BRK.A (BRK.A) Q2 2008 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter Earnings Conference Call. Now, at this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions] As a reminder, today's call is being recorded. And your hosting speaker, Mark Sutherland, please go ahead.

Thank you Kevin, and thank you for joining us today, July 31'st, 2008 for a discussion of our second quarter 2008 results, which were released yesterday. This call is being webcast by ccbn.com and will be available for replay beginning about 6:00 p.m. 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 a presentation entitled Second Quarter Teleconference Slideshow and you can follow along with us during today's teleconference. From this site you can also access the 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 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 open today's call with some brief comments on the quarter and how we see performance going forward. Charlie Cooley will discuss the quarter's results and update our outlook for 2008. We will then open the lines 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 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. With that I'd now like turn the conference over to James.

Thank you, Mark, and thank all of you for joining us for today's teleconference. As usual, I am going to keep my comments brief. Let me start by telling you this is a very notable date for us. It's the 80th anniversary of the Corporation. On July 31st, 1928, the company was incorporated here in Cleveland, six founders and investors pulled a sum total of $21,000 in capital and set us on a path to where we are today, a global specialty chemical company with about 7,000 employees and facilities in 28 countries, serving customers, representing dozens of industries in over a hundred countries. Over the years as we roll our reputation for innovative technologies and market leading positions across and expanding range of valued product lines. It's very fitting today. On this occasion, it will be reviewing the best quarter ever in corporation's history. Didn't emphasize in yesterday's earnings release, but I would like to highlight that we achieved new quarterly records for revenues, for volume and for earnings as adjusted. Obviously, I'm very pleased with our results and quite proud of the collective effort of my entire organization. Charlie will lead us through the discussion of the results, but I'd like to give you my perspective on the headlines. Overall, both segments performed very well. Additives continued what I considered to be near-perfect execution, pricing actions to overcome margin headwinds were superb and strong volume growth in the quarter provided good operating leverage. The manufacturing facilities just performed admirably. Additives continued volume growth reflects real market changes; it's also a testimony to our customer relationships, the value of our technology and our global supply capabilities. Advanced Materials demonstrated good improvement in a quarter, its going in the right direction. Here too, we took very good pricing actions to offset raw material pressures. The consumer specialties and TPU engineered polymers product lines were strong contributors to out overall performance. CPVC engineered polymers demonstrated resilience in the slower North American plumbing demand and Performance Coatings progress it's restructuring and focus on selective high value applications. International market growth was favorable across the board. Volume revenue growth in Asia-Pacific was particularly strong for both segments, reinforcing our past decisions and future ones to invest in the region, especially in China where we are establishing larger commercial, technical and manufacturing capabilities to support that growth. Both segments continued with significant, sustained and very successful pricing actions in the quarter in the face of frequent and large raw material cost increases in the quarter. We took multiple large actions across every product line to insure timely recovery. Our performance this quarter and our track record over the last several years should allay any concerns that you might have about our ability to manage input cost challenges even when they come out as at unprecedented rates. We are perfect, but in these very difficult environments we are as good as anybody in the sector, that's in my considered opinion. Another headline I should like to highlight is our performance with operating expense control, our consolidated selling, testing, administrative and research expenses weren't level with the year ago quarter, even as we build out geographically. And our manufacturing expenses excluding energy and currency were also flat year-over-year and that translated into excellent productivity and operating leverage with our volume growth. We also continued to improve our operating structure. While we're building out in Asia and other regions, we announced additional North American facility reductions in both segments. We will see modest benefit from these actions in 2008, but they helped set the stage for 2009. And with respect to the topic that never makes a headline until it is one, our acquisitions, alliance and portfolio growths were continues. Let me conclude by saying we continue to execute well and we are properly positioned as we enter in the second half of the year. No doubt, we are going to continue to face a challenging environment, but I am very confident in our performance and our future prospects and thus the increase in the 2008 guidance range for adjusted earnings per share. We aren't the same company that was founded 80 years ago. We are not even the same company that we were five years ago but we do remain totally committed to our founders four must guiding principle of ensuring we provide investors with appropriate returns. That's our commitment and that's our track record. I'll turn it over to Charlie.

