ======== Gross Profit: FTT $ 438.4 $ 467.8 $ 427.8 FTI 141.0 126.5 105.5 All other 8.3 6.0 2.0 ------- ------- ------- Total $ 587.7 $ 600.3 $ 535.3 ======= ======= ======= Segment Contribution Income: FTT $ 286.9 $ 312.0 $ 283.4 FTI 73.3 70.3 46.5 All other (7.7) (10.2) (18.2) ------- ------- ------- Total $ 352.5 $ 372.1 $ 311.7 ======= ======= =======
FLUID TECHNOLOGIES FOR TRANSPORTATION SEGMENT Segment revenues decreased $21.3 million, or 1%, in 2003 compared with 2002 due to a 9% decrease in shipment volume partially offset by an 8% increase in average selling price. The increase in average selling price in 2003 primarily was due to favorable currency effects of 4.5% and the remainder was due to higher prices and favorable product mix. THE LUBRIZOL CORPORATION 17 The FTT segment implemented a price increase in December 2002 for the North America zone and in January 2003 for the rest of the world. A second price increase that was structured as a surcharge was implemented in late March 2003 for North America and in late April for Asia and Latin America as well as for select products in Europe. This surcharge was designed to address the continuing rise in raw material prices and natural gas-fired utility costs that had occurred since our last price increase in the fourth quarter of 2002. In February 2004, we announced an additional price increase, effective March 2004, for products sourced from North America and effective April 2004, for products sourced from Latin America, in response to recent increases in the prices of raw materials and energy. The following table shows the changes in shipment volume by geographic zone in 2003 compared with 2002: ANALYSIS OF VOLUME - 2003 VS. 2002
% Change -------- North America (11%) Europe (9%) Asia-Pacific / Middle East (6%) Latin America (4%) Total (9%)
Approximately half of the total shipment volume decline in 2003 was due to business losses associated with a major international customer. Lower unit sales of viscosity modifiers in 2003 also contributed to the decline, principally caused by a shift from liquid polymers to solid polymers. Generally, solids are one-tenth the volume of liquids. Excluding this shift in our viscosity modifier product line, total shipment volume decreased 8% in 2003. The shift had no impact on gross profit dollars. All geographic zones were affected by the loss of business with this customer and the viscosity modifier shift, though the effects were mostly seen in North America and Europe. The declines in North America for 2003 also were due to the conversion of some products in our specialties business to more concentrated formulations. In addition, weak worldwide demand for lubricants contributed to the declines in the North America and Europe zones in 2003. The decrease in Asia-Pacific/Middle East volume primarily was due to the weak business environment stemming from economic and political conditions in some parts of this region. Segment gross profit (net sales less cost of sales) decreased $29.4 million, or 6%, in 2003 compared with 2002. The decrease primarily was due to lower shipment volume, higher average raw material cost and higher manufacturing expenses, partially offset by higher average selling price and favorable net currency effects. In calculating gross profit at the operating segment level, we exclude our estimate of the cost of excess capacity from product costs (see Note 13 to the financial statements). For these reasons, the gross profit percentage for this segment decreased to 28.2% in 2003, compared with 29.7% in 2002. Direct selling, marketing and technology expenses decreased $6.3 million, or 4%, in 2003 compared with 2002, primarily due to lower technical spending at outside test laboratories. Segment contribution income (revenues less expenses directly identifiable to the product lines aggregated within each segment) decreased $25.1 million, or 8%, in 2003 compared with 2002 as a result of lower gross profit and lower equity earnings from our joint venture in Saudi Arabia, partially offset by lower technology expenses. In 2002, segment revenues increased $55.2 million, or 4%, compared with 2001, with 6% higher shipment volume. Excluding the impact of the consolidation of Lubrizol India, revenues increased $6.5 million, or less than 1%, due to a 2.5% increase in ongoing shipment volume, partially offset by a 2% decrease in average selling price. The combination of lower prices and product mix effects reduced average selling price by 2.5%, but partially was offset by slightly favorable currency effects, due to the weakening of the dollar against the euro and the yen. The following table shows the changes in shipment volume by geographic zone in 2002 compared with 2001: ANALYSIS OF VOLUME - 2002 VS. 2001
Excluding LZ India % Change % Change -------- ------------------ North America 7% 7% Europe 5% 5% Asia-Pacific / Middle East 8% (7%) Latin America (4%) (4%) Total 6% 2.5%
The 2002 shipment volume increases in North America and Europe primarily were due to the strengthening of our engine oils additives business and, to a lesser extent, our specialty driveline additives business. In North America, this increase was with major international accounts, while in Europe it was across our customer base. Excluding Lubrizol India, the decline in Asia-Pacific volume primarily was as a result of lost engine oil business in Japan in mid-2001 and the weak business environment and competitive intensity in Asia. Latin America, our smallest zone, experienced volume declines as the result of economic conditions, timing of orders and some business losses after the first quarter of 2001 due to price increases. Segment gross profit increased $40.0 million, or 9%, in 2002 compared with 2001. Excluding the impact of the consolidation of Lubrizol India, gross profit increased by $26.6 million, or 6%. The increase was due to higher shipment volume and lower average raw material cost, partially offset by increased manufacturing expenses and lower average selling price. The gross profit percentage for this segment was 29.7% in 2002 compared with 28.2% in 2001. Segment contribution income increased $28.6 million, or 10%, in 2002 compared with 2001. The increase primarily was due to higher gross profit, partially offset by higher direct technology and marketing expenses. FLUID TECHNOLOGIES FOR INDUSTRY SEGMENT Segment revenues increased $81.6 million, or 21% ($38.5 million, or 10%, excluding acquisitions), in 2003 compared with 2002. The acquisition-related increase primarily was due to the 2002 acquisitions of Dock Resins Corporation and Chemron Corporation and the 2003 acquisition of a personal care ingredients business. The 2003 increase in segment revenues, excluding acquisitions, was due to a 6% increase in shipment volume along with a 4% increase in average selling price, due almost entirely to favorable currency effects. 18 THE LUBRIZOL CORPORATION The following table shows the changes in shipment volume by geographic zone in 2003 compared with 2002: ANALYSIS OF VOLUME - 2003 VS. 2002
Excluding Acquisitions % Change % Change -------- ------------ North America 23% 4% Europe 10% 10% Asia-Pacific / Middle East 15% 14% Latin America 16% 16% Total 19% 6%
The 2003 shipment volume increase in North America primarily was due to the 2002 acquisitions of Chemron and Dock Resins and the 2003 acquisition of a personal care ingredients business. Excluding acquisitions, the increase in North America in 2003 was due to market share gains in our personal care and specialty emulsifiers businesses along with increases in the coatings and inks business from the introduction of new products. The increase in Europe in 2003 was related to increases in our metalworking and compressor lubricant businesses due to market share gains and new applications in our specialty monomers business. The increase in 2003 for the Asia-Pacific / Middle East zone was spread across many of the FTI businesses. Approximately half of the increase in 2003 for Asia-Pacific / Middle East was due to increased shipments in our metalworking business as a result of a distributor relationship that was terminated at the beginning of 2002. Our metalworking sales in this zone in the first half of 2002 were below normal levels because customers were buying from the distributor's inventory. These customers subsequently commenced purchasing the products directly from us beginning in the second half of 2002. The increase in Latin America in 2003 was due to a shift from North America to Latin America of our specialty emulsifiers business with some of our existing customers, along with some business gains in our coatings and inks, defoamer and specialty monomers businesses. Segment gross profit increased $14.5 million, or 11% ($1.4 million increase, or 1%, excluding acquisitions), in 2003 compared with 2002. Excluding acquisitions, the increase in segment gross profit in 2003 was due to higher shipment volume and higher average selling price due to favorable currency effects, partially offset by higher average raw material cost and higher manufacturing expenses. The increase in manufacturing expenses was due to higher shipment volume, $3.4 million in costs related to the fire at the Detroit manufacturing facility, $2.4 million in expenses associated with the integration of a multipurpose chemical production facility in Spartanburg, South Carolina that was purchased in the second quarter of 2003, and the reclassification to manufacturing expenses of $2.6 million charged in 2002 as selling and administrative expenses. The gross profit percentage for this segment was 30.5% in 2003, compared with 33.2% in 2002. The decrease in the gross profit percentage in 2003 was due to higher raw material costs and increased manufacturing expenses as a result of the metalworking fire and the reclassification of selling and administrative expenses to manufacturing expenses. In addition, unfavorable product mix in the compressor lubricant business and lower volume of anti-wear hydraulics products contributed to the lower segment gross profit in 2003. Segment contribution income increased $3.0 million, or 4%, in 2003 compared with 2002. The increase primarily was due to higher gross profit, after costs related to the fire and integration of the Spartanburg facility referred to previously, partially offset by higher direct technology and selling expenses and higher amortization expenses of intangibles other than goodwill that resulted from acquisitions. In 2002, segment revenues increased $82.3 million, or 27%, compared with 2001, primarily due to a 58% increase in total shipment volume. The acquisitions of Chemron and Kabo Unlimited, Inc. contributed $51.5 million toward the $56.7 million total increase in revenues due to acquisitions. Segment revenues, excluding acquisitions, increased $25.5 million, or 8%, primarily due to 9% ongoing volume growth as a result of strengthening markets compared with 2001, partially offset by a slight decrease in average selling price. The following table shows the changes in shipment volume by geographic zone in 2002 compared with 2001: ANALYSIS OF VOLUME - 2002 VS. 2001
Excluding Acquisitions % Change % Change -------- ------------ North America 101% 9% Europe 6% 6% Asia-Pacific / Middle East 31% 24% Latin America 4% 4% Total 58% 9%
The increase in North America shipment volume primarily was due to the acquisitions of Chemron and Kabo. Excluding acquisitions, the ongoing volume growth in North America and all of the increase in Europe was due to strengthening markets, particularly in coatings and inks and metalworking, as well as the introduction of new products and some business gains in both these areas. The increase in the Asia-Pacific zone primarily was due to new business gains across all of our businesses. Segment gross profit increased $21.0 million, or 20%, in 2002 compared with 2001. Excluding acquisitions, gross profit increased $11.5 million, or 11%. The increases primarily were due to higher shipment volume and lower average raw material cost. The gross profit percentage for this segment was 33.2% in 2002, compared with 35.4% in 2001. The decrease in the gross profit percentage primarily was due to the impact of the Chemron acquisition, due to its lower- priced product mix. Segment contribution income increased $23.8 million, or 51%, in 2002 compared with 2001. The increase was due to higher gross profit and the accounting change for goodwill amortization. The elimination of goodwill amortization, effective January 1, 2002, benefited this segment by approximately $6.1 million in 2002. THE LUBRIZOL CORPORATION 19 RETURN ON AVERAGE SHAREHOLDERS' EQUITY Return on average shareholders' equity was 10% in 2003, 14% in 2002 and 12% in 2001 (10%, 15% and 12%, respectively, excluding the cumulative effect of the change in accounting principle in 2002). The return on average shareholders' equity is calculated as current year net income divided by the average of year-end shareholders' equity for the current and prior year. The restructuring charge in 2003 lowered the return on average shareholders' equity by approximately 2%. WORKING CAPITAL, LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our financial performance indicators of liquidity: SELECTED MEASURES OF LIQUIDITY AND CAPITAL RESOURCES - ----------------------------------------------------
2003 2002 ---- ---- Cash and short-term investments (millions of dollars) $ 258.7 $ 266.4 Working capital (millions of dollars) $ 638.4 $ 602.0 Current ratio 3.1 3.0 Debt as a % of capitalization 29.0% 31.6% Net debt as a % of capitalization 14.2% 15.5% Average number of days sales in accounts receivable 54.1 52.7 Average number of days sales in inventory 89.4 80.6 ------- --------
The following table summarizes the major components of cash flow: SUMMARY OF CASH FLOWS - ---------------------
(Millions of Dollars) 2003 2002 2001 - --------------------- ---- ---- ---- Cash provided from/(used for): Operating activities $ 194.8 $ 244.9 $ 195.8 Investing activities (155.9) (148.5) (81.6) Financing activities (59.5) (30.4) (68.7) Effect of exchange-rate changes on cash 12.9 11.4 (2.4) --------- -------- -------- Net increase/(decrease) in cash and short-term investments $ (7.7) $ 77.4 $ 43.1 ======== ======== =========
OPERATING ACTIVITIES Cash provided from operating activities in 2003 decreased $50.1 million, or 20%, compared with 2002. The decrease primarily was due to lower earnings and an unfavorable change in working capital items of $9.0 million in 2003 compared with a favorable change of $13.9 million in working capital items in 2002. Lower receivable and inventory levels partially offset the increase in the other working capital items, when currency effects and acquisitions are considered. We manage our levels of inventories and accounts receivable on the basis of average days sales in inventory and average days sales in receivables. Our target for days sales in inventory is established with the goal of minimizing our investment in inventories while at the same time ensuring adequate supply for our customers. Our 2003 target for days sales in inventory was 87.0 days. The 2003 average days sales in inventory of 89.4 days exceeded target because we built strategic stock in mid-year to secure supply of certain key materials and because shipment volume was lower than anticipated, especially in the third quarter of 2003. The 2002 average days sales in inventory of 80.6 days was below the 2002 target level of 85.0 days because of strong demand and high plant utilization in 2002. Our target for days sales in accounts receivable is established primarily as a function of the average credit terms offered to our customers. Our average days sales in receivables of 54.1 days was approximately equal to our target of 53.5 days in 2003. Our 2004 targets for inventory and receivables are 90.0 days and 53.5 days, respectively. We reduced accounts payable and accrued liabilities by $26.8 million in 2003 compared with a buildup of $2.6 million in 2002, due to lower variable pay accrual and the timing of procurement and payment to vendors. We have not changed our payment terms to suppliers. INVESTING ACTIVITIES Our capital expenditures in 2003 were $88.5 million compared with $65.3 and $66.3 million in 2002 and 2001, respectively. We manage our capital investments at the authorization level and the expenditures occur over the period required to complete the individual projects. We authorized projects totaling $105.4 million in 2003, $97.2 million in 2002 and $87.8 million in 2001. Significant capital expenditures in 2003 included the purchase and integration of a multipurpose chemical production facility in Spartanburg, South Carolina, for $5.2 million, a number of projects at our Deer Park, Texas, facility and expanded production capabilities at our joint venture in China. In 2004, we are budgeting our capital authorizations at approximately $95 million, which approximates our estimated annual depreciation expense. We also estimate capital expenditures will approximate $95 million in 2004. In 2003, we completed two acquisitions in the FTI segment for cash totaling $68.6 million. In September 2003, we acquired a personal care ingredients business from Amerchol Corporation, a subsidiary of The Dow Chemical Company. Products from this business are utilized in a wide variety of end-use applications, including skin care and hair conditioners. Products include methyl glucoside derivatives, lanolin derivatives and Promulgen(TM) personal care ingredients. Historical annualized revenues of this acquisition approximate $30 million. In July 2003, we purchased silicone product lines from BASF with historical annualized revenues of approximately $6 million, which expanded our foam control additives business to approximately $40 million in annual revenues. Silicones are used in the manufacture of sealants, caulks and waterproofing products. In 2002, we completed four acquisitions in the FTI segment for cash of $86.7 million. In the first quarter, we purchased Kabo, which specializes in the development, manufacture and sale of antifoam and defoaming agents to the food, fermentation, mining and wastewater industries. Kabo's product lines expanded our defoamer business. In the second quarter, we purchased Chemron, which formulates, produces and supplies specialty surfactants used in personal care products, industrial cleaners and a wide range of other consumer and industrial products. The acquisition extended our existing surfactants business into growth markets where we previously had not competed. 20 THE LUBRIZOL CORPORATION In October 2002, we acquired Dock Resins, which develops, manufactures and sells proprietary polymers including acrylic, methacrylic, alkyd and polyester resins to customers in the paint and coatings, printing ink, laminating, adhesives and sealants and grease markets. In October, we also acquired Brose Chemical Company, which has product lines that complement our integrated defoamer business that are now manufactured in our Kabo foam control facility. Annualized 2002 revenues from these acquisitions in the aggregate were approximately $85 million. On January 30, 2004, we completed the acquisition of the additives business of Avecia for approximately $125 million. This additives business is headquartered in Blackley, United Kingdom, and develops, manufactures and markets high-value additives that are based on polymeric dispersion technology and used in coatings and inks. These products enrich and strengthen color while reducing production costs and solvent emissions, and are marketed under the brand names Solsperse(TM), Solplus(TM)and Solthix(TM). Historical annualized revenues of this business are approximately $50 million. We funded the acquisition through Euro 43 million borrowings ($55 million equivalent) under a 364-day credit facility, $5 million in yen borrowings and the remainder in cash. At December 31, 2003, we had a foreign currency forward contract of $125 million in order to fix the U.S. dollar price for this acquisition. (See Note 6 to the financial statements.) FINANCING ACTIVITIES Cash used in financing activities increased in 2003 primarily because 2002 included proceeds of $18.1 million from the termination of the interest rate swaps that did not recur in 2003. The remainder of the increase was due to a net decrease in borrowings of $6.8 million and a $4.0 million reduction of cash received from exercise of stock options. During the first half of 2001, we repurchased approximately 1.0 million common shares for $30.0 million pursuant to our share repurchase program. We suspended this program indefinitely in the second quarter of 2001 in order to hold our financial resources for acquisitions. CAPITALIZATION AND CREDIT FACILITIES Our net debt as a percent of capitalization of 14.2% is relatively low, which enhances our ability to borrow funds, if needed, to make acquisitions or for other purposes. 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. At December 31, 2003, we had a $350 million credit facility that matures in July 2006, which allows us to borrow at or below the U.S. prime rate. There were no borrowings under this agreement at December 31, 2003. We had an additional $175 million revolving credit facility that expired in July 2003, which we chose not to renew. In January 2004, we obtained a separate revolving credit facility that enables us to borrow up to Euro 50 million for the purpose of financing European acquisitions. We borrowed Euro 43 million under this facility in January 2004. This facility expires in January 2005. CONTRACTUAL CASH OBLIGATIONS The following table shows our contractual cash obligations (in millions of dollars) under debt agreements, leases, non-cancelable purchase commitments and other long-term liabilities at December 31, 2003. Additional information on debt and operating leases can be found in Notes 5 and 12 to the financial statements. CONTRACTUAL CASH OBLIGATIONS
