Summary of LUBRIZOL CORP - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. Historical results and percentage relationships set forth in the consolidated financial statements, including trends that might appear, should not be taken as indicative of future operations. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in such forward-looking statements as a result of various factors, including those described under the section "Cautionary Statements for Safe Harbor Purposes" included elsewhere in this Quarterly Report on Form 10-Q.
OVERVIEW
We are an innovative specialty chemical company that produces and supplies technologies that improve the quality and performance of our customers' products in the global transportation, industrial and consumer markets. Our business is founded on technological leadership. Innovation provides opportunities for us in growth markets as well as advantages over our competitors. From a base of approximately 1,600 patents, we use our product development and formulation expertise to sustain our leading market positions and fuel our future growth. We create additives, ingredients, resins and compounds that enhance the performance, quality and value of our customers' products, while minimizing their environmental impact. Our products are used in a broad range of applications and are sold into relatively stable markets such as those for engine oils, specialty driveline lubricants and metalworking fluids, as well as higher-growth markets such as personal care and over-the-counter pharmaceutical products, performance coatings and inks and compressor lubricants. Our specialty chemical products also are used in a variety of industries, including the construction, sporting goods, medical products and automotive industries. We are geographically diverse, with an extensive global manufacturing, supply chain, technical and commercial infrastructure. We operate facilities in 27 countries, including production facilities in 18 countries and laboratories in 13 countries, in key regions around the world through the efforts of approximately 6,800 employees. We sell our products in more than 100 countries and believe that our customers recognize and value our ability to provide customized, high quality, cost-effective performance formulations and solutions worldwide. We also believe our customers highly value our global supply chain capabilities.
We use a broad range of raw materials in our manufacturing processes. The majority of our raw materials are derived from petroleum and petrochemical-based feedstocks, with lubricant base oil being our single largest raw material. The cost of our raw materials can be highly volatile. As a result, our financial performance is influenced significantly by how effectively we manage the margin between our selling prices and the cost of our raw materials.
We are organized into two operating and reportable segments called Lubrizol Additives and Lubrizol Advanced Materials, and we are an industry leader in many of the markets in which our product lines compete. Lubrizol Additives consists of two product lines: (i) engine additives and (ii) driveline and industrial additives. Engine additives is comprised of additives for lubricating engine oils, such as for gasoline, diesel, marine and stationary engines, and additives for fuels, refinery and oil field chemicals. Driveline and industrial additives is comprised of additives for driveline oils, such as automatic transmission fluids, gear oils and tractor lubricants and industrial additives, such as additives for hydraulic, grease and metalworking fluids, as well as compressor lubricants. Both product lines sell viscosity modifiers, as well as provide services for supply chain and knowledge center management.
The Lubrizol Advanced Materials segment consists of three product lines:
(i) engineered polymers, (ii) performance coatings and (iii) Noveon® consumer specialties. The engineered polymers product line includes products such as TempRite® engineered polymers and Estane® thermoplastic polyurethane used within the construction, automotive, telecommunications, electronics and recreation industries. The performance coatings product line includes high-performance polymers and additives for specialty paper, graphic arts, paints, textiles and coatings applications that are sold to customers worldwide. The Noveon consumer specialties product line includes acrylic thickeners, film formers, fixatives, emollients, silicones, specialty surfactants, methyl glucoside, lanolin derivatives and cassia hydrocolloids used within cosmetics, personal care and household products.

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The following factors most affected our consolidated results during the nine months ended September 30, 2009:
• The ongoing global recession has affected the markets we serve and negatively impacted our sales volume. Volume declined 18% compared with the same period in 2008 as demand declined sharply and customers reduced their inventory levels. However, we believe inventory destocking substantially was complete in the first quarter as we experienced sequential quarterly volume growth of 13% and 15% in the third and second quarters, respectively, influenced by customers replenishing their inventories.

