UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-5263

THE LUBRIZOL CORPORATION

(Exact name of registrant as specified in its charter)

Ohio		34-0367600
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

29400 Lakeland Boulevard
Wickliffe, Ohio 44092-2298
(Address of principal executive offices)
(Zip Code)

(440) 943-4200
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Number of the registrant’s common shares, without par value, outstanding as of October 30, 2009: 68,266,296.

 

 

THE LUBRIZOL CORPORATION
Quarterly Report on Form 10-Q
Three and Nine Months Ended September 30, 2009

Table of Contents

		Page Number
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited):
Consolidated Statements of Income			1
Consolidated Balance Sheets			2
Consolidated Statements of Cash Flows			3
Notes to Consolidated Financial Statements			4
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			25
Item 3 Quantitative and Qualitative Disclosures About Market Risk			42
Item 4 Controls and Procedures			43
PART II. OTHER INFORMATION
Item 1 Legal Proceedings			44
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			44
Item 6 Exhibits			45
Signatures			46
EX-10.1
EX-31.1
EX-31.2
EX-32.1

PART I. FINANCIAL INFORMATION

Item 1.		Financial Statements

THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In Millions of Dollars Except Per Share Data)		2009				2008				2009				2008
Revenues		$	1,274.6			$	1,362.7			$	3,398.0			$	3,940.2
Cost of sales			814.0				1,078.2				2,269.7				3,057.4
Gross profit			460.6				284.5				1,128.3				882.8
Selling and administrative expenses			117.7				111.0				323.3				321.5
Research, testing and development expenses			54.8				55.8				153.0				165.6
Amortization of intangible assets			6.3				6.8				18.8				20.8
Restructuring and impairment charges			5.8				5.7				27.3				25.1
Other expense (income) — net			2.8				(4.5	)			(7.7	)			(13.4	)
Interest income			(1.5	)			(3.3	)			(5.8	)			(10.6	)
Interest expense			26.5				21.6				83.4				60.2
Income before income taxes			248.2				91.4				536.0				313.6
Provision for income taxes			73.5				26.2				160.2				91.7
Net income			174.7				65.2				375.8				221.9
Net income attributable to noncontrolling interests			4.2				2.0				9.2				7.0
Net income attributable to The Lubrizol Corporation		$	170.5			$	63.2			$	366.6			$	214.9
Net income per share attributable to The Lubrizol Corporation, basic		$	2.50			$	0.93			$	5.40			$	3.15
Net income per share attributable to The Lubrizol Corporation, diluted		$	2.46			$	0.92			$	5.34			$	3.12
Dividends paid per share		$	0.31			$	0.31			$	0.93			$	0.92

The accompanying notes are an integral part of these consolidated financial statements.

THE LUBRIZOL CORPORATION
CONSOLIDATED BALANCE SHEETS

		September 30,				December 31,
(In Millions of Dollars Except Share Data)		2009				2008
ASSETS
Cash and cash equivalents		$	1,127.4			$	186.2
Investments			1.0				9.8
Receivables			728.7				608.5
Inventories			604.9				814.6
Other current assets			115.9				80.8
Total current assets			2,577.9				1,699.9
Property and equipment — at cost			2,954.9				2,878.0
Less accumulated depreciation			1,763.4				1,680.4
Property and equipment — net			1,191.5				1,197.6
Goodwill			798.0				782.1
Intangible assets — net			347.2				361.0
Investments in non-consolidated companies			10.7				7.3
Other assets			99.6				102.6
TOTAL		$	5,024.9			$	4,150.5
LIABILITIES AND SHAREHOLDERS’ EQUITY
Short-term debt and current portion of long-term debt		$	223.9			$	391.2
Accounts payable			332.3				350.4
Accrued expenses and other current liabilities			370.9				279.7
Total current liabilities			927.1				1,021.3
Long-term debt			1,477.9				954.6
Pension obligations			332.7				340.1
Other postretirement benefit obligations			86.6				83.1
Noncurrent liabilities			149.9				129.1
Deferred income taxes			40.0				37.7
Total liabilities			3,014.2				2,565.9
Contingencies and commitments
Preferred stock without par value — unissued			—				—
Common shares without par value:
Authorized - 120,000,000 shares
Outstanding - 68,149,758 shares at September 30, 2009, after deducting 18,046,136 treasury shares; 67,257,963 shares at December 31, 2008, after deducting 18,937,931 treasury shares			808.7				764.7
Retained earnings			1,209.9				906.3
Accumulated other comprehensive loss			(76.0	)			(147.3	)
Total of The Lubrizol Corporation shareholders’ equity			1,942.6				1,523.7
Noncontrolling interests			68.1				60.9
Total shareholders’ equity			2,010.7				1,584.6
TOTAL		$	5,024.9			$	4,150.5

The accompanying notes are an integral part of these consolidated financial statements.

THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

		Nine Months Ended
		September 30,
(In Millions of Dollars)		2009				2008
CASH PROVIDED BY (USED FOR):
OPERATING ACTIVITIES
Net income		$	375.8			$	221.9
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization			125.6				128.1
Deferred income taxes			(2.2	)			(7.2	)
Stock-based compensation			17.1				10.6
Restructuring and impairment charges			11.0				15.1
Gain from investments and sales of property and equipment			—				(0.1	)
Change in current assets and liabilities, net of acquisitions:
Receivables			(106.2	)			(143.7	)
Inventories			215.9				(107.6	)
Accounts payable, accrued expenses and other current liabilities			99.2				74.8
Other current assets			(15.4	)			(0.1	)
			193.5				(176.6	)
Other items — net			13.3				(3.8	)
Total operating activities			734.1				188.0
INVESTING ACTIVITIES
Capital expenditures			(107.1	)			(146.8	)
Acquisitions			(1.0	)			0.9
Purchase of investments			—				(50.0	)
Proceeds from investments			5.6				—
Other items — net			0.2				1.4
Total investing activities			(102.3	)			(194.5	)
FINANCING ACTIVITIES
Changes in short-term debt — net			(4.8	)			0.2
Repayments of long-term debt			(286.0	)			(0.2	)
Proceeds from the issuance of long-term debt			646.3				0.4
Payment of Treasury rate lock upon settlement			(16.7	)			—
Payment of debt issuance costs			(4.8	)			—
Dividends paid			(62.8	)			(62.6	)
Dividends to noncontrolling interests			(2.5	)			(5.3	)
Common shares purchased			—				(75.1	)
Proceeds from the exercise of stock options			22.5				3.8
Excess tax benefit from the exercise of stock options and awards			7.0				2.2
Total financing activities			298.2				(136.6	)
Effect of exchange rate changes on cash			11.2				13.2
Net increase (decrease) in cash and cash equivalents			941.2				(129.9	)
Cash and cash equivalents at the beginning of period			186.2				502.3
Cash and cash equivalents at the end of period		$	1,127.4			$	372.4

The accompanying notes are an integral part of these consolidated financial statements.

