Lubrizol Q4 2008 Earnings Call Transcript

Feb. 5.09 | About: Berkshire Hathaway (BRK.A)

Lubrizol Corp. (LZ) Q4 2008 Earnings Call February 5, 2009 11:00 AM ET

Executives

Mark Sutherland - Investor Relations

James L. Hambrick - Chairman, President and Chief Executive Officer

Charlie Cooley - Senior Vice President, Treasurer and Chief Financial Officer

Analysts

Jeffrey Zekauskas - JPMorgan

David Begleiter - Deutsche Bank

Laurence Alexander - Jefferies & Co

Saul Ludwig - KeyBanc Capital Markets

Christopher Willis - Impala Asset Management

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Lubrizol Corporation Fourth Quarter Earnings Results and Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions being given at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Mark Sutherland. Please go ahead.

Mark Sutherland

Thank you, Rochelle and thank you all for all for joining us today, February 5, 2009 for a discussion of our fourth quarter 2008 results, which were released this morning. This call is being webcast by ccbn.com and will be available for replay, beginning about 1 PM Eastern Time today and continuing for the next 30 days.

Our internet site, www.lubrizol.com, has several supporting documents for this call, at the Investor Relations/Earnings Release page. You can access the presentation entitled fourth quarter teleconference overview presentation that will allow you follow along during today's teleconference. From this site, you can also access a replay and a written transcript of this call.

Also on our site, you will find reconciliations to GAAP financials. Our prepared remarks today include references to non-GAAP financials in our discussions of earnings, EBIT and outlook. We want to remind everyone that this webcast contains time-sensitive information that is accurate only as of today. Any redistribution, retransmission or reproduction of this call without written company's consent is prohibited.

Participating in the call with me today are James L. Hambrick, Chairman, President and Chief Executive Officer; Charlie Cooley, Senior Vice President, Treasurer and Chief Financial Officer; Greg Taylor, Vice President for Planning, Development and Communications; and Scott Emerick, our Controller.

James will start today's call with some opening remarks. Charlie will then provide his prepared remarks and provide an update on our outlook for 2009. We will then open the line for questions and discussions. I need to remind you that some of the information to be furnished in today's session will constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are those focused on future plans, objectives or performance as opposed to historical items. We remind you that actual results could differ materially from results projected or referenced in these forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those factors in the forward-looking statements in this teleconference are contained in the Risk Factor section and the Forward-Looking Statement section of Lubrizol's most recent filings with the Securities and Exchange Commission.

I will now turn this teleconference over to James.

James L. Hambrick

Thank you, Mark and good morning everyone. In previous years, I would generally start this fourth quarter teleconference by listing our business accomplishments for the year. Be assured, in 2008, we had many and we made very good progress on our longer-term objectives as well.

However, even though 2008 represented another year of growth in earnings as adjusted, we clearly did not finish the year as we projected we would in our third quarter earnings teleconference.

Given the dramatic change in the economic environment during the fourth quarter and its impact on our business, we issued a press release on January 16th that reduced our 2008 earnings guidance, announced an estimate of restructuring and impairment charges, and described actions to reduce operating costs and capital spending in 2009.

I'd like to speak to the volume decline and cost reductions actions and allow Charlie Cooley to speak to the restructuring and impairment charges in his prepared remarks here in a few moments.

The steep drop in our full-year guidance was primarily the result of a severe decline in volume in both segments during the last two months of the year. Very weak end-use demand was clearly a major factor in net volume decline. The impact was felt essentially in all geographies and all product lines.

We also attributed a good portion of the decline to inventory de-stocking by our customers, especially in the Lubrizol Additives segment. The decline in volume occurred so sharply, that we were not able to adjust our cost structure quickly enough in those last few weeks to minimize it's impact.

Despite preparing conservative operating and capital budgets for our initial annual plan, we determined that additional actions were necessary. And so, the pre-release also announced significant cost-reduction actions that we estimate will reduce operating expenses by approximately $40 million to $50 million during 2009 compared to 2008.

These actions reflect reductions in selling, testing, administrative and research expenses and manufacturing costs, and the postponement of pay increases, all of this on global basis. Additionally, we will defer some capital spending in 2009 which will result in approximately $30 million lower compared to 2008.

We estimate that restructuring charges associated with these actions will be approximately $11 million, with $9 million likely to be incurred in the first quarter. There might be additional actions whose charges would be reflected in later quarters.

Although we see 2009 to be a challenging year, our growth strategies remain unchanged: Driving organic growth, by selling on value delivered, with a focus on helping our customers succeed, improving our operating profitability with the efficiency and productivity improvements, and strengthening our product line portfolio particularly through bolt-on acquisitions remain our enduring strategies.

On this last point, we'd like to report some positive news with respect to the Dow thermoplastic polyurethane business that we closed on December 31, 2008. Like our Refrigeration Lubricants acquisition the year earlier, this is another good example of the type of bolt-on that we intend to pursue and is expected to provide good cost synergies, new technology and the opportunity to take existing products into new geographies. We'll continue to selectively explore similar opportunities in 2009.

Looking into an uncertain economic picture, our 2009 priorities will be as I have already indicated, managing margins, improving operational efficiencies and expenses, and controlling capital expenditures. Good margins are especially important in this higher cost of capital environment, making it even more difficult to earn appropriate returns and justify investments in plant and equipment, increased regulatory compliance and new technologies.

