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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ    No o

Number of the registrant’s common shares, without par value, outstanding as of July 31, 2005: 67,885,976

 

 

THE LUBRIZOL CORPORATION
Quarterly Report on Form 10-Q
Quarter Ended June 30, 2005

Table of Contents

						Page Number
PART I. FINANCIAL INFORMATION
		Item 1		Financial Statements (unaudited)			3
				Consolidated Statements of Income			3
				Consolidated Balance Sheets			4
				Consolidated Statements of Cash Flows			5
				Notes to Consolidated Financial Statements			6
		Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations			27
		Item 3		Quantitative and Qualitative Disclosures about Market Risk			49
		Item 4		Controls and Procedures			50
PART II. OTHER INFORMATION
		Item 1		Legal Proceedings			50
		Item 2		Unregistered Sales of Equity Securities and Use of Proceeds			50
		Item 4		Submission of Matters to a Vote of Security Holders			52
		Item 6		Exhibits			53
				Signatures			53
EX-31.1 Certification
EX-31.2 Certification
EX-32.1 Certification

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME

		Three Months								Six Months
		Ended June 30,								Ended June 30,
(in millions except per share data)		2005				2004				2005				2004
Net sales		$	1,066.0			$	720.2			$	2,036.1			$	1,298.1
Royalties and other revenues			0.6				1.3				1.6				2.1
Total revenues			1,066.6				721.5				2,037.7				1,300.2
Cost of sales			795.1				529.5				1,512.2				955.8
Selling and administrative expenses			94.3				70.2				187.3				122.0
Research, testing and development expenses			50.9				45.5				101.4				86.3
Amortization of intangible assets			6.1				4.5				12.7				6.4
Write-off of acquired in-process research and development			—				35.0				—				35.0
Restructuring charges			5.4				8.0				11.5				8.0
Total costs and expenses			951.8				692.7				1,825.1				1,213.5
Other income (expense) – net			0.7				(1.9	)			1.4				2.4
Interest income			1.9				1.0				3.7				1.9
Interest expense			(26.8	)			(18.1	)			(53.1	)			(24.3	)
Income before income taxes			90.6				9.8				164.6				66.7
Provision for income taxes			30.5				5.9				56.0				25.2
Net income		$	60.1			$	3.9			$	108.6			$	41.5
Net income per share, basic		$	0.88			$	0.08			$	1.60			$	0.80
Net income per share, diluted		$	0.87			$	0.08			$	1.59			$	0.80
Dividends per share		$	0.26			$	0.26			$	0.52			$	0.52
Weighted-average common shares outstanding			68.0				51.9				67.7				51.8

Amounts shown are unaudited.

See accompanying notes to the financial statements.

THE LUBRIZOL CORPORATION
CONSOLIDATED BALANCE SHEETS

		June 30,				December 31,
(in millions except per share data)		2005				2004
ASSETS
Cash and short-term investments		$	279.0			$	335.9
Receivables – net			641.1				582.8
Inventories			559.1				568.7
Other current assets			106.8				110.6
Total current assets			1,586.0				1,598.0
Property and equipment – at cost			2,596.0				2,731.3
Less accumulated depreciation			1,391.9				1,413.4
Property and equipment – net			1,204.1				1,317.9
Goodwill			1,147.9				1,153.8
Intangible assets – net			419.3				437.1
Investments in non-consolidated companies			7.3				7.4
Other assets			48.4				52.1
TOTAL		$	4,413.0			$	4,566.3
LIABILITIES AND SHAREHOLDERS’ EQUITY
Short-term debt and current portion of long-term debt		$	4.3			$	8.2
Accounts payable			302.9				339.6
Accrued expenses and other current liabilities			299.9				309.5
Total current liabilities			607.1				657.3
Long-term debt			1,836.5				1,964.1
Postretirement health-care obligations			106.5				106.4
Noncurrent liabilities			185.1				170.7
Deferred income taxes			75.5				90.7
Total liabilities			2,810.7				2,989.2
Minority interest in consolidated companies			52.3				53.6
Contingencies and commitments
Shareholders’ equity:
Preferred stock without par value – authorized and unissued:
Serial preferred stock – 2,000,000 shares			—				—
Serial preference shares – 25,000,000 shares			—				—
Common shares without par value:
Authorized 120,000,000 shares Outstanding - 67,819,761 shares as of June 30, 2005 after deducting 18,376,133 treasury shares, 66,778,865 shares as of December 31, 2004 after deducting 19,417,029 treasury shares			651.6				610.6
Retained earnings			988.4				897.4
Accumulated other comprehensive (loss) income			(90.0	)			15.5
Total shareholders’ equity			1,550.0				1,523.5
TOTAL		$	4,413.0			$	4,566.3

Amounts shown are unaudited.

See accompanying notes to the financial statements.

