Wild swings in the price of oil and other natural materials have wreaked havoc on forecasting for companies around the world. Charles Cooley, CFO of Lubrizol Corp., doesn't claim to own a magic algorithm to solve the forecasting dilemma that undermines finance and business organizations. But the strategies he's implemented at the chemical maker specializing in lubricants have brought an unusual sense of stability at a time of unprecedented volatility elsewhere.
That calm has served Cooley well. And it's certainly helped Lubrizol stand out. So much so that in March, America's best-known investor, Warren Buffett, and his company Berkshire Hathaway struck a deal to buy Lubrizol for $9 billion in cash.
In many ways, Lubrizol, which is based in Wickliffe, Ohio, fits the Berkshire model: it's large and generates consistent earnings, with $732 million in profits last year, atop $5.4 billion in revenue. Its business model is fairly simple—centered on producing components for both industrial uses, like automotive lubricants, and household products, such as lotions and dishwashing liquid.
Cooley has announced his intent to retire once the transition is complete, which is timed for somewhere in the third quarter, depending on the close of the purchase. He sat down with Business Finance recently to discuss the challenge of forecasting in a business so heavily predicated on natural materials, how his department weathered the financial gales of recent years and how the role of CFO is about to change with new ownership.
Business Finance: This must be an extraordinarily busy period with the purchase by Berkshire Hathaway. What can you tell us about what's to come in the next several months?
Charles Cooley: Most of what we're able to say has been expressed in our formal SEC document. But I can say it's a very exciting transaction for Lubrizol's shareholders. It's great for the organization. Warren Buffett is a great owner. Berkshire Hathaway is a great family of companies and in recent months we've been increasing our interactions with the folks in Omaha, getting ready for the close and our new life as part of the Berkshire Hathaway portfolio.
Depending on the receipt of various governmental approvals outside the U.S., the close will probably take place at the end of the third quarter, if not shortly thereafter. But it's not in our hands when that will happen.
BF: Any company so reliant on raw material costs, such as Lubrizol, has felt the rising price of commodities and inflation. What have been some of the approaches you've overseen in the role of Finance to combat this?
CC: Our finance organization has had a very important role to play in implementing a strategy of price increases to recover those rising raw material costs. I have to give credit to our commercial organization because it's not easy regularly talking to your customers about price increases and at the same time trying to make them happy with your product.
A small group of folks in our Lubrizol Additives organization, with the assistance of a very well-designed SAP ERP system, was able to in a very data-driven way provide the commercial organization with the necessary information to present irrefutable justification to our customers what the impact was to us and the basis by which we would persuade our customers that the price increases were due.
BF: How have you used the ERP system to build strategy?
CC: What it enabled us to do, among other things, is create profit and loss statements by customer, by product, by geographic zone. That can do a number of things for us. It can tell us where we're making our money in a very detailed way, where we're seeing the margin challenges. This enables us to really understand in a very factual and clear way where our costs are—our raw material costs and our other operating expenses, so we can understand exactly what our earnings contribution is by customer.
We can also slice it different ways as well, by customer by zone, by customer by product by zone. It gives us a lot of information so we can in a very targeted way know where the margin pressures are and make a very detailed price increase recommendation to the commercial organization. It allows us to be sensitive to the customer, so we're not with too blunt an instrument trying to raise prices, at the risk of unduly harming our relationship with the customer.
BF: Strategically, how have you been able to budget or forecast with any accuracy with all the swings in raw material costs?
CC: I have yet to talk to a CFO who has felt they have completely nailed their forecasting process. I think we do ours as well as we can. Over the last decade we've done a lot to improve our forecasting. Our SAP system has a rolling forecast module based on salesforce input about their customer forecast of the next 12 months of sales—that's a key input. We also build up from that revenue and volume and material margin forecast and our own forecast of operating expenses. We have a lot of flexibility in terms of scenario planning to do what-ifs if raw materials start to swing in price what the range of earnings outcomes we would have going forward.
BF: What were some of the unique pressures Finance was under during the financial crisis?
CC: We were faced with a potential big problem that not every company faced. We had a large bond maturity coming due in October of 2009. In late 2008, the bond market completely dried up. We didn't have sufficient cash in the balance sheet to satisfy a $400 million maturity. A prudent finance organization facing a maturity like that would want to be in a position to issue new debt to pay off the retiring debt, certainly within 12 months of doing so.