THE LUBRIZOL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Nine Months Ended September 30, 2009 and 2008
(Unaudited)

1. Basis of Presentation

The Lubrizol Corporation (the company) is an innovative specialty chemical company that produces and supplies technologies that improve the quality and performance of its customers’ products in the global transportation, industrial and consumer markets. These technologies include lubricant additives for engine oils, other transportation-related fluids and industrial lubricants, as well as additives for gasoline and diesel fuel. In addition, the company makes ingredients and additives for personal care products and pharmaceuticals; engineered polymers, including plastics technology; and performance coatings in the form of specialty resins and additives.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all normal and recurring adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2009, are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

The consolidated balance sheet at December 31, 2008, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for a complete set of financial statements.

The company has evaluated subsequent events occurring through November 6, 2009, the date upon which the consolidated financial statements were issued.

2. Significant Accounting Policies

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Net Income per Share Attributable to The Lubrizol Corporation

Net income per share attributable to The Lubrizol Corporation is computed by dividing net income attributable to The Lubrizol Corporation by the weighted-average common shares of The Lubrizol Corporation outstanding during the period, including contingently issuable shares. Net income per diluted share attributable to The Lubrizol Corporation includes the dilutive impact resulting from outstanding stock options and awards. Per share amounts are computed as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Numerator (in millions):
Net income attributable to The Lubrizol Corporation		$	170.5			$	63.2			$	366.6			$	214.9
Denominator (in millions of shares):
Weighted-average common shares outstanding			68.1				67.8				67.9				68.2
Dilutive effect of stock options and awards			1.3				0.7				0.8				0.8
Denominator for net income per share, diluted			69.4				68.5				68.7				69.0
Net income per share attributable to The Lubrizol Corporation, basic		$	2.50			$	0.93			$	5.40			$	3.15
Net income per share attributable to The Lubrizol Corporation, diluted		$	2.46			$	0.92			$	5.34			$	3.12

Options to purchase 0.9 million shares were excluded from the diluted earnings per share calculation because they were antidilutive for the nine months ended September 30, 2009. Options to purchase 0.5 million shares and 0.4 million shares were excluded from the diluted earnings per share calculations because they were antidilutive for the three and nine months ended September 30, 2008, respectively.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

New Accounting Standards

ACCOUNTING STANDARDS ADOPTED IN 2009

In June 2009, the Financial Accounting Standards Board (FASB) issued an update to Accounting Standards Codification (ASC) topic 105, “Generally Accepted Accounting Principles.” The update establishes the ASC as the sole source of authoritative, nongovernmental U.S. GAAP. The ASC does not create new accounting or reporting guidance, but rather is intended to facilitate research of applicable U.S. GAAP to a particular transaction or accounting issue by organizing existing U.S. GAAP literature into various accounting topics. The ASC is effective for financial statements that cover interim and annual periods ending after September 15, 2009. The adoption of this update on July 1, 2009, did not have a material effect on the company’s consolidated financial statements.

In May 2009, the FASB issued ASC topic 855, “Subsequent Events.” ASC 855 establishes standards of accounting for, and disclosures of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 is effective for interim or fiscal periods ending after June 15, 2009. The adoption of this topic on June 30, 2009, did not have a material effect on the company’s consolidated financial statements.

In April 2009, the FASB issued updates to ASC topic 470, “Debt” and ASC topic 270, “Interim Reporting.” The updates increase the frequency of fair value disclosures for financial instruments that are not reflected currently on a company’s balance sheet at fair value. The updates require disclosure of the fair values of assets and liabilities

not measured on the balance sheet at fair value on a quarterly basis, in addition to qualitative and quantitative information about fair value estimates for those financial instruments. The company adopted these updates on June 30, 2009. Refer to Note 6 for further discussion.

In March 2008, the FASB issued an update to ASC topic 815, “Derivatives and Hedging.” This update requires enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The company adopted this update on January 1, 2009. Refer to Note 7 for further discussion.

In December 2007, the FASB issued an update to ASC topic 810, “Consolidation.” This update establishes accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This update requires consolidated net income attributable to both the parent and the noncontrolling interest to be reported and disclosed in the consolidated financial statements. This update also requires expanded disclosures in the consolidated financial statements that clearly identify and distinguish between the interests of the parent’s owners and the interests of the noncontrolling owners of a subsidiary. The company adopted this update on January 1, 2009, and retrospectively applied the presentation and disclosure requirements.

In December 2007, the FASB issued an update to ASC topic 805, “Business Combinations.” The update requires an acquirer to recognize the assets acquired, the liabilities assumed and any noncontrolling interests in the acquiree at the acquisition date measured at their fair values as of that date, with limited exceptions. The update requires that costs incurred to effect the acquisition be recognized separately from the acquisition as period costs. The update also requires the recognition of restructuring costs that the acquirer expects to incur, but is not obligated to incur, separately from the business combination. Other key provisions of the update include the requirement to recognize the acquisition-date fair values of research and development assets separately from goodwill and the requirement to recognize changes in the amount of deferred tax benefits that are recognizable due to the business combination in either income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. At September 30, 2009, the company had amounts recorded in its financial statements for unrecognized tax benefits and deferred tax valuation allowances related to past acquisitions that will affect the income tax provision in the period of reversal under the updated topic. With the exception of certain tax-related aspects described above, the update applies prospectively to business combinations for which the acquisition date is on or after fiscal years beginning after December 15, 2008. The adoption of this update on January 1, 2009, did not have a material effect on the company’s consolidated financial statements.

ACCOUNTING STANDARDS NOT YET ADOPTED

In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13, “Multiple-Deliverable Revenue Arrangements, a Consensus of the FASB Emerging Issues Task Force.” ASU 2009-13 allows companies to allocate consideration in multiple deliverable arrangements based on the company’s best estimate of selling price when vendor specific objective evidence or vendor objective evidence of the fair value of deliverables is not available. In addition, the residual method of allocating consideration to delivered items is no longer permitted. ASU 2009-13 is effective for fiscal years beginning on or after June 15, 2010, with early application permitted. The company is evaluating the impact of this update on its consolidated financial statements.

In June 2009, the FASB issued an update to ASC topic 810, “Consolidation.” This update eliminates the exception to consolidating qualifying special-purpose entities, contains new criteria for determining the primary beneficiary and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. This update also contains a new requirement that any term, transaction or arrangement that does not have a substantive effect on an entity’s status as a variable interest entity, a company’s power over a variable interest entity or a company’s obligation to absorb losses or its right to receive benefits of an entity must be disregarded in determining whether a company is the primary beneficiary of a variable interest entity. This update is effective for fiscal years beginning after November 15, 2009, and for interim periods within that first

period, with earlier adoption prohibited. The company is evaluating the impact of this update on its consolidated financial statements.