THE LUBRIZOL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

		Six Months
		Ended June 30,
(in millions of dollars)		2005				2004
Cash provided by (used for):
Operating activities:
Net income		$	108.6			$	41.5
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization			91.7				60.9
Write-off of acquired in-process research and development			—				35.0
Deferred income taxes			3.9				1.2
Restructuring charges			5.1				1.6
Change in current assets and liabilities, net of acquisitions:
Receivables			(88.0	)			(77.0	)
Inventories			(8.4	)			(1.8	)
Accounts payable, accrued expenses and other current liabilities			(3.5	)			19.9
Other current assets			7.4				(2.1	)
Other items – net			23.8				17.0
Total operating activities			140.6				96.2
Investing activities:
Capital expenditures			(58.6	)			(42.2	)
Acquisitions – net of cash received and liabilities assumed			—				(960.7	)
Other items – net			3.2				—
Total investing activities			(55.4	)			(1,002.9	)
Financing activities:
Changes in short-term debt – net			(3.7	)			1,800.1
Repayments of long-term debt			(125.0	)			(934.9	)
Long-term borrowings			—				25.0
Dividends paid			(35.0	)			(26.8	)
Proceeds from the exercise of stock options			37.4				5.5
Total financing activities			(126.3	)			868.9
Effect of exchange rate changes on cash			(15.8	)			6.4
Net decrease in cash and short-term investments			(56.9	)			(31.4	)
Cash and short-term investments at beginning of period			335.9				258.7
Cash and short-term investments at end of period		$	279.0			$	227.3

Amounts shown are unaudited.

See accompanying notes to the financial statements.

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals unless otherwise noted) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

2. Significant Accounting Policies

Net Income Per Share

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

		Three Months								Six Months
		Ended June 30,								Ended June 30,
(in millions except per share data)		2005				2004				2005				2004
Numerator:
Net income		$	60.1			$	3.9			$	108.6			$	41.5
Denominator:
Weighted-average common shares outstanding			68.0				51.9				67.7				51.8
Dilutive effect of stock options and awards			0.7				0.3				0.8				0.3
Denominator for net income per share, diluted			68.7				52.2				68.5				52.1
Net income per share, basic		$	0.88			$	0.08			$	1.60			$	0.80
Net income per share, diluted		$	0.87			$	0.08			$	1.59			$	0.80

Weighted-average shares issuable upon the exercise of stock options that were excluded from the diluted earnings per share calculations because they were antidilutive for the three and six months ended June 30, 2004 were 1.7 million and 1.8 million, respectively.

Stock-Based Compensation

The company has elected the intrinsic value method to account for stock-based employee compensation. The following table shows the pro forma effect on net income per share if the company had applied the fair value recognition provisions of the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

		Three Months								Six Months
		Ended June 30,								Ended June 30,
(in millions of dollars except per share data)		2005				2004				2005				2004
Reported net income		$	60.1			$	3.9			$	108.6			$	41.5
Plus: stock-based employee compensation (net of tax) included in net income			1.4				0.8				2.8				0.9
Less: stock-based employee compensation (net of tax) using the fair value method			(1.3	)			(1.6	)			(3.5	)			(2.6	)
Pro forma net income		$	60.2			$	3.1			$	107.9			$	39.8
Reported net income per share, basic		$	0.88			$	0.08			$	1.60			$	0.80
Pro forma net income per share, basic		$	0.88			$	0.06			$	1.59			$	0.77
Reported net income per share, diluted		$	0.87			$	0.08			$	1.59			$	0.80
Pro forma net income per share, diluted		$	0.87			$	0.06			$	1.58			$	0.77

New Accounting Standards

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” This standard establishes new standards on accounting for changes in accounting principles. Pursuant to the new rules, all such changes must be accounted for by retrospective application to the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 completely replaces Accounting Principles Board (APB) Opinion No. 20 and SFAS No. 3, though it carries forward the guidance in those pronouncements with respect to accounting for changes in estimates, changes in the reporting entity and the correction of errors. The company does not believe the adoption of this standard will have a material impact on its financial position, results of operations or cash flows.

In March 2005, the FASB issued Interpretation (FIN) No. 47, “Accounting for Conditional Asset-Retirement Obligations.” This standard codifies SFAS No. 143, “Asset-Retirement Obligations,” and states that companies must recognize a liability for the fair value of a legal obligation to perform asset-retirement obligations that are conditional on a future event if the amount can be reasonably estimated. Specifically, FIN No. 47 provides additional guidance on whether the fair value is reasonably estimable. FIN No. 47 is effective for the company starting January 1, 2006. The company does not believe the adoption of this standard will have a material impact on its financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” This standard will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be remeasured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This standard replaces SFAS No. 123 and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and applies to all awards granted, modified, repurchased or cancelled after July 1, 2005. In April 2005, the Securities and Exchange Commission (SEC) amended the compliance date of SFAS No. 123(R) through an amendment of Regulation S-X. The new effective date for the company is January 1, 2006. The company currently is evaluating the provisions of this standard to determine the impact on its consolidated financial statements. It is, however, expected to reduce consolidated net income.

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets.” This standard amended APB Opinion No. 29, “Accounting for Nonmonetary Transactions,” to eliminate the exception from fair-value measurement for nonmonetary exchanges of similar productive assets. This standard replaces this exception with a general exception from fair-value measurement for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This statement is effective for all nonmonetary asset exchanges completed by the company starting January 1, 2006. The company does not believe the adoption of this standard will have a material impact on its financial position, results of operations or cash flows.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. This standard requires that such items be recognized as current-period charges. The standard also establishes the concept of “normal capacity” and requires the allocation of fixed production overhead to inventory based on the normal capacity of the production facilities. Any unallocated overhead must be recognized as an expense in the period incurred. This standard is effective for inventory costs incurred starting January 1, 2006. The company does not believe the adoption of this standard will have a material impact on its financial position, results of operations or cash flows.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions 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.

