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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________
Commission file number 1-32532
ASHLAND INC.
(a Kentucky corporation)
I.R.S. No. 20-0865835
50 E. RiverCenter Boulevard
P.O. Box 391
Covington, Kentucky 41012-0391
Telephone Number (859) 815-3333
Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes |X| No
|_|
Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the
Exchange Act. (Check One):
Large Accelerated Filer |X| Accelerated Filer |_| Non-Accelerated Filer |_|
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
At July 31, 2006, there were 71,102,809 shares of Registrant's Common
Stock outstanding.
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PART I - FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
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Three months ended Nine months ended
June 30 June 30
----------------------- ------------------------
(In millions except per share data - unaudited) 2006 2005 2006 2005
------------------------------------------------------------------------------------------- ------------------------
REVENUES
Sales and operating revenues $ 2,691 $ 2,492 $ 7,378 $ 6,731
Equity income 4 315 9 530
Other income 13 14 49 49
---------- ---------- ---------- ----------
2,708 2,821 7,436 7,310
COSTS AND EXPENSES
Cost of sales and operating expenses 2,252 2,074 6,217 5,678
Selling, general and administrative expenses 329 337 948 957
---------- ---------- ---------- ----------
2,581 2,411 7,165 6,635
---------- ---------- ---------- ----------
OPERATING INCOME 127 410 271 675
Gain (loss) on the MAP Transaction (a) - 1,295 (2) 1,295
Loss on early retirement of debt - (143) - (145)
Net interest and other financing income (costs) 9 (31) 29 (89)
---------- ---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 136 1,531 298 1,736
Income tax (expense) benefit (43) 236 (90) 157
---------- ---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS 93 1,767 208 1,893
Results from discontinued operations (net of income taxes) - - (1) -
---------- ---------- ---------- ----------
NET INCOME $ 93 $ 1,767 $ 207 $ 1,893
========== ========== ========== ==========
BASIC EARNINGS PER SHARE - Note H
Income from continuing operations $ 1.31 $ 24.13 $ 2.91 $ 26.11
Results from discontinued operations - - (.01) -
---------- ---------- ---------- ----------
Net income $ 1.31 $ 24.13 $ 2.90 $ 26.11
========== ========== ========== ==========
DILUTED EARNINGS PER SHARE - Note H
Income from continuing operations $ 1.29 $ 23.65 $ 2.87 $ 25.48
Results from discontinued operations - - (.01) -
---------- ---------- ---------- ----------
Net income $ 1.29 $ 23.65 $ 2.86 $ 25.48
========== ========== ========== ==========
DIVIDENDS PAID PER COMMON SHARE $ .275 $ .275 $ .825 $ .825
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(a) "MAP Transaction" refers to the June 30, 2005 transfer of Ashland's
38% interest in Marathon Ashland Petroleum LLC (MAP), Ashland's maleic
anhydride business and 60 Valvoline Instant Oil Change centers in
Michigan and northwest Ohio to Marathon Oil Corporation in a
transaction valued at approximately $3.7 billion.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
2
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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June 30 September 30 June 30
(In millions - unaudited) 2006 2005 2005
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ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $ 363 $ 985 $ 692
Available-for-sale securities 621 403 -
Accounts receivable proceeds from the MAP Transaction - Note C - - 913
Accounts receivable 1,805 1,642 1,564
Allowance for doubtful accounts (46) (43) (44)
Inventories - Note E 625 527 567
Deferred income taxes 96 122 113
Other current assets 153 121 125
--------- --------- ---------
3,617 3,757 3,930
INVESTMENTS AND OTHER ASSETS
Goodwill and other intangibles 710 650 649
Asbestos insurance receivable (noncurrent portion) 446 370 374
Deferred income taxes 182 175 160