In June 2009, the FASB issued an update to ASC topic 860, “Transfers and Servicing.” This update eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets. This update is effective for transfers of financial assets in fiscal years beginning after November 15, 2009, and in interim periods within those fiscal years, with earlier adoption prohibited. The company is evaluating the impact of this update on its consolidated financial statements.

In December 2008, the FASB issued an update to ASC topic 715, “Compensation-Retirement Benefits.” This update requires additional disclosure surrounding the benefit plan investment allocation decision-making process, the fair value of each major category of plan assets, the valuation techniques used to measure the fair value of plan assets and any significant concentrations of risk within plan assets. This update is effective for annual periods ending after December 15, 2009, with early application permitted. As this update only requires enhanced disclosures, the company does not expect that the adoption of this update will have a material effect on its consolidated financial statements.

3. Acquisitions

On December 31, 2008, the company completed the acquisition of the thermoplastic polyurethane business from The Dow Chemical Company for approximately $59.9 million in cash, including transaction costs. The acquisition included technology, trade names, customer lists and manufacturing know-how. As part of the transaction, the company also acquired a manufacturing facility in La Porte, Texas, which included equipment and inventory. The preliminary purchase price allocation for this acquisition included goodwill of $2.4 million and intangible assets of $19.4 million, which included $1.6 million of in-process research and development.

On October 10, 2008, the company completed the acquisition of the thermoplastic polyurethane business from SK Chemicals Co., Ltd. for approximately $5.0 million in cash, which will be paid in 2009 and 2010. The acquisition included equipment, technology, customer lists and manufacturing know-how. The purchase price allocation for this acquisition included goodwill of $0.3 million and intangible assets of $0.6 million.

The pro forma impacts of acquisitions in 2008 were immaterial to the company’s consolidated financial statements.

4. Inventories

The company’s inventories were comprised of the following:

		September 30,				December 31,
(In Millions of Dollars)		2009				2008
Finished products		$	358.5			$	468.8
Products in process			105.9				137.8
Raw materials			104.4				172.8
Supplies and engine test parts			36.1				35.2
Total inventory		$	604.9			$	814.6

During the nine months ended September 30, 2009, a reduction in inventory resulted in a liquidation of LIFO inventory quantities carried at higher costs and increased cost of sales by $8.5 million.

5. Goodwill and Intangible Assets

Goodwill is tested for impairment at the reporting unit level as of October 1 of each year or if events or circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The company has determined that the Lubrizol Additives operating segment constitutes a reporting unit, and that the Noveon^® consumer specialties product line, Estane^® engineered polymers business, TempRite^® engineered polymers business and performance coatings product line within the Lubrizol Advanced Materials operating segment constitute separate reporting units. The carrying amount of goodwill by reportable segment was as follows:

		Lubrizol
		Advanced				Lubrizol
(In Millions of Dollars)		Materials				Additives				Total
Balance, December 31, 2008		$	599.0			$	183.1			$	782.1
Purchase adjustments			(0.3	)			—				(0.3	)
Translation adjustments			14.0				2.2				16.2
Balance, September 30, 2009		$	612.7			$	185.3			$	798.0

The major components of the company’s identifiable intangible assets are customer lists, technology, trademarks, patents, land-use rights, favorable lease arrangements and non-compete agreements. Finite-lived intangible assets are amortized over their useful lives, which range between 3 and 20 years, except for land-use rights, which have useful lives up to 50 years. The company’s indefinite-lived intangible assets include certain trademarks that are tested for impairment each year as of October 1 or more frequently if impairment indicators arise.

The following table shows the components of identifiable intangible assets:

		September 30, 2009								December 31, 2008
		Gross								Gross
		Carrying				Accumulated				Carrying				Accumulated
(In Millions of Dollars)		Amount				Amortization				Amount				Amortization
Amortized intangible assets:
Customer lists		$	193.6			$	54.4			$	189.2			$	44.1
Technology			148.6				61.0				160.3				66.9
Trademarks			31.3				10.0				30.3				8.3
Patents			11.0				5.7				10.2				4.6
Land-use rights and favorable lease arrangements			11.4				2.1				14.6				1.9
Non-compete agreements			0.8				0.3				1.0				0.3
Total amortized intangible assets			396.7				133.5				405.6				126.1
Non-amortized trademarks			84.0				—				81.5				—
Total		$	480.7			$	133.5			$	487.1			$	126.1

6. Debt

The company’s debt was comprised of the following:

		September 30,				December 31,
(In Millions of Dollars)		2009				2008
Short-term debt and current portion of long-term debt:
Current portion of long-term debt		$	223.9			$	386.3
Other short-term debt			—				4.9
		$	223.9			$	391.2
Long-term debt:
4.625% notes, due 2009, net of original issue discount of $0.1 million and fair value adjustment of $4.3 million for unrealized gains on derivative instruments at December 31, 2008		$	204.9			$	386.0
5.5% notes, due 2014, net of original issue discount of $1.7 million and $1.9 million at September 30, 2009, and December 31, 2008, respectively, and fair value adjustments of $5.6 million for unrealized gains on derivative instruments at September 30, 2009			453.9				448.1
8.875% notes, due 2019, net of original issue discount of $3.6 million at September 30, 2009			496.4				—
7.25% debentures, due 2025			100.0				100.0
6.5% debentures, due 2034, net of original issue discount of $4.7 million at both September 30, 2009, and December 31, 2008			295.3				295.3
Debt supported by banking arrangements:
Term loan, at LIBOR plus 2.75% (3.00% at September 30, 2009)			150.0				—
U.S. revolving credit borrowing, at prime (3.25% at December 31, 2008)			—				75.0
Euro revolving credit borrowing, at EURIBOR plus .325% (3.036% at December 31, 2008)			—				34.9
Other			1.3				1.6
			1,701.8				1,340.9
Less: current portion of long-term debt			223.9				386.3
Total long-term debt		$	1,477.9			$	954.6

In July 2009, the company entered into a three-year, unsecured €150.0 million revolving credit facility maturing in July 2012. In conjunction with this new facility, the company terminated the €250.0 million revolving credit facility that would have matured in September 2010. This new facility permits the company to borrow at variable rates based on EURIBOR for euro borrowings or LIBOR for dollar or pound sterling borrowings plus a specified credit spread. The company may elect to increase the facility amount once each year in increments of €10.0 million, up to an aggregate maximum of €200.0 million, subject to approval by the lenders.