Payments Due by Period ------------------------------------------------------ Less Than 1 1-3 4-5 After 5 Total Year Years Years Years ----- ------ ----- ----- ----- Debt $ 389.6 $ 2.9 $ 54.7 $ 0.1 $ 331.9 Operating leases 51.6 15.0 16.5 8.5 11.6 Non-cancelable purchase commitments 72.2 24.8 42.6 4.3 0.5 Other long-term liabilities 40.9 1.9 15.5 8.3 15.2 -------- ------- -------- ------- -------- Total contractual cash obligations $ 554.3 $ 44.6 $ 129.3 $ 21.2 $ 359.2 ======== ======= ======== ======= ========
Non-cancelable purchase commitments primarily include raw materials purchased under take or pay contracts, drumming, warehousing and service contracts, terminal agreements and toll processing arrangements. Other long-term liabilities disclosed in the table represent long-term liabilities reported in our consolidated balance sheet at December 31, 2003, under "other noncurrent liabilities," excluding pension, postretirement and other non-contractual liabilities. In 2004, we expect to make a minimum required contribution to the U.S. qualified plan in the range of $2.5 million to $3.0 million and a contribution to the U.K. plan of approximately $5.0 million. These two plans represent approximately 90% of consolidated pension obligations. In addition, non-pension postretirement benefit payments in the United States are expected to be approximately $4 million in 2004. In addition, we have contingent obligations aggregating $18.0 million under standby letters of credit issued in the ordinary course of business to financial institutions, customers and insurance companies to secure short-term support for a variety of commercial transactions, insurance and benefit programs. These standby letters of credit expire in 2004. We believe our future operating cash flows will be more than sufficient to cover debt repayments, other contractual obligations, capital expenditures and dividends. In addition, we believe our existing cash position, together with our untapped borrowing capacity, provides us with substantial additional financial resources. If we were to incur significant additional indebtedness (for example, to make a large acquisition) that would cause an adverse change in our current long-term debt ratings, we would expect to be able to continue to meet our liquidity needs but at some increased cost for interest and commitment fees under our credit facilities. We do not believe any such increased costs would have a material impact upon our results of operations or financial condition. THE LUBRIZOL CORPORATION 21 CRITICAL ACCOUNTING POLICIES The determination and application of our accounting policies is an important process that has developed as our business activities have evolved and as the accounting rules have developed. Accounting rules generally do not allow a selection among alternatives, but involve an implementation and interpretation of existing rules and the use of judgment to the specific set of circumstances existing in our business. We believe the proper implementation and consistent application of the accounting pronouncements are critical. However, not all situations are specifically addressed in the accounting rules and we use our best judgment to adopt a policy for accounting for those situations not addressed. We accomplish this by analyzing similar situations and the accounting guidance governing them, and often consult with our independent auditors about the appropriate interpretation and application of these policies. Accounting policies for which our subjective judgment is particularly important include estimating valuation reserves and contingencies, determining the net periodic pension cost and postretirement benefit cost and accounting for business combinations and goodwill impairment. To the extent actual experience differs from our assumptions and estimates, we may have to increase or decrease these reserves and contingencies and earnings could be affected. ACCOUNTING FOR RESERVES AND CONTINGENCIES Our accounting policies for reserves and contingencies cover a wide variety of business activities, including reserves for potentially uncollectible receivables, slow-moving or obsolete inventory, legal and environmental exposures, and tax exposures. We accrue these reserves when our assessments indicate that it is probable that a liability has been incurred or an asset will not be recovered and an amount can be reasonably estimated. We review these estimates quarterly based on currently available information. Actual results may differ from our estimates and our estimates may be revised upward or downward, depending upon the outcome or changed expectations based on the facts surrounding each exposure. We discuss annually with the audit committee of our Board of Directors our reserves and contingencies, as well as our policies and processes for evaluating them. DETERMINATION OF NET PERIODIC PENSION COST Each year we review with our actuaries the actuarial assumptions used in the determination of U.S. net periodic pension cost, as prescribed by SFAS 87, "Employers Accounting for Pensions." The determination of net periodic pension cost is based upon a number of actuarial assumptions, including the expected return on plan assets, the discount rate for determining the funded status, and the rate of compensation increase. We also annually review our international pension plan assumptions by country with the applicable plan actuary and appropriately adjust the assumptions. Additionally, the assumptions for each of our pension plans are reviewed with the audit committee of our Board of Directors. Our net periodic pension cost for all pension plans was $14.1 million in 2003, $8.4 million in 2002 and $6.2 million in 2001. In 2003, our U.S. pension expense represented approximately 60% of the consolidated total pension expense. Our assumption for the expected return on plan assets is based upon our long-term experience and return targets for specific investment classes. During 2003, we maintained our assumption for the U.S. plans of 9% because we believe that it represents a reasonable return that can be achieved over the long term using our current asset allocation. We did not substantially change our investment philosophy or investment mix of the asset portfolio in the U.S. plans. A change in the rate of return of 100 basis points would have the following effects on the net periodic pension cost: INCREASE (DECREASE) IN NET PERIODIC PENSION COST FROM CHANGE IN RATE OF RETURN - ------------------------------------------------------------------------------
100 Basis Point ------------------------ (Millions of Dollars) Increase Decrease - --------------------- -------- -------- U.S. pension plans $(2.0) $2.0 International pension plans (1.2) 1.2 ---- --- All pension plans $(3.2) $3.2 ===== ====
The selection of a discount rate for pension plans is required to determine future pension obligations and represents our estimate of the available cost in the market place of settling all pension obligations through annuity purchases. We determine the discount rate based upon current market indicators, including rates of return on AA-rated corporate bonds or on long-term U.S. Treasury obligations. We lowered the 2003 discount rate assumption for our U.S. pension plans to 6.25% from 6.75% used in 2002. On a worldwide basis, the 2003 weighted average discount rate was lowered to 5.88% from 6.34% used in 2002. A change in the discount rate of 100 basis points would have the following effects on the periodic pension cost: INCREASE (DECREASE) IN NET PERIODIC PENSION COST FROM CHANGE IN DISCOUNT RATE - -----------------------------------------------------------------------------
100 Basis Point ------------------------ (Millions of Dollars) Increase Decrease - -------------------- -------- -------- U.S. pension plans $(2.1) $4.3 International pension plans (2.2) 2.5 ---- --- All pension plans $(4.3) $6.8 ===== ====
The value of our U.S. plan assets increased in 2003 and the value of the assets exceeds the accumulated benefit obligation liability by approximately $19 million at the end of the year. The higher investment returns in 2003 have increased the funded level of our U.S. plans. The accumulated benefit obligation for all pension plans worldwide exceeds the value of plan assets by approximately $23 million. Changes in pension plan assumptions are expected to increase pension expense for all pension plans worldwide in 2004 by approximately $6 to $7 million, which will not have a significant impact on our financial condition or results of operations. The increase in the pension expense is due primarily to the decline in the discount rate, the addition of approximately $1.0 million of unrecognized loss amortization in 2004, market returns and other factors. 22 THE LUBRIZOL CORPORATION DETERMINATION OF POSTRETIREMENT BENEFIT COST Annually we review with our actuaries the key economic assumptions used in calculating postretirement benefit cost as prescribed by SFAS 106, "Employers' Accounting for Postretirement Benefits Other than Pensions." Postretirement benefits include health care and life insurance plans. The determination of postretirement benefit cost is based upon a number of actuarial assumptions, including the discount rate for determining the accumulated postretirement benefit obligation, the assumed health care cost trend rates and ultimate health care trend rate. The same discount rate selected for the pension plan generally is used for calculating the postretirement benefit obligation. Net non-pension postretirement benefit cost was $5.6 million in 2003, $4.7 million in 2002 and $3.9 million in 2001. Our U.S. non-pension postretirement benefit cost in 2003 approximated 92% of the total non-pension postretirement benefit cost. A change in the discount rate of 100 basis points would have the following effects on the postretirement benefit cost: INCREASE (DECREASE) IN POSTRETIREMENT BENEFIT COST FROM CHANGE IN DISCOUNT RATE - -------------------------------------------------------------------------------
100 Basis Point ---------------------- (Millions of Dollars) Increase Decrease - --------------------- -------- -------- U.S. postretirement plans $(1.4) $1.7 International postretirement plans 0.1 ----- ---- All postretirement plans $(1.4) $1.8 ===== ====
A change in the assumed health care cost trend rate of 100 basis points would have the following effects on the postretirement benefit cost: INCREASE (DECREASE) IN POSTRETIREMENT BENEFIT COST FROM CHANGE IN ASSUMED HEALTH - -------------------------------------------------------------------------------- CARE COST TREND RATE - --------------------
100 Basis Point ---------------------- (Millions of Dollars) Increase Decrease - --------------------- -------- -------- U.S. postretirement plans $1.6 $(1.2) International postretirement plans (0.1) ---- ----- All postretirement plans $1.6 $(1.3) ==== =====
ACCOUNTING FOR BUSINESS COMBINATIONS During the past three years, we have completed several business combination transactions. In the future, we anticipate growing our business through additional acquisitions. We accounted for our past combinations using the purchase method of accounting, which is the only method allowed under SFAS 141, "Business Combinations." The accounting for business combinations is complicated and involves the use of significant judgment. Under the purchase method of accounting, a business combination is accounted for at a purchase price based upon the fair value of the consideration given including direct acquisition costs, whether it is in the form of cash, assets, stock or the assumption of liabilities. The assets and liabilities acquired are measured at their fair values and the purchase price is allocated to the assets and liabilities based upon these fair values. Generally, the acquisition price exceeds the fair value of the tangible assets acquired and the various intangible assets also acquired must be valued. Determining the fair values of the assets and liabilities acquired involves the use of judgment, since some of the assets and liabilities acquired do not have fair values that are readily determinable. Different techniques may be used to determine fair values, including market prices, where available, appraisals, comparisons to transactions for similar assets and liabilities and present value of estimated future cash flows. Since these estimates involve the use of significant judgment, they can change as new information becomes available. During 2003, we used an outside appraiser for our largest acquisition, Amerchol products, to assist in the allocation of the purchase price to intangible assets and goodwill. The appraiser used the income approach to value the intangibles, in which the value is developed on the basis of capitalization of net earnings that would be generated for a specific stream of income attributed to an asset or group of assets. The value of the intangibles identified by the appraiser for the Amerchol products acquisition was $17.9 million and goodwill was determined to be $36.1 million. Amortization of the Amerchol intangible assets will result in annual amortization expense of approximately $.8 million. ACCOUNTING FOR GOODWILL IMPAIRMENT We expect acquisitions to play an important role in our future growth strategy and accordingly expect the accounting required under SFAS 142, "Goodwill and Other Intangible Assets," to be important to the fair presentation of our financial condition and results of operations. SFAS 142 requires goodwill to be tested annually and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of an operating segment below its carrying amount. We have elected October 1 as the annual evaluation date to test for potential goodwill impairment. The annual goodwill impairment test requires us to make a number of assumptions and estimates concerning future levels of earnings and cash flow, which are based upon our strategic plans. A discounted cash flow model is used to determine the fair value of each operating segment. The integrity of the model was reviewed by an outside independent appraiser during 2002 and found to be appropriate. No impairment of goodwill was identified in the annual impairment test completed in 2003. (See Note 4 to the financial statements.) NEW ACCOUNTING PRONOUNCEMENTS The impact of new accounting pronouncements is reviewed and discussed in Note 2 to the financial statements. THE LUBRIZOL CORPORATION 23 CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS (CAUTIONARY STATEMENTS UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995) This Management's Discussion and Analysis of Financial Condition and Results of Operations and the letter "To Our Shareholders" from W. G. Bares, Chairman and Chief Executive Officer of Lubrizol, and J. L. Hambrick, President, contain forward-looking statements within the meaning of the federal securities laws. As a general matter, forward-looking statements are those focused upon future plans, objectives or performance as opposed to historical items and include statements of anticipated events or trends and expectations and beliefs relating to matters not historical in nature. Forward-looking statements are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. These uncertainties and factors could cause our actual results to differ materially from those matters expressed in or implied by any forward-looking statements. We believe that the following factors, among others, could affect our future performance and cause our actual results to differ materially from those expressed or implied by forward-looking statements made in this annual report: - - the overall demand for lubricant and fuel additives on a worldwide basis, which has a slow growth rate in mature markets such as North America and Europe; - - the effect on our business resulting from economic and political uncertainty within the Asia-Pacific, Middle East and Latin American regions; - - the lubricant additive demand in developing regions such as China and India, which geographic areas are an announced focus of our activities; - - the potential negative impact on product pricing and volume demand from the consolidation of finished lubricant marketers; - - the degree of competition resulting from lubricant additive industry overcapacity; - - technology developments that affect longer-term trends for lubricant additives, such as improved equipment design, fuel economy, longer oil drain intervals, alternative fuel powered engines and emission system compatibility; - - the overall global economic environment, which affects the operating results of fluid technologies for industry in particular; - - the extent to which we are successful in expanding our business in new and existing fluid technology markets incorporating chemicals, systems and services for industry and transportation; - - our ability to identify, complete and integrate acquisitions for profitable growth; - - our success at continuing to develop proprietary technology to meet or exceed new industry performance standards and individual customer and original equipment manufacturers' expectations; - - the frequency of change in industry performance standards, which affects the level and timing of our technology costs, the product life cycles and the relative quantity of additives required for new specifications; - - our ability to continue to reduce complexities and conversion costs and modify our cost structure to maintain and enhance our competitiveness; - - our success in strengthening relationships and growing business with our largest customers, including those with affiliated lubricant additive companies, and retaining the business of our largest customers over extended time periods; - - the cost, availability and quality of raw materials, including petroleum-based products; - - the cost and availability of energy, including natural gas and electricity; - - the effects of fluctuations in currency exchange rates upon our reported results from international operations, together with non-currency risks of investing in and conducting significant operations in foreign countries, including those relating to political, social, economic and regulatory factors; - - the extent to which we achieve market acceptance of our commercial development programs in the area of contaminant management and advanced fluid systems; - - significant changes in government regulations affecting environmental compliance; - - the ability to identify, understand and manage risks inherent in new markets in which we choose to expand. 