3. Acquisitions and Pro Forma Financial Information

On June 3, 2004, the company completed the acquisition of Noveon International, Inc. (Noveon International) for cash of $920.2 million (inclusive of $32.9 million in certain seller expenses) plus transaction costs of $11.4 million and less cash acquired of $103.0 million. In addition, the company assumed $1,103.1 million of long-term indebtedness from Noveon International. With the acquisition of Noveon International, the company has accelerated its program to attain a substantial presence in the personal care and coatings markets by adding a number of higher-growth, industry-leading products under highly recognizable brand names, including Carbopol^®, to the company’s portfolio of lubricant and fuel additives and consumer products. Additionally, Noveon International has a number of industry-leading specialty materials businesses, including TempRite^® chlorinated polyvinyl chloride and Estane^® thermoplastic polyurethane.

The acquisition and related costs were financed initially with the proceeds of a $2,450.0 million 364-day bridge credit facility. Shortly after the acquisition, the company repaid substantially all of the assumed long-term debt of Noveon International with proceeds of the temporary bridge loan. In addition, the temporary bridge loan was repaid in full in September 2004 with the proceeds from the permanent financing obtained by the issuance of senior notes, debentures, bank term loans and equity.

The consolidated balance sheets as of June 30, 2005 and December 31, 2004 reflect the acquisition of Noveon International under the purchase method of accounting. The company recorded the various assets acquired and liabilities assumed, primarily working capital accounts, of Noveon International at their estimated fair values determined as of the acquisition date. Actuarial valuations were completed for the projected pension and other post-employment benefit obligations and were reflected in the purchase price allocation. Appraisals of long-lived assets and identifiable intangible assets, including an evaluation of in-process research and development (IPR&D) projects, were also obtained. Through June 2005, the company was still finalizing certain aspects of the purchase price

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

allocation primarily surrounding the valuation of the property, plant and equipment and the deferred tax accounts. In connection with the acquisition of Noveon International, the company has targeted non-core businesses with total revenues of approximately $500.0 million for disposition. This plan was contemplated at the time of acquisition and plan activities have been underway since the fourth quarter of 2004. In addition, through June 2005, the company was still in the process of finalizing its reconciliation of the underlying fixed-asset records to the respective appraisals. As a result of both of these efforts, in the six months ended June 30, 2005, the company reduced the amount allocated to property, plant and equipment by $55.2 million since December 31, 2004. Depreciation expense for the three and six months ended June 30, 2005 included a related adjustment of $1.1 million and $2.3 million, respectively, representing the change in depreciation expense associated with the change in the estimated fair values assigned to property, plant and equipment. In addition, the deferred tax accounts were adjusted in June 2005 resulting in a decrease of $17.7 million to the net deferred tax liabilities since December 31, 2004. The goodwill associated with the transaction increased by $33.7 million in the six months ended June 30, 2005 representing the net impact of all adjustments recorded. The allocation of the purchase price was complete as of June 30, 2005 and the related actuarial valuations and appraisals obtained have been finalized.

The purchase price included the estimated fair value of IPR&D projects totaling $34.0 million that, as of the acquisition date, had not yet reached technological feasibility and had no alternative future use. As a result, the full amount allocated to IPR&D was expensed in 2004. The amount charged to expense in the second quarter of 2004 was $35.0 million. This amount was subsequently adjusted to $34.0 million in the second half of 2004. There have been no changes to the valuation of IPR&D in 2005. The inventory step-up to fair value totaled $24.2 million, of which $4.9 million was expensed in the second quarter of 2004. As the remaining step-up relates to inventories accounted for on the LIFO method of accounting, the company does not anticipate that additional amounts of step-up will be expensed in the near term.

The adjusted fair value of the assets acquired and liabilities assumed in connection with the Noveon International acquisition was as follows as of June 30, 2005:

		Fair Value of Net
(in millions of dollars)		Assets Acquired
Receivables		$	191.5
Inventories			180.5
Other current assets			47.4
Property and equipment			559.6
Goodwill			863.8
Intangible assets			379.1
Other non-current assets			18.2
Total assets			2,240.1
Accounts payable			129.4
Accrued expenses			107.2
Current and long-term debt			1,103.1
Noncurrent liabilities			71.8
Total liabilities			1,411.5
Increase in net assets from acquisition		$	828.6

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

The company’s operating results for the three and six months ended June 30, 2004 only include revenues and expenses of Noveon International since June 3, 2004, the date of acquisition.

The following unaudited pro forma operating data is presented for the three and six months ended June 30, 2004 as if the Noveon International acquisition had been completed at the beginning of each of the periods presented below in the table. The pro forma data gives effect to actual operating results prior to the acquisition. Adjustments to cost of sales for the inventory step-up charge, fixed asset depreciation, intangible asset amortization, the write-off of acquired IPR&D, interest expense and income taxes related to the acquisition are reflected in the pro forma data. In addition, the company assumed that the bridge loan obtained at the time of the transaction closing was not replaced with the permanent long-term financing consisting of both debt and equity until the end of the fourth month in the period presented. These pro forma amounts do not purport to be indicative of the results that actually would have been obtained if the acquisition had occurred as of the beginning of the periods presented or that may be obtained in the future.

		Three Months				Six Months
		Ended				Ended
(in millions of dollars except per share data)		June 30, 2004				June 30, 2004
Total revenues		$	939.0			$	1,837.8
Net income		$	15.0			$	59.7
Net income per share, basic		$	0.29			$	1.06
Net income per share, diluted		$	0.29			$	1.05

On January 30, 2004, the company completed the acquisition of the coatings hyperdispersants business of Avecia. This business is headquartered in Blackley, United Kingdom and develops, manufactures and markets high-value additives that are based on polymeric dispersion technology and used in coatings and inks. These products enrich and strengthen color while reducing production costs and solvent emissions, and are marketed under the brand names Solsperse^®, Solplus^® and Solthix^®. Historical annual revenues of this business are approximately $50.0 million. The 2004 historical results only include revenues and expenses of hyperdispersants since the date of acquisition.