In March 2009, the company repurchased $177.0 million of the 4.625% notes due October 1, 2009, at a purchase price of 100.5% per note, resulting in a loss on retirement of $1.3 million. The company also accelerated amortization of $0.6 million in debt issuance costs, Treasury rate lock agreements and original issue discounts associated with the repurchased notes. The loss on retirement and accelerated amortization costs resulting from the repurchase of the 4.625% notes were included in interest expense within the accompanying consolidated statements of income.

In February 2009, the company entered into a $150.0 million term loan. The term loan is an unsecured, senior obligation of the company that matures in February 2012 and bears interest based upon LIBOR plus a specified credit spread. Beginning in April 2010, the company is required to make quarterly principal payments. The total annual principal payments are $28.1 million in 2010, $54.4 million in 2011 and $67.5 million in 2012. The term loan

is prepayable without penalty. The company used a portion of the proceeds from this loan to repay in full the $75.0 million of indebtedness outstanding under its U.S. revolving credit facility at December 31, 2008.

In January 2009, the company issued senior unsecured notes having an aggregate principal amount of $500.0 million at a price of 99.256%. The notes mature in February 2019 and bear interest at 8.875% per annum, payable semi-annually on February 1 and August 1 of each year. Including debt issuance costs, original issue discounts and losses on Treasury rate lock agreements, the notes have an effective annualized interest rate of approximately 9.2%. The notes include a step-up in interest payable in the event of certain ratings downgrades by credit rating agencies. Upon the occurrence of a change of control triggering event, as defined in the indenture, the company would be required to make an offer to repurchase the notes at 101% of their principal amount. The company used a portion of the net proceeds from these notes to repurchase $177.0 million of the 4.625% notes in March 2009 and repay in full on October 1, 2009, the $204.9 million remaining aggregate principal amount of the 4.625% notes.

The U.S. and euro bank credit agreements contain customary affirmative covenants including, among others, compliance with laws, payment of taxes, maintenance of insurance, conduct of business, keeping of books and records, maintenance of properties and ensuring the credit facilities receive the same rights and privileges as any future senior unsecured debt. The agreements also contain customary negative covenants including, among others, restrictions on: liens and encumbrances, sale of assets and affiliate transactions. Additionally, the company is required to comply with financial ratios of debt to consolidated earnings before interest, income taxes, depreciation and amortization, extraordinary, unusual or non-recurring non-cash gains or losses, including the sale of property and equipment and goodwill impairments, and non-cash gains or losses from less than wholly owned subsidiaries and investments (Consolidated EBITDA), as defined in the credit agreements, and Consolidated EBITDA to interest expense.

In March 2009, the company amended the required debt to Consolidated EBITDA ratio within the bank credit agreements. Effective with the amendments, to the extent that the company has cash or cash equivalents in an amount sufficient for the payment of the outstanding 4.625% notes, the company may exclude these notes from the calculation of debt for all periods prior to October 1, 2009. At September 30, 2009, the credit agreements required that the ratio of debt to Consolidated EBITDA be less than 3.5:1 and the ratio of Consolidated EBITDA to interest expense be greater than 3.5:1. At September 30, 2009, the company maintained a ratio of debt to Consolidated EBITDA of 1.8:1 and a ratio of Consolidated EBITDA to interest expense of 8.6:1.

The bank credit agreements also contain customary events of default including, among others, failure to make payment when due, materially incorrect representations and warranties, breach of covenants, events of bankruptcy, the occurrence of one or more unstayed judgments in excess of $25.0 million that is not covered by an acceptable policy of insurance, a party obtaining a beneficial ownership in excess of 20% of the company’s voting stock, or the incurrence of $25.0 million of liabilities related to violations of employee benefit plan regulations or the withdrawal or termination of a multiemployer benefit plan. At September 30, 2009, the company was in compliance with all of its covenants and has not committed any acts of default.

The estimated fair value of the company’s debt instruments at September 30, 2009, and December 31, 2008, approximated $1,869.1 million and $1,239.3 million, respectively, compared with a carrying value of $1,701.8 million and $1,345.8 million, respectively. The fair value of the company’s debt instruments was estimated using prevailing market interest rates on long-term debt with similar creditworthiness, terms and maturities.

7. Derivative Instruments and Hedging Activities

In the normal course of business, the company uses derivative financial instruments, including interest rate swap agreements, Treasury rate lock agreements, commodity purchase contracts and foreign currency forward contracts, to manage its risks. The company’s objective in managing its exposure to changes in interest rates is to limit the impact of such changes on its earnings and cash flow. The company manages its interest rate risk using a mix of fixed-rate and variable-rate debt. To achieve this mix, the company may enter into interest rate swap agreements whereby 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. The company also is exposed to interest rate risk on forecasted debt issuances. To manage this risk, the company may use Treasury rate lock agreements to fix the rate used to determine the interest payments related to all or a portion of the forecasted debt issuance. The company’s objective in managing its exposure to changes in commodity prices is to reduce the volatility of utility expense on earnings through the use of commodity purchase contracts. The company’s objective in managing its exposure to changes in foreign currency exchange rates is to reduce the volatility on earnings and cash flow of such changes through the use of foreign currency forward contracts. The company does not hold derivatives for trading purposes.

Derivative financial instruments are recognized on the balance sheet as either assets or liabilities and are measured at fair value. Derivatives that are not designated as hedges are recorded at fair value through adjustments to current earnings. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gains or losses on the derivatives, along with any gains and losses upon termination of the derivatives, are reported as a component within accumulated other comprehensive gain or loss and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

The company designated its interest rate swap agreements as fair value hedges of fixed-rate borrowings, commodity purchase contracts as cash flow hedges of forecasted purchases of natural gas and Treasury rate lock agreements as cash flow hedges of the semi-annual interest payments associated with forecasted debt issuances. Foreign currency forward contracts are not designated as hedging instruments. The company’s derivative instruments do not contain any credit-risk-related contingent features.