• Our disciplined margin management and cost reduction initiatives offset the decline in volume and resulted in an increase in our gross profit percentage to 33.2% from 22.4% in the same period in 2008.

• Our inventory reduction initiatives contributed to the significant increase in cash flow from operations. We reduced production to respond to lower sales volume and reduce inventories. As a result of our abnormally low production, we incurred $61.2 million of unabsorbed manufacturing costs. The reduction in inventory also resulted in charges of $8.5 million due to a liquidation of LIFO inventory quantities carried at higher costs.

• Our aggressive cost reduction actions and organizational restructuring increased operating efficiencies and improved profitability. We reduced manufacturing expenses by curtailing production and reducing spending on supplies and services. Selling, testing, administrative and research (STAR) expenses declined by 2% due to reductions in information technology and travel expenses. Manufacturing and STAR expenses both benefited from a favorable currency impact. The effect of our cost reduction initiatives partially was offset by the increase in incentive and deferred compensation expenses described below. In conjunction with our organizational restructuring, we incurred $15.2 million of severance and benefit charges and $3.6 million of asset impairment charges due to our decision to cease manufacturing at two U.S. facilities.

• Our actual and projected financial performance relative to the financial objectives contained within our annual and long-term incentive compensation programs resulted in additional compensation expense of $21.2 million compared with the same period in 2008. Further, appreciation in the liabilities recorded for our deferred compensation plans and stock appreciation rights, which primarily are based on the value of Lubrizol stock, resulted in additional compensation expense of $18.1 million compared with the same period in 2008.

• The additional interest costs associated with the issuance of $500.0 million of 8.875% notes and the $150.0 million term loan, coupled with lower interest income, reduced our earnings by approximately $0.27 per share as compared with the same period in 2008. The proceeds from these borrowings provided us with sufficient funds to retire in full the 4.625% notes due 2009, enabled us to repay in full our outstanding U.S. revolver balance and to fund the acquisition of the thermoplastic polyurethane business from The Dow Chemical Company (Dow), and strengthened our liquidity with approximately $175.0 million of additional cash.

During the year ended December 31, 2008, we determined goodwill associated with our performance coatings, Estane and TempRite reporting units within our Lubrizol Advanced Materials segment was impaired as the carrying value of goodwill within these reporting units exceeded its fair value. No goodwill remained within our performance coatings reporting unit at September 30, 2009. The remaining value of goodwill associated with our Estane and TempRite reporting units totaled $65.2 million and $77.3 million at September 30, 2009, respectively. A 10% decrease in the fair value of our Estane reporting unit or any further decrease in the fair value of our TempRite reporting unit could indicate the potential for an additional impairment of goodwill. The products within our Estane reporting unit are used within film and sheet for various coating processes, wire and cable insulation, athletic equipment (such as footwear), medical applications, pneumatic tubing and automotive molded parts, and the demand for these products are affected by overall economic conditions. Our TempRite reporting unit serves customers who produce plastic piping for residential and commercial plumbing, fire sprinkler systems and industrial piping applications, and is therefore subject to cyclical demand patterns within these markets. To the extent the weakness in the economy, including the residential and commercial construction markets, persists longer than expected or our cost of capital increases, our Estane or TempRite reporting units could experience a decline in fair value that may result in an additional impairment of goodwill.

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RESULTS OF OPERATIONS
Three Months Ended September 30, 2009 Compared With Three Months Ended
September 30, 2008

                                                           Three Months
                                                        Ended September 30,
(In Millions of Dollars Except Per Share Data)         2009             2008           $ Change         % Change
Revenues                                            $  1,274.6        $ 1,362.7        $   (88.1 )             (6 %)
Cost of sales                                            814.0          1,078.2           (264.2 )            (25 %)

Gross profit                                             460.6            284.5            176.1               62 %