Thank you, James. Good morning everyone. I will start my comments on the quarter with a few headlines and then I will get into the more detailed discussion. As James had said, Lubrizol sets quarterly record for consolidated revenues, sales revenues and as adjusted earnings, thanks to record performance in the Lubrizol Additive segment for revenue volume and operating income. As in the first quarter, the Additive segment delivered double-digit revenue growth in all international zones. The Lubrizol advanced material segments delivered significantly improved performance sequentially though some business areas do remain affected by weak demand in North America. In this quarter we continued to implement our coating improvement plan by announcing additional actions to consolidate North American manufacturing capacity. And lastly, both segments under took timely and significant price actions in the quarter to address the significantly higher raw material and operating costs. If you are following along with the PowerPoint presentation on our website and investor relations release page, I am now on page four, where you can see the consolidated earnings for second quarter of 2008 compared with the year ago period. As a reminder, all references to earnings per share will be on a diluted basis. Yesterday, we announced at that consolidated earnings for the second quarter of 2008 were $78.1 million or $1.13 per share including restructuring and impairment charges of $0.13 per share primarily related to the business improvement initiatives and North American manufacturing consolidation in our performance coatings product line. Consolidated earnings for the second quarter of 2007 were $81 million or $1.15 per share and included a restructuring and impairment charge of $0.01 per share primarily related to the impairment of an investment in one of the advanced material product lines. So, when we exclude the restructuring and impairment charges in both years, adjusted earnings or $1.26 per share for the quarter, were 9% higher than the second quarter 2007. The primary drivers of the consolidated earnings growth were improvement and a combination of price and product mix, higher volumes, favorable currency and contributions from acquisitions. These positive factors to earnings more than offset the impact of higher raw material costs, higher manufacturing costs and an increase in the effected tax rate. Turning to slide five, consolidated revenues increased 17% from the second quarter 2007 to $1.35 billions. Compared with the year ago period, improvements in the combination of price and product mix increased revenues by 8%, volume increased 5% and currency had a 4% favorable impact to revenues. Included in these factors was the incremental impact from last year's Refrigeration Lubricant acquisition which contributed 2% to consolidated revenues in the quarter. Gross profit rose 3% in the quarter, as the higher revenues more than offset higher raw material and manufacturing costs. Continuing the pattern we've seen over the last several years, gross profit dollars increased year-over-year even though gross profit percentage declined 300 basis points, because the rate of increases in revenue due to pricing has out paced the rate of increase in gross profit dollars. If you look at the gross profit performance since 2005, this phenomenon is quite dramatic. Lubrizol's first half gross profits has grown over $120 million, representing a compound annual growth rate of 8% since the first half of 2005, yet over that period gross profits percentage has declined 340 basis points. This mainly reflects Lubrizol Additive success in recovering the extraordinary rise in raw material costs over this timeframe. STAR expenses were leveled with the second quarter of 2007. Research and testing expenses of $56 million in the quarter were up 4% largely due to increased outside testing expenses with the remainder of the increase primarily attributable to unfavorable currency. Selling and administrative expenses of $102 million were down 1% due to favorable swing related to the mark-to-market affects of our stock based incentive compensation plan for international participants. This decline partially was offset by unfavorable currency effects and incremental SAP project costs. Over the last several years we have been providing our estimates of the impact of currency fluctuations on the bottom-line. Currency provided $0.01 EPS benefit in the quarter relative to what we were expecting at the time of our May guidance. Compared to the second quarter of 2007, we estimate the impact of currency to be a favorable $0.16 per share. But I want to know note that in the current environment of dramatically increasing material costs, the impact of currency cannot be viewed in isolation, because our pricing actions take currency change into account. For example its fair to say that had the dollar fallen less relative to the Euro recently, we likely would have pushed forth and achieved greater price increases in Europe. Adjust EBIT which excludes restructuring and impairment charges and credits rose 8% in the quarter to $142 million. Net interest expense was comparable to the year ago quarter at $17.6 million. Turning to taxes, earnings as adjusted for restructuring and impairment charges were taxed as an effective rate of 29.1% in the quarter as compared with 28.3% in the last quarter second quarter. As you may recall, last years rate benefited from the resolution of some tax matters from prior years. The 29.1% tax rate for the current quarter is lower than stated in our previous guidance, largely as a result of the tax favorable improvement in geographic earnings mix. And now I will turn to segment results which are shown starting on slide six. Revenue for the Lubrizol Additive segment in the quarter were 22% year-over-year, a 9% higher volume. The combination of price and product mix improved revenues 8% and the currency contributed 5%. Volumes surpassed the quarterly record established in the first quarter of this year and was particularly strong outside of North America. Latin America volumes increased 30%. Asia-Pacific was up 26% and Europe was up 9% while North America volumes declined 6%. The Refrigeration Lubricant acquisition completed in late 2007 contributed one-fourth of the volume growth in the quarter. We attribute the outstanding volume growth in our International regions to three factors. First we are very well positioned in the fastest growing market. Second, we have a solid technology position and extensive supply-chain that customer's value. And third, we are well-positioned with the customers that are winning in the marketplace. In North America, we attribute two percentage points of the decline to a general demand weakness and the remainder to changes in customer order pattern and sales of more highly concentrated products. Lubrizol Additives has announced four price increases since landfall. The most recent increase was announced July 3rd. The magnitude of our price increases has grown as the rate of raw material cost increases have grown. Furthermore, we have shortened even further the time lag between raw material cost increase and selling price increase implementation. To boil it all down, we project the current round of price increases will bring us up to unit material margin levels that is material margin dollars per unit of product sold that exceed the levels we saw in mid 2007, a period that preceded the recent rapid run-up in material costs. Unit material margin is our primary metric for price measuring price increase success. Segment operating income in the quarter increased 10%, primarily as a result of the improvement and combination of the price and product mix. Higher volume, favorable currency and the contribution from the refrigeration lubricants acquisition, which all combined more than offset the impacts of higher raw materials and manufacturing costs. Excluding the contribution from the acquisition, operating income increased 7%. Before I move to the Advanced Materials segment, I want to note that this past Tuesday we announced plans to close our Lubrizol Additives blending facility in Canada. We expect to record restructuring charges associated with the closure of $0.06 per share in the second half, with additional charges expected in 2009 and 2010 totaling approximately $0.06 per share. Annual savings from this closure which will be completed by mid-2009 are projected to be $4 million. Turning to the Lubrizol Advanced Materials segment on slide seven, second quarter revenues were up 8% over last year. The increase reflected a 7% favorable impact from the combination of price and product mix, a 4% favorable currency impact and the 3% decline in volume. The increase in the combination of price and product mix reflects pricing actions across all product lines in the segment. And to that point, unit material margins in this segment were 2% higher in the quarter versus the comparable quarter last year. The decrease in volume primarily was due to general weakness in our North