4. Inventory

The company’s inventory was comprised of the following as of June 30, 2005 and December 31, 2004:

		June 30,				December 31,
(in millions of dollars)		2005				2004
Finished products		$	305.9			$	311.2
Products in process			86.6				75.9
Raw materials			138.3				153.1
Supplies and engine test parts			28.3				28.5
Total inventory		$	559.1			$	568.7

5. Goodwill and Intangible Assets

The major components of the company’s identifiable intangible assets are customer lists, technology, trademarks, patents, land-use rights and non-compete agreements. Excluding the non-amortized trademarks, which are indefinite-lived and will not be amortized, the intangible assets are amortized over the lives of the respective agreements or other periods of value, which range between three and forty years. We assess the indefinite-lived trademarks for impairment separately from goodwill.

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

The following table shows the components of the company’s identifiable intangible assets as of June 30, 2005 and December 31, 2004:

		June 30, 2005								December 31, 2004
		Gross								Gross
		Carrying				Accumulated				Carrying				Accumulated
(in millions of dollars)		Amount				Amortization				Amount				Amortization
Amortized intangible assets:
Customer lists		$	153.2			$	11.3			$	151.9			$	6.4
Technology			144.4				30.5				144.4				25.4
Trademarks			24.5				3.3				24.4				2.3
Patents			12.4				2.0				13.2				1.5
Land-use rights			7.1				0.9				7.1				0.8
Non-compete agreements			8.9				4.8				8.9				3.8
Other			5.6				0.6				11.3				0.9
Total amortized intangible assets			356.1				53.4				361.2				41.1
Non-amortized trademarks			116.6				—				117.0				—
Total		$	472.7			$	53.4			$	478.2			$	41.1

Annual intangible amortization expense for the next five years will approximate $25.6 million for 2005, $25.4 million in 2006, $23.9 million in 2007, $22.4 million in 2008 and $20.6 million in 2009.

The carrying amount of goodwill by reporting segment as of June 30, 2005 is as follows:

		Lubricant				Specialty
(in millions of dollars)		Additives				Chemicals				Total
Balance, January 1, 2005		$	100.9			$	1,052.9			$	1,153.8
Goodwill adjustments			—				33.7				33.7
Foreign currency translation adjustments			(2.2	)			(37.4	)			(39.6	)
Balance, June 30, 2005		$	98.7			$	1,049.2			$	1,147.9

The adjustment to goodwill recorded in 2005 relates to the Noveon International purchase accounting.

Goodwill is tested for impairment at the reporting unit level annually 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.

6. Comprehensive Income

Total comprehensive income for the three and six months ended June 30, 2005 and 2004 was comprised of the following:

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

		Three Months								Six Months
		Ended June 30,								Ended June 30,
(in millions of dollars)		2005				2004				2005				2004
Net income		$	60.1			$	3.9			$	108.6			$	41.5
Foreign currency translation adjustment			(58.4	)			(5.0	)			(107.1	)			(7.8	)
Pension plan minimum liability			—				—				—				0.3
Unrealized gains (losses) - natural gas hedges			(0.5	)			—				0.2				0.2
Unrealized gains - interest rate swaps			—				1.7				—				2.1
Amortization of treasury rate locks			0.8				(8.0	)			1.4				(8.0	)
Total comprehensive income (loss)		$	2.0			$	(7.4	)		$	3.1			$	28.3

7. Segment Reporting

The company is organized into two operating and reporting segments: Lubricant Additives and Specialty Chemicals. The Lubricant Additives segment, also referred to as Lubrizol Additives, represented 58% and 56% of the company’s consolidated revenues for the three and six months ended June 30, 2005, respectively, and is comprised of the company’s businesses in fluid technologies for transportation, advanced fluid systems, emulsified products and the industrial additives product group. The Specialty Chemicals segment, also referred to as the Noveon segment, represented 42% and 44% of the company’s consolidated revenues for the three and six months ended June 30, 2005, respectively, and is comprised of the businesses of the acquired Noveon International and the former performance chemicals group of the company.

Lubricant Additives consists of three product lines: engine additives; specialty driveline and industrial oil additives; and services and equipment. Engine additives is comprised of additives for lubricating engine oils, such as for gasoline, diesel, marine and stationary gas engines and additive components, and additives for fuel products and refinery and oil field chemicals. In addition, this product line sells additive components and viscosity improvers within its lubricant and fuel additives product areas. Specialty driveline and industrial oil additives is comprised of additives for driveline oils, such as automatic transmission fluids, gear oils and tractor lubricants and industrial oil additives, such as additives for hydraulic, grease and metalworking fluids, as well as compressor lubricants. Services and equipment is comprised of fluid metering devices, particulate emission trap devices, FluiPak^® sensor systems and outsourcing strategies for supply chain and knowledge center management. Lubricant Additives product lines are produced generally in company-owned shared manufacturing facilities and sold largely to a common customer base.