Even in this economic environment, Additives, which enjoys a large market share, will continue to focus on managing margins not on managing share. Advanced Materials will focus on both managing margins and on increased volume from new applications and from geographic expansion. Our work in 2009 is definitely cut out for us, and I remain absolutely confident that the organization can respond and will deliver a solid performance in the coming year.

With that, I'll turn it over to Charlie.

Charlie Cooley

Thank you, James. Good morning, everyone.

I have three topics to cover before delving into the quarter's details. The first is a description of the restructuring and impairment charges and an acquisition related write-off that we took in the fourth quarter. The second topic pertains to our recent activities in the debt markets. And the third is just to point out some details related to organizational changes we announced in the third quarter.

In the January 16 press release referred to by James, we provided a preliminary estimate for pre-tax restructuring and impairment charges for 2008 of approximately $356 million. Of that number, $31 million were restructuring and impairment charges related to our Performance Coatings improvement initiatives, the closure of a Canadian additives facility and a year-end impairment of a European Performance Coatings facility.

$325 million of the charges were related to a preliminary estimate of goodwill impairment in our Performance Coatings and Engineered Polymers product lines. The impairment charge reflects the full impairment of the Performance Coatings goodwill and is driven mainly by the product line's weak current performance and near-term outlook.

The goodwill impairment charge also includes the partial impairment of Estane and TempRite engineered polymers goodwill and is driven mainly by the increase in our cost of capital in the fourth quarter of 2008. Following the impairments, we have $173 million of combined goodwill remaining for engineered polymers. We will refine this preliminary estimate of the goodwill impairment prior to the filing of our 2008 10-K.

And just for the sake of completeness, the Lubrizol Additives segment carries only $186 million of goodwill, and our Noveon Consumer Specialties product line has goodwill of $461 million. There were no impairment issues with those two businesses. Separately, we also incurred an expense of $1.6 million for the write-off of in-process research and development associated with the Dow TPU acquisition.

My next preamble topic is our liquidity situation. We have been quite active in the debt markets recently and are very pleased with what we have accomplished in early 2009.

On January 27th, we completed the issuance of $500 million of ten-year notes. Though the coupon of eight and seven-eighth percent is certainly high by our historical standards, we believe the transaction was enormously successful and very competitively priced in the current environment. The proceeds will be used to repay at maturity $382 million of notes due in October, as well as to provide additional liquidity for general corporate purposes.

And this morning, we drew down on a new $150 million three-year bank term loan. A portion of the proceeds were used to repay in full the outstanding $75 million outstanding under our U.S. revolver, which largely resulted from the $61 million acquisition of the Dow TPU business on December 31st. The remainder of the term loan proceeds will provide additional liquidity for general corporate purposes.

So to recap, the $650 million raised over the last few weeks in the public debt and bank markets have provided us with cash sufficient to retire the notes due in October, pay down in full our U.S. revolver outstanding balance, and leave us with approximately $175 million of additional cash. Given the importance of liquidity in this market, this was a great outcome.

Of course, the pre-funding of the October maturity will result in eight months of negative carry. And I'll talk more about this in my outlook section. My final introductory topic is to make you aware of our decision to reassign two of our smaller businesses from the Advanced Materials segment to the Driveline and Industrial Additives product line in the Lubrizol Additives segment.

These two businesses are the AMPS specialty monomer business, with 2008 annual revenues of $35 million, which was previously reported as part of the Noveon Consumer Specialties product line, and the ADEX explosives emulsifier business, with 2008 annual revenues of $45 million, which was previously reported as part of the Engineered Polymers product line. These businesses contributed segment operating income of approximately $5 million in 2008. And we made this change to better align these businesses with others of similar asset and technology base. The effective date of this reporting change was October 1st. So the fourth quarter and full year results in both years reflect this realignment.

Okay. So if now you're following along with the PowerPoint presentation on our website's Investor Earnings Release page, I'm now on slide five where you can see the consolidated earnings for the fourth quarter of 2008 compared with the year-ago period.

As a reminder, all references to earnings per share will be on a diluted basis. However, our U.S. GAAP net loss per share amounts exclude diluted shares in the denominator of the loss per share calculation, since the inclusion of diluted shares would only reduce our net loss per share.

This morning, we announced a consolidated loss of $243 million or $3.59 per share, for the fourth quarter of 2008, including pre-tax restructuring and impairment charges of $331 million, or $4.30 per share, primarily related to the previously mentioned non-cash goodwill impairment. For comparisons, consolidated earnings for the fourth quarter of 2007 were $59.7 million or $0.86 per share and included restructuring and impairment charges of $0.01 per share.

When we exclude the restructuring and impairment charges in both years and the in-process R&D from 2008, adjusted earnings of $0.74 per share for the quarter decreased 15% when compared with the fourth quarter of 2007. The most significant factor that drove the earnings decline was lower volumes. Other negative drivers of the consolidated earnings decline were higher raw material costs, and increase in the effective tax rate, higher net interest expense and an unfavorable impact of currency on our results.

The unfavorable factors to earnings more than offset the positive impacts of an improvement in the combination of price and product mix, reduced Selling, Testing, Administrative and Research or STAR expenses and reduced manufacturing costs. Both operating segments grew unit material margins both year-over-year and sequentially.

Turning to slide six, consolidated revenues decreased 5% from the fourth quarter of 2007 to $1.09 billion. Compared with the year-ago period, volumes decreased by 21% and currency had an unfavorable impact on revenues of 2%. Improvement in the combination of price and product mix had an 18% favorable impact on revenues.