Selling and administrative expenses                      117.7            111.0              6.7                6 %
Research, testing and development expenses                54.8             55.8             (1.0 )             (2 %)
Amortization of intangible assets                          6.3              6.8             (0.5 )             (7 %)
Restructuring and impairment charges                       5.8              5.7              0.1                  *
Other expense (income) - net                               2.8             (4.5 )           (7.3 )                *
Interest income                                           (1.5 )           (3.3 )           (1.8 )            (55 %)
Interest expense                                          26.5             21.6              4.9               23 %

Income before income taxes                               248.2             91.4            156.8              172 %
Provision for income taxes                                73.5             26.2             47.3              181 %

Net income                                               174.7             65.2            109.5              168 %
Net income attributable to noncontrolling
interests                                                  4.2              2.0              2.2              110 %

Net income attributable to The Lubrizol
Corporation                                         $    170.5        $    63.2        $   107.3              170 %


Basic earnings per share attributable to The
Lubrizol Corporation                                $     2.50        $    0.93        $    1.57              169 %


Diluted earnings per share attributable to The
Lubrizol Corporation                                $     2.46        $    0.92        $    1.54              167 %

* Calculation not meaningful

Revenues The decrease in revenues compared with the same period in 2008 was due to a 6% decrease in volume and a 2% unfavorable currency impact, partially offset by a 2% improvement in the combination of price and product mix. Included in these factors were incremental revenues from the thermoplastic polyurethane businesses acquired from Dow and SK Chemicals Co., Ltd. (SK), which contributed 2% to revenues for the quarter.

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The following table shows the geographic mix of our volume as well as the percentage changes compared with the same quarter last year:

                                                                       Excluding
                                                                     the Impact of
                                       2009       2009 vs. 2008      Acquisitions
                                      Volume        % Change           % Change
        North America                    39 %           (12 %)               (13 %)
        Europe                           26 %            (9 %)                (9 %)
        Asia-Pacific / Middle East       28 %             7 %                  5 %
        Latin America                     7 %             -                    -

        Total                           100 %            (6 %)                (7 %)

Volume decreased within our North American and European markets as a result of the continued weakness in the global economy and its impact on demand for our products. Volume increased within our Asia-Pacific / Middle East market due to stronger customer demand as well as temporary business gains due to a competitor's supply difficulties. Compared with the second quarter of 2009, improvements in all of our markets in the third quarter of 2009 led to a 13% sequential increase in volume.
Segment volume variances by geographic zone, as well as the factors explaining the changes in segment revenues during the third quarter of 2009 compared with the same quarter last year, are contained within the "Segment Analysis" section. Cost of Sales The decrease in cost of sales compared with the same quarter last year primarily was due to lower volume, a 25% decline in average raw material cost and reduced manufacturing expenses. Total manufacturing expenses decreased 8% compared with the same quarter last year primarily due to reductions in spending on supplies and services, a favorable currency impact, lower utility costs and a $6.2 million insurance recovery for previously incurred environmental remediation costs. We reduced production to respond to lower sales volume and reduce inventories, and as a result, we incurred $3.8 million of unabsorbed manufacturing costs due to abnormally low production. In the same quarter last year, manufacturing costs included $8.5 million of unabsorbed costs attributed to the temporary shutdown of our two Houston-area manufacturing facilities as well as incremental maintenance and repair costs due to Hurricane Ike.
Gross Profit Gross profit increased $176.1 million, or 62%, compared with the same quarter last year. The increase primarily was due to lower raw material and manufacturing costs and an improvement in the combination of price and product mix, which more than offset lower volume and an unfavorable currency impact. Our gross profit percentage increased to 36.1% compared with 20.9% in the same quarter last year as a result of lower average raw material cost and price increases initiated in 2008.
Selling and Administrative Expenses Selling and administrative expenses increased $6.7 million, or 6%, compared with the same quarter last year. The increase primarily was due to higher deferred compensation expense of $10.0 million and incentive compensation expense of $6.0 million, partially offset by our cost reduction initiatives that included lower expenses for information technology and travel, and a favorable currency impact. Research, Testing and Development Expenses Research, testing and development expenses decreased $1.0 million, or 2%, compared with the same quarter last year primarily due to a favorable currency impact.