24 THE LUBRIZOL CORPORATION 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 largely mitigated due to the stability of the countries in which our largest foreign operations are located. In the normal course of business, we use derivative financial instruments including interest rate and commodity hedges and forward foreign currency exchange contracts to manage our market risks. Additional information regarding our financial instruments is contained in Notes 5 and 6 to the financial statements. Our objective in managing our exposure to changes in interest rates is to limit the impact of such changes on our earnings and cash flow. Our objective in managing the exposure to changes in foreign currency exchange rates is to reduce volatility on our earnings and cash flow associated with such changes. Our principal currency exposures are the euro, the pound sterling, the Japanese yen and certain Latin American currencies. Our objective in managing our exposure to changes in commodity prices is to reduce the volatility on earnings of utility expense. We do not hold derivatives for trading purposes. We measure our market risk related to our holdings of financial instruments based on changes in interest rates, foreign currency rates and commodity prices utilizing a sensitivity analysis. The sensitivity analysis measures the potential loss in fair value, cash flow and earnings based on a hypothetical 10% change (increase and decrease) in interest, currency exchange rates and commodity prices. We use current market rates on our debt and derivative portfolios to perform the sensitivity analysis. Certain items such as lease contracts, insurance contracts and obligations for pension and other postretirement benefits are not included in the analysis. Our primary interest rate exposures relate to our cash and short-term investments, fixed and variable rate debt and interest rate swaps. The calculation of potential loss in fair value is based on an immediate change in the net present values of our interest rate-sensitive exposures resulting from a 10% change in interest rates. The potential loss in cash flow and income before tax is based on the change in the net interest income/expense over a one-year period due to an immediate 10% change in rates. A hypothetical 10% increase in interest rates would have had a favorable impact and a hypothetical 10% decrease in interest rates would have had an unfavorable impact on fair values of $12.2 million, cash flows of $.2 million and income before tax of $.2 million in 2003, and $13.3 million, $.2 million and $.2 million in 2002, respectively. Our primary currency rate exposures are to foreign denominated debt, intercompany debt, cash and short-term investments and forward foreign currency exchange contracts. The calculation of potential loss in fair value is based on an immediate change in the U.S. dollar equivalent balances of our currency exposures due to a 10% shift in exchange rates. The potential loss in cash flow and income before tax is based on the change in cash flow and income before tax over a one-year period resulting from an immediate 10% change in currency exchange rates. A hypothetical 10% increase in currency exchange rates would have had an unfavorable impact and a hypothetical 10% decrease in currency exchange rates would have had a favorable impact on fair values of $6.8 million, cash flows of $16.5 million and income before tax of $4.0 million in 2003, and $13.3 million, $19.5 million and $4.2 million in 2002, respectively. Beginning in 2003, we had commodity hedge exposures related to natural gas and electric utility expenses. The calculation of potential loss in fair value is based on an immediate change in the U.S. dollar equivalent balances of our commodity exposures due to a 10% shift in the underlying commodity prices. The potential loss in cash flow and income before tax is based on the change in cash flow and income before tax over a one-year period resulting from an immediate 10% change in commodity prices. A hypothetical 10% increase in commodity prices would have had a favorable impact and a hypothetical 10% decrease in commodity prices would have had an unfavorable impact on fair value of $.5 million, cash flow of $.5 million, and income before tax of $.5 million in 2003. THE LUBRIZOL CORPORATION 25 QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended -------------------------------------------------- March 31 June 30 Sept. 30 Dec. 31 -------- ------- -------- ------- (In Thousands of Dollars Except Per Share Data) 2003 Net sales ...................................... $507,000 $514,276 $509,107 $518,718 Gross profit ................................... 138,737 141,665 131,621 129,286 Net income ..................................... 26,023 29,383 24,298 11,070 Net income per share ........................... $ 0.50 $ 0.57 $ 0.47 $ 0.21 Net income per share, diluted .................. $ 0.50 $ 0.57 $ 0.47 $ 0.21 2002 Net sales ...................................... $466,713 $507,505 $509,427 $496,644 Gross profit ................................... 135,503 145,735 150,577 132,219 Net income before cumulative effect of change in accounting principle ....................... 29,817 34,487 36,478 25,490 Net income ..................................... 22,032 34,487 36,478 25,490 Net income per share before cumulative effect of change in accounting principle ............. $ 0.58 $ 0.67 $ 0.71 $ 0.49 Net income per share before cumulative effect of change in accounting principle, diluted ....... $ 0.58 $ 0.66 $ 0.71 $ 0.49 Net income per share ........................... $ 0.43 $ 0.67 $ 0.71 $ 0.49 Net income per share, diluted .................. $ 0.43 $ 0.66 $ 0.71 $ 0.49
In the first quarter of 2002, the company recorded an after-tax $7.8 million ($.15 per share) goodwill impairment charge as a cumulative effect of a change in accounting principle. [DELOITTE GRAPHIC] INDEPENDENT AUDITORS' REPORT TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF THE LUBRIZOL CORPORATION We have audited the accompanying consolidated balance sheets of The Lubrizol Corporation and its subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of The Lubrizol Corporation and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. As discussed in Notes 2 and 4 to the consolidated financial statements, in 2002 the Corporation changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 142. [DELOITTE & TOUCHE GRAPHIC] Cleveland, Ohio February 6, 2004 26 THE LUBRIZOL CORPORATION CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31 (In Thousands of Dollars Except Per Share Data) 2003 2002 2001 - ---------------------------------------------- ---- ---- ---- Net sales ................................................ $ 2,049,101 $ 1,980,289 $ 1,839,244 Royalties and other revenues ............................. 3,022 3,578 5,400 ----------- ----------- ----------- Total revenues ......................................... 2,052,123 1,983,867 1,844,644 ----------- ----------- ----------- Cost of sales ............................................ 1,507,792 1,416,255 1,335,461 Selling and administrative expenses ...................... 202,904 196,940 177,431 Research, testing and development expenses ............... 166,942 168,303 158,473 Restructuring charge ..................................... 22,534 ----------- ----------- ----------- Total cost and expenses ................................ 1,900,172 1,781,498 1,671,365 Other expense - net ...................................... (1,565) (5,380) (15,076) Interest income .......................................... 3,799 6,697 6,787 Interest expense ......................................... (25,114) (23,298) (25,041) ----------- ----------- ----------- Income before income taxes and cumulative effect of change in accounting principle ................................. 129,071 180,388 139,949 Provision for income taxes ............................... 38,297 54,116 45,833 ----------- ----------- ----------- Income before cumulative effect of change in accounting principle .................................... 90,774 126,272 94,116 Cumulative effect of change in accounting principle ...... (7,785) ----------- ----------- ----------- Net income ............................................... $ 90,774 $ 118,487 $ 94,116 =========== =========== =========== Net income per share: Income before cumulative effect of change in accounting principle ............................... $ 1.76 $ 2.45 $ 1.84 Cumulative effect of change in accounting principle .... (0.15) ----------- ----------- ----------- Net income per share ..................................... $ 1.76 $ 2.30 $ 1.84 =========== =========== =========== Diluted net income per share: Income before cumulative effect of change in accounting principle .............................. $ 1.75 $ 2.44 $ 1.83 Cumulative effect of change in accounting principle .... (0.15) ----------- ----------- ----------- Net income per share, diluted ............................ $ 1.75 $ 2.29 $ 1.83 =========== =========== =========== Dividends per share ...................................... $ 1.04 $ 1.04 $ 1.04 =========== =========== ===========
The accompanying notes to the financial statements are an integral part of these statements. THE LUBRIZOL CORPORATION 27 CONSOLIDATED BALANCE SHEETS
December 31 (In Thousands of Dollars) 2003 2002 - ------------------------- ---- ---- ASSETS Cash and short-term investments ............................................................ $ 258,699 $ 266,428 Receivables ................................................................................ 324,567 295,508 Inventories ................................................................................ 311,919 302,968 Other current assets ....................................................................... 42,663 44,875 ----------- ----------- Total current assets ..................................................................... 937,848 909,779 ----------- ----------- Property and equipment - at cost ........................................................... 1,960,599 1,809,071 Less accumulated depreciation .............................................................. 1,270,605 1,129,916 ----------- ----------- Property and equipment - net ............................................................. 689,994 679,155 ----------- ----------- Goodwill ................................................................................... 208,726 168,352 Intangible assets - net .................................................................... 62,402 43,162 Investments in non-consolidated companies .................................................. 6,296 6,690 Other assets ............................................................................... 37,050 52,999 ----------- ----------- TOTAL ................................................................................... $ 1,942,316 $ 1,860,137 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Short-term debt and current portion of long-term debt ...................................... $ 2,899 $ 17,046 Accounts payable ........................................................................... 143,120 140,424 Accrued expenses and other current liabilities ............................................. 153,458 150,271 ----------- ----------- Total current liabilities ................................................................ 299,477 307,741 ----------- ----------- Long-term debt ............................................................................. 386,726 384,845 Postretirement health care obligations ..................................................... 98,387 96,495 Noncurrent liabilities ..................................................................... 100,330 92,655 Deferred income taxes ...................................................................... 52,810 55,761 ----------- ----------- Total liabilities ........................................................................ 937,730 937,497 ----------- ----------- Minority interest in consolidated companies ................................................ 51,281 53,388 Contingencies and commitments Preferred stock without par value - unissued Common shares without par value - outstanding 51,588,190 shares in 2003 and 51,457,642 shares in 2002 ............................................................ 123,770 118,985 Retained earnings .......................................................................... 865,488 828,318 Accumulated other comprehensive loss ....................................................... (35,953) (78,051) ----------- ----------- Total shareholders' equity ............................................................... 953,305 869,252 ----------- ----------- TOTAL ................................................................................... $ 1,942,316 $ 1,860,137 =========== ===========
The accompanying notes to the financial statements are an integral part of these statements. 28 THE LUBRIZOL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31 (In Thousands of Dollars) 2003 2002 2001 - ------------------------- ---- ---- ---- CASH PROVIDED FROM (USED FOR): OPERATING ACTIVITIES Net income .................................................... $ 90,774 $ 118,487 $ 94,116 Adjustments to reconcile net income to cash provided by operating activities....................................... Depreciation and amortization ............................... 100,423 95,831 98,832 Deferred income taxes ....................................... 1,491 3,158 (2,392) Restructuring charge ........................................ 3,327 Cumulative effect of change in accounting principle ......... 7,785 Change in current assets and liabilities net of acquisitions: Receivables ................................................ 4,726 28,984 2,217 Inventories ................................................ 17,372 (10,152) 866 Accounts payable, accrued expenses and other current liabilities ................................. (26,835) 2,566 (8,399) Other current assets ....................................... (4,308) (7,475) (3,171) --------- --------- --------- (9,045) 13,923 (8,487) Change in noncurrent liabilities ............................ 11,648 3,636 4,740 Other items - net ........................................... (3,864) 2,048 9,029 --------- --------- --------- Total operating activities ................................ 194,754 244,868 195,838 INVESTING ACTIVITIES Capital expenditures .......................................... (88,453) (65,285) (66,316) Acquisitions and investments in nonconsolidated companies ..... (68,597) (86,671) (14,989) Other - net ................................................... 1,146 3,420 (340) --------- --------- --------- Total investing activities ................................ (155,904) (148,536) (81,645) FINANCING ACTIVITIES Short-term repayment .......................................... (5,754) (1,399) (4,579) Long-term borrowing ........................................... 4,479 Long-term repayment ........................................... (9,194) (2,308) (3,120) Debt issuance costs............................................ Dividends paid ................................................ (53,571) (53,430) (53,218) Proceeds from termination of interest rate swaps .............. 18,134 Common shares purchased ....................................... (30,039) Common shares issued upon exercise of stock options ........... 4,569 8,569 22,294 --------- --------- --------- Total financing activities ................................ (59,471) (30,434) (68,662) Effect of exchange rate changes on cash ....................... 12,892 11,435 (2,373) --------- --------- --------- Net increase (decrease) in cash and short-term investments .... (7,729) 77,333 43,158 Cash and short-term investments at the beginning of year ...... 266,428 189,095 145,937 --------- --------- --------- Cash and short-term investments at the end of year ............ $ 258,699 $ 266,428 $ 189,095 ========= ========= =========
The accompanying notes to the financial statements are an integral part of these statements. THE LUBRIZOL CORPORATION 29 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Shareholders' Equity -------------------------------------------------------------- Number of Accumulated Other Shares Common Retained Comprehensive (In Thousands of Dollars) Outstanding Shares Earnings Income (Loss) Total - ------------------------- ----------- ----------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2000 ...................... 51,307,688 $ 82,128 $ 750,779 $ (80,626) $ 752,281 ----------- Comprehensive income: Net income 2001 ............................ 94,116 94,116 Other comprehensive income (loss) .......... (19,186) (19,186) ----------- Comprehensive income ............................ 74,930 Cash dividends .................................. (53,206) (53,206) Deferred stock compensation ..................... 5,474 5,474 Common shares - treasury: Shares purchased ........................... (967,610) (1,662) (28,377) (30,039) Shares issued upon exercise of stock options 812,029 23,752 23,752 ----------- ----------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2001 ...................... 51,152,107 109,692 763,312 (99,812) 773,192 ----------- Comprehensive income: Net income 2002 ............................ 118,487 118,487 Other comprehensive income (loss) .......... 21,761 21,761 ----------- Comprehensive income ............................ 140,248 Cash dividends .................................. (53,481) (53,481) Deferred stock compensation ..................... 507 507 Common shares - treasury: Shares issued upon exercise of stock options and awards ................. 305,535 8,786 8,786 ----------- ----------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2002 ...................... 51,457,642 118,985 828,318 (78,051) 869,252 ----------- Comprehensive income: Net income 2003 ............................ 90,774 90,774 Other comprehensive income (loss) .......... 42,098 42,098 ----------- Comprehensive income ............................ 132,872 Cash dividends .................................. (53,604) (53,604) Deferred stock compensation ..................... 1,053 1,053 Common shares - treasury: Shares issued upon exercise of stock options and awards ................. 130,548 3,732 3,732 ----------- ----------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 2003 ...................... 51,588,190 $ 123,770 $ 865,488 $ (35,953) $ 953,305 =========== =========== =========== =========== ===========