The Specialty Chemicals segment consists of consumer specialties, specialty materials and performance coatings product lines. The consumer specialties product line is characterized by global production of acrylic thickeners, specialty monomers, film formers, fixatives, emollients, silicones, surfactants, botanicals, active pharmaceutical ingredients and intermediates, process chemicals, benzoate preservatives, fragrances, defoamers, synthetic food and technical dyes, rubber and lubricant antioxidants and rubber accelerators. The company markets products in the consumer specialties product line to the following primary end-use industries: personal care, pharmaceuticals, textiles, food and beverage, automotive and aerospace. The consumer specialties products are sold to customers worldwide and these customers include major manufacturers of cosmetics, personal care products, water soluble polymers, household products, soft drinks and food products and major manufacturers in the automotive and aerospace industries. The specialty materials product line is characterized by products such as chlorinated polyvinyl chloride (CPVC) resins and compounds and is also a producer of thermoplastic polyurethane (TPU) and cross-linked polyethylene compounds (PEX). The company markets products of specialty materials through the primary product category of specialty plastics. Specialty materials products are sold to a diverse customer base comprised of major

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

manufacturers in the construction, automotive, telecommunications, electronics and recreation industries. The performance coatings product line includes high-performance polymers for specialty paper, printing and packaging, industrial and architectural specialty coatings and textile applications. The company markets the performance coatings products through the primary product categories of performance polymers and coatings and textile performance chemicals. Performance coatings products serve major companies in the specialty paper, printing and packaging, paint and coatings, and textile industries.

The company primarily evaluates performance and allocates resources based on segment operating income, defined as revenues less expenses identifiable to the product lines included within each segment, as well as projected future returns. Segment operating income will reconcile to consolidated income before tax by deducting corporate expenses and corporate other income (expense) that are not directly attributable to the operating segments, the write-off of acquired IPR&D, restructuring charges and net interest expense.

The following table presents a summary of the results of the company’s reportable segments for the three and six months ended June 30, 2005 and 2004:

		Three Months								Six Months
		Ended June 30,								Ended June 30,
(in millions of dollars)		2005				2004				2005				2004
Revenues from external customers:
Lubricant Additives		$	619.9			$	522.8			$	1,144.5			$	1,014.7
Specialty Chemicals			446.7				198.7				893.2				285.5
Total revenues		$	1,066.6			$	721.5			$	2,037.7			$	1,300.2
Segment operating income:
Lubricant Additives		$	85.2			$	72.8			$	154.0			$	135.5
Specialty Chemicals			51.4				11.4				103.0				16.4
Segment operating income			136.6				84.2				257.0				151.9
Corporate expenses			(15.8	)			(12.3	)			(30.8	)			(21.6	)
Corporate other income (expense)			0.1				(2.0	)			(0.7	)			1.8
Write-off of acquired IPR&D			—				(35.0	)			—				(35.0	)
Restructuring charges			(5.4	)			(8.0	)			(11.5	)			(8.0	)
Interest expense – net			(24.9	)			(17.1	)			(49.4	)			(22.4	)
Income before income taxes		$	90.6			$	9.8			$	164.6			$	66.7

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

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

		June 30,				December 31,
(in millions of dollars)		2005				2004
Segment total assets:
Lubricant Additives		$	1,223.8			$	1,337.1
Specialty Chemicals			2,749.2				2,733.3
Total segment assets			3,973.0				4,070.4
Corporate assets			440.0				495.9
Total consolidated assets		$	4,413.0			$	4,566.3

8. Pension and Postretirement Benefits

The components of net periodic pension cost and postretirement benefits costs consist of the following:

		Three Months								Six Months
		Ended June 30,								Ended June 30,
(in millions of dollars)		2005				2004				2005				2004
Pension benefits:
Service cost - benefits earned during period		$	7.2			$	5.2			$	14.2			$	8.7
Interest cost on projected benefit obligation			8.1				8.1				15.9				12.9
Expected return on plan assets			(6.7	)			(7.9	)			(13.5	)			(13.2	)
Amortization of prior service costs			0.6				0.6				1.1				1.0
Amortization of initial net asset obligation			—				(0.2	)			0.1				(0.4	)
Recognized net actuarial loss			1.5				1.5				2.7				1.8
Net periodic benefit cost		$	10.7			$	7.3			$	20.5			$	10.8
Other benefits:
Service cost - benefits earned during period		$	0.2			$	0.7			$	0.9			$	1.3
Interest cost on projected benefit obligation			1.1				1.8				2.9				3.5
Amortization of prior service costs			(2.2	)			(1.5	)			(3.8	)			(3.1	)
Recognized net actuarial loss			0.4				0.6				1.0				1.3
Net periodic benefit (income) cost		$	(0.5	)		$	1.6			$	1.0			$	3.0

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

Expected employer contributions worldwide for pension benefits in 2005 approximate $31.9 million for the qualified plans, of which $11.3 million was paid in the six months ended June 30, 2005. The portion of the 2005 total expected contributions attributable to the U.S. qualified pension plans is $17.7 million, of which $3.1 million was paid in the six months ended June 30, 2005. The non-qualified pension plans and postretirement benefit plans are unfunded. As a result, the 2005 expected contributions to these plans of $2.1 million and $4.7 million, respectively, represent actuarial estimates of future assumed payments based on historic retirement and payment patterns as well as medical trend rates and historical claim information, as appropriate.

As part of the Noveon International integration efforts to provide consistent benefits, the company communicated to employees in May 2005 changes to the benefits structure of certain of its U.S. pension and postretirement benefit plans. This communication triggered a remeasurement of the related benefit obligations and net periodic benefit cost in 2005 for both the legacy Noveon International U.S. pension plans as well as for the U.S. postretirement benefit plan. As a result of the second quarter remeasurement date, the discount rate for the legacy Noveon International U.S. pension plans was reduced by 25 basis points to 5.75%. In addition, the discount rate for the U.S. postretirement benefit plan was reduced by 50 basis points to 5.75%. The net impact of the above changes reduced our aggregate net periodic pension and postretirement benefit cost by $0.9 million in the three and six months ended June 30, 2005. The annual savings projected for 2005 are estimated at approximately $3.5 million and the annualized savings are estimated to be approximately $5.3 million.