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Restructuring and Impairment Charges The components of restructuring and impairment charges during the third quarter of 2009 were as follows:

                                                               Three Months Ended September 30, 2009
                                                  Asset              Other Plant            Severance
(In Millions of Dollars)                       Impairments           Exit Costs           and Benefits          Total
Corporate organizational restructuring        $           -         $           -         $         1.5        $   1.5
Long-lived asset impairments                            0.5                     -                     -            0.5
Lubrizol Additives plant closure and
workforce reductions                                      -                   0.1                     -            0.1
Lubrizol Advanced Materials plant
closures and workforce reductions                       3.6                     -                     -            3.6
Performance coatings 2008 business
improvement initiatives                                   -                     -                   0.1            0.1

Total restructuring and impairment
charges                                       $         4.1         $         0.1         $         1.6        $   5.8

Restructuring charges of $1.5 million related to our organizational restructuring initiated during the year, which increased operating efficiencies and improved profitability.
To improve segment profitability, we decided to cease manufacturing at two U.S. facilities within the performance coatings and engineered polymers product lines of the Lubrizol Advanced Materials segment. Manufacturing of engineered polymers products at the closed facility will be transferred to other facilities to improve the utilization of existing assets. In connection with these facility closures, we recorded asset impairment charges of $3.6 million and expect to record additional restructuring charges of $1.5 million in the remainder of 2009.
The components of restructuring and impairment charges during the third quarter of 2008 were as follows:

                                                                Three Months Ended September 30, 2008
                                                  Asset              Other Plant            Severance
(In Millions of Dollars)                       Impairments           Exit Costs           and Benefits           Total
Lubrizol Additives plant closure and
workforce reductions                          $           -         $           -         $         5.0         $   5.0
Lubrizol Advanced Materials plant
closures and workforce reductions                         -                     -                   0.2             0.2
Performance coatings 2008 business
improvement initiatives                                 0.3                     -                   0.2             0.5

Total restructuring and impairment
charges                                       $         0.3         $           -         $         5.4         $   5.7

Restructuring charges of $5.0 million related to our decision in the third quarter of 2008 to close a Lubrizol Additives blending, packaging and warehouse facility in Ontario, Canada. Manufacturing at this facility ceased during the second quarter of 2009.
Interest Expense The increase in interest expense compared with the same quarter last year primarily was due to the incremental interest expense associated with the issuance of 8.875% notes due 2019 and borrowings under the $150.0 million term loan in the first quarter of 2009.
Provision for Income Taxes Our effective tax rate of 29.6% increased from 28.7% in the same quarter last year primarily as a result of an unfavorable geographic earnings mix, partially offset by an increase in non-taxable foreign currency translation gains associated with international subsidiaries whose functional currency is the U.S. dollar and the benefit from the U.S. research credit that was not available in the prior-year period.
Net Income Attributable to The Lubrizol Corporation Primarily as a result of the above factors, net income per diluted share attributable to The Lubrizol Corporation increased 167% to $2.46 compared with $0.92 in the same quarter last year.

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Nine Months Ended September 30, 2009 Compared With Nine Months Ended

September 30, 2008

                                                            Nine Months
                                                        Ended September 30,
(In Millions of Dollars Except Per Share Data)         2009             2008           $ Change         % Change
Revenues                                            $  3,398.0        $ 3,940.2        $  (542.2 )            (14 %)
Cost of sales                                          2,269.7          3,057.4           (787.7 )            (26 %)

Gross profit                                           1,128.3            882.8            245.5               28 %