The accompanying notes to the financial statements are an integral part of these statements. 30 THE LUBRIZOL CORPORATION NOTES TO FINANCIAL STATEMENTS (In Thousands of Dollars Unless Otherwise Indicated) NOTE 1 -- NATURE OF OPERATIONS The Lubrizol Corporation is a global fluid technology company that develops, produces and sells high-performance chemicals, systems and services for transportation and industry. The company creates these products by applying advanced chemical and mechanical technologies to enhance the performance, quality and value and reduce the environmental impact of the customer products in which our products are used. The company groups its product lines into three reportable segments: fluid technologies for transportation, fluid technologies for industry and all other, which is comprised of the advanced fluid systems and emulsified products operating segments. Fluid technologies for transportation comprise approximately 76% of the company's consolidated revenues and 81% of the company's segment contribution income. Refer to Note 13 for a further description of the nature of the company's operations, the product lines within each of the operating segments, segment contribution income and related financial disclosures for the reportable segments. NOTE 2 -- ACCOUNTING POLICIES CONSOLIDATION -- The consolidated financial statements include the accounts of The Lubrizol Corporation and its subsidiaries where ownership is 50% or greater and the company has effective management control. For nonconsolidated companies (affiliates), the equity method of accounting is used when ownership exceeds 20% and when the company has the ability to exercise significant influence over the policies of the investee. The book value of investments carried on the equity method was $5.6 million and $5.9 million at December 31, 2003 and 2002, respectively. Investments carried at cost were $.7 million and $.8 million at December 31, 2003 and December 31, 2002, respectively. CONSOLIDATION OF VARIABLE INTEREST ENTITIES -- In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. (FIN) 46, "Consolidation of Variable Interest Entities." FIN 46 provides guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, non-controlling interests and results of operations of a VIE need to be included in a company's consolidated financial statements. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R), which provided additional guidance on the definition of a variable interest entity and delayed the effective date until the first reporting period ending after March 15, 2004, except for special-purpose entities, which must be accounted for under FIN 46 or FIN 46R no later than the end of the first reporting period ending after December 15, 2003. The adoption of FIN 46R did not have a material impact on the company's consolidated financial position or results of operations. ESTIMATES -- The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions pending completion of related events. These estimates and assumptions affect the amounts reported at the date of the consolidated financial statements for assets, liabilities, revenues and expenses and the disclosure of contingencies. Actual results could differ from those estimates. CASH EQUIVALENTS -- The company invests its excess cash in short-term investments with various banks and financial institutions. Short-term investments are cash equivalents, as they are part of the cash management activities of the company and are comprised of investments having maturities of three months or fewer when purchased. INVENTORIES -- Inventories are stated at the lower of cost or market value. Cost of inventories is determined by either the first-in, first-out (FIFO) method or the moving average method, except in the United States for chemical inventories, which are primarily valued using the last-in, first-out (LIFO) method. The company accrues volume discounts on purchases from vendors where it is probable that the required volume will be attained and the amount can be reasonably estimated. The company records the discount as a reduction in the cost of the purchase (generally raw materials), based on projected purchases over the purchase agreement period. PROPERTY AND EQUIPMENT -- Property and equipment are carried at cost. Repair and maintenance costs are charged against income while renewals and betterments are capitalized as additions to the related assets. Costs incurred for computer software developed or obtained for internal use are capitalized for application development activities and immediately expensed for preliminary project activities or post-implementation activities. Accelerated depreciation methods are used in computing depreciation on certain machinery and equipment, which comprise approximately 12% of the depreciable assets in both 2003 and 2002. The remaining assets are depreciated using the straight-line method. The estimated useful lives are 10 to 40 years for buildings and land and building improvements and range from 3 to 20 years for machinery and equipment. IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS -- The company reviews the carrying value of its long-lived assets, including property and equipment, whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. An impairment loss may be recognized when estimated undiscounted future cash flows expected to result from the use of the asset, including disposition, are less than the carrying value of the asset. The measurement of the impairment loss to be recognized is based on the difference between the fair value and the carrying amounts of the assets. Fair value is generally determined based on a discounted cash flow analysis. In order to determine if an asset has been impaired, assets are grouped and tested at the lowest level for which identifiable, independent, cash flows are available. THE LUBRIZOL CORPORATION 31 GOODWILL AND INTANGIBLE ASSETS -- In June 2001, the FASB issued Statement of Financial Accounting Standards (SFAS) 142, "Goodwill and Other Intangible Assets," which became effective for the company on January 1, 2002. Intangibles resulting from business acquisitions, including purchased technology, land use rights, non-compete agreements, distributor networks, trademarks and patents, are amortized on a straight-line method over periods ranging from 5 to 40 years. Under SFAS 142, goodwill and other intangibles determined to have indefinite lives are no longer amortized, but are tested for impairment at least annually. The company has elected to perform its annual tests for potential impairment of goodwill and indefinite life intangibles as of October 1 of each year (see Note 4). The company had goodwill amortization expense of approximately $11.0 million in 2001. As part of the annual impairment test required under SFAS 142, the useful lives of the non-amortized trademarks are reviewed to determine if the indefinite status remains appropriate. After considering the expected use of the trademarks and reviewing any legal, regulatory, contractual, obsolescence, demand, competitive or other economic factors that could limit the useful lives of the trademarks, in accordance with SFAS 142, the company determined that the trademarks had indefinite lives. RESEARCH, TESTING AND DEVELOPMENT -- Research, testing and development costs are expensed as incurred. Research and development expenses, excluding testing, were $93.9 million in 2003, $93.5 million in 2002 and $87.6 million in 2001. ENVIRONMENTAL LIABILITIES -- The company accrues for expenses associated with environmental remediation obligations when such expenses are probable and reasonably estimable. These accruals are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are not discounted to their present value. The company's environmental reserves totaled $9.8 million and $9.9 million at December 31, 2003 and 2002, respectively. Of these amounts, $1.2 million and $1.1 million was included in other current liabilities at December 31, 2003 and 2002, respectively. FOREIGN CURRENCY TRANSLATION -- The assets and liabilities of the company's international subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet date, and revenues and expenses are translated at weighted-average exchange rates in effect during the period. Unrealized translation adjustments are recorded as a component of other comprehensive income in shareholders' equity, except for subsidiaries for which the functional currency is the U.S. dollar, where translation adjustments are realized in income. Transaction gains or losses that arise from exchange rate changes on transactions denominated in a currency other than the functional currency, except those transactions that function as a hedge of an identifiable foreign currency commitment or as a hedge of a foreign currency investment, are included in income as incurred. SHARE REPURCHASES -- The company uses the par value method of accounting for its treasury shares. Under this method, the cost to reacquire shares in excess of paid-in capital related to those shares is charged against retained earnings. REVENUE RECOGNITION -- Revenues are recognized at the time of shipment of products to customers, or at the time of transfer of title if later, with appropriate provision for uncollectible accounts. All amounts in a sales transaction billed to a customer related to shipping and handling are reported as revenues. Provisions for sales discounts and rebates to customers are recorded based upon the terms of sales contracts in the same period the related sales are recorded, as a deduction to the sale. Sales discounts and rebates are offered to certain customers to promote customer loyalty and to encourage greater product sales. These rebate programs provide that upon the attainment of pre-established volumes or the attainment of revenue milestones for a specified period, the customer receives credits against purchases. The company estimates the provision for rebates based on the specific terms in each agreement at the time of shipment. COMPONENTS OF COST OF SALES -- Cost of sales is comprised of raw material costs including freight and duty, inbound handling costs associated with the receipt of raw materials, direct production, maintenance and utility costs, plant and engineering overhead, terminals and warehousing costs, and outbound shipping and handling costs. PER SHARE AMOUNTS -- Net income per share is computed by dividing net income by average common shares outstanding during the period, including contingently issuable shares. Net income per diluted share includes the dilution effect resulting from outstanding stock options and stock awards. Per share amounts are computed as follows:
2003 2002 2001 -------- -------- -------- Numerator: Income before cumulative effect of change in accounting principle ...... $ 90,774 $126,272 $ 94,116 Cumulative effect of change in accounting principle ... (7,785) -------- -------- -------- Net income ................... $ 90,774 $118,487 $ 94,116 ======== ======== ======== Denominator: Weighted-average common shares outstanding ........ 51,702 51,514 51,209 Dilutive effect of stock options and awards ........ 182 280 285 -------- -------- -------- Denominator for net income per share, diluted ........ 51,884 51,794 51,494 ======== ======== ======== Income Per Share: Income before cumulative effect of change in accounting principle ...... $ 1.76 $ 2.45 $ 1.84 ======== ======== ======== Net income per share ......... $ 1.76 $ 2.30 $ 1.84 ======== ======== ======== Diluted Net Income Per Share: Income before cumulative effect of change in accounting principle ...... $ 1.75 $ 2.44 $ 1.83 ======== ======== ======== Net income per share, diluted ..... $ 1.75 $ 2.29 $ 1.83 ======== ======== ========
32 THE LUBRIZOL CORPORATION Weighted-average shares issuable upon the exercise of stock options which were excluded from the diluted earnings per share calculations because they were antidilutive were 2.5 million in 2003, 2.4 million in 2002 and 1.8 million in 2001. ACCOUNTING FOR DERIVATIVE INSTRUMENTS -- Derivative financial instruments are recognized on the balance sheet as either assets or liabilities and are measured at fair value. Derivatives that are not hedges are adjusted to fair value through income. Depending upon the nature of the hedge, changes in fair value of the derivative are either offset against the change in fair value of assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in value is immediately recognized in earnings. The company uses derivative financial instruments only to manage well-defined interest rate, foreign currency and commodity price risks. The company does not use derivatives for trading purposes. ASSET RETIREMENT OBLIGATIONS -- In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations," which became 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 is 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 adoption of this statement did not have a material impact on the company's consolidated financial position or results of operations. COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES -- In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with Exit or Disposal Activities," which became effective for the company for exit or disposal activities initiated after December 31, 2002. This statement requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred and is effective for exit or disposal activities initiated after December 31, 2002. GUARANTEES -- In December 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires the disclosure of any guarantees beginning December 31, 2002, and the recognition of a liability for any guarantees entered into or modified after that date. STOCK-BASED COMPENSATION -- The company uses the intrinsic value method to account for employee stock options. The following table shows the pro forma effect on net income and earnings per share if the company had applied the fair value recognition provisions of SFAS 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation.
2003 2002 2001 ----------- ----------- ----------- Reported net income ............ $ 90,774 $ 118,487 $ 94,116 Plus: Stock-based employee compensation (net of tax) included in net income .... 256 123 47 Less: Stock-based employee compensation (net of tax) using the fair value method (4,368) (6,106) (6,033) ----------- ----------- ----------- Pro forma net income ........... $ 86,662 $ 112,504 $ 88,130 =========== =========== =========== Reported net income per share ................. $ 1.76 $ 2.30 $ 1.84 =========== =========== =========== Pro forma net income per share ................. $ 1.68 $ 2.18 $ 1.72 =========== =========== =========== Reported net income per share, diluted ........ $ 1.75 $ 2.29 $ 1.83 =========== =========== =========== Pro forma net income per share, diluted ........ $ 1.67 $ 2.17 $ 1.71 =========== =========== ===========
FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITIES AND EQUITY -- As of July 1, 2003, the company adopted the provisions of SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity," including the deferral of certain effective dates as a result of the provisions of FASB Staff Position (FSP) SFAS 150-3, "Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests Under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." The company does not currently utilize these types of financial instruments and the adoption of this statement had no impact on the company's consolidated financial position or results of operation. ACCOUNTING FOR THE MEDICARE PRESCRIPTION DRUG IMPROVEMENT AND MODERNIZATION ACT - -- In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act was enacted, which introduced a Medicare prescription drug benefit and a federal subsidy to sponsors of retiree health care plans that provide a benefit at least actuarially equivalent to the Medicare benefit. In accordance with FSP SFAS 106-1, the company has elected to defer recognition of the effects of the new Medicare Act. The accumulated postretirement benefit obligation and net periodic postretirement benefit cost do not reflect the provisions of the Act. Specific authoritative guidance on accounting for the federal subsidy is pending and may require changes to previously reported information. The company estimates the annual cash flows from the federal subsidy to be in the range of $.6 million to $.8 million, beginning in 2006, although the accounting treatment for the federal subsidy has not been resolved by the FASB. RECLASSIFICATIONS -- Certain prior period amounts have been reclassified to conform to the current year presentation. THE LUBRIZOL CORPORATION 33 NOTE 3 -- INVENTORIES
2003 2002 -------- -------- Finished products ............ $150,711 $148,478 Products in process .......... 62,306 58,643 Raw materials ................ 78,856 76,779 Supplies and engine test parts 20,046 19,068 -------- -------- Total Inventory .............. $311,919 $302,968 ======== ========
Inventories on the LIFO method were 24% and 26% of consolidated inventories at December 31, 2003 and 2002, respectively. The current replacement cost of these inventories exceeded the LIFO cost at December 31, 2003 and 2002, by $57.2 million and $50.1 million, respectively. During 2003, some inventory quantities were reduced, resulting in a liquidation of certain LIFO inventory quantities carried at lower costs in prior years as compared with costs at December 31, 2003. The effect of this liquidation increased income before income taxes by $.6 million. NOTE 4 -- GOODWILL & INTANGIBLE ASSETS Effective January 1, 2002, the company adopted SFAS 142, "Goodwill and Other Intangible Assets." Under SFAS 142, goodwill and other intangibles determined to have indefinite lives are no longer amortized but are tested for impairment upon adoption and at least annually thereafter. SFAS 142 provided for a six-month period from the date of adoption for the company to perform an assessment of potential impairment of goodwill. Any impairment identified upon adoption was recognized as a cumulative effect of a change in accounting principle effective as of January 1, 2002. Goodwill is tested for impairment at the reporting unit level. The company has determined the reporting units were the same as its four operating segments, since the component businesses have similar economic characteristics and can thus be combined under the aggregation rules. The company determined the carrying value of each operating segment by assigning the company's assets and liabilities to them, including existing goodwill, as of January 1, 2002. The company then determined the implied fair value of each operating segment by using a combination of discounted cash flow analysis and terminal value calculations. The fair value of each operating segment was compared to its carrying value to determine if there was an indication of impairment. This evaluation indicated that goodwill recorded in the advanced fluid systems operating segment was impaired as of January 1, 2002. The economic conditions at the time of impairment testing, including declining revenues, reduced the estimated future expected performance of this operating segment, which includes the equipment businesses the company acquired in fluid metering and particulate traps. Accordingly, the company recognized a transitional impairment charge of $7.8 million retroactive to January 1, 2002 in the all other reporting segment, which includes advanced fluid systems. This was a non-cash charge and was recorded as a cumulative effect of a change in accounting principle on the consolidated statement of income in 2002. There was no tax benefit associated with this charge. In connection with adopting SFAS 142, the company also reassessed the useful lives and the classification of its intangible assets. Excluding the non-amortized trademarks, which are indefinite and are not amortized, the intangible assets will continue to be amortized over the lives of the agreements or other periods of value, which range between 5 and 40 years. The following table shows the components of identifiable intangible assets as of December 31, 2003 and 2002:
2003 2002 --------------------- --------------------- Gross Accumu- Gross Accumu- Carrying lated Carrying lated Amount Amortization Amount Amortization ------- ------------ ------- ------------ Amortized intangible assets: Technology ......................................... $38,720 $18,266 $31,504 $15,540 Land use rights .................................... 7,069 605 6,990 379 Non-compete agreements ............................. 6,892 1,989 6,125 1,472 Distributors networks ................................... 3,350 282 3,136 110 Trademarks .............................................. 2,211 1,116 2,211 757 Other ................................................... 11,592 706 5,583 500 ------- ------- ------- ------- Total amortized intangible assets .................................. 69,834 22,964 55,549 18,758 Non-amortized trademarks ......................................... 15,532 6,380 9 ------- ------- ------- ------- Total ................................................... $85,366 $22,964 $61,929 $18,767 ======= ======= ======= =======
Amortization expense for intangible assets was $5 million in 2003, $4 million in 2002 and $3 million in 2001. Excluding the impact of further acquisitions, estimated annual intangible amortization expense for the next five years will approximate $6 million in 2004 and 2005, $5 million in 2006 and 2007 and $3 million in 2008. The fair value of intangible assets acquired in acquisitions in 2003 and 2002 are shown below by major asset class. The intangible assets will be amortized over a period ranging from 5 to 20 years.
Fair Value of Assets ----------------------------- 2003 2002 ------- ------- Amortized intangible assets: Technology ...................... $ 7,212 $ 1,409 Non-compete agreements .......... 1,442 5,414 Distributors networks ........... 214 3,136 Other ........................... 5,400 900 ------- ------- Total amortized intangible assets.. 14,268 10,859 Non-amortized trademarks ............. 9,173 6,326 ------- ------- Total ................................ $23,441 $17,185 ======= =======
THE LUBRIZOL CORPORATION 34 SFAS 142 also requires goodwill to be tested annually, and between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of a reporting segment below its carrying amount. The company has elected to perform its annual tests for potential goodwill impairment as of October 1 of each year. No impairment of goodwill was identified in the fourth quarter of 2003 or 2002. The carrying amount of goodwill by reporting segment is as follows:
FTT FTI All Other Total --------- --------- --------- --------- Balance, December 31, 2001 ................... $ 42,755 $ 88,850 $ 7,668 $ 139,273 Goodwill acquired .............. 32,484 32,484 Transitional impairment charge . (7,785) (7,785) Translation & other adjustments 2,132 2,131 117 4,380 --------- --------- --------- --------- Balance, December 31, 2002 ................... $ 44,887 $ 123,465 $ 168,352 Goodwill acquired .............. 36,219 36,219 Translation & other adjustments 2,091 2,064 4,155 --------- --------- --------- --------- Balance, December 31, 2003 ................... $ 46,978 $ 161,748 $ -- $ 208,726 ========= ========= ========= =========
In accordance with SFAS 142, the company discontinued the amortization of goodwill and certain trademarks effective January 1, 2002. The following table reconciles the company's net income and earnings per share for 2003, 2002 and 2001. The pro forma results for 2001 have been adjusted to exclude goodwill amortization expense. 2002 results include an adjustment for the cumulative effect of a change in accounting principle for the transitional impairment loss under SFAS 142 and are presented for comparative purposes.