The following table shows the location and fair value of derivative instruments reported in the consolidated balance sheets at September 30, 2009, and December 31, 2008 (in millions of dollars):

Asset Derivatives
						September 30,				December 31,
		Balance Sheet Location				2009				2008
Derivatives designated as hedging instruments:
Interest rate swap agreements		Other current assets				$	—			$	4.3
Commodity purchase contracts		Other current assets					0.3				—
Interest rate swap agreements		Other assets					5.6				—
						$	5.9			$	4.3
Derivatives not designated as hedging instruments:
Foreign currency forward contracts		Other current assets				$	—			$	2.1
Liability Derivatives
						September 30,				December 31,
		Balance Sheet Location				2009				2008
Derivatives designated as hedging instruments:
Treasury rate lock agreements		Accrued expenses and other current liabilities				$	—			$	20.0
Commodity purchase contracts		Accrued expenses and other current liabilities					4.0				5.5
Commodity purchase contracts		Noncurrent liabilities					—				1.5
						$	4.0			$	27.0
Derivatives not designated as hedging instruments:
Foreign currency forward contracts		Accrued expenses and other current liabilities				$	0.5			$	0.3

Fair Value Hedges

In May and June 2009, the company entered into three interest rate swap agreements, each with a notional amount of $50.0 million, that effectively converted the interest on $150.0 million of outstanding 5.5% notes due 2014 to a variable rate of six-month LIBOR plus 134 basis points, 156.25 basis points and 188 basis points. In November 2004, the company entered into four interest rate swap agreements, each with a notional amount of $50.0 million, that effectively converted the interest on $200.0 million of outstanding 4.625% notes due 2009 to a variable rate of six-month LIBOR plus 40 basis points. In June 2004, the company entered into two interest rate swap agreements, each with a notional amount of $100.0 million, that effectively converted the interest on $200.0 million of then outstanding 5.875% notes due 2008 to a variable rate of six-month LIBOR plus 111 basis points. These swaps are designated as fair value hedges of underlying fixed-rate debt obligations.

The effective portions of gains and losses on interest rate swap agreements designated as fair value hedges and the offsetting losses or gains on the hedged liabilities recognized in current earnings for the three and nine months ended September 30, 2009, and 2008 were as follows (in millions of dollars):

						Three Months Ended								Nine Months Ended
		Location of Gain (Loss)				September 30,								September 30,
Derivative		Recognized in Earnings				2009				2008				2009				2008
Interest rate swap agreements		Interest expense				$	1.0			$	(0.1	)		$	1.3			$	2.5

						Three Months Ended								Nine Months Ended
		Location of Gain (Loss)				September 30,								September 30,
Hedged Item		Recognized in Earnings				2009				2008				2009				2008
Long-term debt		Interest expense				$	(1.0	)		$	0.1			$	(1.3	)		$	(2.5	)

Cash Flow Hedges

The company uses commodity purchase contracts to manage its exposure to changes in the price for natural gas. At September 30, 2009, and December 31, 2008, the notional amounts of open contracts totaled $27.3 million and $20.9 million, respectively. Contract maturities are less than 24 months.

In November 2008, the company entered into several Treasury rate lock agreements with an aggregate notional principal amount of $200.0 million, all maturing on March 31, 2009, whereby the company had locked in Treasury rates relating to a portion of the then anticipated debt issuance in the first quarter of 2009. These Treasury rate lock agreements were designated as cash flow hedges of the semi-annual interest payments associated with the forecasted debt issuance. In January 2009, the company incurred a pre-tax loss of $16.7 million on the termination of these agreements in conjunction with the issuance of the 8.875% notes.

In June 2004, the company entered into several Treasury rate lock agreements with an aggregate notional principal amount of $900.0 million, all maturing on September 30, 2004, whereby the company had locked in Treasury rates relating to a portion of the then anticipated debt issuance. These Treasury rate lock agreements were designated as cash flow hedges of the semi-annual interest payments associated with the forecasted debt issuance. In September 2004, the company incurred a pre-tax loss of $73.9 million on the termination of these agreements.

Losses upon termination of Treasury rate lock agreements are reported as a component within accumulated other comprehensive loss (AOCL) and reclassified into earnings over the term of the associated debt issuance. The unamortized balance of the Treasury rate lock agreements recorded in AOCL, net of tax, was $42.4 million and $34.7 million at September 30, 2009, and December 31, 2008, respectively.

The effective portions of gains and (losses) on derivative instruments designated as cash flow hedges recognized in other comprehensive income, net of tax, for the three and nine months ended September 30, 2009, and 2008 were as follows (in millions of dollars):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Derivative		2009				2008				2009				2008
Commodity purchase contracts		$	0.1			$	(7.2	)		$	(2.4	)		$	(0.6	)
Treasury rate lock agreements			—				—				2.1				—
		$	0.1			$	(7.2	)		$	(0.3	)		$	(0.6	)

The effective portions of pre-tax gains and (losses) on derivative instruments designated as cash flow hedges reclassified from AOCL into earnings for the three and nine months ended September 30, 2009 and 2008 were as follows (in millions of dollars):

		Location of Gain (Loss)		Three Months Ended								Nine Months Ended
		Reclassified from		September 30,								September 30,
Derivative		AOCL into Earnings		2009				2008				2009				2008
Commodity purchase contracts		Cost of sales		$	(2.4	)		$	0.7			$	(6.8	)		$	1.3
Treasury rate lock agreements		Interest expense			(1.4	)			(1.2	)			(4.6	)			(4.1	)
				$	(3.8	)		$	(0.5	)		$	(11.4	)		$	(2.8	)

The company estimates that it will reclassify into earnings during the next twelve months losses of approximately $4.9 million ($3.2 million net of tax) and $3.7 million ($2.4 million net of tax) from the amounts recorded in AOCL for Treasury rate lock agreements and commodity purchase contracts, respectively.

Derivative Instruments Not Designated as Hedges

The company selectively uses foreign currency forward contracts, in addition to working capital management, pricing and sourcing, to minimize the potential effect of currency changes on its earnings. The company’s principal currency exposures are the euro, the pound sterling, the Japanese yen, the Canadian dollar and the Brazilian real. The company does not designate these foreign currency forward contracts as hedges, as the objective for entering into these contracts is to minimize the amount of transaction gains or losses that are included in current earnings arising from exchange rate changes. The maximum amount of foreign currency forward contracts outstanding at any one time was $29.3 million during the nine months ended September 30, 2009. At September 30, 2009, and December 31, 2008, the notional amounts of open short-term forward contracts to buy or sell currencies were $10.5 million and $25.0 million, respectively. The company recognized (losses) gains on foreign currency forward contracts for the three and nine months ended September 30, 2009, and 2008 as follows (in millions of dollars):

		Location of (Loss)		Three Months Ended								Nine Months Ended
		Gain Recognized		September 30,								September 30,
Derivative		in Earnings		2009				2008				2009				2008
Foreign currency forward contracts		Other income-net		$	(0.8	)		$	0.9			$	(1.6	)		$	(0.3	)

8. Fair Value Measurements

The company estimates the fair value of financial instruments using available market information and generally accepted valuation methodologies. Fair value is defined as the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value are classified into three levels: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following table shows the company’s financial assets and liabilities accounted for at fair value on a recurring basis at September 30, 2009:

						Fair Value Measurements at Reporting Date Using
						Quoted Prices				Significant
						in Active				Other				Significant
						Markets for				Observable				Unobservable
		September 30,				Identical Assets				Inputs				Inputs
(In Millions of Dollars)		2009				(Level 1)				(Level 2)				(Level 3)
Assets:
Money market mutual funds (1)		$	875.0			$	870.8			$	4.2			$	—
Interest rate swaps (2)			5.6				—				5.6				—
Commodity purchase contracts (3)			0.3				—				0.3				—
		$	880.9			$	870.8			$	10.1			$	—
Liabilities:
Commodity purchase contracts (3)		$	4.0			$	—			$	4.0			$	—
Foreign currency forward contracts (4)			0.5				—				0.5				—
		$	4.5			$	—			$	4.5			$	—

9. Comprehensive Income

Total comprehensive income was comprised of the following:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In Millions of Dollars)		2009				2008				2009				2008
Net income		$	174.7			$	65.2			$	375.8			$	221.9
Foreign currency translation adjustment			51.7				(82.2	)			61.2				(20.0	)
Pension and other postretirement benefit plans			0.4				3.6				3.5				4.4
Gain (loss) on natural gas hedges — net			1.7				(7.6	)			2.0				(1.4	)
Changes in Treasury rate locks — net			0.9				0.8				5.1				2.7
Total comprehensive income (loss)		$	229.4			$	(20.2	)		$	447.6			$	207.6
Less: Comprehensive income attributable to noncontrolling interests			4.6				—				9.7				4.9
Comprehensive income (loss) attributable to The Lubrizol Corporation		$	224.8			$	(20.2	)		$	437.9			$	202.7

10. Shareholders’ Equity

The following table summarizes the changes in shareholders’ equity since January 1, 2009:

						Shareholders’ Equity
														Accumulated
														Other
		Number of				Common				Retained				Comprehensive				Noncontrolling
(In Millions)		Shares Outstanding				Shares				Earnings				Loss				Interests				Total
Balance, January 1, 2009			67.3			$	764.7			$	906.3			$	(147.3	)		$	60.9			$	1,584.6
Comprehensive income:
Net income											366.6								9.2				375.8
Other comprehensive income															71.3				0.5				71.8
Total comprehensive income																							447.6
Dividends declared											(63.0	)							(2.5	)			(65.5	)
Stock-based compensation							15.4																15.4
Shares issued upon exercise of stock options and awards			0.8				22.5																22.5
Tax benefit from stock compensation							6.1																6.1
Balance, September 30, 2009			68.1			$	808.7			$	1,209.9			$	(76.0	)		$	68.1			$	2,010.7

11. Segment Reporting

The company is organized into two operating and reportable segments: Lubrizol Additives and Lubrizol Advanced Materials. 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. Engineered polymers products are sold to a diverse customer base comprised of major manufacturers in 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. The company markets products in the Noveon consumer specialties product line to customers worldwide, which include major manufacturers of cosmetics, personal care and household products.

The company primarily evaluates performance and allocates resources based on segment operating income as well as projected future performance. Segment operating income is defined as revenues less expenses identifiable to the product lines included within each segment. Segment operating income reconciles to consolidated income before income taxes by deducting corporate expenses and corporate other income that are not attributed to the segments, restructuring and impairment charges and net interest expense.

In the fourth quarter of 2008, the company reorganized its reporting structure for the following two businesses:

	•		The AMPS® specialty monomer business, with 2008 annual revenues of $35.3 million, which previously was reported as part of the Noveon consumer specialties product line, and
	•		The ADEXTM explosives emulsifier business, with 2008 annual revenues of $45.0 million, which previously was reported as part of the engineered polymers product line.

The results for these two businesses now are reported in the driveline and industrial additives product line within the Lubrizol Additives segment. Additionally, on January 1, 2009, the company revised its measurement of segment operating income to include income attributable to noncontrolling interests. Previously, segment operating income excluded the portion of income attributable to noncontrolling interests. The results for the prior periods presented have been adjusted retrospectively to conform to the current year presentation.

The following table presents a summary of the results of the company’s reportable segments:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In Millions of Dollars)		2009				2008				2009				2008
Revenues from external customers:
Lubrizol Additives		$	914.5			$	961.9			$	2,445.1			$	2,752.2
Lubrizol Advanced Materials			360.1				400.8				952.9				1,188.0
Total revenues		$	1,274.6			$	1,362.7			$	3,398.0			$	3,940.2
Segment operating income:
Lubrizol Additives		$	256.5			$	102.1			$	596.4			$	341.1
Lubrizol Advanced Materials			60.5				26.5				122.6				90.4
Segment operating income			317.0				128.6				719.0				431.5
Corporate expenses			(31.7	)			(17.0	)			(76.5	)			(50.7	)
Corporate other (expense) income-net			(6.3	)			3.8				(1.6	)			7.5
Restructuring and impairment charges			(5.8	)			(5.7	)			(27.3	)			(25.1	)
Interest expense-net			(25.0	)			(18.3	)			(77.6	)			(49.6	)
Income before income taxes		$	248.2			$	91.4			$	536.0			$	313.6

The company’s total assets by segment were as follows:

		September 30,				December 31,
(In Millions of Dollars)		2009				2008
Segment assets:
Lubrizol Additives		$	1,813.7			$	1,853.8
Lubrizol Advanced Materials			1,846.7				1,843.2
Total segment assets			3,660.4				3,697.0
Corporate assets			1,364.5				453.5
Total consolidated assets		$	5,024.9			$	4,150.5

12. Pension and Postretirement Benefits

The company has noncontributory defined benefit pension plans covering most employees. Pension benefits under these plans are based on years of service and compensation. The company’s funding policy in the United States is to contribute amounts to satisfy the funding standards of the Internal Revenue Code of 1986, as amended, and the Employee Retirement Income Security Act of 1974, as amended. Outside of the United States, the company’s policy is to fund amounts in accordance with local regulations. Several of the company’s smaller defined benefit plans are not funded.

During 2009, the company amended its salaried defined benefit pension plan in the United States to close the plan to new participants effective January 1, 2010. As part of this change, the company will introduce a new defined contribution plan in the United States to salaried employees hired after January 1, 2010.

The company also provides non-pension postretirement benefits, primarily health care benefits, for some employees. Participants contribute a portion of the cost of these benefits. The company’s non-pension postretirement benefit plans are not funded.