American Performance Coatings product line. This decrease partially was offset by very strong overall volume growth in Asia-Pacific/Middle East with Performance Coatings, TempRite Engineered Polymers And Noveon Consumer Specialties all growing over 20% and Estane Engineered Polymers volumes up 9%. Europe volumes declined 7% from the second quarter of last year due to weakness across our Performance Coatings product line. The Performance Coatings product line also shed some low margin business as part of its restructuring initiatives. I will now go into the Advanced Materials product lines in a little more detail. Noveon Consumer Specialties product line had record revenues of $119 million, up 14% from the second quarter of 2007 on record volume. We saw a rebound globally in our powdered Carbopol volume which was up 10% both sequentially and versus the prior year. Our new liquid Carbopol product continued their excellent performance with 27% higher volume. And we continued to see good growth in the surfactants business due to strong demand at key customers. Revenues in the Performance Coatings product line were $141 million in the quarter which were level with the second quarter of 2007. As noted earlier, this product line continues to be impacted by the weakness in the North American and European textiles and coatings industries. We saw very strong volume growth of 28% in Asia-Pacific. China was a major contributor to this growth. We've seen strong performance there and expect this to continue with the completion of our new production facility which will be on line in early 2009. The coatings team took further steps in its business improvement plan. During the quarter, we recorded a restructuring and impairment charge of $0.13 per share, related to the commercial reorganization that we discussed during last quarter's teleconference and the closure of two manufacturing units. The actions that we have announced to date are expected to generate cost savings of approximately $3 million in 2008 and over$7 million in 2009. The team also is continuing to evaluate other steps this year that could produce additional benefits. The Engineered Polymers product line, consisting of TempRite and Estane engineered polymers reported revenues of $167 million in the quarter, up 11% from the second quarter of 2007. Estane revenues increased 15% from the second quarter of 2007, as we had double-digit volume growth in North America and strong pricing and product mix impact across the entire platform. Demand and North American film and sheet and hose and tube applications remain strong TempRite revenues were up 7% due to record volumes in the commercial water and industrial products as well as increased demand in international regions. All international regions saw double-digit increases. North American volume was down 8% due to a continued decline in residential plumbing volumes and weakness in the fire sprinkler market, that partially were offset by higher sales of commercial and industrial products. Profitability in our TempRite business is continued to be challenged due to material cost increases. In April and July, we announced significant price increases in all regions to offset the steep runoff in material cost. To summarize, Lubrizol Advanced Materials segment operating income in the quarter decreased 15% from the second quarter of 2007. Excellent earnings performance by the consumer specialties and Estane businesses were more than offset by the impact of weak North American coatings and construction markets on our Performance Coatings and TempRite businesses. However, we believe that our pricing and business improvement initiatives are gaining traction. We forecast the second half to show solid improvement over 2007 second half results. On June 2nd, we went live with our North American SAP implementation in Advanced Materials. As noted in previous teleconferences, Advanced Materials' operating results reflect the higher level of spending associated with this project. The second quarter results included $5 million in incremental IT expenses versus the second quarter of last year, mostly related to SAP implementation. And for 2008, we are anticipating a $10 million increase over full year 2007. We expect this level of IT spending to abate once SAP has been rolled out globally. We also have been investing in commercial, technical and manufacturing resources, especially in Asia to support our growth plans. For the full year, we estimate incremental growth spending to be $5 million compared with 2007. So, our investments and information technology and growth resources, which we believe are critical to the future success, are adding about $15 million in expense in the current year. I will now comment on several other financial items noted on slide eight. Corporate expenses were $13 million in the second quarter of 2008, down significantly from the second quarter of 2007 partly due to the favorable swing in earnings related to the mark-to-market effects of the stock based incentive compensation plan for international participants. We generated $96 million in cash flow from operations in the first half of 2008, down from $227 million in the same period of 2007. This decrease in operating cash flow compared to last year was driven by the significant inventory reductions we under are took last year in combination with a build in working capital this year. Our management of working capital continues to be excellent. Inventory days improved compared with 2007 while days sales outstanding increased slightly as a result of geographic sales mix. But this year's strong revenues and higher inventory costs drive by the extraordinary increase in raw material cost are the major factors behind the $159 million increase in the value of our networking capital since December 31st. Regarding our uses of cash in the quarter, capital expenditures were $46 million. We were repurchased 451,000 common shares for $25 million and we paid up dividends of slightly over $21 million. As the result of these activities our cash balance at June 30th was $420 million compared with $502 million at December 31, 2007. We currently anticipate using some of this cash in December to retire $200 million in notes. For the 12 months ending June 30, 2008. Return on invested capital improved to 11.5% compared with 11% for the comparable period in 2007. And now, I will turn to the outlook on slides nine and ten. Our outlook is premised on and expectation of continued economic softness in North America as well as in some of our European ends use markets. But in view of our strong first half results and our projection for the balance of the year, we are updating our guidance. Our updated guidance is $4.20 to $4.35 per share including $0.23 per share for restructuring and impairment charges. The last page the teleconference presentation provides an outline of these charges which relate to the improvement initiatives in our Performance Coatings product lines that I described earlier and the plant closure of the Canadian additives blending operation. Our increased guidance for adjusted earnings excluding restructuring and impairment charges is in the range of $4.43 to $4.58 per share which is a 9% to 13% increase in adjusted earnings compared with 2007 results. And here are the updates to our key assumptions. Consolidated revenue growth of approximately 18% to 19% and consolidated adjusted EBIT growth to 11.5% to 12% compared with 2007. For Lubrizol Additives, excluding acquisitions we are raising our volume growth assumption to 3%. For Lubrizol Advanced Material, we now project volumes contraction of approximately 3% due to North American demand weakness and Performance Coatings restructuring activity. We are modeling unit material margin in both segments to improve steadily during the remainder of the year as price increases offset higher second half raw material cost. We are modeling STAR expense to be approximately 12.5% of revenues and we revised downward our effective tax rate assumption for the year to 31% largely as the result of a tax favorable improvement in geographic earnings mix. And finally we are modeling the Euro to average $1.55 is the reminder of the year. The key updates to our cash flow outlook are shown in slide 11 and are these. Capital spending is now projected to be $220 and $230 million down slightly from an earlier guidance. We are now assuming a working capital build in excess of $200 million due to higher inventory values and selling prices as well as our plans to maintain security of supply for our customers. Though not a change, we continue to target share repurchases of $100 million for the full year. I would like to conclude by saying that despite the great challenges and uncertainties out there we are pleased with our operating and financial performance this year. Our overall fundamentals remain strong and we feel we are well positioned into the second half and in fact July has been another strong revenue month for us. And with that I now open it up for Q&A. Kevin? Question And Answer