2003 2002 2001 ----------- ----------- ----------- Reported net income .......... $ 90,774 $ 118,487 $ 94,116 Add: Goodwill & trademark amortization, net of tax 7,697 Cumulative effect of a change in accounting principle . 7,785 ----------- ----------- ----------- Pro forma net income ......... $ 90,774 $ 126,272 $ 101,813 =========== =========== =========== Reported net income per share $ 1.76 $ 2.30 $ 1.84 Add: Goodwill & trademark amortization, net of tax 0.15 Cumulative effect of a change in accounting principle . 0.15 ----------- ----------- ----------- Pro forma net income per share $ 1.76 $ 2.45 $ 1.99 =========== =========== =========== Reported net income per share, diluted ...... $ 1.75 $ 2.29 $ 1.83 Add: Goodwill & trademark amortization, net of tax 0.15 Cumulative effect of a change in accounting principle . 0.15 ----------- ----------- ----------- Pro forma net income per share, diluted ...... $ 1.75 $ 2.44 $ 1.98 =========== =========== ===========
NOTE 5 -- SHORT-TERM AND LONG-TERM DEBT
2003 2002 -------- -------- Long-term debt consists of: 5.875% notes, due 2008, including remaining unamortized gain on termination of swaps of $13,430 and $16,162 ..................... $213,430 $216,162 7.25% debentures, due 2025 ......... 100,000 100,000 Debt supported by long-term banking arrangements: Commercial paper at weighted- average rates of 1.1% and 1.4% .. 50,000 50,000 Marine terminal refunding revenue bonds, at 1.3% and 1.7%, due 2018 18,375 18,375 Term loans: Yen denominated, at 1.0%, due 2006 . 4,673 Yen denominated, at 2.2%, due 2003 . 8,403 Euro denominated, at 3.5% to 5.0%, due 2003 - 2010 ................. 344 366 Other, at a weighted-average rate of 5.6%, due 2003 ............... 182 -------- -------- 386,822 393,488 Less current portion .................... 96 8,643 -------- -------- $386,726 $384,845 ======== ======== Short-term debt consists of: Yen denominated, at weighted- average rates of 8% and 5% ...... $ 2,803 $ 8,403 Current portion of long-term debt .. 96 8,643 -------- -------- $ 2,899 $ 17,046 ======== ========
In May 2000, the company borrowed $18,375,000 through the issuance of marine terminal refunding revenue bonds, the proceeds of which were used to repay previously issued marine terminal refunding revenue bonds. The bonds have a stated maturity of July 1, 2018, and bear interest at a variable rate which is determined weekly by the remarketing agent. The bonds may be put to the company by the bond holders at each weekly interest reset date; however, the company expects that these bonds would then be remarketed. In November 1998, the company issued notes having an aggregate principal amount of $200 million. The notes are unsecured, senior obligations of the company that mature on December 1, 2008, and bear interest at 5.875% per annum, payable semi-annually on June 1 and December 1 of each year. The notes have no sinking fund requirement but are redeemable, in whole or in part, at the option of the company. The company incurred debt issuance costs aggregating $10.5 million, including a loss of $6.5 million related to closed Treasury rate lock agreements originally entered into as a hedge against changes in interest rates relative to the anticipated issuance of these notes. Debt issuance costs are deferred and then amortized as a component of interest expense over the term of the notes. Including debt issuance costs and the remaining unrealized gain on termination of interest rate swaps (see Note 6), these notes have an effective annualized interest rate of 5.0%. The company has debentures outstanding, issued in June 1995, in an aggregate principal amount of $100 million. These debentures are unsecured, senior obligations of the company that mature on June THE LUBRIZOL CORPORATION 35 15, 2025, and bear interest at an annualized rate of 7.25%, payable semi-annually on June 15 and December 15 of each year. The debentures are not redeemable prior to maturity and are not subject to any sinking fund requirements. As of December 31, 2003, the company had committed revolving credit facilities of $350 million that expire on July 17, 2006. These facilities, which were unused at December 31, 2003, permit the company to borrow at or below the U.S. prime rate. These facilities also permit the company to refinance beyond one year $350 million of debt, which by its terms is due within one year. As a result, the company classified as long-term, at each balance sheet date, the portion of commercial paper borrowings expected to remain outstanding throughout the following year and the amount due under the marine terminal refunding revenue bonds, whose bondholders have the right to put the bonds back to the company. The company had an additional $175 million of committed revolving credit facilities that expired in July 2003, which the company chose not to renew. In January 2004, the company obtained a committed revolving credit facility of Euro 50 million for the purpose of financing acquisitions. This facility expires on January 24, 2005. On January 30, 2004, the company borrowed Euro 43 million to finance a portion of the acquisition of the additives business of Avecia. Amounts due on long-term debt are $.1 million in 2004, $54.7 million in 2006, $.1 million in 2008 and $331.9 million thereafter. In July 2002, the company terminated its interest rate swap agreements expiring December 2008, which converted fixed rate interest on $100 million of its 5.875% debentures to a variable rate. In terminating the swaps, the company received cash of $18.1 million, which is being amortized as a reduction of interest expense through December 1, 2008, the due date of the underlying debt. Gains and losses on terminations of interest rate swap agreements designated as fair value hedges are deferred as an adjustment to the carrying amount of the outstanding obligation and amortized as an adjustment to interest expense related to the obligation over the remaining term of the original contract life of the terminated swap agreement. In the event of early extinguishment of the outstanding obligation, any unamortized gain or loss from the swaps would be recognized in the consolidated statement of income at the time of such extinguishment. The company recorded a $17.3 million unrealized gain, net of accrued interest, on the termination of the interest rate swaps as an increase in the underlying long-term debt. The remaining unrealized gain is $13.4 million and $16.2 million at December 31, 2003 and 2002, respectively. The company has interest rate swap agreements, which expire in March 2005, that exchange variable rate interest obligations on a notional principal amount of $50 million for a fixed rate of 7.6%. The company also has an interest rate swap agreement that expires in October 2006, that exchanges variable rate interest obligations on a notional principal amount of Japanese yen 500 million for a fixed rate of 2.0% (see Note 6). Interest paid, net of amounts capitalized, amounted to $26.1 million, $23.8 million and $23.3 million during 2003, 2002 and 2001, respectively. The company capitalizes interest on qualifying capital projects. The amount of interest capitalized during 2003, 2002 and 2001 amounted to $.2 million, zero and $.2 million, respectively. NOTE 6 -- FINANCIAL INSTRUMENTS The company has various financial instruments, including cash and short-term investments, investments in nonconsolidated companies, foreign currency forward contracts, commodity forward contracts, interest rate swaps and short- and long-term debt. The company has determined the estimated fair value of these financial instruments by using available market information and generally accepted valuation methodologies. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts. The estimated fair value of the company's debt instruments at December 31, 2003 and 2002 approximated $424.9 million and $441.0 million, compared with the carrying value of $389.6 million and $401.9 million, respectively. The company uses derivative financial instruments only to manage well-defined foreign currency, commodity price and interest rate risks. The company does not use derivative financial instruments for trading purposes. Effective January 1, 2001, the company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. SFAS 133 requires the company to recognize all derivatives on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. Depending upon the nature of the hedge, changes in fair value of the derivative are either offset against the change in fair value of assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in value is immediately recognized in earnings. The adoption of SFAS 133 did not have a material cumulative effect on net income as of January 1, 2001, but did result in a $2.0 million reduction ($1.3 million net of tax) of other comprehensive income. The company is exposed to the effect of changes in foreign currency rates on its earnings and cash flow as a result of doing business internationally. In addition to working capital management, pricing and sourcing, the company selectively uses foreign currency forward contracts to lessen the potential effect of currency changes. These contracts relate to transactions with maturities of less than one year. The maximum amount of foreign currency forward contracts outstanding at any one time was $130.9 million in 2003, $14.8 million in 2002 and $17.9 million in 2001. At December 31, 2003, the company had short-term forward contracts to buy or sell currencies at various dates during the first quarter of 2004 for $128.0 million, most of which relate to the company's acquisition of the additives business of Avecia. At December 31, 2002, the company had short-term forward contracts to sell currencies at various dates during 2003 for $3.1 million. These forward contracts are not designated as hedges. Any changes in the fair value of these contracts are either recorded in other income, or deferred as an acquisition purchase price adjustment. The fair value of these instruments at December 31, 2003 and 2002, and the related adjustments recorded in other income or deferred as an acquisition purchase price adjustment were an unrealized gain of $1.6 million and an unrealized loss of $.1 million, respectively. The company is exposed to market risk from changes in interest rates. The company's policy is to manage interest expense using a mix of fixed and variable rate debt. To manage this mix in a cost-efficient 36 THE LUBRIZOL CORPORATION manner, the company may enter into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. Interest payments receivable and payable under the terms of the interest rate swap agreements are accrued over the period to which the payment relates and the net difference is treated as an adjustment of interest expense related to the underlying liability. In July 2002, the company terminated its interest rate swap agreements expiring December 2008, which converted fixed rate interest on $100 million of 5.875% debentures to a variable rate (see Note 5). At December 31, 2003 and 2002, the company had interest rate swap agreements to convert the interest on existing variable rate debt to fixed rates on a notional principal amount of $50 million. The fair values of these swaps at December 31, 2003 and 2002, were an unrealized loss of $3.5 million and $6.0 million, respectively. These swaps are designated as cash flow hedges of underlying variable rate debt obligations and are recorded as a noncurrent liability. The adjustments to record the net changes in fair value during 2003 of $2.2 million ($1.4 million net of tax) and 2002 of $1.2 million ($.8 million net of tax) were recorded in other comprehensive income. Ineffectiveness was determined to be immaterial in 2003 and 2002. The company does not expect any significant portion of these existing losses to be reclassified into earnings within the next 12 months. At December 31, 2003, the company also had an interest rate swap agreement that exchanges variable rate interest obligations for a fixed rate on a notional principal amount of Japanese yen 500 million. This interest rate swap is not designated as a hedge. Accordingly, the decrease in the fair value of this contract of $.1 million was recorded in other expense at December 31, 2003. The company is exposed to market risk from changes in commodity prices. In 2003, the company modified its commodity hedging program policy to include the use of financial instruments to manage the cost of natural gas and electricity purchases. These contracts have been designated as cash flow hedges and, accordingly, any effective unrealized gains or losses on open contracts are recorded in other comprehensive income, net of related tax effects. At December 31, 2003, open contracts totaled $5.4 million. A hedge asset of $.1 million ($.1 million net of tax) was recorded on December 31, 2003, which represents the net unrealized gain based upon current futures prices at that date. Ineffectiveness was determined to be immaterial in 2003. Contract maturities are less than 12 months. As such, the company expects that all of these gains will be reclassified into earnings within the next 12 months. NOTE 7 -- OTHER BALANCE SHEET INFORMATION
Receivables: 2003 2002 - ------------ -------- -------- Customers..... $284,617 $267,085 Affiliates.... 4,734 3,804 Other ........ 35,216 24,619 -------- -------- $324,567 $295,508 ======== ========
Receivables are net of allowance for doubtful accounts of $4.2 million in 2003 and $4.4 million in 2002. Property and Equipment - at cost: 2003 2002 - --------------------------------- ---------- ---------- Land and improvements ........... $ 121,568 $ 113,698 Buildings and improvements ...... 363,951 343,241 Machinery and equipment ......... 1,420,169 1,311,060 Construction in progress ........ 54,911 41,072 ---------- ---------- $1,960,599 $1,809,071 ========== ==========
Depreciation and amortization of property and equipment were $95.5 million in 2003, $91.6 million in 2002 and $84.7 million in 2001.
Accrued Expenses and Other Current Liabilities: 2003 2002 - -------------------------- -------- -------- Employee compensation.... $ 59,800 $ 61,334 Income taxes ............ 18,707 32,496 Taxes other than income.. 15,519 16,606 Sales allowances ........ 11,937 9,766 Restructuring charge .... 12,385 Other ................... 35,110 30,069 -------- -------- $153,458 $150,271 ======== ========
Dividends payable at the end of 2003 and 2002 was $13.4 million and is included in accounts payable.