We were realizing the public markets aren't there and so we, meaning me and my soon-to-be successor and treasurer, Brian Valentine, immediately jumped in and started looking at alternate sources of finance that we might need to tap if indeed the public markets weren't going to be there.
We started looking at private placement opportunities, the bank market and a number of other potential sources of finance. As it turned out, we were the first Triple-B industrial company to issue in a public market when they reopened in January of 2009. We also tapped the bank market and drew a three-year term loan from a group of syndicate banks, which was also a first coming out of the complete drying up of the capital markets.
BF: I understand one of the key initiatives you oversaw at Lubrizol was a stronger cash flow forecasting system.
CC: Yes, one of the things that I was a little frustrated with when I first came here was while we were pretty good at forecasting net income, it was a much greater challenge forecasting cash flow and working capital changes.
We're a global company and we sell in 120 countries, virtually every continent except Antarctica. Where we sell and where we manufacture are not precisely in balance. A disproportionate amount of our manufacturing is in North America, but the majority of our sales is outside of North America. So our cash inflows and outflows are not in balance. A disproportionate amount of our global operating expenses are in the U.S. because we manufacture so much, particularly in Texas. In addition, all of our debt service and dividend payments came out of the U.S. We're long cash, therefore, outside the U.S.
So back in the credit crisis, not only did I have this maturity that I didn't know how we'd be able to refinance, we were also running out of cash in the U.S. We had a lot of cash offshore, but it would have been very tax-inefficient to bring it back. One of the tools we have in place gives us a better view on what our cash ins and outs will be over the rolling three-month period.
BF: How has your philosophy of the role of CFO evolved from when you first stepped in 15 years ago and how has it changed over the last four years?
CC: The demands have changed. They've become more challenging, particularly over the last four years. I remember back when the crisis was at its scariest, in late 2008, I found myself spending a disproportionate amount of time at my desk just reading. I remember one day one of my colleagues walked by and saw me reading The Wall Street Journal. I kind of sheepishly looked up, and I told him I was just catching up, almost apologetically. He says, "Charlie, if you're not reading what's going on, we're really in trouble."
I think that's true of the CFO. We almost have to absorb it all and have a full view on matters. It's all about staying informed. In the world we're in right now, where things are changing so rapidly, the pace of development is so overwhelming from anything we saw in recent history.
BF: What are some of the recent structural initiatives you've undertaken?
CC: Lubrizol as a culture is very team oriented, but historically what we've battled are silos of teams and chimneys of teams. Various efforts have been under way to tackle that. But within the finance organization, one of the challenges we faced is how we're organized. We're very matrixed.
Right now, the way we're set up, we have two operating segments: Lubrizol Additives and Lubrizol Advanced Materials. Each of those businesses has a segment CFO and a segment controller. We also have regional finance organizations, one based in Shanghai and another based in Rio and a third based in Brussels. So how do those guys interact? Those people I have reporting solid line to me the same way I have those segment CFOs solid line to me.
There are many areas of responsibility where those regional finance directors actually have upward reporting responsibility to those second CFOs, so I need to make sure that balance is right so those people in the field have the right amount of independence and autonomy to do what they need to do. At the same time, I have make sure they are being very responsive to the needs of the business.
BF: One of the biggest changes with the purchase by Berkshire Hathaway is Lubrizol will no longer be a public company. What opportunities does this present?
CC: The job responsibilities will change very significantly for my successor in that they're not going to include the public markets orientation. Certainly a quarter of my time was about the debt and equity capital markets, contacts with shareholders, interaction with commercial banks, with a whole array of people called the public markets for financing. All that is going to go away.
It enables my successor to focus a lot more on internal activities. It will be an opportunity for finance to focus on the organic and M&A growth that the company's going to pursue. In some ways, this job gets a lot more fun, not having to do those quarterly teleconferences.
I'm excited for Lubrizol, my successor and the rest of the finance organization, for the opportunity to network with the Berkshire Hathaway family. There's going to be opportunities going forward for relationship building and sharing best practices and drawing upon this multitude of expertise that's out there. Lubrizol is probably the most complex international operation in Berkshire Hathaway's portfolio. That might allow some of the Lubrizol folks to contribute to the Berkshire family in terms of experience and expertise.