Absolutely. [Operator Instructions]. And our first question in queue is from Jeff Zekauskas with J P Morgan. Please go ahead.

Hi Good morning. In terms of your raw material price inflation and your price increases … is it fair to say that the hit was, I don't know $25million or that was the difference between raw materials going up and prices going up for something on that order?

It seems like to say the calculus of raw material cost and pricing Jeff, has gotten to be so complex, when we look at the fact that we are … at any moment in time looking at multiple price increases and dealing with a range of raw material cost increases. I really prefer to stay away from quantifying the dollars of raw material cost increases in revenues and that's why in the prepared remarks, it might boil it all down statement, I was trying to bring it all together and say that, given all that is been going on with raw material increases and price increases, we expect to get back to unit and material margins in the early fall that are comparable to where we were mid last year which was the time preceding with us most recent rapid run-up in material cost.

The early fall means that, you may not fully catch up in the third quarter. But you think all things being equal. You should fully catch up in the fourth.

All having, said that though Jeff. When we look at our margin outlook by quarter, it does reflect steady improvement in both segments, in Q3 and then Q4

And it also still includes some upward pressure.

And that also that's right … that also includes an expectation that there is tempt of upward pressure in raw material cost and we're factoring that in our models.

And just I guesses, just one more subject. You talked about your return on capital being 11.5%, so do you … in rough terms what's the return on capital for Additives and what is the return for Advanced Materials.

I will give you directional answer to that one, Jeff. On the return on capital is much higher in Lubrizol Additives. Its historical installed asset based, so I'd say it is 150 to 200 basis points above what the corporation did as a whole. Which obviously implies that the Advanced Materials segment had less ... Advanced Materials overall is returning our cost to capital but of course the purchase price of Noveon International increased fairly substantially the installed capital base for that segment.

I think so in terms of capital expenditures of, I guess, roughly 220, how much goes to Additives and how much goes to Advanced Materials?

It's approximately 50/50, Jeff, approximately. And remember, there is a large SAP project that kind of weighs heavily on the Advanced Materials half. So, big expensive global project, but the route numbers are about half to each.

Thanks very much, James, thank you. Thanks Charlie.

Yeah. Thanks, Jeff.

Our next question is from the line of Laurence Alexander, Jefferies & Company. Go ahead.

Yes, first of all, to follow up on the question on Lubrizol Additives margins; are you taking in a significant continued rise in base oil or are you assuming that its starting about from here?

No, we have factored in across the mix a continued upward pressure. I am not going to get down and portion it down into ethylene-based streams, propylene-based streams, basal-based streams, but the fact is, we have factored continued upward pressure that will filter through. And it is not all based on just driven by crude. There is also supply/demand balances that are, we have accounted for here are large.

This is Greg. Some of that is really from past increases and still need to filter through the system.

All Right. With the Consumer Specialties segment, given the volumes and the FX with the overall segment, was there a negative mix effect or a negative regional effect because the top-line growth in the Consumer Specialties lies than one would have expected?

No, I don't think so. Charlie, look at the bottom.

I'm sorry, Laurence, you are asking about the Consumer Specialties products line?

Yes, particularly, I guess for the Carbopol, the two set parts of the Carbopol business being up 10% and 27% and then given a FX was there a negative volume of regional mix effect?

We had good volume growth. We also had some nice margin growth as well. This is one of the product line that has been successfully raising prices. Actually we probably would've had good favorable mix so far as powdered Carbopol volume growth sequentially and year-over-year was double-digit.

And then, lastly on the cash flow outlook, what do you think is the longer term outlook for working capital. That is, if raw materials were to stabilize, how quickly could you bring it back down?

The working capital levels that we're working with now are value driven, not biometrically driven. Our management of inventories on a biometric basis has been exactly on our target. And actually, as we said in past teleconferences, we've been struggling to build inventories because of the very high utilizations and high demand coming from our customers. So, our US inventories are on a LIFO basis, so you will see a reduction in LIFO commensurate with pricing over a fairly short period of time, but the remainder of our inventory is elsewhere average in and the average cost in FIFO where the reduction in values will take longer to take place.