Noncurrent Liabilities: 2003 2002 - ----------------------- -------- -------- Pensions ..................................... $ 48,602 $ 49,444 Employee benefits ............................ 32,828 25,223 Other ........................................ 18,900 17,988 -------- -------- $100,330 $ 92,655 ======== ========
NOTE 8 -- SHAREHOLDERS' EQUITY The company has 147 million authorized shares consisting of 2 million shares of serial preferred stock, 25 million shares of serial preference shares and 120 million common shares, each of which is without par value. Common shares outstanding exclude common shares held in treasury of 34,607,704 and 34,738,252 at December 31, 2003 and 2002, respectively. The company has a shareholder rights plan under which one right to buy one-half common share has been distributed for each common share held. The rights may become exercisable under certain circumstances involving actual or potential acquisitions of 20% or more of the common shares by a person or affiliated persons who acquire stock without complying with the requirements of the company's articles of incorporation. The rights would entitle shareholders, other than this person or affiliated persons, to purchase common shares of the company or of certain acquiring persons at 50% of then current market value. At the option of the directors, the rights may be exchanged for common shares, and may be redeemed in cash, securities or other consideration. The rights will expire in 2007 unless redeemed earlier. THE LUBRIZOL CORPORATION 37 Accumulated other comprehensive income (loss) shown in the consolidated statements of shareholders' equity at December 31, 2003, 2002 and 2001 is comprised of the following:
Foreign Unrealized Accumulated Currency Losses Pension Plan Other Translation on Interest Minimum Comprehensive Adjustment Rate Swaps Liability Income (Loss) ----------- ----------- ------------ ------------- December 31, 2000 ............................................ $(79,648) $ (978) $(80,626) Other comprehensive income (loss): Pre-tax cumulative effect of accounting change - SFAS 133 $ (2,021) (2,021) Pre-tax ................................................. (17,022) (1,715) (538) (19,275) Tax benefit (provision) ................................. 528 1,308 274 2,110 -------- -------- -------- -------- Total ................................................... (16,494) (2,428) (264) (19,186) -------- -------- -------- -------- December 31, 2001 ............................................ (96,142) (2,428) (1,242) (99,812) Other comprehensive income (loss): Pre-tax ................................................. 44,179 (1,181) (29,331) 13,667 Tax benefit (provision) ................................. (1,236) 413 8,917 8,094 -------- -------- -------- -------- Total ................................................... 42,943 (768) (20,414) 21,761 -------- -------- -------- -------- December 31, 2002 ............................................ (53,199) (3,196) (21,656) (78,051) Other comprehensive income (loss): Pre-tax ................................................. 51,536 2,216 (12,038) 41,714 Tax benefit (provision) ................................. (2,435) (776) 3,595 384 -------- -------- -------- -------- Total ................................................... 49,101 1,440 (8,443) 42,098 -------- -------- -------- -------- December 31, 2003 ............................................ $ (4,098) $ (1,756) $(30,099) $(35,953) ======== ======== ======== ========
NOTE 9 -- OTHER INCOME (EXPENSE) - NET
2003 2002 2001 -------- -------- -------- Equity earnings of nonconsolidated companies $ 133 $ 986 $ 2,196 Amortization of goodwill and intangible assets ....... (4,938) (4,206) (14,118) Currency exchange/transaction gain (loss) ............. 3,544 (427) (3,041) Other - net .................. (304) (1,733) (113) -------- -------- -------- $ (1,565) $ (5,380) $(15,076) ======== ======== ========
Dividends received from the nonconsolidated companies were $1.0 million in 2003, $2.7 million in 2002 and $3.8 million in 2001. NOTE 10 -- INCOME TAXES The provision for income taxes is based upon income before tax for financial reporting purposes. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the tax bases of assets and liabilities and their carrying values for financial reporting purposes. In estimating future tax consequences, the company considers anticipated future events, except changes in tax laws or rates, which are recognized when enacted. Income before income taxes and cumulative effect of change in accounting principle consists of the following:
2003 2002 2001 -------- -------- -------- United States $ 39,244 $ 95,482 $ 79,576 Foreign ..... 89,827 84,906 60,373 -------- -------- -------- Total ....... $129,071 $180,388 $139,949 ======== ======== ========
The provision for income taxes consists of the following:
2003 2002 2001 -------- -------- -------- Current: United States ........................... $ 6,089 $ 14,791 $ 25,891 Foreign ................................. 30,717 36,167 22,334 -------- -------- -------- 36,806 50,958 48,225 -------- -------- -------- Deferred: United States ........................... 3,019 1,208 (4,992) Foreign ................................. (1,528) 1,950 2,600 -------- -------- -------- 1,491 3,158 (2,392) -------- -------- -------- Total ........................................ $ 38,297 $ 54,116 $ 45,833 ======== ======== ========
The United States tax provision includes the U.S. tax on foreign income distributed to the company. The provision for taxes outside the United States includes withholding taxes. The differences between the provision for income taxes at the U.S. statutory rate and the tax shown in the consolidated statements of income are summarized as follows:
2003 2002 2001 -------- -------- -------- Tax at statutory rate of 35% $ 45,175 $ 63,136 $ 48,982 U.S. tax on foreign dividends 3,574 (946) 369 U.S. tax benefit on exports . (3,715) (4,114) (4,223) Technology donation ......... (5,163) Untaxed translation (gains)/losses ......... (5,422) 1,625 2,940 Other - net ................. (1,315) (422) (2,235) -------- -------- -------- Provision for income taxes .. $ 38,297 $ 54,116 $ 45,833 ======== ======== ========
38 THE LUBRIZOL CORPORATION The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31 are as follows:
2003 2002 --------- --------- Deferred tax assets: Accrued compensation and benefits .. $ 65,528 $ 56,362 Intercompany profit in inventory ... 8,733 10,554 Net operating losses carried forward 2,737 5,722 Other .............................. 2,373 6,184 --------- --------- Total gross deferred tax assets ......... 79,371 78,822 Less valuation allowance ................ (1,910) (3,602) --------- --------- Net deferred tax assets ................. 77,461 75,220 --------- --------- Deferred tax liabilities: Depreciation and other basis differences ............... 101,901 101,475 Undistributed foreign equity income 2,870 3,199 Inventory basis differences ........ 2,729 1,659 Other .............................. 7,445 3,132 --------- --------- Total gross deferred tax liabilities .... 114,945 109,465 --------- --------- Net deferred tax liabilities ............ $ 37,484 $ 34,245 ========= =========
At December 31, 2003, certain foreign subsidiaries had net operating loss carryforwards of $9.1 million for income tax purposes, all of which have no expiration. After evaluating tax planning strategies and historical and projected profitability, a valuation allowance has been recognized to reduce the deferred tax assets related to those carryforwards to the amount expected to be realized. The net change in the total valuation allowance for the years ended December 31, 2003, 2002 and 2001, was a decrease of $1.7 million, a decrease of $.7 million and an increase of $.1 million, respectively. U.S. income taxes and foreign withholding taxes are not provided on undistributed earnings of foreign subsidiaries, which are considered to be indefinitely reinvested in the operations of such subsidiaries. The amount of these earnings was approximately $500.6 million at December 31, 2003. Determination of the net amount of unrecognized U.S. income tax with respect to these earnings is not practicable. Income taxes paid during 2003, 2002 and 2001 were $50.8 million, $48.8 million and $49.7 million, respectively. NOTE 11 -- PENSION, PROFIT SHARING AND OTHER POSTRETIREMENT BENEFIT PLANS The company has noncontributory defined benefit pension plans covering most employees. Pension benefits under these plans are based on years of service and the employee's compensation. The company's funding policy in the United States is to contribute amounts to satisfy the Internal Revenue Service funding standards and elsewhere to fund amounts in accordance with local regulations. Several of the company's smaller defined benefit plans are not funded. The investment objective of the funded U.S. pension plan is to assure payment of benefits at a minimum cost consistent with prudent standards of investment, given the strength of the company and its earnings record, the adequacy of the plan's funding and the age of the company's work force. The plan utilizes a diversified portfolio of investments and seeks to earn returns consistent with a reasonable level of risk. The expected return on plan assets is based upon the company's long term experience and return targets for specific investment classes. During 2003, the company maintained the expected long-term rate of return assumption for the U.S. plan of 9%. As long-term asset allocation is recognized as the primary determinant of performance, the company has established the following allocation targets to achieve the U.S. pension plan objectives: 70% equity securities, 25% debt securities and 5% real estate. As appropriate, allocation targets and ranges have been established for various subcategories. Allocations are reviewed quarterly and adjusted as necessary. Approved U.S. pension plan investments include: equities, fixed-income securities, real estate, venture capital, cash and cash equivalent instruments and such other instruments (including mutual fund investments), as the company may approve. Investments in tax-exempt securities, commodities and options, other than covered calls, and the use of leverage are prohibited. Plan investment managers may use derivatives to hedge currency risk and to keep fully invested. Any other use of derivative instruments must be approved by the company. The market values of U.S. pension plan assets are compared annually to the value of plan benefit obligations. The future value of assets, as calculated based on the expected long-term rate of return, are also compared to expected future plan benefit distributions and contributions to determine the sufficiency of expected plan funding levels. Investment asset allocations are revised as appropriate. Plan assets are invested principally in marketable equity securities and fixed income instruments. The allocation of U.S. pension plan assets by major asset class is shown below:
Percentage of Plan Assets at December 31 2003 2002 - ---------------------------------------- ---- ---- Asset Category Equity securities .................................... 72% 73% Debt securities ...................................... 23% 21% Real estate .......................................... 5% 6% --- --- Total ................................................ 100% 100% === ===
Equity securities included no company common stock in the asset percentages reported above for 2003 and 2002, respectively. The company also provides certain non-pension postretirement benefits, primarily health care and life insurance benefits, for retired employees. Most of the company's full-time employees in the United States become eligible for health care benefits after attaining specified years of service and age 55 at retirement. Full-time employees who retired before January 1, 2003, are also eligible for life insurance benefits. Participants contribute a portion of the cost of these benefits. The company's non-pension postretirement benefit plans are not funded. THE LUBRIZOL CORPORATION 39 The change in the projected benefit obligation and plan assets for 2003 and 2002 and the amounts recognized in the consolidated balance sheets at December 31 of the company's defined benefit pension and non-pension postretirement plans are as follows:
Pension Plans Other Benefits ------------------------ ------------------------- 2003 2002 2003 2002 --------- --------- --------- --------- Change in projected benefit obligation: Projected benefit obligation at beginning of year .............. $ 355,898 $ 311,959 $ 106,524 $ 91,746 Service cost .............................................. 14,454 12,648 2,028 1,636 Interest cost ............................................. 22,351 20,467 6,959 6,509 Plan participants' contributions .......................... 286 249 2,515 1,879 Actuarial loss ............................................ 26,758 15,694 6,514 11,181 Currency exchange rate change ............................. 16,965 11,589 721 233 Amendments ................................................ 869 2,126 (5,440) Divestitures .............................................. (107) (5) Benefits paid ............................................. (18,164) (18,829) (6,625) (6,660) --------- --------- --------- --------- Projected benefit obligation at end of year .................... 419,310 355,898 113,196 106,524 --------- --------- --------- --------- Change in plan assets: Fair value of plan assets at beginning of year ................. 249,100 273,714 Actual return on plan assets .............................. 53,690 (19,267) Divestitures .............................................. (107) (5) Employer contributions .................................... 10,604 5,218 4,110 4,781 Plan participants' contribution ........................... 286 249 2,515 1,879 Currency exchange rate change ............................. 11,113 8,020 Benefits paid ............................................. (18,164) (18,829) (6,625) (6,660) --------- --------- --------- --------- Fair value of plan assets at end of year ....................... 306,522 249,100 --------- --------- --------- --------- Plan assets greater (less) than the projected benefit obligation (112,788) (106,798) (113,196) (106,524) Unrecognized net loss ..................................... 89,457 89,510 49,193 44,809 Unrecognized net transition obligation (asset) ............ (82) (957) Unrecognized prior service cost ........................... 24,160 26,100 (39,813) (39,965) --------- --------- --------- --------- Net amount recognized .......................................... $ 747 $ 7,855 $(103,816) $(101,680) ========= ========= ========= ========= Amount recognized in the consolidated balance sheets: Prepaid benefit cost ...................................... $ 5,458 $ 27,778 Accrued benefit liability ................................. (53,070) (55,798) $(103,816) $(101,680) Accumulated other comprehensive income .................... 43,483 31,445 Intangible asset .......................................... 4,876 4,430 --------- --------- --------- --------- Net amount recognized .......................................... $ 747 $ 7,855 $(103,816) $(101,680) ========= ========= ========= ========= Accumulated benefit obligation at end of year .................. $ 329,451 $ 272,006 $ 113,196 $ 106,524 The weighted-average assumptions used to determine benefit obligations at December 31: Measurement date .......................................... 12/31/2003 12/31/2002 12/31/2003 12/31/2002 Discount rate ............................................. 5.88% 6.34% 6.2% 6.7% Expected long-term return on plan assets................... 8.32% 8.34% Rate of compensation increase ............................. 3.87% 3.78% The weighted-average assumptions used to determine net periodic benefit cost for years ended December 31: Discount rate ............................................. 6.34% 6.67% 6.7% 7.3% Expected long-term return on plan assets................... 8.34% 8.45% Rate of compensation increase ............................. 3.78% 3.82% --------- --------- --------- ---------
The projected benefit obligation and fair value of plan assets for pension plans with projected benefit obligations in excess of plan assets were $414.5 million and $301.5 million, respectively, as of December 31, 2003, and $355.2 million and $248.4 million, respectively, as of December 31, 2002. The accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $149.8 million and $98.5 million, respectively, as of December 31, 2003, and $121.9 million and $85.6 million, respectively, as of December 31, 2002. 40 THE LUBRIZOL CORPORATION The following table shows the amounts the company contributed to its U.S. pension plans in 2003 and 2002 and the expected contribution for 2004:
Pension Other Total Employer Contributions Benefits Benefits Benefits - ---------------------- -------- -------- -------- 2002 ................................... $ 221 $4,618 $4,839 2003 ................................... $4,315 $3,949 $8,264 2004 (expected) ........................ $5,196 $4,147 $9,343
Expected employer contributions for pension benefits in 2004 consist of $2.7 million to the U.S. qualified plan and $2.5 million to the U.S. non-qualified plan. The expected contribution to the non-qualified plan, which is unfunded, represents an actuarial estimate of future assumed payments based on historic retirement and payment patterns. Actual amounts paid could differ from this estimate. Contributions by participants to the other benefit plans were $2.5 million and $1.9 million for the years ending December 31, 2003 and 2002, respectively. Net periodic pension cost of the company's defined benefit pension plans consists of:
2003 2002 2001 -------- -------- -------- Service cost - benefits earned during period .............. $ 14,453 $ 12,648 $ 11,673 Interest cost on projected benefit obligation ......... 22,351 20,467 20,425 Expected return on plan assets .. (26,416) (26,685) (26,860) Amortization of prior service costs .............. 3,287 3,208 3,127 Amortization of initial net asset (688) (703) (1,218) Recognized net actuarial (gain) loss ...... 814 (543) (1,045) Settlement loss ................. 274 142 -------- -------- -------- Net non-pension postretirement benefit cost $ 14,075 $ 8,392 $ 6,244 ======== ======== ========
The company also has defined contribution plans, principally involving profit sharing plans and a 401(k) savings plan, covering most employees in the United States and at certain non-U.S. subsidiaries. Expense for all defined contribution retirement plans was $9.5 million in 2003, $10.0 million in 2002 and $9.6 million in 2001. Net non-pension postretirement benefit cost consists of:
2003 2002 2001 ------- ------- ------- Service cost - benefits earned during period ........... $ 2,028 $ 1,636 $ 1,569 Interest cost on projected benefit obligation ...... 6,959 6,509 6,387 Amortization of prior service costs ........... (5,592) (5,180) (4,501) Recognized net actuarial loss 2,230 1,723 944 Curtailment gain ............. (1,358) Settlement loss .............. 853 ------- ------- ------- Net periodic pension cost .... $ 5,625 $ 4,688 $ 3,894 ======= ======= =======
The weighted average of the assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation for the company's postretirement benefit plans at December 31, 2003, was 7.98%, (8.77% at December 31, 2002), with subsequent annual decrements to an ultimate trend rate of 4.9% by 2009. The assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in the assumed health care cost trend rate would have the following effects as of and for the year ended December 31, 2003:
One-Percentage-Point ------------------------------- Increase Decrease -------- -------- Effect on postretirement benefit obligation $ 17,700 $(14,244) Effect on total service and interest cost components ...................... $ 1,648 $ (1,287)