Included in these factors was the incremental impact from last year's Refrigeration Lubricants acquisition, which contributed approximately 1% to consolidated revenues in the quarter. Gross profit decreased 12% in the quarter, primarily due to lower volumes and higher raw material costs, which together more than offset the improvement in the combination of price and product mix.

As noted earlier, the quarter benefited from lower STAR expenses, which decreased 11%, compared with the fourth quarter of 2007. Research and testing expenses of $55 million in the quarter were down 4%, largely due to favorable currency impact. Selling and administrative expenses decreased 15% to $96 million, primarily due to lower incentive compensation expense, favorable currency, lower benefits expense and lower project costs associated with our SAP implementation in the Advanced Materials segment.

Other income in the fourth quarter of 2008 primarily reflects foreign exchange gains, as the U.S. dollar strengthened quickly against other currencies early in the quarter. Adjusted EBIT, which excludes restructuring and impairment charges and the write-off of acquired in-process research and developments, declined approximately 4% in the quarter to $90 million.

Net interest expense was $16 million in the quarter, approximately $1.5 million higher than a year ago, largely due to lower interest income. Gross interest expense decreased primarily due to the December repayment of $200 million in senior notes.

Turning to taxes; earnings as adjusted for restructuring and impairment charges were taxed at an effective rate of 32.2% for the quarter, as compared to 23.7% in last year's fourth quarter. The higher rate is driven primarily by non-deductible currency translation losses. Our public reporting for the quarter shows an unusually low effective tax rate of 6.1% as a result of the large goodwill impairment charge, a majority of which has no tax benefit.

Now despite the currency exchange gains that we reported in other income, overall we estimate that currency was $0.27 unfavorable to the bottom line for the quarter, according to our pro forma calculation which compares actual results to pro forma results translated at the prior period's exchange rates. Currency translation losses, especially for inventory in the Lubrizol Additives segment, were the primary driver of the overall negative currency impact.

And now, I'll turn to segment results, which are shown starting on slide seven. Revenues for the Lubrizol Additives segment in the quarter were up 1% year-over- year, as the cumulative effect of selling price increases during the year mitigated lower volume and slightly unfavorable currency. A combination of price and product mix improved revenues 21%, while unfavorable currency hurt revenues by 2%.

Volume for Lubrizol Additives was unfavorably affected by the deepening global recession, particularly in the last two months of the quarter. Volume was down 18% as compared to last year's fourth quarter. We estimate that approximately half of the volume declines was the result of customers choosing to reduce inventories at year end. The magnitude of the decline was uniform in all of our product lines and geographic zones, with the exception of Latin America, which showed a small increase due to business gains.

Our unit material margins is one of our primary metrics for measuring price increase success. In our ongoing effort to restore unit material margins to levels that justify capital investment and to recover the significant increases in raw material and operating costs, Lubrizol Additives implemented four price increases since the third quarter of 2007.

In last quarter's earnings call, we forecasted our unit material margin to grow significantly in the fourth quarter compared to the third quarter as a result of the full implementation of our pricing actions. In the quarter, Lubrizol Additives unit material margins did indeed improve sequentially. While we have made good progress in improving unit margins, we have not yet recovered fully the margin dollars lost by the run-up of raw material costs during 2008 which increased 29% over the same quarter of the prior year. Managing the margin spread during these volatile and uncertain times and recovering the loss margin dollars will remain a major focus for us.

Segment gross profit declined 2% to approximately $173 million, as higher selling prices mitigated the impacts of lower volume, higher raw material costs and unfavorable currency. Segment's STAR was 7% lower in the fourth quarter, primarily driven by lower incentive compensation accruals and favorable currency. Segment operating income increased 6% primarily as a result of the improvements and the combination of price and mix and lower STAR which more than offset the lower volume.

Turning now to the Lubrizol Advanced Materials segment on slide eight. Fourth quarter revenues were down 18% from last year. The decrease reflected a 29% decline in volume and a 2% unfavorable currency impact that were partially offset by a 13% improvement in the combination of price and product mix.

The increase in price mix was comparable to the levels achieved in the third quarter, as we successfully maintain prior price increases and offset continued raw material increases in the fourth quarter with additional pricing actions. This was evident across all product lines and regions. Unit material margin was 15% higher than last year's fourth quarter and also increased sequentially. While we made this progress in improving unit material margin in this segment during the course of 2008, we still have not yet recovered fully the recent increases in raw material costs.

Reviewing segment volume by regions, we saw significant declines in all regions ranging from a 14% decline in Asia Pacific to a 43% decline in Latin America. All regions and businesses were impacted by weak product demand and customer inventory de-stocking. This was particularly true in the North American and European construction and textiles markets, as well in electronics and military applications in Asia-Pacific. The significant decline in demand in Latin America was heavily driven by the stronger U.S. dollar which caused a large drop in export sales to that region.

And now I'll go in to the Advanced Materials product lines in a little more detail. Lower volumes was the primary factor negatively impacting revenues for all three Advanced Materials product lines, in practically all regions.

In summary, revenues in the Noveon consumer specialties product line were $94 million, a decline of 1% from the fourth quarter of 07 due to the lower Carbopol and surfactant volumes. Revenues in the performance coatings product line were $97 million, down 25% from the fourth quarter of 2007. One-third of the 36% volume decline in this product line was attributable to business we have exited or are in the process of exiting.