Thank you.

Our next question is from the line of P.J. Juvekar, Citi. Please go ahead.

Yes, hi, Good morning.

Hi, P J.

You know, [inaudible] sale was cancelled by its owner, I was wondering if you can comment on how do you see that playing out? Is that a positive or a negative for you?

I would say, it's neither, it's neutral. You know everything that we know everything about it, P.J.

Okay. And Charlie, do you expect cash release from working capital in the second half?

No. I expect that, put it this way, P.J. relative to prior quarters' model, our outlook for year-end cash balance is down, something slightly exceeding $100 million. And that's heavily driven by the investment in working capital that we have been talking about.

Okay. And then, you had good price and volume growth in lubricant additives, I was wondering why your margins declined. Was it primarily due to price catch up with raw materials?

P J, when you refer to margins, are you thinking in percentage terms?

Yes.

Yeah, that's why. I try to take great pains in prepared remarks when I was talking about gross profit, to just make the point that if people are looking at our profitability, margins on a percentage basis, they are going to be tricked into thinking that somehow we are underperforming. The inflationary effects in our industry are going to naturally push down margins on a percentage basis. Yet on a dollars per unit or product sold, we actually have been doing quite well and that explains the overall earnings performance. So, I'd say that in this extraordinary period of rising material cost, we've turned our main metric evaluating profitability to dollars per unit sold as opposed to percentage because overtime, you get the apples to oranges comparison.

Okay. Thank you.

Yeah, thanks, P.J.

Our next question is from the line of Dmitry Silversteyn, Longbow Research. Please go ahead.

Good morning, gentlemen. Couple of questions. In your prepared remarks, you talked about the additives business and the volume growth there indicating market changes. Can you clarify what you meant by that? What market changes are you seeing in the additives business that give you confidence that the volume growth you enjoyed in the first half of the year is going to continue in the second given at least a North American kind of slowing, perhaps demand for additives in fuels and lubricants?

Dmitry. This is James. I put that in my prepared remarks because I wanted to try to address the fact that for the last several years, we have publicly and privately have been characterizing the lubricant additive business as a kind of 0 to 1% volume growth market. And the reality is that if you go back and look over the last … let's just take the last three-year period; we have been growing at a much higher rate than that. And as we look at it, we clearly understand that our results don't match our projections. We have been doing some analysis. There are some clear market changes. We are still doing analysis. And later on this fall, we will come out with a fairly detailed summary view of, not only what we think has happened but what we believe will continue to happen. There is no question, the market is growing faster than 0 to 1 and that is the point. And we will clarify that in some more detail here in the fall.

Some of the things, Dmitry that James is talking about would be using higher treat rates in the Additive formulations. Increased growth in vehicle population in some sectors within lubricant additives drain intervals were actually beginning to extend, for example in heavy duty diesel.

Contract.

Sorry to contract. In other words, more frequent drains and the growth rates in Asia and Eastern Europe have been very strong and so, hence higher demand.

Okay, all right, fair enough. Going to the Advanced Materials, switching gears a little bit, the sustained business delivered pretty good growth. I think globally, if I remember correctly. Can you, kind of, give us an idea of what is driving that performance across the board? Is it particularly market segments, are you gaining shares … the product substitution going on?

I would actually say … first of all, it's a very diverse set of end use markets. And those markets have always existed Dmitry. I would characterize our improvements in terms of us really focusing our product innovation portfolio. Really targeting higher value applications and frankly, continuing to pour growth resources into that business, and it is beginning to pay off and we project it will continue to pay off.

Okay, and then in the Carbopol business, is the growth you have seen there in powdered and liquid Carbopol … was that more International or more U.S. and the reason I am asking … I thought you already had a pretty high market share in the U.S. business. So, I don't think demand for any products of Carbopol has used that has grown 10 to 20% a year. So, are you still getting share in the U.S. or is this the global vision of the business that is driving the volume growth.

It is global business, its Charlie, Dmitry. It's a global business. I think we have … actually slightly down volumes in North America. In normal times we would expect steady growth even in North America. But the higher growth rates have been outside the U.S.

Dmitry, besides Carbopol which is the primary product line, there are some allied product lines in that portfolio that are newer and growing at very fast rates and so some of that is actually getting big enough now that it's actually beginning to make an impact that you could see from the outside.

Okay, and then final question, if I may. On the SG&A cost which you have done a great job controlling, including … excluding the FX, given what's going on here, can you continue to keep a lid on SG&A expenses given your globalization strategy for the Advanced Materials business or are you going to have to sink some costs ahead of revenue as you try to take this business beyond North America.

We are going to definitely keep it under control. By the way, that was not on an FX adjusted basis. That was just sort of, comparison to comparison basis. I didn't … what I did was for the manufacturing expenses, I did currency and energy adjust those, but STAR on a global basis is flat and we have been investing up front. Charlie talked about SAP; he talked about some of the growth resources we're adding. We are going to stay ahead of the curve on this one.

So, if I understand you correctly, you are kind of over the hump as far as the expense wobble is concerned.

Yes.

Okay, that's good to hear. Okay. Thank you.