9. Restructuring Charges

In the three and six months ended June 30, 2005, the company recorded aggregate restructuring charges of $5.4 million and $11.5 million, respectively, primarily related to the phase-out of manufacturing facilities in both the Lubricant Additives and Specialty Chemicals segments as well as other workforce reductions.

The following table shows the reconciliation of the restructuring liability since December 31, 2004 by major restructuring activity:

		Liability																Liability
		December 31,				Restructuring								Asset				June 30,
(in millions of dollars)		2004				Charges				Cash Paid				Impairments				2005
Performance coatings plant closures and workforce reductions		$	—			$	7.1			$	(1.0	)		$	(4.4	)		$	1.7
Bromborough, United Kingdom closure			—				3.4				(0.6	)			(0.7	)			2.1
Corporate workforce reductions			2.7				0.7				(2.7	)			—				0.7
Noveon International restructuring liabilities assumed			6.1				0.3				(4.3	)			—				2.1
		$	8.8			$	11.5			$	(8.6	)		$	(5.1	)		$	6.6

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

In May 2005, the company announced the reorganization of the Specialty Chemicals performance coatings product line. This product line includes businesses acquired from Noveon International as well as businesses included in the company’s legacy operations. In connection with the reorganization, management eliminated 14 positions in North America and Europe. These reductions were completed by June 30, 2005 and resulted in a severance-related charge of $1.1 million recorded in the three and six months ended June 30, 2005.

In the first quarter of 2005, management made the decision and announced the future closure of two Specialty Chemicals performance coatings production facilities in the United States. The aggregate restructuring charge recorded for these closures for the three months ended June 30, 2005 was $1.1 million, comprised of $0.5 million in exit costs and $0.6 million in severance costs. The aggregate restructuring charge recorded for these closures for the six months ended June 30, 2005 was $6.0 million, comprised of $4.4 million in asset impairments, $0.9 million in exit costs and $0.7 million in severance costs. The company estimates it will incur cumulative severance costs of approximately $2.1 million relating to these closures. An impairment charge for both plants was recorded in the first quarter of 2005 to reflect the related assets at their estimated fair values. The estimated fair value of the assets primarily was determined from third-party appraisals. Production for these sites will be transferred to other facilities in the United States. The facility in Mountaintop, Pennsylvania is scheduled to close in the third quarter of 2005. The facility in Linden, New Jersey is scheduled to close in the second quarter of 2006. These closures will result in a workforce reduction of 62 employees by the second quarter of 2006.

In December 2004, management made the decision to close the Lubricant Additives manufacturing facility in Bromborough, United Kingdom. The company announced this decision in January 2005. The company determined, as of December 31, 2004, that an impairment of certain of the facility’s long-lived assets had been triggered by this decision in the fourth quarter of 2004. As a result, a $17.0 million impairment charge was recorded in December 2004 to reflect the related assets at their estimated fair values. The estimated fair value of the assets was determined using a discounted cash flow model. Production phase-out of this site is planned to begin in the third quarter of 2005 and is expected to be completed by late 2006. During this phase-out, United Kingdom production will be transferred to facilities in France and the United States. Approximately 69 employees will be impacted by this closure. The aggregate restructuring charge recorded for this closure for the three months ended June 30, 2005 was $2.5 million, comprised of $0.7 million in asset impairments, $0.3 million in exit costs and $1.5 million in severance costs. The aggregate restructuring charge recorded for this closure for the six months ended June 30, 2005 was $3.4 million, comprised of $0.7 million in asset impairments, $0.5 million in exit costs and $2.2 million in severance costs. The company currently anticipates that pre-tax charges for cash expenditures of approximately $13.5 million to $15.5 million will be incurred in 2005 through 2007 to satisfy severance and retention obligations, plant dismantling, site restoration and other site environmental evaluation costs and lease-related costs, including the $2.7 million recorded through June 30, 2005.

In June 2004, the company eliminated more than 100 positions, primarily affecting technical and commercial employees located at the Wickliffe, Ohio headquarters. Most of these workforce reductions were related to the restructuring following the acquisition of Noveon International. These reductions were completed by December 31, 2004. In the three months ended June 30, 2005, the company began a process of identifying further opportunities to increase efficiency and productivity, reduce costs and support the company’s integration strategy of the Noveon International acquisition. As a result, the company reduced headcount in the general and administrative area of its headquarters’ offices in Ohio. Through these restructuring efforts, the company eliminated seven positions resulting in a severance-related charge of $0.7 million. All of the affected employees had left their positions by June 30, 2005 and the remaining personnel-related costs are expected to be paid by 2006. The company continues to evaluate other opportunities to integrate general and administrative functions. As such opportunities are identified in future periods, the company expects further restructuring charges.

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

The company assumed a restructuring liability of $7.2 million in 2004 relating to the legacy operations of Noveon International. This liability was $6.1 million at December 31, 2004 and $2.1 million at June 30, 2005.

The charges for these cost reduction initiatives are reported as a separate line item in the consolidated income statements, entitled “Restructuring charges” and are included in the “Total cost and expenses” subtotal on the consolidated income statements.