Engineered Polymer product line revenues were $107 million in the quarter, down 22% from the fourth quarter of 07. Demand for Estane products was down in all regions, especially Asia-Pacific. The TempRite CPVC volumes were down due to the combination of price increase pre-buying in the third quarter and inventory de-stocking and a dramatically reduced demand for construction materials in the fourth quarter. Segment gross profits declined 31% to approximately $66 million, as higher selling prices were not enough to offset significantly lower volumes and higher raw materials.

Advanced Materials segment operating income in the quarter decreased $22 million from the fourth quarter of 2007 to a loss of $1.5 million. The impact of favorable pricing and lower operating expenses were significantly outweighed by the large decrease in volumes. This was particularly true in our Performance Coatings, TempRite and Estane businesses. Our Consumer Specialties product line was able to offset volume declines with improved pricing and lower operating expenses.

And now I'll comment on several other financial items noted on slide nine. Corporate expenses were $10 million in the fourth quarter 2008, a decrease of more than $6 million from the year-earlier quarter. More than two-thirds of this reduction was due to lower incentive compensation expense, with the balance of the decrease attributable to lower benefits expenses.

We generated $218 million in cash flow from operations in the full year of 2008, down from our record of $476 million in 2007. This decrease in the operating cash flow was primarily the result of cash consumed to support higher working capital in 2008. The higher working capital level primarily reflected the change in inventory driven both by higher quantities and increased year-over-year costs in each of our segments. We are now reducing inventory during the first quarter of 2009, in line with our current outlook.

Regarding other uses of cash in the quarter: Capital expenditures were $56 million. We paid our dividends of approximately $21 million, and we repaid debt of $200 million in senior notes that have matured on December 1st. So our cash balance at December 31, 2008 was $186 million, compared with $502 million at December 31, 2007.

And now I'd like to make a few more comments regarding our liquidity. And I am now on slide ten. At December 31st, we had $75 million and €25 million outstanding under our $350 million and €250 million revolving credit facilities, respectively. These borrowings were used for the initial funding of the Dow TPU business and for short-term working capital needs that arose at year end in North America and Europe.

As of today, with the funding of the $150 million bank term loan, our U.S. revolver is undrawn and we expect to fully repay the small amount outstanding under the euro revolver later this quarter. And our January 31st pro forma global cash balance, reflecting today's term loan draw, the reduction in our revolver balance and the anticipated repayment of the $382 million of notes due in October, stood at approximately $390 million.

And now I'll turn to our outlook on slide 11 and 12. We have observed many companies choosing not to provide guidance for 2009. And this is certainly understandable given the very uncertain state of the global economy. Never in most of our memories has there been such a lack of visibility. Nevertheless, we believe it is important for us to provide you a window on our current thinking for what lies ahead. We will update you on our outlook, as we always do, as the year progresses.

Our outlook for 2009 is similar to many specialty chemical companies. In that, we expect the weakness and demand that we experienced in the fourth quarter of 2008 to continue at least into the first half of 2009. Chemical markets will remain weak until key end users such as vehicle production, housing and consumer goods starts to recover. We also believe that some de-stocking will continue into the first quarter as customers adjust inventories to the reduced level of demand.

For the year, we expect demand for some product areas, such as personal care and lubricant additives to be less affected. However, we expect significantly weak volumes in our construction-related Performance Coatings product line and TempRite business. Overall, our plan assumes approximately 10% lower volumes for the year.

Our 2009 guidance is $3.48 to $3.88 per share, including $0.12 per share for restructuring and impairment charges largely associated with our cost reduction actions we have undertaken this quarter. Excluding these charges, our guidance for adjusted earnings is in the range of $3.60 to $4.00 per share. Considering the environment that we are in, we believe this compares quite well with the adjusted earnings of $4.09 per share achieved in 2008.

Here are our key assumptions: A decline in consolidated volume of approximately 10%. Consolidated STAR down approximately 4% due to the cost-reduction actions recently taken. Our current projection is for consolidated adjusted EBIT to range from level of 2008 to grow at 9% compared with 2008, reflecting our continued effort to recover lost margins during last year's run up in raw material costs. This assumption also reflects the $40 million to $50 million of cost-reduction actions we have implemented and it also reflects our assumption that 2009 pension expense will be leveled with 2008.

We project net interest expense of approximately $110 million, up about $45 million from 2008. About half of this increase is a result of the negative carry associated with the pre-funding of our October debt maturity. And in addition, we have increased our gross debt through the upsized public offering and the new bank term loan in order to provide greater liquidity. We project an effective tax rate for the year of 31% and we assume the euro to average $1.25 for the year.

The key updates to our cash flow outlook are shown on slide 12, and these are: Capital spending is projected to be between $160 million and $170 million. We project pension contributions of $60 million which is flat with 2008. We are modeling dividends of $85 million, consistent with the current dividend rate. And we currently project approximately $150 million of cash flow generated by working capital changes in 2009, driven primarily by our plans to reduce inventories. This compares with $247 million use of cash in 2008.

So, to wrap up here are the main takeaways for our outlook: In response to a significant decline in demand, we have initiated steps to reduce operating expenses, capital spending and working capital. We enter 2009 with much improved unit margins in all of our businesses, thanks to the pricing actions taken last year.

As a result, despite our outlook for demand, we project adjusted EBIT to be flat to up 9%. 2009 earnings will be temporarily burdened by a sizeable negative carry that will disappear in the fourth quarter; and we have successfully refinanced our upcoming debt maturity and added valuable liquidity to make our balance sheet even stronger.

And I'll stop here and open the call up for Q&A. Rochelle?

Question-and-Answer Session

Operator

(Operator Instructions). And the first question comes from the line of P.J. Juvekar of Citi. Please go ahead.