Before we go to next question, I just want to … there are two prior questions that I failed to answer particularly well. I think Lawrence asked about the [penitential] mix issue with consumer specialties. And as a prior, last year's last quarter teleconferencing we talked about our AMPS Monomer business being down because of losses, we had some production issues and losses in business. That was driving the mix effect at the top line but profitability grew because of, for the reasons I stated. And then where [inaudible] asked about our working capital outlook for the second half and we do see working capital coming down slightly in the second half versus the first. Sorry, in the second half working capital being at $40 million to $50 million additional use in cash. I hope I made that clear. So the additional working capital for use of cash in the second half was $40 million to $50 million. Sorry. Next question?

Our next question is the line of Robert Felice, Gabelli & Company. Please go ahead.

Hey guys congrats on a nice quarter. Just a couple of questions, I guess, first on the additive side. What's the magnitude of the price increase you announced on July 3rd and how much of that have you realized and in addition what's the cumulative amount before increases today?

Actually I am just going to be straight up with you, Robert. I'm not going to answer that question but I will talk to you a little bit. One of the things I tried to do is … we made a press release announcement about … on a cross to broad range, which was trying to capture, and I know it actually caused a little bit of confusion. I had actually … so many different price increases out in the market that people were trying to understand if that was what we had already done, what we were doing, what we planned to do, and its kind of some of the all of the above. In addition to that, we have gone back out again …really in every product line in every area and there is no one size fits all. Frankly, I have to … never was astound to figure out where we are at any given moment, but sufficed to say, they are large enough to cover what amounts to several hundred million dollars in run up and raw material year-on-year. And our attainment level is quite good, or you would see us … we would be sinking and that's about as detailed as I'm going to get. Charlie, do you want to add anything?

The numbers are so large, and I don't know, if its really that meaningfully to get into it … hundreds of millions of dollars, you look the full run rate, if you add up the four price increases ... the last four price increases. You're getting to annual incremental revenues in an excess of $700 million, so its just a magnitude and so it gives you a sense of the magnitude of material cost increases that we've been experiencing.

I guess I am trying to get my hands around the magnitude of the price cost, GAAP as we looked at the back half of the year and how the margins will play out and it seems to me that most of the cost increases we've seen in the last six or eight weeks on the base oil side, we will hit the third quarter, probably bit harder than they hit the second quarter. So, given the pricing that you have in place, do you expect the magnitude of third quarter margin compression and that if its to be worst than that in the second quarter, do you expect it to improve?

No, no, no, Robert, you got it wrong. You got it wrong, base oil it it's the tank. I mean we are spinning in base oil, and three day its coming its end. That's how fast it's flowing through. We are all in pace, don't fear that because you didn't see the margin compression, you expected in the second quarter, its coming in the third quarter, that's not the case. We're on top of our game.

By our main metric margin … this is Charlie, by our main metric margin, and if margins are projected to grow steadily through the remainder of the year and not contract.

Okay. That's helpful. Okay, guess you are doing better than, moving quicker on the price than I had thought you would.

We've been moving faster and larger. So the 12% to 18% number … and that was announced in June. This July 3rd increase was at even higher level than that.

That was the urgency around getting up quickly with the substantial increases. I want to take all of you back to our fourth quarter teleconference which was in February of this year and I am not going to sit here and tell you that I am the all seeing and the all knowing, but I could see raw materials coming at us in a way that we're unprecedented and I talked about it in the conference. For this specific purpose of preparing you, my organization and our customers for what was going to come and it has come and we have managed it. And we will continue to manage it.

I guess, to that ends, James, lastly … the last time we saw a situation like this one where additives really experienced rapid cost inflation, was in late '05 into '06 and then cost stabilized and later '06 into '07, you really had strong earnings growth, 25% or 30% as you played catch up to the cost increases. So, in your opinion, how does the current environment feel relative to that period and you think we could see another '07 kind of year in '09?

Well, here's what I am going to say. I never get ahead of myself. I never read our own press. Okay, we upped our guidance. That gives you an idea of how we think we're positioned for the second half of the year and we feel very good about that and we wouldn't do it. We are not going to begin to talk about '09 until we get with this … still a long way between now and the end of the year. We have lot of work to do and we will get it done. When we come back in the third quarter, here, late in the year and give you an update, we will give you a better view of that, but I am confident that we are going to continue to perform as we have been performing. And there is going to be little quarterly ups and downs. But if you want to look year after year after year, we are going to perform. That's my commitment to you.

Okay. Then finally, just a clarification, getting back to mid '07 margins in the fall, that for additives or for the entire firm?

I was speaking to additives specifically when I was going through that.

Okay, great. Thanks for taking my questions.

Thanks Robert.

Our next question is from the line of David Begleiter, Deutsche Bank. Please go ahead.

Thank you, good morning. James, given your target of $100 million of share buybacks and given the low share price during May and June, why didn't you move more of that into Q2?

Couple of things. Charlie and I spent a lot of time talking about this over the course of the first half of the year. And I think he has already touched on it, but to put them together for you, if he hasn't taken you through where all our cash is, it's when we look at our balance sheet, it is not all available. It's, quite a bit of … its sitting offshore and is not tax effective to bring it in. Two, we poured the better part of $200 million into additional working capital during the first half of the year as we needed to keep up with these rising raw material costs. We watched the stock price as it came down, continued to come down, and frankly it is relatively small buyback anyway in the overall scheme of things. I still want to reserve the couple hundred million to payoff the debt in December and when I looked at it, there are so many moving parts that I just decided to leave it alone frankly. Charlie.