NOTE 12 -- LEASES The company has commitments under operating leases primarily for office space, terminal facilities, land, railroad tank cars and various computer and office equipment. Rental expense was $15.8 million in 2003, $15.6 million in 2002 and $14.0 million in 2001. Future minimum rental commitments under operating leases having initial or remaining non-cancelable lease terms exceeding one year are $15.0 million in 2004, $10.0 million in 2005, $6.5 million in 2006, $5.1 million in 2007, $3.4 million in 2008 and $11.6 million thereafter. Minimum rental commitments are net of estimated credits for railroad usage of $1.1 million in 2004, $1.0 million in 2005, $.6 million in 2006, $.3 million in 2007, $.2 million in 2008 and $.2 million thereafter. NOTE 13 -- BUSINESS SEGMENTS AND GEOGRAPHIC REPORTING Beginning in 2002, the company reorganized its product lines into four principal operating segments: fluid technologies for transportation, fluid technologies for industry, advanced fluid systems and emulsified products. The segment information for prior years has been restated to conform to the current operating structure. Fluid technologies for transportation (FTT) is comprised of additives for lubricating engine oils, such as gasoline, diesel, marine and stationary gas engines and additive components; additives for driveline oils, such as automatic transmission fluids, gear oils and tractor lubricants; and additives for fuel products and refinery and oil field chemicals. In addition, this segment sells additive components and viscosity improvers within its lubricant and fuel additives product lines. The company's fluid technologies for transportation product lines are generally produced in shared company manufacturing facilities and sold largely to a common customer base. Fluid technologies for industry (FTI) includes industrial additives, such as additives for hydraulic, grease and metalworking fluids and compressor lubricants; and performance chemicals, such as additives for coatings and inks, defoamers, process chemicals and surfactants for personal care and industrial cleaners. The advanced fluid systems and emulsified products operating segments do not constitute reportable business segments. The results of these two operating segments have been aggregated into the all other segment. Advanced fluid systems is comprised of fluid metering devices, particulate emission trap devices, and FluiPak(TM) sensor systems. Emulsified products is comprised of PuriNOx(TM) low-emissions diesel fuel. THE LUBRIZOL CORPORATION 41 The company's accounting policies for its operating segments are the same as those described in Note 2. The company evaluates performance and allocates resources based on segment contribution income, which is revenues less expenses directly identifiable to the product lines aggregated within each segment, as well as projected future returns. Segment contribution income reflects the exclusion for internal management reporting purposes of excess production capacity from product costs. The following table presents a summary of the company's reportable segments for the years ended December 31:
2003 2002 2001 ----------- ----------- ----------- Fluid technologies for transportation: Revenues from external customers............................... $ 1,554,733 $ 1,575,998 $ 1,520,766 Equity earnings................................................ 107 923 4,078 Goodwill and intangibles amortization.......................... 2,552 2,924 5,593 Segment contribution income.................................... 286,880 312,033 283,449 Segment total assets........................................... 1,101,343 1,121,387 1,079,903 Capital expenditures........................................... 73,858 56,965 60,304 Depreciation................................................... 85,986 83,624 78,208 Fluid technologies for industry: Revenues from external customers............................... $ 464,085 $ 382,427 $ 300,191 Equity earnings................................................ 26 62 280 Goodwill and intangibles amortization.......................... 2,386 1,282 7,410 Segment contribution income.................................... 73,276 70,335 46,486 Segment total assets........................................... 448,328 326,728 212,137 Capital expenditures........................................... 14,347 8,043 5,586 Depreciation................................................... 8,687 7,019 5,570 All Other: Revenues from external customers............................... $ 33,305 $ 25,442 $ 23,687 Equity earnings (loss)......................................... (2,162) Goodwill and intangibles amortization.......................... 1,115 Segment contribution income (loss)............................. (7,658) (10,247) (18,175) Segment total assets........................................... 22,045 22,278 29,303 Capital expenditures........................................... 248 277 426 Depreciation................................................... 812 982 936 Reconciliation to consolidated income before income taxes and cumulative effect of change in accounting principle: Segment contribution income.................................... $ 352,498 $ 372,121 $ 311,760 Corporate expenses............................................. (183,878) (172,927) (150,217) Corporate other income (loss).................................. 4,300 (2,205) (3,340) Restructuring charge........................................... (22,534) Interest expense - net......................................... (21,315) (16,601) (18,254) ----------- ----------- ----------- Income before income taxes and cumulative effect of change in accounting principle........................................ $ 129,071 $ 180,388 $ 139,949 =========== =========== =========== Revenues from external customers by product group: Engine oil additives........................................... $ 1,053,671 $ 1,070,394 $ 1,018,999 Driveline oil additives........................................ 413,787 412,086 396,808 Fuel additives and refinery oil additives...................... 64,035 67,871 75,596 Additive components............................................ 23,240 25,647 29,363 ----------- ----------- ----------- Fluid technologies for transportation.......................... 1,554,733 1,575,998 1,520,766 ----------- ----------- ----------- Industrial additives........................................... 208,096 195,159 182,249 Performance chemicals.......................................... 255,989 187,268 117,942 ----------- ----------- ----------- Fluid technologies for industry................................ 464,085 382,427 300,191 ----------- ----------- ----------- All Other...................................................... 33,305 25,442 23,687 ----------- ----------- ----------- Total revenues from external customers.......................... $ 2,052,123 $ 1,983,867 $ 1,844,644 =========== =========== ===========
In order to conform to current-year classifications, prior-year 2002 and 2001 amounts have been restated to reflect reclassifications of products between fluid technologies for transportation and fluid technologies for industry operating segments. 42 THE LUBRIZOL CORPORATION Revenues are attributable to countries based on the location of the customer. The United States of America is the only country where sales to external customers comprise in excess of 10% of the company's consolidated revenues. Revenues from external customers by geographic zone are as follows:
2003 2002 2001 ---------- ---------- ---------- United States............................. $ 829,554 $ 810,991 $ 738,384 Other North America....................... 86,506 87,763 85,722 Europe.................................... 601,942 552,278 511,697 Asia-Pacific/Middle East.................. 403,345 405,469 376,652 Latin America............................. 130,776 127,366 132,189 ---------- ---------- ---------- Total revenues from external customers.... $2,052,123 $1,983,867 $1,844,644 ========== ========== ==========
The company's sales and receivables are concentrated in the oil and chemical industries. The company's lubricant and fuel additive customers consist primarily of oil refiners and independent oil blenders and are located in more than 100 countries. The 10 largest customers, most of which are international oil companies and a number of which are groups of affiliated entities, comprised approximately 52% of consolidated sales in 2003, 55% of consolidated sales in 2002 and 53% of consolidated sales in 2001. In 2003, the company had one customer, including its affiliated entities, predominantly within fluid technologies for transportation segment, with revenues of $217.6 million that represented more than 10% of consolidated revenues. In 2002, the company had two customers with revenues of $229.7 million and $195.2 million, respectively, that individually accounted for more than 10% of consolidated revenues. In 2001, there was no single customer that accounted for more than 10% of revenues. The table below presents a reconciliation of segment total assets to consolidated total assets for the years ended December 31:
2003 2002 2001 ---------- ---------- ---------- Total segment assets........... $1,571,716 $1,470,393 $1,321,343 Corporate assets............... 370,600 389,744 340,976 ---------- ---------- ---------- Total consolidated assets...... $1,942,316 $1,860,137 $1,662,319 ========== ========== ==========
Segment assets include receivables, inventories and long-lived assets including goodwill and intangible assets. Corporate assets include cash and short-term investments, investments accounted for on the cost basis and other current and noncurrent assets. The company's principal long-lived assets are located in the following countries at December 31:
2003 2002 2001 -------- -------- -------- United States............... $670,668 $617,410 $532,827 France...................... 77,941 69,421 66,638 England..................... 80,243 81,267 106,008 All other................... 132,270 122,571 105,366 -------- -------- -------- Total long-lived assets..... $961,122 $890,669 $810,839 ======== ======== ========
Net income of non-U.S. subsidiaries was $61 million in 2003, $41 million in 2002 and $35 million in 2001; dividends received from these subsidiaries were $28 million, $12 million and $55 million, respectively. NOTE 14 -- STOCK COMPENSATION PLANS The 1991 Stock Incentive Plan provides for the granting of restricted and unrestricted shares and options to buy common shares up to an amount equal to 1% of the outstanding common shares at the beginning of any year, plus any unused amount from prior years. Options are intended either to qualify as "incentive stock options" under the Internal Revenue Code or to be "non-statutory stock options" not intended to so qualify. Under the 1991 Plan, options generally become exercisable 50% one year after grant, 75% after two years, 100% after three years and expire up to 10 years after grant. "Reload options," which are options to purchase additional shares if a grantee uses already-owned shares to pay for an option exercise, are granted automatically once per year for options granted prior to March 28, 2000, under the 1991 Plan; may be granted at the discretion of the administering committee under the 1985 Employee Stock Option Plan and for options granted on or after March 28, 2000, under the 1991 Plan; and have been eliminated under the 1991 Plan for grants of options occurring on or after November 11, 2002. The 1991 Plan generally supersedes the 1985 Plan, although options outstanding under the 1985 Plan remain exercisable until their expiration dates. The option price for stock options under the 1985 Plan is the fair market value of the shares on the date of grant. The option price for stock options under the 1991 Plan is not less than the fair market value of the shares on the date of grant. Both plans permit or permitted the granting of stock appreciation rights in connection with the grant of options. In addition, the 1991 Plan provides to each outside director of the company an automatic annual grant of an option to purchase 2,500 common shares, with terms generally comparable to employee stock options. In 2001, the 1991 Plan provided for the grant to each outside director of a one-time additional option to purchase 2,500 common shares as an incentive relating to Lubrizol's five-year strategic initiatives. Under the 1991 Stock Incentive Plan, the company has granted performance share stock awards to certain executive officers. Common shares equal to the number of performance share stock awards granted were to be issued if the market price of the company's common stock reached $45 per common share for 10 consecutive trading days, or on March 24, 2003, whichever occurred first. Under certain conditions such as retirement, a grantee of performance share stock awards could have been issued a pro-rata number of common shares. The market value of the company's common shares at date of grant of the performance share stock awards was $33.45 per share (for 500 awards) in 2002, $30.40 per share (for 750 awards) in 2001, $28.06 per share (for 3,000 awards) and $25.38 (for 1,500 awards) in 2000. The company recognized compensation expense related to performance share stock awards ratably over the estimated period of vesting. Compensation costs recognized for performance share stock awards were approximately $15 thousand in 2003, $56 thousand in 2002 and $50 thousand in 2001. 3,500 shares were issued on March 24, 2003, and 57,250 shares were deferred to the deferred compensation plan for officers. The company has allocated 1,415 share units under this plan in 2003, which represent quarterly dividends paid on the company's shares. At December 31, 2003, 58,665 share units were outstanding. Compensation expense recognized for the dividend on the deferred shares was less than $50 thousand in 2003. 43 THE LUBRIZOL CORPORATION Under a supplemental retirement plan, an account for the participant is credited with 500 share units each year and is credited with additional share units for quarterly dividends paid on the company's shares. When the participant retires, the company will issue shares equal to the number of share units in the participant's account or the cash equivalent. The company has allocated 567, 546 and 528 share units under this plan in 2003, 2002 and 2001, respectively. At December 31, 2003, 2,159 share units were outstanding. Compensation costs recognized for this plan were less than $20 thousand per year in 2003, 2002 and 2001. For share units attributable to grants credited after January 1, 2004, the payment will be in cash. Under the deferred stock compensation plan for outside directors, each nonemployee director receives 500 share units on each October 1 and is credited with additional share units for quarterly dividends paid on the company's shares. When a participant ceases to be a director, the company issues shares equal to the number of share units in the director's account. The company has allocated to nonemployee directors, 6,048, 6,208 and 6,028 share units under this plan in 2003, 2002 and 2001, respectively. Director fee expense recognized for share units was approximately $.2 million in 2003, 2002 and 2001. At December 31, 2003, 46,552 share units for nonemployee directors were outstanding. No new grants will be made under this plan after January 1, 2004. In addition, under a separate deferred compensation plan for outside directors, the company has allocated to nonemployee directors 620, 573 and 547 share units under this plan in 2003, 2002 and 2001, respectively. These share units continue to accrue quarterly dividends paid on the company's shares. When a participant ceases to be a director, the company issues shares equal to the number of share units in the director's account. At December 31, 2003, 18,607 share units for nonemployee directors were outstanding. Director fee expense recognized for share units for this plan was less than $20 thousand per year in 2003, 2002 and 2001. Under the deferred compensation plan for executive officers, participants may elect to defer any amount of their variable pay. Deferred amounts are converted into share units based on the current market price of the company's shares. There is a 25% company match. Additional share units are credited for quarterly dividends paid on the company's shares. At the end of the deferral period, which is at least three years, the company issues shares equal to the number of share units in the participant's account. The company has allocated to executive officers 23,060, 8,010 and 16,628 share units under this plan in 2003, 2002 and 2001, respectively. Compensation costs recognized for share units were approximately $.7 million in 2003, $.3 million in 2002 and $.5 million in 2001. At December 31, 2003, 68,315 share units for executive officers were outstanding. For share units attributable to company match credited after January 1, 2004, distributions will be made in cash. Under the 1991 Stock Incentive Plan, effective January 1, 2003, the company granted 15,000 restricted shares to each of three executive officers and 5,000 restricted shares to one executive officer. The shares will be issued only if the executive remains an employee until January 1, 2008. There are no voting or dividend rights on these shares unless and until they are issued. The restricted shares stock awards had a fair value of $25.83 at the date of grant. The company recognizes compensation expense related to restricted shares ratably over the estimated period of vesting. Compensation costs recognized for restricted share stock awards were approximately $.3 million in 2003. Under the Long-Term Incentive Plan, dollar-based target awards were determined by the organization and compensation committee in December 2002 for the three-year performance period of 2003-2005. A portion of the award was converted into a number of share units based on the price of Lubrizol stock on the date of the award. There are no voting or dividend rights associated with the share units until the end of the performance period and a distribution of shares, if any, is made. The target awards correspond to a pre-determined three-year earnings per share growth rate target. Based on the awards granted for the 2003-2005 performance period the company does not believe it is probable that shares will be issued under this plan and as a result no expense has been recorded. Accounting principles generally accepted in the United States encourage the fair-value based method of accounting for stock compensation plans under which the value of stock-based compensation is estimated at the date of grant using valuation formulas, but permit the use of intrinsic-value accounting. The company accounts for its stock compensation plans using the intrinsic-value accounting method (measured as the difference between the exercise price and the market value of the stock at the measurement date). Disclosures under the fair value method are estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants of stock options in the following years:
2003 2002 2001 ---- ---- ---- 1991 Plan: Risk-free interest rate......... 3.9% 5.2% 5.1% Dividend yield.................. 3.4% 3.1% 2.9% Volatility...................... 24.0% 24.0% 25.0% Expected life (years)........... 10.0 8.4 9.7 Performance Share Plan: Risk-free interest rate......... n/a 2.4% 3.2% Dividend yield.................. n/a 3.1% 2.9% Volatility...................... n/a 24.0% 25.0% Expected life (years)........... n/a 1.0 2.0 Restricted Share Plan: Risk-free interest rate......... 2.7% n/a n/a Dividend yield.................. 3.3% n/a n/a Volatility...................... 24.0% n/a n/a Expected life (years)........... 5.0 n/a n/a
If the fair value method to measure compensation cost for the company's stock compensation plans had been used, including the performance share stock awards and the restricted share stock awards, the company's net income would have been reduced by $4.4 million in 2003, $6.1 million in 2002 and $6.0 million in 2001 with a corresponding reduction in net income per share of $.08, in 2003, $.12 in 2002 and $.12 in 2001. 44 THE LUBRIZOL CORPORATION Information regarding these option plans, excluding the performance share stock awards, the restricted share stock awards and the long- term incentive plan stock awards, follows:
Weighted- Average Shares Exercise Price ------ -------------- Outstanding, January 1, 2003............. 5,272,723 $31.38 Granted.................................. 525,401 30.35 Exercised................................ (151,112) 27.87 Forfeited................................ (253,970) 33.60 -------- Outstanding, December 31, 2003........... 5,393,042 $31.28 ========= ====== Options exercisable, December 31, 2003....................... 4,173,632 $31.18 ========= ====== Weighted-average fair value of options granted during the year......... $ 6.78 ====== Outstanding, January 1, 2002............. 4,827,266 $30.74 Granted.................................. 949,102 34.06 Exercised................................ (396,420) 29.25 Forfeited................................ (107,225) 34.11 -------- Outstanding, December 31, 2002........... 5,272,723 $31.38 ========= ====== Options exercisable, December 31, 2002....................... 3,560,650 $31.10 ========= ====== Weighted-average fair value of options granted during the year......... $ 8.99 ====== Outstanding, January 1, 2001............. 4,624,135 $30.68 Granted.................................. 1,461,945 30.39 Exercised................................ (911,696) 28.05 Forfeited................................ (347,118) 35.64 -------- Outstanding, December 31, 2001........... 4,827,266 $30.74 ========= ====== Options exercisable, December 31, 2001....................... 2,850,184 $31.73 ========= ====== Weighted-average fair value of options granted during the year......... $ 8.69 ======