Unidentified Analyst

Hi this is Anthony Petinari (ph) standing in for P.J. Following up on your 2009 guidance; one of your assumptions is that volumes would be down 10% on a consolidated basis. So teasing that out a little, can you give us a range for Lubricant Additive volume declines that you expect for the year?

Charlie Cooley

Yeah sure, this is Charlie. Maybe I'll purpose answer to that question, anticipating there will be likely other kind of detailed question and guidance. With the fact I am really I am going to deliberately try to stay high level on this. But having said that let me do my best to answer your question.

Between the Additives and Advanced Material segments, we estimate that about 60% of our volumes are in the consumable-type applications service still for Additives and our personal care business also is a consumables-type business which tend to be fairly cycle-resilient.

So the key reason for why one like the one and why we're only looking down to the down 10% is because of that large proportion of our volumes that are consumables service-filled in the Additives terminology. Now drilling down a lit bit further within Additives, we are projecting different downward growth rates. For example, the non-consumable components of Additives, namely what we factory fill and that obviously that's driven by new vehicle production. We anticipate an even lower growth rate... decline rate than 10%, but that's been offset by a less than 10% decline in the service-fill component of this segment.

I think I'll stop there and really won't be diplomatic to drill down too much, because emphasizing James' initial point at the outset, these are very uncertain times. We're doing our best to give folk a view on the things. We wouldn't be providing this guidance if we weren't comfortable doing so. So we also are being careful not get drilling down into too much details this early in the year.

Unidentified Analyst

Okay. Thank you. And moving back to the quarter, did all three of Advance Materials businesses experience an operating loss in the quarter?

Charlie Cooley

Actually, we will talk about the earning at level within the product line. But let me answer the question this way. If it weren't for the overheads associated with that segment, all of those businesses will be profitable in the quarter. It's that, the operating leverage is such that with the magnitude of volume decline that we saw in those three product lines caused the slight loss in the quarter.

Unidentified Analyst

Okay. And given that visibility is obviously very poor, do you expect operating income to move back positively for Advanced Materials in 1Q?

Charlie Cooley

Yes. And in fact and I was just looking at January now; both segments are looking up sequentially from December. So while year-over-year comparisons are not pretty, the trend is at least getting off to the early start of the year in an upward direction. But I do want to stay away from getting into too much detail, what we think the first quarter is going to be and so on.

Unidentified Analyst

Okay. And thank you, very much.

Operator

Okay. Thank you. And the next question comes from the line Jeff Zekauskas of JPMorgan. Please go ahead.

Jeffrey Zekauskas - JPMorgan

Hi, good morning.

James Hambrick

Hi, Jeff.

Jeffrey Zekauskas - JPMorgan

In the Lub Additive business, base oil prices are obviously coming down very, very sharply or they came down sharply in the first quarter. They continue to come down sharply. And you are trying as best as you can to hold on to your raw material margin. Because of the swift decline in base oil prices and other chemical intermediates you use. Does this mean that the first quarter volumes in Lubricant Additives will probably drop at and even faster rate than you had in fourth quarter, as customers wait for price concessions by Lub Additives suppliers?

James Hambrick

Jeff, this is James. There is no question there is a lot of volatility in raw materials clearly customers in the fourth quarter or particularly in the last six weeks in the year saw the raw material declining. We know that there was drop in usage, there was de-stocking going on. We know that that's not phenomena that quits on December 31. But almost anything I can say is not going to be helpful towards the overall health with the enterprise. So, I am not going to answer your question.

Jeffrey Zekauskas - JPMorgan

Well. Are you dropping your prices yet?

James Hambrick

Jeff, I am not going to answer your question. We have managed price and margin extremely well, on ups as it's come down. I have said many, many times, this is not science, its art. Leave it to me and my team to manage, you judge the results at the end of the quarter, please sir. Thank you.

Charlie Cooley

Jeff, I will maybe make one comment on volume in Additive. Really it's just reiterating something we already said in our prepared remarks on the ways to de-stocking. A large proportion of Additives volume decline we do attribute to de-stocking in the fourth quarter. And we also noted in our prepared remarks that it's reasonable to think that further restocking... de-stocking sorry, could continue into the first quarter.

At some point though to just do the nature of de-stocking, we would expect things to... there should be restocking to take place. But we are just in no position to predict when that will be.

Jeffrey Zekauskas - JPMorgan

Well, maybe if I could just try a politically correct portion of what I asked. How do see the Lubricant Additive industry globally in 2009. That is I mean normally one expects this industry to sort of shrink by couple of percent or grow by a couple percent each year. What do you think 2009 will look for the industry as whole?

James Hambrick

The volume... the overall global consumption of lubricant will decrease, Jeff. But that's, of course that's only part of the equation, there is margin times volume and we are dedicated to the task of maintaining and improving our margins so that we can justify continuing to invest in this business for the benefit our customers. We will perform well this year, despite of a downward volume trend.

Jeffrey Zekauskas - JPMorgan

I guess lastly then just a clarification, did you say that the $8 million in other income or other corporate income was currency gains or is it something else?

Charlie Cooley

Yeah those were transaction gains or exchange gains, but we also noted that there are a lot of other currency effects that go throughout our P&L and you know Jeff that in the past tried to give sort of a bottom-line estimate of what we think the currency impact is. And in the fourth quarter, it was quite negative actually. So even taking into account for those exchange gains in other income, net, the currency impact on the quarter was, as I said in my prepared remarks about $0.27 per share negative.