Yeah, David, I think we've talked about this before. We have already taken the view when we are into the market to buyback shares that will do it ratably over the course of the authorization period. So, it is not an accident that we spend $25 million each in the first two quarters. It is a fair question. We choose not to take a view on the stock price… part of our conversation internally on this. We always point out to ourself, had we decided to take a view on our stock price in the first quarter because the value of our shares unfortunately dropped earlier this year as well. We might have accelerated share purchases and buying back shares that are higher level than buying back at current levels, unfortunately, but that is one aspect of why we choose not to take a view and be in the market ratably overtime. We take that point. Nothing is ever hard and fast, but as a general philosophy, that's our approach.

Very clear, thank you. And James just on the … you touched on the M&A pipeline. Can you describe the types of deals you are looking at, size and areas of focus?

As a matter of fact, David, I wish I could.

But he is not going to.

I have said as I have had an opportunity to talk with investors, analysts and interested parties. As I look at the kind of the typical pie chart that we use to depict the business that we are continuing to pursue, boultons [ph] related to the lubricant additives business. We are working on some there, we made two last year and for additives and we are working on some activities there. With regard to the Advanced Materials portfolio, there are opportunities across each of those sectors. I think I have previously said that while there are opportunities for coatings, I really want to stay focused on coatings as an internal turnaround effort. Let's get the fundamentals right and then we will think about acquisitions to add to our capabilities there. Particular areas of focus are in the engineered materials area and in the personal care area. In terms of size I would characterize it there is range of opportunities.

Understood. Thank you. And just on lubricant additives, is any of the volume growth share gain?

When we look at that, it would seem to us that the answer to that is only to the extent that our customers are being more successful than maybe our non-customers … is the way to think about that. We are not taking share away from our competitors; in fact the industry is pretty stable right now. It does appear to be generally speaking an overall increase in the volumetric usage of Lubricant Additive across the globe.

And just lastly on Performance Coatings, was that business profitable in Q2?

Yes. It was, absolutely David.

It has never been not profitable. And it's going to be more profitable. Charlie, you want to add any more color to that?

It is operating income as a percentage of sales and on EBIT margin was in the mid-single digits. So, it's at comparable levels, unfortunately to what we see in the past, we have plans to improve it, but definitely making money.

Just checking. Thank you very much.

Yeah.

Yeah.

Our next question is from the line of Saul Ludwig, KeyBanc. Please go ahead.

Hi Good Morning. I hopped on a little late. I hope this wasn't asked before. But, James, you just talked about the volumetric use of lubricants increasing, which seems to be sort of corner actually there with people driving less and driving smaller cars. So A, how do you think about that? And B, did you give us, what was your volume change in the four sectors, you know, North America, Europe, Asia and South America in the quarter?

Okay. Well, first, I will let Charlie answer the second half of your question because he covered that. Charlie, you want to go back.

Well, Saul, in my prepared remarks which I gather you missed, I went through on additives, how the segment did by region, and your asking specific, I can give volume. Is that what you are looking for?

Yes. With volume.

Okay. So Latin America volume in additives was up 30%. Asia-Pacific was up 26%, Europe was up 9%, North America was down 6%. And of that 6%, we really attribute just 2% to economic slow down, the rest of that 6% decline in North America was really order pattern and in fact some of our products that we have been selling more recently and were concentrated form.

Okay now to the kind of the first part of the question, which is really what are the fundamentals? First Saul, actually you can think of the vast majority of Lubricant Additives to be a service fill as opposed to a factory fill. So, if you are thinking about what we're … the world is building fewer vehicles it has almost no effect. It is a service fill. In terms of service, you own a car, and I don't know how many miles per year you drive, but you change your oil, let say for example two-times a year and whether you are driving 10,000 miles or 12,000 miles or 15,000 miles. You are still going to change your oil twice per year. When we look at International growth, there is just tremendous growth internationally in the developing world, there is more marine traffic than ever, in terms of the engine sizes. All people are going to drive smaller cars …it sum sizes are the same. Drain intervals are decreasing, in fact when you … one of the phenomena that I project you will see going out is, as the world focuses out on how to get more fuel efficient in the transportation sector. You will actually find that drain intervals are going to further decrease. If you want better fuel economy change your oil. It is not un-green to do that because all that drain oil winds up getting recycled back into the fuel and refinery pool. So usage is up as a result of design changes and as the world moves from gasoline to diesel, in the developing world versus the developed world, I think that would kind of give you a high level summary to go further than that, I am not satisfied with that, that's a high level view. I have asked my team to do a much more detailed analysis, so that we can more articulately show you the exactly where and why the industry is changing.

Saul, this is Greg. You missed that commentary a little bit earlier in the call. We talked about the study that's underway and we do expect to come out in the fall with a revised outlook for long term growth.

Great. Well thank you very much. And James, your enthusiasm about going forward does here comes through loud and clear and look forward to seeing that progress unfold.

Thank you, sir.

Our next question is from the line of Ivan Marcuse. Please go ahead.

Hi, most of my questions are answered. I just have a real quick one. On the corporate expense, I assume that I guess absolute value of $5 million benefit with result of the stock being lower, for every dollar that your stock moves how will that effect your corporate expense line?

Actually in the second quarter, our mark-to-market affects was a little less than $4 million and for every $3 the share price move, it's as penny of earnings. I could extend on that a little bit. We certainly benefited from that mark-to-market reversal benefit I perhaps put an close because it was driven by a driven by the different of profit at the share price.