10. Debt

On March 29, 2005, the company amended and restated its five-year unsecured bank credit agreement to reduce the credit spread that is paid on the outstanding $500.0 million term loans. Based on the company’s current unsecured senior debt ratings from Standard and Poor’s and Moody’s Investors Services, the credit spread on the term loans was reduced by 50 basis points. No other terms or conditions of the agreement were modified.

In the three months ended June 30, 2005, the company repaid $125.0 million against the bank term loan. The balance outstanding at June 30, 2005 under the term-loan arrangement was $375.0 million. In July 2005, the company repaid an additional $25.0 million against the bank term loan to reduce the remaining outstanding balance to $350.0 million.

11. Shareholders’ Equity

The following table summarizes the changes in shareholders’ equity since December 31, 2004:

						Shareholders’ Equity
														Accumulated
		Number of												Other
		Shares				Common				Retained				Comprehensive
		Outstanding				Shares				Earnings				Income (Loss)				Total
(in millions)
Balance, January 1, 2005			66.8			$	610.6			$	897.4			$	15.5			$	1,523.5
Comprehensive income:
Net income											108.6				—				108.6
Other comprehensive loss											—				(105.5	)			(105.5	)
Comprehensive income																			3.1
Dividends declared											(17.6	)			—				(17.6	)
Deferred stock compensation							4.7				—				—				4.7
Common shares — treasury:
Shares issued upon exercise of stock options and awards			1.0				36.3				—				—				36.3
Balance, June 30, 2005			67.8			$	651.6				988.4			$	(90.0	)		$	1,550.0

12. Contingencies

The company has numerous purchase commitments for materials, supplies and energy in the ordinary course of business. The company has numerous sales commitments for product supply contracts in the ordinary course of business.

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

General

On May 13, 2005, the company was named in a suit alleging patent infringement. The suit is pending in federal court in Norfolk, Virginia and pertains to some of the company’s additives for automatic transmission fluids sold by the Lubricant Additives segment. The company is contesting the suit vigorously and neither the company nor its counsel believes that an unfavorable outcome is probable.

In addition, there are pending or threatened claims, lawsuits and administrative proceedings against the company or its subsidiaries, all arising from the ordinary course of business with respect to commercial, product liability and environmental matters, which seek remedies or damages. The company believes that any liability that may finally be determined with respect to commercial and product liability 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 is also involved in legal proceedings as a plaintiff involving contract, patent protection, environmental 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 and, where appropriate, the company initiates corrective and/or preventive environmental projects to ensure environmental compliance and safe and lawful activities at its current operations. The company also conducts compliance and management systems audits.

The company and its subsidiaries are generators 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 and, under certain circumstances, liability may be joint and several resulting in one party being held responsible for the entire obligation. Liability may also 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 Noveon 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 including both third party sites and/or current operating facilities.

The company participates in the remediation process for onsite and third-party waste management 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, which primarily include 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, remediation standards and evolving technologies for managing investigations and remediations. The company revises its estimates accordingly as events in this process occur and additional information is obtained.

The company’s environmental reserves, measured on an undiscounted basis, totaled $28.5 million at June 30, 2005 and $26.4 million at December 31, 2004. Of these amounts, $4.1 million and $4.5 million were included in accrued expenses and other current liabilities at June 30, 2005 and December 31, 2004, respectively. The company’s June 30, 2005 balance sheet includes liabilities, measured on an undiscounted basis, of $17.8 million to cover future environmental expenditures for Noveon International sites either payable by Noveon International or indemnifiable by Goodrich. Accordingly, the current portion of the Noveon International environmental obligations of $0.7 million is recorded in accrued expenses and other current liabilities and $0.4 million of the recovery due from Goodrich is

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

recorded in receivables. Non-current Noveon International liabilities include $17.1 million and other assets include $2.6 million reflecting the recovery due from Goodrich.

Goodrich provided Noveon International with an indemnity for various environmental liabilities. The company estimates Goodrich’s share of such currently identified liabilities under the indemnity, which extends through February 2011, to be approximately $3.0 million. There are specific environmental contingencies for company-owned sites for which third parties such as past owners and/or operators are the named PRPs and also for which the company is indemnified by Goodrich. Goodrich is currently indemnifying Noveon International for several environmental remediation projects. 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. The company believes that it is reasonably possible that $3.9 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 extends through February 2011, changes in assumptions regarding when costs will be incurred may result in additional expenses to the company. Additional costs in excess of $3.9 million cannot currently be estimated.

13. Guarantor and Non-Guarantor Subsidiary Information

The repayment of the unsecured senior notes, debentures and bank term loans is unconditionally guaranteed on a joint and several basis by the company and its direct and indirect, wholly owned, domestic subsidiaries. The following supplemental condensed consolidating financial information presents the company’s statements of income for the three and six months ended June 30, 2005 and 2004, its balance sheets as of June 30, 2005 and December 31, 2004 and its statements of cash flow for the six months ended June 30, 2005 and 2004. The elimination of intercompany profit in inventory as of the respective balance sheet date is reflected in the eliminations columns of the condensed consolidating financial information.