Jeffrey Zekauskas - JPMorgan

Okay. Thank you very much.

James Hambrick

Yes. Thanks Jeff.

Operator

Okay. Thank you. And the next question comes from the line of David Begleiter of Deutsche Bank. Please go ahead.

David Begleiter - Deutsche Bank

Thank you. James, I'm going stay on the pricing issue, it's so critical. What is the typical lag when base oil prices do go down versus industry practices for lowering selling price increases?

James Hambrick

Yes, typical lag is all dependant on where we are, David, in terms of... as you know I've talked about this, really I feel like agnosiant (ph) there. Quarter after quarter, we really are tracking total cash, total margin cash. That tends to be the key for us in managing those margins. It's not so much what does price do, it's what does margin do. And so you're normally looking at about a 60 day lag as raw materials drop, we're looking at about 60 days for that to flow through completely. And then I'll be bouncing that against where are we on a cash position and where are we on volume.

My intention, all along has been, and I've made no secret about this, not only with in the financial community but also within the industry itself, if we were to go back in time a few years ago, our Additive business and the Additive business as a whole was not generating profits sufficient to justify continuing to re-invest in it and it is our mission to lead that forward into a better state. We've got it there, we intend to keep it there.

David Begleiter - Deutsche Bank

Does that metric resonate with customers?

James Hambrick

Yes sir, it does. The value that we deliver, the technology that we deliver, our customers are in fact more successful today than they have been in the last decade.

David Begleiter - Deutsche Bank

And just on the four price increases since Q3 07; were they all successful and can you say where it got you on the cost curve versus higher...

James Hambrick

Yes sir, they were all successful and I'd like to leave it there please.

David Begleiter - Deutsche Bank

And just last on Performance Coatings, what's your current view on that business within Lubrizol portfolio?

James Hambrick

Current view from a portfolio point of view is, I've got my three best players working on it and they're making great progress.

David Begleiter - Deutsche Bank

Thank you very much.

Operator

Okay. Thank you. And the next question comes from the line of Laurence Alexander of Jefferies. Please go ahead.

Laurence Alexander - Jefferies & Co

Good morning. I guess, first question is on the debt financing. Why did you decide to go out now and go for the full 500 rather than just 200 to 300, and given where interest rates are, is there any... are there any moving parts that are affecting free cash flow that serves, that will be a concern for the year that motivated that?

Charlie Cooley

Well I appreciate your asking the question, Laurence, this is Charlie. We've been planning for this refinancing of the October 09 maturity starting in the second quarter of last year thinking about when we want to do it when we go monitor the market.

Absent the absolute disastrous financial prices that had came upon us in the fall, we still would have been thinking about going to the market to refinance that notes, say with six months to go. And as it is, we did nine months in advance. And then when you layer on top of that, the fact that we emerged recently from two-plus months of been completely frozen out of the public debt markets with an outlook by just by anybody that is and as per the stats uncertain at best, frankly I think that we did very much the right thing by taking that risk off the table.

We ask ourselves which is the bigger mistake looking back and wish that we had issued at a lower price or looking back and finding out that we will never be able to access the markets in the first place. So I think it was absolutely the right thing to do, and by no means is indicating a liquidity concern on our part other than I simply want to make sure that we didn't find ourselves unable to refinance that near $400 million maturity in October.

James Hambrick

And Laurence, as Charlie and I talked to the particularly part of your question about 250, 300, 400 versus 500, as we talked about it, really the decision that we made was, if we felt like within the regime we are in that we could get some good pricing. We ought to go ahead and go for the... for a full 501. It would be an extra wrap around the arm force, because of so much uncertainty. Just we want to make sure that we have got a good strong balance sheet and we're capable of operating our enterprise likely and properly.

And also wanted the opportunity. If the world continues to degenerate a little bit, should there be a nice little bolt-on come along. Let there be a little bit extra liquidity to take advantage of that, if it was possible. So we considered it to be really the right thing do all way around.

Laurence Alexander - Jefferies & Co

And then secondly just if I can follow-up on... an earlier question on the remark on January being slightly better than December. And really the year is still very young, but given the 18% or 29% volume declines you saw in Q4, is January materially better or you're seeing like maybe 15% and 25% year-over-year comps was reasonable in the first quarter? What you are trying to signal on that?

Charlie Cooley

I am not trying to signal that just as a very minor data point at this very early junction in the year. The year is going as we had anticipated. I don't want anyone to conclude some by remarks that anything other than that. And we really are trying to steer clear of providing investors with more specific inputs to help and build that quarter-by-quarter, because quite frankly there is just a wider potential range of deviation as we look forward as we have ever seen in the past.

Laurence Alexander - Jefferies & Co

Thank you.

Operator

Thank you. And the next question comes from line of Dmitry Silversteyn of Longbow Research. Please go ahead.

Unidentified Analyst

Good morning. This is a Jon Fergusson (ph) for Dmitry. I just... looking at the '09 guidance, I guess can us provide us a little more detail on what assumptions you have for raw material costs both in the first half and the second half of the year?

Charlie Cooley

Yeah, our outlook is that the raw materials will be essentially flat through the balance of the year from where they are right now.

James Hambrick

And layered on top of that is the same assumption we always use. It really doesn't matter because we're going to be managing margin. We know that's not true. We just don't know what they are going to be. So our real assumption is we will manage margin.

Unidentified Analyst

Okay, I understand that. So in your guidance right now you don't have any assumption that they can lower raw material cost in the second half of the year?

James Hambrick

No sir we do not.