Right.

In the second quarter, in our model we've have actually assumed that we are going to be re-accruing that, roughly that amount in the third quarter. So that you can view that as a temporary benefit that we saw in the year. Our run rate, all of the things being equal, if people want to have a modeling assumption for our corporate expenses is $16 million a quarter. So what I am saying is we are looking more like $20 million in the third quarter that down to 16 in the fourth quarter. I would also finish by saying one or the other reasons why our second quarter corporate expenses were down was frankly because we had good control of operating expenses. Some categories we were actually projecting to come in lower overall for the year.

Great thanks. That's all I had.

And we do have a follow up question from the line of Jeff Zekauskas from JPMorgan. Please go ahead.

Thanks, very much. Charlie, you said that the Advanced Materials' profits would be up in the second half. Advanced Materials was pretty weak in the fourth quarter of last year. Do you mean that they will be up both in the third and the fourth quarter or only the fourth quarter?

They will be up in the second half and if you look sequentially, we are looking at second half versus first half, which probably even a better comparison. You're right, fourth quarter last year was not particularly strong. We are looking at 5% to 6% kind of growth in the second half versus the first half in Advanced Materials.

And In terms of lube additives, if you think you are going to grow 3% for the year, does that mean you are going to have flat volume growth in the second half?

Jeff, no, that's my number. I knew you would probably ask that. I am going to obfuscate here. I don't want to say how big that number might be.

Well, 3% full-year excluding acquisitions. And I am just looking at quarterly volumes. That looks probably about right, flattish, for the second half went slightly up.

So, this is another volume number, presumably you can hope to exceed. In terms of CapEx this year, philosophically, does CapEx go down next year because you don't have the same level of SAP spending?

No. Jeff, I have not forecasted that. SAP is going to go away. I am in a growth mode. And I am going to continue to invest. I am not going to take my foot off the throttle here, I got to manage it. And it will be prudent investments. But for everything that goes away, I have more places to spend money to continue to take account for growth.

We still have to continue the implementation for SAP into next year anyway.

Just maybe a last question for James, it's a philosophical question. You know, if we went back five years and we looked at the lubricant additive growth rate, probably people would be pretty pessimistic about it and for Advanced Materials if we went back five years ago and what Noveon was like in the old days, their volume growth looked relatively strong. And overtime what's happened is that the world has entirely changed where the additive business has grown strongly and Advanced Materials is having its issues. So in the light of that how does that change the way or affect the way you target new acquisitions. Given that … predicting volume over a longer period of time in this chemical business is a thorny task. Very good question, Jeff. You know, who would have thought it, right?

Right.

So, we made a couple of boultons in the additives area last year and if we are, successful as I would like us to be, we might do some more work in the area. So, of course our opportunities are more limited for obvious reasons but to the extent that we can acquire and invest to maintain that market leadership position and expand ... continue to expand those product lines. We certainly will do that. On the Advanced Materials side, any time you are building, its ... there is always a bit of a long-term nature that you need to stay oriented. Sometimes it is two steps forward and one step back. So, if I look at their growth rates at the time that Noveon was purchased when it was owned by financial sponsors and then look at the fundamental rebuild rate that we are going through. Actually the personal care business has never missed a leg. Estane has improved. It went through a dip but it really has improved and it's in a much better position. The TempRite business has been impacted by North American plumbing. That's where, its primary market share, market position was in North America but we have begun to expand that geographically and so we're well positioned there. Coatings on a volume basis was, by far in a way the largest part of the segment. Unfortunately there is a loan value stuff in there that ... it is a great buildable position but not in the commodity end. And I am going to hack that away and rebuild that into a real high value niche business.

And just to put a little bit of a wrap on the VAM I think you have to consider the economy and what's done to the underlying demand or some of those businesses. So to look at that and say we don't want to continue to build that, its probably short sighted.

And to trail in our pile on, its really important not to paint Advance material with a broad single brush. The personal care business in terms of revenue, volume and margin growth has met, it's not exceeded our expectation since the time we've bough Noveon. Likewise I would sat that Estane has been meeting our expectations in terms of ... and incredible ability to innovate and grow top line end volume and it showed pricing power recently. TempRite ... seems that it has ... slow pass with respect to North American construction and housing, but [OIS] has been doing extremely well internationally so, I'd say largely its been meeting our expectations. Coatings have been the much talked about topic and we're working on it. I think the real surprise there has been the pace at which the North American textile business has disappeared. So, I just want to be careful. There is a lot we like about Advanced Materials and therefore a lot we would like to add on to it.

Okay. Thank you.

[Operator Instructions]

Gentlemen, I think we've used up our time and I think if there are no further questions.

And we have no further questions in queue.

Very good. Thank you. I would like to thank everyone for dialing in this morning and before signing off, I'll provide two phone numbers for follow-up. One is my direct line for clarifications and second will be the dial in for telephone replay. My telephone number is (440)347-1206, and Kevin, can you provide the replay number.

Absolutely. Replay number will be 1-800-475-6701, if you're dialing within the United States. International, area code 320-365-3844 with the access code 935-353. Once again numbers are 1-800-475-6701 for the US, international 320-365-3844 with the access code 935-353 and that replay will begin today at approximately 1 P.M. Eastern time and will run through August 15th midnight.

Okay very good. With that, thanks everyone and we will conclude the call now.

We do thank you for joining. You may now disconnect. Have a good day.