Information regarding the performance share stock awards follows:
Shares ------ Outstanding, January 1, 2003............... 60,750 Granted.................................... 0 Forfeited.................................. 0 Common Shares Issued / Deferred............ (60,750) ------ Outstanding, December 31, 2003............. 0 ====== Outstanding, January 1, 2002............... 66,250 Granted.................................... 500 Forfeited.................................. (918) Common Shares Issued....................... (5,082) ------ Outstanding, December 31, 2002............. 60,750 ====== Outstanding, January 1, 2001............... 65,500 Granted.................................... 750 ------ Outstanding, December 31, 2001............. 66,250 ======
The weighted-average fair value per share was $32.16 in 2002 and $28.69 in 2001. The following table summarizes information about stock options outstanding, excluding the performance share stock awards, restricted share stock awards and long-term incentive plan awards at December 31, 2003:
Options Outstanding Options Exercisable -------------------------------------------------- ---------------------------- Number Weighted-Average Weighted- Number Weighted- Range of Outstanding Remaining Average Exercisable Average exercise prices at 12/31/03 Contractual Life Exercise Price at 12/31/03 Exercise Price - --------------- ------------ ---------------- -------------- ----------- -------------- $19- $25 295,519 4.8 Years $21.35 295,519 $21.35 25- 31 3,076,880 6.6 29.68 2,267,895 29.44 31- 38 2,014,643 4.8 35.15 1,604,218 35.43 38- 45 6,000 4.3 38.25 6,000 38.25 --------- --------- 5,393,042 5.8 31.28 4,173,632 31.18 ========= =========
45 THE LUBRIZOL CORPORATION NOTE 15 -- ACQUISITIONS AND INVESTMENTS IN NONCONSOLIDATED SUBSIDIARIES In the third quarter of 2003, the company completed two acquisitions in the fluid technologies for industry segment, for cash of $68.6 million. In July 2003, the company purchased the product lines of a silicones business from BASF, which expanded the foam control additives business to approximately $40 million in annual revenues. Assets acquired from BASF included customer lists, certain trademarks, manufacturing technology and other related intellectual property specifically developed for silicone products in the North America region and finished goods inventory. Silicones are used in the manufacture of sealants, caulks and water proofing products. Historical annual revenues for these silicone products approximate $6 million. In September 2003, the company completed an acquisition of selected personal care ingredients business from Amerchol Corporation, a subsidiary of The Dow Chemical Company. Products from this business go into a wide range of end uses, including skin care and hair conditioners. Products include methyl glucoside derivatives, lanolin derivatives and Promulgen(TM) personal care ingredients. Annualized revenues of the acquisition are approximately $30 million. The fair value of assets acquired and liabilities assumed in 2003 acquisitions is as follows:
Assets and Liabilities Acquired in 2003 -------------------- Receivables................................... $ 400 Inventories................................... 7,715 Property...................................... 1,804 Goodwill...................................... 36,219 Intangibles................................... 23,441 Other assets.................................. 223 ------ Total assets.................................. 69,802 ------ Accrued expenses.............................. 1,019 Deferred taxes-non current.................... 186 ------ Total liabilities............................. 1,205 ------ Increase in net assets from acquisitions...... $68,597 =======
In 2002, the company completed several acquisitions in the fluid technologies for industry segment for cash of $86.7 million. In the first quarter, the company acquired Kabo Unlimited, Inc., which specializes in the development, manufacture and sale of antifoam and defoaming agents to the food, fermentation, mining and wastewater industries. Kabo's product lines expand the company's defoamer business. In the second quarter, the company acquired Chemron Corpo- ration, which formulates, produces and supplies specialty surfactants used in personal care products, industrial cleaners and a wide range of other consumer and industrial products. The acquisition extends the company's existing surfactants business into growth markets where the company had not previously competed. In October 2002, the company acquired Dock Resins Corporation, which develops, manufactures and sells proprietary polymers including acrylic, methacrylic, alkyd and polyester resins to customers in the paint and coatings, printing ink, laminating, adhesives and sealants and grease markets. In October 2002, the company also acquired Intermountain Specialties, Inc., known as Brose Chemical Company, which has product lines that complement the company's integrated defoamer business that are now manufactured in the Kabo foam control facility. Annualized 2002 revenues for these acquisitions in the aggregate are approximately $85 million. Effective January 1, 2002, the company began accounting for the investment in its India joint venture, Lubrizol India Private Limited (Lubrizol India), through consolidation because an amendment to the joint venture agreement gave the company control as of that date. The company has ownership of 50% of the voting shares. The amended joint venture agreement grants the company the authority to appoint three of Lubrizol India's six board directors and the unilateral and perpetual ability to appoint its managing director. Further, the amended joint venture agreement delegates to the managing director the authority to make all significant decisions to run the day-to-day business of Lubrizol India. The company had previously accounted for its investment under the equity method of accounting because the company's joint venture partner held certain substantive participating rights, which were eliminated with the amendment to the joint venture agreement. The change to consolidate Lubrizol India had the effect of increasing revenues and total cost and expenses by $50.4 million and $41.1 million, respectively, for the year ended 2002. The change had no impact on net income, but resulted in the recording of 100% of Lubrizol India's assets and liabilities, which is offset by our partner's minority interest. The fair value of assets acquired and liabilities assumed in the 2002 acquisitions and the impact on the balance sheet from the consolidation of Lubrizol India is as follows:
Assets and Liabilities Acquired in 2002 -------------------- Cash........................................... $ 2,762 Receivables.................................... 23,463 Inventories.................................... 25,816 Prepaid assets................................. 767 Property....................................... 43,752 Investment in equity affiliates (Lubrizol...... (22,911) India) Goodwill....................................... 32,672 Intangibles.................................... 17,185 Other assets................................... 482 ------- Total assets................................... 123,988 ------- Short-term debt................................ 1,006 Accounts payable............................... 10,984 Accrued expenses............................... 1,495 Long-term debt................................. 1,248 Minority interest.............................. 22,584 ------- Total liabilities.............................. 37,317 ------- Increase in net assets from acquisitions and consolidation of LZ India................. $ 86,671 =========
46 THE LUBRIZOL CORPORATION In 2001, the company spent $14.7 million on an acquisition to purchase ROSS Chem, Inc., a manufacturer and supplier of antifoam and defoaming agents, with annual revenues of $10.0 million, that expanded the company's product lines in metalworking and paints, coatings and inks. Also in 2001, the company dissolved the joint venture with GE Transportation Systems and replaced the joint venture with separate cross-licensing agreements. On January 30, 2004, the company acquired the additives business of Avecia for approximately $125 million. The additives business of Avecia has annualized revenues of approximately $50 million and develops, manufactures and markets high-value additives used in coatings and inks. NOTE 16 -- RESTRUCTURING CHARGE In 2003, the company recorded a restructuring charge of $22.5 million, or $.29 per share, related to the separation of 252 employees in the United States, Europe and India, comprising 5% of our worldwide workforce. The workforce reductions are estimated to result in annual pretax savings of approximately $20 million beginning in 2004. The company began to realize savings in 2003 of approximately $5 million. In February 2003, the company initiated a restructuring at its Bromborough, England, facility by consolidating various operational activities to achieve greater efficiency through improved business processes. There was a workforce reduction of 45 employees, or approximately 41% of the facility's headcount, by the end of January 2004. As a result of these changes, the company recorded a restructuring charge for Bromborough of $7.0 million in 2003 comprised of $3.5 million in severance costs, $3.3 million in asset impairments and $.2 million in other miscellaneous costs. Cash expenditures in 2003 were $3.5 million and an accrued liability of $.2 million remained at December 31, 2003, relating to employee severance costs. The restructuring charge also included $1.5 million for a voluntary separation program for approximately 55 employees at the company's India joint venture, Lubrizol India Private Limited, which is accounted for using the consolidated method. The workforce reduction occurred primarily in the second quarter of 2003. Cash expenditures for India were $1.4 million in 2003 and an accrued liability of $.1 million remained at December 31, 2003. Lastly, in November 2003, the company announced workforce reductions of approximately 150 employees at its headquarters in Wickliffe, Ohio, its Deer Park and Bayport, Texas, manufacturing facilities and its Hazelwood, England, technical facility. All of the workforce reductions occurred prior to December 31, 2003. This resulted in a restructuring charge in the United States of $12.8 million, comprised of $11.2 million in severance costs and $1.6 million in outplacement and other miscellaneous costs and a restructuring charge in Europe for $1.2 million, primarily for employee severance costs. The charge for Europe included $.8 million for the Hazelwood, England, testing facility and $.4 million for the closing of a sales office in Scandinavia. Cash expenditures in 2003 were $.7 million in the United States and $1.2 million in Europe with an accrued liability as of December 31, 2003, of $12.1 million in the United States. Most of the accrued liability will be paid during the first quarter of 2004. The charge for these cost reduction initiatives are reported as a separate line item in the consolidated income statement, entitled "Restructuring charge" and are included in the "Total cost and expenses" subtotal on the consolidated income statement. The charge related primarily to the fluid technologies for transportation segment. The following table shows the reconciliation of the December 31, 2003 liability balance:
Year Ended December 31, 2003 ----------------- December 31, 2002 balance $ -- Restructuring charge................. 22,534 Less cash paid....................... (6,857) Less asset impairments............... (3,327) Translation adjustments.............. 35 -------- December 31, 2003 balance............ $ 12,385 ========
NOTE 17 -- LITIGATION The company is party to lawsuits, threatened lawsuits and other claims arising out of the normal course of business. Management is of the opinion that any liabilities that may result were adequately covered by insurance, or to the extent not covered by insurance, are adequately accrued for at December 31, 2003, or would not be significant in relation to the company's financial position at December 31, 2003, or its results of operations for the year then ended. 47 THE LUBRIZOL CORPORATION HISTORICAL SUMMARY
(In Millions, Except Shareholders, Employees and Per Share Data) 2003 2002 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------------------------ OPERATING RESULTS Revenues..................................................... $ 2,052.1 $ 1,983.9 $ 1,844.6 $ 1,775.8 $ 1,780.3 Total cost and expenses*..................................... 1,900.2 1,781.5 1,671.4 1,592.5 1,574.1 Gain on litigation settlements............................... 19.4 17.6 Net interest expense & other income.......................... (22.9) (22.0) (33.3) (32.3) (28.5) Income before cumulative effect of change in accounting principle................................... 90.8 126.3 94.1 118.0 123.0 Cumulative effect of change in accounting principle...................................... (7.8) Net income................................................... 90.8 118.5 94.1 118.0 123.0 Income per share before cumulative effect of change in accounting principle......................... 1.76 2.45 1.84 2.22 2.25 Cumulative effect of change in accounting principle per share....................................... (0.15) Net income per share......................................... 1.76 2.30 1.84 2.22 2.25 FINANCIAL RATIOS Gross profit percentage...................................... 26.4 28.5 27.4 27.8 30.9 Percent of revenues: Selling and administrative expenses....................... 9.9 9.9 9.6 9.5 10.2 Research and testing expenses............................. 8.1 8.5 8.6 8.5 8.2 Return on average shareholders' equity (%)................... 10.0 14.4 12.3 15.3 15.8 Debt to capitalization (%)................................... 29.0 31.6 33.9 34.5 33.8 Current ratio................................................ 3.1 3.0 2.9 2.6 2.5 OTHER INFORMATION Dividends declared per share................................. $ 1.04 $ 1.04 $ 1.04 $ 1.04 $ 1.04 Average common shares outstanding............................ 51.6 51.5 51.2 53.1 54.6 Capital expenditures......................................... $ 88.5 $ 65.3 $ 66.3 $ 85.8 $ 64.9 Depreciation expense......................................... 95.5 91.6 84.7 88.0 88.3 At year end: Total assets.............................................. $ 1,942.3 $ 1,860.1 $ 1,662.3 $ 1,659.5 $ 1,682.4 Total debt................................................ 389.6 401.9 397.2 395.9 403.0 Total shareholders' equity................................ 953.3 869.3 773.2 752.3 790.1 Shareholders' equity per share............................ 18.48 16.89 15.12 14.66 14.50 Common share price........................................ 32.52 30.50 35.09 25.75 30.88 Number of shareholders.................................... 3,903 4,081 4,335 4,681 5,126 Number of employees....................................... 5,032 5,231 4,530 4,390 4,074
* Includes restructuring charges of $22.5 million in 2003 and $19.6 million in 1999 and a restructuring credit of $4.5 million in 2000. 48 THE LUBRIZOL CORPORATION EX-21 12 l05101aexv21.txt EX-21 PRINCIPAL SUBSIDIARIES . . . EXHIBIT 21 THE LUBRIZOL CORPORATION
% OF STATE/COUNTRY PRINCIPAL SUBSIDIARIES OWNERSHIP OF INCORPORATION Lubrizol Adibis (UK) Limited 100% United Kingdom Lubrizol do Brasil Aditivos Ltda. 100% Brazil Lubrizol Canada Limited 100% Canada Lubrizol de Chile Limitada 100% Chile Lubrizol China, Inc. 100% Ohio Lubrizol Deutschland GmbH 100% Germany Lubrizol Espanola, S.A. 100% Spain Lubrizol Europe B.V. 100% The Netherlands Lubrizol Foam Control Additives, Inc. 100% South Carolina Lubrizol France S.A.S. 100% France Lubrizol Gesellschaft m.b.H. 100% Austria Lubrizol International, Inc. 100% Cayman Islands Lubrizol International Management Corporation 100% Nevada Lubrizol Italiana S.p.A. 100% Italy Lubrizol Japan Limited 100% Japan Lubrizol Limited 100% United Kingdom Lubrizol de Mexico Comercial, S. de R.L. de C.V. 100% Mexico Lubrizol Overseas Trading Corporation 100% Delaware Lubrizol Performance Systems Inc. 100% Georgia Lubrizol Performance Systems Limited 100% United Kingdom Lubrizol Servicios Tecnicos, S. de C.V. 100% Mexico Lubrizol South Africa (Pty) Limited 100% South Africa Lubrizol Southeast Asia (Pte.) Ltd. 100% Singapore Lubrizol de Venezuela, C.A. 100% Venezuela Carroll Scientific, Inc. 100% Illinois Chemron Corporation 100% Delaware CPI Engineering Services, Inc. 100% Michigan Engine Control Systems Europe AB 100% Sweden Engine Control Systems Ltd. 100% Nevada Engine Control Systems Ltd. 100% United Kingdom Gateway Additive Company 100% Nevada Lanzhou Lubrizol - Lanlian Additive Co., Ltd. 50% China Shanghai Lubrizol International Trading Co., Ltd. 100% China Tianjin Lubrizol - Lanlian Additive Co., Ltd. 50.05% China Lubrizol India Private Limited 50% India AFFILIATES Terminal Industrial Apodaca, S.A. de C.V. 40% Mexico Lubrizol Transarabian Company Limited 49% Saudi Arabia
EX-23 13 l05101aexv23.txt EX-23 INDEPENDENT AUDITORS CONSENT EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT THE LUBRIZOL CORPORATION We consent to the incorporation by reference in Registration Statement Nos. 2-99983, 33-61091, 33-42211, and 333-42338 on Form S-8 of The Lubrizol Corporation of our report dated February 6, 2004, (which report expresses an unqualified opinion and includes an explanatory paragraph related to the adoption of Statement of Financial Accounting Standards No. 142 in 2002) incorporated by reference in this Annual Report on Form 10-K of The Lubrizol Corporation for the year ended December 31, 2003. /s/Deloitte & Touche LLP - ---------------------------- DELOITTE & TOUCHE LLP Cleveland, Ohio February 27, 2004 EX-31 14 l05101aexv31.txt EX-31 302 CERTIFICATIONS THE LUBRIZOL CORPORATION Exhibit 31 Rule 13a-14(a) Certification I, William G. Bares, certify that: 1. I have reviewed this annual report on Form 10-K of The Lubrizol Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based upon such evaluation; c) disclosed in this report any change in registrant's internal control over financial reporting that occurred during registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ William G. Bares - --------------------------- William G. Bares Chief Executive Officer February 18, 2004 THE LUBRIZOL CORPORATION Exhibit 31 Rule 13a-14(a) Certification I, Charles P. Cooley, certify that: 1. I have reviewed this annual report on Form 10-K of The Lubrizol Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based upon such evaluation; c) disclosed in this report any change in registrant's internal control over financial reporting that occurred during registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Charles P. Cooley - -------------------------- Charles P. Cooley Chief Financial Officer February 18, 2004 EX-32 15 l05101aexv32.txt EX-32 906 CERTIFICATIONS THE LUBRIZOL CORPORATION Exhibit 32 Certification of Chief Executive Officer and Chief Financial Officer of The Lubrizol Corporation Pursuant to 18 U.S.C. Section 1350 I certify that, to the best of my knowledge and belief, the Annual Report on Form 10-K of The Lubrizol Corporation for the period ending December 31, 2003: (1) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of The Lubrizol Corporation. /s/ William G. Bares - --------------------------- William G. Bares Chief Executive Officer February 18, 2004 I certify that, to the best of my knowledge and belief, the Annual Report on Form 10-K of The Lubrizol Corporation for the period ending December 31, 2003: (1) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of The Lubrizol Corporation. /s/ Charles P. Cooley - --------------------------- Charles P. Cooley Chief Financial Officer February 18, 2004 -----END PRIVACY-ENHANCED MESSAGE-----