Unidentified Analyst

And then just on the inventory levels; it looks they increased significantly both sequentially and year-over-year. Assuming that's largely due to a significant drop in demand with maybe inability to not low production that was quick enough. I guess can you provide us your expectations towards shedding this inventory. And what the fixed cost absorption of the lower production levels is having on your 2009 guidance?

Charlie Cooley

Sure. Actually we had so-called FAS 151 or fixed class absorption charge in the... part of our fourth quarter results of that $13 million. And we are bit baking into our outlook for 09 the appropriate amount of additional charges associated with... I said in introduction. I don't want to give you that number. I think that's helpful but we're taking that into account. The bulk of that $150 million I gave of cash generated from working capital changes in 2009 is driven by inventory reduction in the Lubricant Additives side of the business. So it's basically, it's working back down what we've essentially built up in the fourth quarter.

Unidentified Analyst

Okay. And I guess the slower production levels, they are fixed cost absorption, is I guess to what level is that impacting the 09 guidance?

Charlie Cooley

As I said I don't think that's a helpful number to give you, because I don't know what you really do with it.

Unidentified Analyst

Okay. And then just finally the Additives business showed Latin America volumes were up 6%. Is there any acquisitions in that number and I guess can you describe kind of what you saw in that market in December relative to November and October?

Charlie Cooley

Yeah. I made it in my remarks, again this is Charlie. There were some business gains that we had achieved well back and so does the fourth quarter results is not that bad and so we were seeing that in the quarter. But there is nothing else of note in Latin America. If the fall market, Latin America represents less, a single-digit percent of the Lubricant Additives business.

Unidentified Analyst

Okay. Thank you.

Operator

Okay. Thank you. And the next question comes from the line of Ivan Marcuse of KeyBanc Capital Markets. Please go ahead.

Saul Ludwig - KeyBanc Capital Markets

Hi. This is Saul with Ivan. In the Lub Additive sector how much did acquisitions contribute to that volume?

James Hambrick

Close to 1%.

Charlie Cooley

I guess 2% Saul.

Saul Ludwig - KeyBanc Capital Markets

2%?

Charlie Cooley

We're talking about the --

Saul Ludwig - KeyBanc Capital Markets

Right. And the unobserved earnings that you just alluded to the $13 million, how was that split between Lub Additives and Advance Materials?

Charlie Cooley

I think about $10 million in Additives and $3 million in Advance Materials.

Saul Ludwig - KeyBanc Capital Markets

And you mentioned that your pension expense would be fairly flat in 2009. I guess I was surprised by that, given the drop that you must have had in your pension assets. So with lower pension assets on which you can earn your estimated rate of return, what you're doing to keep your pension expense flat.

Charlie Cooley

Great question, Saul. In fact our U.S. pension expense is going up as a result of the increase in the under-funded status of the U.S. plant. But that's being equally offset by lower pension expense in our non-U.S. plants.

Saul Ludwig - KeyBanc Capital Markets

Why would that be going down.

Charlie Cooley

We made some design changes.

Saul Ludwig - KeyBanc Capital Markets

Okay. And then you've got this new plant in China which is already to get crank up, I think. What do you think, you're going to be able to do in terms of utilizing that plant as demand dissipating, and how are you factoring in that added expensive if you will, the fixed costs that you're going to have in 09 in your outlook?

James Hambrick

I am just reviewing that this morning, Saul. Clearly we're in the final stages of construction start-up due to begin here, just couple of months down the road. Most of our Coatings business in China is for the indigenous market and of course some of the turns around and comes back as exported goods. And so the question that I have been asking is, where are we in terms of business levels and what do the margins look like? And I don't want to look at it on certainly on a P&L basis, I want to look at on a cash basis.

I just looked in, and Charlie was looking at it I'm sure this morning, Ernie as well. And I was pretty pleased by what I saw in terms of the way the forecast is holding up. It's good solid business. I think I had said before that we were preceding the construction of this plant that we had been out building market position at little or no margin using imported products and so, I really like where we are and so we'll be far and up there.

Charlie Cooley

And Saul I will just add just a quick fact to what James said. We actually... our Advance Materials business was actually up 6% in the quarter in China. So just reflecting that despite down elsewhere that China business hanging in there for us in the Advanced Materials.

Saul Ludwig - KeyBanc Capital Markets

Charlie, what's D&A going to be in '09?

Charlie Cooley

D&A total is 175.

Saul Ludwig - KeyBanc Capital Markets

That's about the same as the year that you just ended, right?

Charlie Cooley

Yeah

Saul Ludwig - KeyBanc Capital Markets

And then are you going to give us sort of you changed where you put the AMPS monomer and that host of business. Does that go back and change what you previously reported for your first quarter in sales and op income for a first quarter, second quarter and third quarter of '07 and '08?

Charlie Cooley

Yes, correct.

Saul Ludwig - KeyBanc Capital Markets

So we get a little release on what... so we can adjust our models appropriately?

Charlie Cooley

Yes, you can call in. Anyone can call and we can provide that. That will be in our disclosures. We have and as I said in my prepared remarks, we're recasting prior year and current year segment information for that change in businesses.

Saul Ludwig - KeyBanc Capital Markets

And just not to get too specific about the first quarter, but make sure we're on the right planet. Is this type of volume decline that we saw in the first quarter, fourth quarter, should we be thinking in that order of magnitude in the first quarter, because of de-stocking continuing and than they may be moving to lesser degrees of negativism in the next couple of quarters. Is that reasonable?