The components of net periodic pension cost consisted of the following:

		Three Months Ended												Three Months Ended
		September 30, 2009												September 30, 2008
		Non-												Non-
(In Millions of Dollars)		U.S. Plans				U.S. Plans				Total				U.S. Plans				U.S. Plans				Total
Service cost — benefits earned during period		$	5.4			$	2.1			$	7.5			$	4.6			$	3.0			$	7.6
Interest cost on projected benefit obligation			7.0				3.5				10.5				6.1				4.5				10.6
Expected return on plan assets			(5.9	)			(3.2	)			(9.1	)			(5.7	)			(3.6	)			(9.3	)
Amortization of prior service costs			0.6				0.1				0.7				0.5				0.3				0.8
Recognized net actuarial loss			1.1				0.3				1.4				0.1				0.5				0.6
Net periodic pension cost		$	8.2			$	2.8			$	11.0			$	5.6			$	4.7			$	10.3

		Nine Months Ended												Nine Months Ended
		September 30, 2009												September 30, 2008
		Non-												Non-
(In Millions of Dollars)		U.S. Plans				U.S. Plans				Total				U.S. Plans				U.S. Plans				Total
Service cost — benefits earned during period		$	16.2			$	6.1			$	22.3			$	14.0			$	9.3			$	23.3
Interest cost on projected benefit obligation			20.8				10.8				31.6				19.2				13.6				32.8
Expected return on plan assets			(17.8	)			(9.5	)			(27.3	)			(16.9	)			(11.4	)			(28.3	)
Amortization of prior service costs			1.8				0.3				2.1				1.6				0.7				2.3
Recognized net actuarial loss			3.4				0.9				4.3				0.7				1.5				2.2
Net periodic pension cost		$	24.4			$	8.6			$	33.0			$	18.6			$	13.7			$	32.3

The components of net periodic non-pension postretirement benefit cost consisted of the following:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In Millions of Dollars)		2009				2008				2009				2008
Service cost — benefits earned during period		$	0.3			$	0.5			$	1.0			$	1.4
Interest cost on projected benefit obligation			1.4				1.4				4.1				4.5
Amortization of prior service credits			(1.7	)			(1.7	)			(5.2	)			(5.1	)
Amortization of initial net obligation			0.1				0.1				0.3				0.4
Recognized net actuarial loss			0.1				0.1				0.3				0.6
Settlement / curtailment gain			—				—				—				(1.1	)
Net periodic non-pension postretirement benefit cost		$	0.2			$	0.4			$	0.5			$	0.7

13. Stock-Based Compensation

The company utilizes the 2005 Stock Incentive Plan (2005 Plan) to provide equity awards to its key employees and directors. The 2005 Plan provides for the granting of up to 4,000,000 common shares in the form of stock appreciation rights, restricted and unrestricted shares, share units (collectively referred to as “full-value awards”) and options to buy common shares, of which no more than 2,000,000 can be settled as full-value awards. After the 2,000,000 limit has been reached, full-value awards are counted in a 3-to-1 ratio against the 4,000,000 limit. Options become exercisable 50% one year after date of grant, 75% after two years, 100% after three years and expire 10 years after grant. In addition, the 2005 Plan provides each nonemployee director of the company an automatic annual grant of restricted share units worth approximately $0.1 million based on the fair market value of the company’s common shares on the date of each annual meeting of shareholders. A pro-rata number of restricted share units are granted to directors appointed between annual meetings of shareholders. All of these restricted share units vest on the date of the next annual meeting of shareholders.

Under the company’s long-term incentive program, dollar-based target awards for three-year performance periods are determined by the organization and compensation committee of the board of directors. The target awards correspond to pre-determined three-year earnings per share growth rates. The dollar-based target awards are converted into a combination of stock options and performance-based share units based on the fair value of the respective awards on the date of grant.

The fair value of stock option awards is estimated using the Black-Scholes option pricing model. There were 438,600 and 253,100 stock options granted during the nine months ended September 30, 2009, and 2008, respectively. Options under the 2005 Plan have been granted to employees at fair market value at the date of grant. The weighted-average assumptions used to value the options granted were as follows:

		Nine Months Ended
		September 30,
		2009				2008
Risk-free interest rate			2.8	%			3.5	%
Dividend yield			4.5	%			2.1	%
Expected volatility			27.9	%			20.0	%
Expected life (years)			6.5				6.5
Weighted-average fair value per share of options granted during the period		$	5.03			$	12.27

The fair value of performance-based share units is based on the closing price of the company’s common shares on the date of grant. The company granted 290,520 and 116,990 performance-based share units during the nine months ended September 30, 2009, and 2008, respectively. There are no voting or dividend rights associated with the performance-based share units until the end of the performance period and a distribution of shares from the 2005 Plan, if any, is made. Nonvested performance-based share units at September 30, 2009, and changes during 2009 were as follows:

						Weighted-
						Average
		Share				Grant Date
		Units				Fair Value
Nonvested at January 1, 2009			232,161			$	53.07
Granted			290,520			$	27.77
Performance increase			519,544			$	41.28
Forfeited			(29,371	)		$	40.21
Nonvested at September 30, 2009			1,012,854			$	40.14

The following table identifies the number of shares expected to be issued based on current expectations of performance and the stock price on the date of grant for the nonvested performance-based share units outstanding at September 30, 2009:

		Expected				Weighted-
		Number				Average
		of Units				Grant Date
Performance Period		to be Issued				Fair Value
2007-2009			236,476			$	53.07
2008-2010			213,328			$	58.45
2009-2011			563,050			$	27.77

During the nine months ended September 30, 2009, the award for the 2006-2008 performance period was distributed resulting in the issuance of 172,381 common shares and the deferral of 112,411 common shares into a deferred

compensation plan. During the nine months ended September 30, 2008, the award for the 2005-2007 performance period was distributed resulting in the issuance of 134,578 shares and the deferral of 96,969 shares into a deferred compensation plan.

The terms of the performance-based share units granted to international employees states that payment will be in cash at the end of the performance period. As such, liability accounting is used for these awards and compensation expense is calculated based on the company’s common share price. In addition, some international employees received stock-based awards in prior years that are similar to stock appreciation rights. The value of these awards is based on the company’s common share price and is paid in cash upon exercise. A portion of these awards expires through 2014, while the remainder expires upon retirement. At September 30, 2009, the unexercised portion of these fully vested awards was accounted for as a liability. Compensation expense recognized in the consolidated statements of income for the three and nine months ended September 30, 2009, related to these stock-based liability awards was $5.9 million and $8.8 million, respectively. Credits to compensation expense recognized in the consolidated statements of income for the three and nine months ended September 30, 2008, related to these stock-based liability awards was $0.5 million and $2.1 million, respectively.

Total stock-based compensation expense recognized in the consolidated statements of income for the three and nine months ended September 30, 2009, was $14.1 million and $25.9 million, respectively, compared with $3.0 million and $8.5 million, respectively, for the three and nine months ended September 30, 2008. The related tax benefit for the three and nine months ended September 30, 2009, was $5.0 million and $9.1 million, respectively, compared with $1.1 million and $3.0 million, respectively, for the three and nine months ended September 30, 2008. At September 30, 2009, there was $20.8 million of total pre-tax unrecognized compensation cost related to all stock-based awards that were not vested. That cost is expected to be recognized over a weighted-average period of 1.8 years.