		Condensed Consolidating Statement of Income
		Three Months Ended June 30, 2005
		Parent				Subsidiary				Other								Total
(in millions of dollars)		Company				Guarantors				Subsidiaries				Eliminations				Consolidated
Net sales		$	355.8			$	329.7			$	531.2			$	(150.7	)		$	1,066.0
Royalties and other revenues			0.5				0.1				—				—				0.6
Total revenues			356.3				329.8				531.2				(150.7	)			1,066.6
Cost of sales			279.4				254.0				412.4				(150.7	)			795.1
Selling and administrative expenses			36.7				33.4				24.2				—				94.3
Research, testing and development expenses			22.8				10.3				17.8				—				50.9
Amortization of intangible assets			0.8				4.1				1.2				—				6.1
Restructuring charges			1.0				1.0				3.4				—				5.4
Total costs and expenses			340.7				302.8				459.0				(150.7	)			951.8
Other income (expense) - net			6.6				2.9				(7.4	)			(1.4	)			0.7
Interest income (expense) - net			(26.0	)			(1.5	)			2.6				—				(24.9	)
Equity in income of subsidiaries			71.8				27.3				—				(99.1	)			—
Income before income taxes			68.0				55.7				67.4				(100.5	)			90.6
Provision for income taxes			7.9				11.1				11.5				—				30.5
Net income		$	60.1			$	44.6			$	55.9			$	(100.5	)		$	60.1

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

		Condensed Consolidating Statement of Income
		Six Months Ended June 30, 2005
		Parent				Subsidiary				Other								Total
(in millions of dollars)		Company				Guarantors				Subsidiaries				Eliminations				Consolidated
Net sales		$	661.8			$	660.1			$	1,009.4			$	(295.2	)		$	2,036.1
Royalties and other revenues			1.3				0.2				0.1				—				1.6
Total revenues			663.1				660.3				1,009.5				(295.2	)			2,037.7
Cost of sales			522.3				513.1				772.0				(295.2	)			1,512.2
Selling and administrative expenses			73.2				59.3				54.8				—				187.3
Research, testing and development expenses			46.1				20.1				35.2				—				101.4
Amortization of intangible assets			1.5				8.1				3.1				—				12.7
Restructuring charges			4.7				2.6				4.2				—				11.5
Total costs and expenses			647.8				603.2				869.3				(295.2	)			1,825.1
Other income (expense) – net			14.4				6.8				(18.3	)			(1.5	)			1.4
Interest income (expense) - net			(52.1	)			(0.9	)			3.6				—				(49.4	)
Equity in income of subsidiaries			131.9				45.2				—				(177.1	)			—
Income before income taxes			109.5				108.2				125.5				(178.6	)			164.6
Provision for income taxes			0.9				22.7				32.4				—				56.0
Net income		$	108.6			$	85.5			$	93.1			$	(178.6	)		$	108.6

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

		Condensed Consolidating Statement of Income
		Three Months Ended June 30, 2004
		Parent				Subsidiary				Other								Total
(in millions of dollars)		Company				Guarantors				Subsidiaries				Eliminations				Consolidated
Net sales		$	319.0			$	135.8			$	368.7			$	(103.3	)		$	720.2
Royalties and other revenues			0.9				0.4				—				—				1.3
Total revenues			319.9				136.2				368.7				(103.3	)			721.5
Cost of sales			234.9				108.7				289.2				(103.3	)			529.5
Selling and administrative expenses			40.2				10.8				19.2				—				70.2
Research, testing and development expenses			27.7				5.6				12.2				—				45.5
Amortization of intangible assets			0.5				3.0				1.0				—				4.5
Write-off of acquired in-process research and development			—				35.0				—				—				35.0
Restructuring charges			5.7				0.6				1.7				—				8.0
Total costs and expenses			309.0				163.7				323.3				(103.3	)			692.7
Other income (expense) – net			7.0				3.7				(11.7	)			(0.9	)			(1.9	)
Interest income (expense) – net			(14.0	)			(3.3	)			0.2				—				(17.1	)
Equity in income of subsidiaries			1.4				6.8				—				(8.2	)			—
Income (loss) before income taxes			5.3				(20.3	)			33.9				(9.1	)			9.8
Provision for (benefit from) income taxes			1.5				(3.8	)			8.2				—				5.9
Net income (loss)		$	3.8			$	(16.5	)		$	25.7			$	(9.1	)		$	3.9

THE LUBRIZOL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2005

		Condensed Consolidating Statement of Income
		Six Months Ended June 30, 2004
		Parent				Subsidiary				Other								Total
(in millions of dollars)		Company				Guarantors				Subsidiaries				Eliminations				Consolidated
Net sales		$	615.8			$	198.4			$	682.1			$	(198.2	)		$	1,298.1
Royalties and other revenues			1.6				0.4				0.1				—				2.1
Total revenues			617.4				198.8				682.2				(198.2	)			1,300.2
Cost of sales			452.4				156.5				545.1				(198.2	)			955.8
Selling and administrative expenses			72.8				16.6				32.6				—				122.0
Research, testing and development expenses			55.2				7.1				24.0				—				86.3
Amortization of intangible assets			1.5				3.6				1.3				—				6.4
Write-off of acquired in-process research and development			—				35.0				—				—				35.0
Restructuring charges			5.7				0.6				1.7				—				8.0
Total costs and expenses			587.6				219.4				604.7				(198.2	)			1,213.5
Other income (expense) – net			19.9				6.8				(23.0	)			(1.3	)			2.4
Interest income (expense) – net			(19.6	)			(3.3	)			0.5				—				(22.4	)
Equity in income of subsidiaries			21.4				8.4				—				(29.8	)			—
Income (loss) before income taxes			51.5				(8.7	)			55.0				(31.1	)			66.7
Provision for (benifit from) income taxes			10.0				(0.2	)			15.4				—				25.2
Net income (loss)		$	41.5			$	(8.5	)		$	39.6			$	(31.1	)		$	41.5