James Hambrick

Okay. Look I have got some hands one way and other hands going the other. Let me tell you how I think about it Saul. At a very high level, I think the worst is behind us. Alright? Now I having said that I don't want to and we are just a few weeks into the year and everyone is running scared. And I just don't know the behaviors buying behaviors, consumption behaviors are typical. I believe the worst is behind us. But the first quarter is going to be weak, there is no doubt about it.

Saul Ludwig - KeyBanc Capital Markets

No. I think we're all facing this how do we know what's going to happen and whatever you say may or may not come the past because of the unpredictability.

James Hambrick

Well that makes, I will say the first is going to better than the fourth?

Charlie Cooley

I'd say the answer of your question is yes.

Saul Ludwig - KeyBanc Capital Markets

So there were comments in the script about kind of our view whether first half second half so I'd think that kind of?

Charlie Cooley

Yes. And then we said we anticipate the de-stocking and weakness to continue through the first half at least.

Saul Ludwig - KeyBanc Capital Markets

Basically you said first quarter is not bad as the fourth. Got you.

James Hambrick

That's what I said. Okay, it may or may not have to change.

Saul Ludwig - KeyBanc Capital Markets

I do not have a crystal ball. I am just thinking, how you are thinking about it today. Hey that's great. Thank you very much guys.

Charlie Cooley

Thanks Saul.

Operator

Okay thank you. Your next question comes from the line of Christopher Willis of Impala Asset Management. Please go ahead.

Christopher Willis - Impala Asset Management

Just I have two quick questions. So what is the non-cash pension expense flowing through your P&L. I guess it's going to be same in '09 at it was in '08. And then secondly, just looking at your cash flow and the recent financing; most of my questions have actually been answered. I am just curious what you think sort of the normal or maybe even minimal operating level of cash you need to have on your balance sheet. Because it looks like based in your guidance and if you want to make a bolt-on and want to buyback any stock during '09, your cash balance might be kind of brimming over the $500 million level by the end of the year. So I am just curious what a typical operating levels that you are comfortable with?

Charlie Cooley

Okay. This is Charles. I will answer your cash question and then our Controller Scott will address your pension question. All on, kind of minimum cash necessary just to run the business we estimate to be about $150 million and I love your character... your prediction that we will have cash brimming at the end of the year that will be wonderful. So we will cross that bridge when we can't do it and see what we want do with those cash balances. But 150 is what we need just to keep the working capital level cash, so the system can operate. The pension expense in 2008 was $48 million.

Christopher Willis - Impala Asset Management

Great. Thank you.

Operator

Okay, thank you. And you have a follow-up question from the line of Jeff Zekauskas, with J.P. Morgan. Please go ahead.

Jeffrey Zekauskas - JPMorgan

Thanks very much. The inventories in the quarter, I think were 815 versus 706 in the third quarter? Were they cancelled orders or why did your inventories go up so much? And was that more on the Additive side or more on the so-called Advanced Material side? Can you talk about that change?

James Hambrick

It's not a singular reason Jeff, there is actually more than one reason. Remember as we left the third quarter, we just suffered through a couple of hurricanes and we were running like crazy to refill that pipeline. So, that's part of it.

The other part of it is, demand really did precipitously decline. I would not... I wouldn't go so far to say we actually had orders come off of the books, we just didn't have orders that materialized, as we would have had it modeled in our normal kind of October, November, December order patterning. We do have enough history here, over years that we know what that order pattern should look like, and it is just didn't materialize.

Jeffrey Zekauskas - JPMorgan

So, that's helpful. Maybe a question for Charlie is, are you going to have to take inventory write-downs in 2009?

Charlie Cooley

No, the only inventory related P&L impact that we'll be looking at is this charge to a cost that I alluded to earlier, comparable to what we needed to do in the fourth quarter. But that's just a FAS accounting requirement just to make sure that you have some kind of normalized recognition of your period expenses in periods where you've got large drop-offs in capacity utilizations. But really, you're asking about LIFO or lower cost to market type questions.

Jeffrey Zekauskas - JPMorgan

Okay. And then lastly, I think earlier in the call you said that your working capital benefit may be would be 125 or 150 in '09. I don't recall exactly.

Charlie Cooley

150.

Jeffrey Zekauskas - JPMorgan

150. Why wouldn't it be 250? You know that is and I think your working capital use was about 250 this year and certainly raws will come down and inventories will come down and the level of business will come down. Or else are you being a little conservative on your estimates?

Charlie Cooley

There may be a little bit conservatism in our estimate, although I hesitate even say that. What we're really talking about now is what will inventories and sales demand would be in the fourth quarter. So we're now looking way into the future and so there is some estimate that we should see higher sales in the fourth quarter of 09 relative to what we saw in the fourth quarter of '08.

Jeffrey Zekauskas - JPMorgan

That's helpful. Thanks very much.

Operator

Okay. Thank you. And there are no further questions in queue. Please continue.

Mark Sutherland

Very good. Rochelle, I think we're ready to wrap up the call. Excuse me. So given the time and I want to thank everyone for dialing in. Rochelle, could you please provide the dial-in number. I'd also like to note that my direct dial for clarification of any questions is 440-347-1206.

Operator

Okay, thank you. Ladies and gentlemen, this conference will be made available for replay after 1 O' Clock PM today until Thursday, March 5th at midnight. You may access AT&T Executive Playback service at any time by dialing 1800-475-6701, entering the access code 981775. International participants, dial 1-320-365-3844 and again that access code is 981775.

And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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