The company is using previously purchased treasury shares for all net shares issued for option exercises and performance-based and restricted share units. The company issued 591,139 and 714,514 common shares from treasury upon exercise of employee stock options during the three and nine months ended September 30, 2009, respectively. The company issued 27,000 and 124,475 common shares from treasury upon exercise of employee stock options during the three and nine months ended September 30, 2008, respectively.

14. Restructuring and Impairment Charges

During the three and nine months ended September 30, 2009, the company recorded aggregate restructuring and impairment charges of $5.8 million and $27.3 million, respectively. The restructuring and impairment charges during 2009 primarily related to severance and benefits associated with organizational restructuring decisions, which increased operating efficiencies and improved profitability. In the second quarter of 2009, the company recorded asset impairment charges primarily related to the write-off of preliminary process engineering design work associated with its plans to build a lubricant additives plant in China. Due to lower expected demand caused by the global recession, the company has delayed the China project and is revising its plans with respect to the scope and location of the plant. As a result, the recoverability of the asset for preliminary process engineering design work performed to date has been affected adversely and the associated asset has been impaired. In the third quarter of 2009, the company recorded asset impairment charges related to long-lived assets within the performance coatings and engineered polymers product lines of the Lubrizol Advanced Materials segment due to its decision to cease manufacturing at two U.S. facilities. Manufacturing of engineered polymers products at the closed facility will be transferred to other facilities to improve the utilization of existing assets. The company expects to record an additional $1.5 million of restructuring charges in 2009 associated with these facility closures. The remaining charges primarily related to the closing of a Lubrizol Additives blending, packaging and warehouse site in Ontario, Canada that was announced in 2008. The company expects to record an additional $6.8 million of restructuring charges related to this facility closure in 2010 upon the final settlement of the related employee benefit plans.

The following table shows the reconciliation of the restructuring liability since January 1, 2009, by major restructuring activity:

						Restructuring
		Liability				and												Liability
		January 1,				Impairment								Non-cash				September 30,
(In Millions of Dollars)		2009				Charges				Cash Paid				Adjustments				2009
Corporate organizational restructuring		$	—			$	15.2			$	(11.3	)		$	—			$	3.9
Long-lived asset impairments			—				7.4				—				(7.4	)			—
Lubrizol Additives plant closure and workforce reductions			0.7				1.0				(1.7	)			—				—
Lubrizol Advanced Materials plant closures and workforce reductions			—				3.6				—				(3.6	)			—
Performance coatings 2008 business improvement initiatives			0.9				0.1				(0.7	)			—				0.3
Noveon International, Inc. restructuring liabilities assumed			0.5				—				(0.5	)			—				—
		$	2.1			$	27.3			$	(14.2	)		$	(11.0	)		$	4.2

During the three and nine months ended September 30, 2008, the company recorded aggregate restructuring and impairment charges of $5.7 million and $25.1 million, respectively, primarily related to business improvement initiatives in the performance coatings product line of the Lubrizol Advanced Materials segment. The company completed the disposition of a textile compounding plant and recognized an asset impairment for a textile coatings production line in the first quarter of 2008. In the second quarter of 2008, the company announced additional steps in the improvement of its U.S. performance coatings business. Manufacturing of select products at various locations ceased or was transferred to more efficient production facilities in order to align manufacturing with its end-use markets. In addition, the company restructured the sales, marketing and research and development organizations within the performance coatings product line. In the third quarter of 2008, the company announced a plan to close a Lubrizol Additives blending, packaging and warehouse site in Ontario, Canada.

15. Contingencies

General

There are pending or threatened claims, lawsuits and administrative proceedings against the company, all arising from the ordinary course of business with respect to commercial, premises liability, product liability, employment and environmental matters, which seek remedies or damages. Environmental matters and liabilities are addressed specifically below. The company believes that any liability that finally may be determined with respect to these claims should not have a material adverse effect on the company’s consolidated financial position, results of operations or cash flows. From time to time, the company also is involved in legal proceedings as a claimant involving contract, patent protection and other matters. Gain contingencies, if any, are recognized when they are realized.

Environmental

The company’s environmental engineers and consultants review and monitor environmental issues at operating facilities. Where appropriate, the company initiates corrective and/or preventive environmental projects to ensure safe and lawful activities at its current operations. The company also conducts compliance and management systems audits.

The company is a generator of both hazardous and non-hazardous wastes, the treatment, storage, transportation and disposal of which are regulated by various laws and governmental regulations. These laws and regulations generally impose liability for costs to investigate and remediate contamination without regard to fault. Under certain circumstances liability may be joint and several resulting in one party being held responsible for the entire obligation. Liability also may include damages to natural resources.

Although the company believes past operations were in substantial compliance with the then-applicable regulations, either the company or the predecessor of Lubrizol Advanced Materials International, Inc. (LZAM International), the Performance Materials Segment of Goodrich Corporation (Goodrich), has been designated under a country’s laws and/or regulations as a potentially responsible party (PRP) in connection with several sites. The company participates in the remediation process for current operating facilities and for third-party sites at which the company has been identified as a PRP. This process includes investigation, remedial action selection and implementation, as well as discussions and negotiations with other parties, such as other PRPs, past owners and operators and governmental agencies. The estimates of environmental liabilities are based on the results of this process. Inherent uncertainties exist in these estimates primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability and remediation standards and evolving technologies for managing investigations and remediation. The company revises its estimates as events in this process occur and additional information is obtained.

The company’s environmental reserves, measured on an undiscounted basis, totaled $10.1 million and $12.7 million at September 30, 2009, and December 31, 2008, respectively. Of these amounts, $3.5 million and $6.5 million were included in accrued expenses and other current liabilities at September 30, 2009, and December 31, 2008, respectively. Goodrich provided LZAM International with an indemnity for various environmental liabilities which extends through February 2011. Pursuant to this indemnity, Goodrich currently is indemnifying LZAM International for the costs of several environmental remediation projects. The company estimates Goodrich’s share of such currently identified liabilities to be approximately $1.4 million, of which $0.5 million of the recovery is included in receivables and $0.9 million is included in other assets. There are specific environmental contingencies for company-owned sites for which third parties such as past owners and/or operators are the named PRPs, for which the company is indemnified by Goodrich. Goodrich’s share of all of these liabilities may increase to the extent such third parties fail to honor their obligations through February 2011.

The company believes that its environmental accruals are adequate based on currently available information. However, it is reasonably possible that approximately $4.6 million in additional costs may be incurred at certain locations beyond the amounts accrued as a result of new information, newly discovered conditions, changes in remediation standards or technologies or a change in the law. Additionally, as the indemnification from Goodrich only extends through February 2011, the timing of the incurrence of remediation costs may result in additional expenses to the company.

 

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.

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.

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	%