Selling and administrative expenses                      323.3            321.5              1.8                1 %
Research, testing and development expenses               153.0            165.6            (12.6 )             (8 %)
Amortization of intangible assets                         18.8             20.8             (2.0 )            (10 %)
Restructuring and impairment charges                      27.3             25.1              2.2                  *
Other income - net                                        (7.7 )          (13.4 )           (5.7 )            (43 %)
Interest income                                           (5.8 )          (10.6 )           (4.8 )            (45 %)
Interest expense                                          83.4             60.2             23.2               39 %

Income before income taxes                               536.0            313.6            222.4               71 %
Provision for income taxes                               160.2             91.7             68.5               75 %

Net income                                               375.8            221.9            153.9               69 %
Net income attributable to noncontrolling
interests                                                  9.2              7.0              2.2               31 %

Net income attributable to The Lubrizol
Corporation                                         $    366.6        $   214.9        $   151.7               71 %


Basic earnings per share attributable to The
Lubrizol Corporation                                $     5.40        $    3.15        $    2.25               71 %


Diluted earnings per share attributable to The
Lubrizol Corporation                                $     5.34        $    3.12        $    2.22               71 %

* Calculation not meaningful

Revenues The decrease in revenues compared with the same period in 2008 was due to an 18% decrease in volume and a 3% unfavorable currency impact, partially offset by a 7% improvement in the combination of price and product mix. Included in these factors were incremental revenues from the thermoplastic polyurethane businesses acquired from Dow and SK, which contributed 2% to revenues.

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The following table shows the geographic mix of our volume as well as the percentage changes compared with the same period in 2008:

                                                                       Excluding
                                                                     the Impact of
                                       2009       2009 vs. 2008      Acquisitions
                                      Volume        % Change           % Change
        North America                    40 %           (22 %)               (23 %)
        Europe                           27 %           (18 %)               (18 %)
        Asia-Pacific / Middle East       26 %           (11 %)               (12 %)
        Latin America                     7 %           (15 %)               (15 %)

        Total                           100 %           (18 %)               (19 %)

We experienced volume decreases across all geographic zones and product categories as a result of inventory destocking by our customers, predominately in the first quarter of 2009, and the continued weakness in the global economy and its impact on demand for our products. However, we experienced sequential quarterly volume growth of 13% and 15% in the third and second quarters of 2009, respectively, influenced by customers replenishing their inventories. Segment volume variances by geographic zone, as well as the factors explaining the changes in segment revenues compared with the same period in 2008, are contained within the "Segment Analysis" section.
Cost of Sales The decrease in cost of sales compared with the same period in 2008 primarily was due to lower volume, a 16% decline in average raw material cost and reduced manufacturing expenses. Total manufacturing expenses decreased 6% compared with the same period last year primarily due to a favorable currency impact, lower utility costs and reductions in spending on supplies and services. Cost of sales also included $61.2 million of unabsorbed manufacturing costs due to abnormally low production and charges of $8.5 million associated with a liquidation of LIFO inventory quantities carried at higher costs. Manufacturing costs during the same period in 2008 included costs of $8.5 million due to Hurricane Ike.
Gross Profit Gross profit increased $245.5 million, or 28%, compared with the same period in 2008. The increase primarily was due to lower raw material and manufacturing costs and an improvement in the combination of price and product mix, partially offset by lower volume and an unfavorable currency impact. Our gross profit percentage increased to 33.2% compared with 22.4% in the same period last year as a result of lower average raw material cost and price increases initiated in 2008.
Selling and Administrative Expenses Selling and administrative expenses increased $1.8 million, or 1%, compared with the same period in 2008 primarily due to higher incentive compensation expense of $13.9 million and deferred compensation expense of $17.9 million. The increase in selling and administrative expenses substantially was offset by our cost reduction initiatives, including lower expenses for information technology and travel, and a favorable currency impact.
Research, Testing and Development Expenses Research, testing and development expenses decreased $12.6 million, or 8%, compared with the same period in 2008 primarily due to our cost reduction initiatives that included lower expenses for supplies, services and travel, and a favorable currency impact. The decrease in research, testing and development expenses partially was offset by increased incentive compensation.

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