Other noncurrent assets 464 441 428
--------- --------- ---------
1,802 1,636 1,611
PROPERTY, PLANT AND EQUIPMENT
Cost 3,463 3,274 3,219
Accumulated depreciation, depletion and amortization (1,949) (1,852) (1,839)
--------- --------- ---------
1,514 1,422 1,380
--------- --------- ---------
$ 6,933 $ 6,815 $ 6,921
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Debt due within one year $ 18 $ 12 $ 78
Trade and other payables 1,420 1,520 1,358
Income taxes 48 13 71
--------- --------- ---------
1,486 1,545 1,507
NONCURRENT LIABILITIES
Long-term debt (less current portion) 70 82 90
Employee benefit obligations 417 358 444
Reserves of captive insurance companies 182 182 190
Asbestos litigation reserve (noncurrent portion) 592 521 534
Other long-term liabilities and deferred credits 385 388 409
--------- --------- ---------
1,646 1,531 1,667
STOCKHOLDERS' EQUITY 3,801 3,739 3,747
--------- --------- ---------
$ 6,933 $ 6,815 $ 6,921
========= ========= =========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
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Accumulated
other
Common Paid-in Retained comprehensive
(In millions - unaudited) stock capital earnings loss (a) Total
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BALANCE AT SEPTEMBER 30, 2004 $ 72 $ 478 $ 2,262 $ (106) $ 2,706
Total comprehensive income (b) 1,893 11 1,904
Cash dividends (60) (60)
Distribution of Marathon shares
from the MAP Transaction - Note C (936) (936)
Issued 2,620,653 common shares under
stock incentive and other plans 2 131 133
----------- ----------- ----------- ----------- -----------
BALANCE AT JUNE 30, 2005 $ 74 $ 609 $ 3,159 $ (95) $ 3,747
=========== =========== =========== =========== ===========
BALANCE AT SEPTEMBER 30, 2005 $ 1 $ 605 $ 3,251 $ (118) $ 3,739
Total comprehensive income (b) 207 22 229
Cash dividends (59) (59)
Issued 629,994 common shares under
stock incentive and other plans 31 (1) 30
Repurchase of 2,402,030 common shares (138) (138)
----------- ----------- ----------- ----------- -----------
BALANCE AT JUNE 30, 2006 $ 1 $ 498 $ 3,398 $ (96) $ 3,801
=========== =========== =========== =========== ===========
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(a) At June 30, 2006, the accumulated other comprehensive loss of $96
million (after tax) was comprised of net unrealized translation gains
of $65 million, a minimum pension liability of $160 million and net
unrealized losses on cash flow hedges of $1 million.
(b) Reconciliations of net income to total comprehensive income follow.
Three months ended Nine months ended
June 30 June 30
-------------------------- --------------------------
(In millions) 2006 2005 2006 2005
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Net income $ 93 $ 1,767 $ 207 $ 1,893
Unrealized translation gains (losses) 27 (27) 21 11
Related tax benefit - (1) 1 1
Net unrealized gains (losses) on cash flow hedges - (2) - (1)
----------- ----------- ----------- -----------
Total comprehensive income $ 120 $ 1,737 $ 229 $ 1,904
=========== =========== =========== ===========
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SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
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Nine months ended
June 30
-----------------------
(In millions - unaudited) 2006 2005
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CASH FLOWS FROM OPERATING ACTIVITIES FROM CONTINUING OPERATIONS
Net income $ 207 $ 1,893
Results from discontinued operations (net of income taxes) 1 -
Adjustments to reconcile income from continuing operations to cash flows from operating activities
Depreciation, depletion and amortization 159 141
Deferred income taxes 7 (515)
Equity income from affiliates (9) (530)
Distributions from equity affiliates 9 277
Loss (gain) on the MAP Transaction - Note C 2 (1,295)
Loss on early retirement of debt - Note C - 145
Change in operating assets and liabilities (a) (revised - see Note A) (259) 5
Other items (2) (5)
--------- ---------
115 116
CASH FLOWS FROM FINANCING ACTIVITIES FROM CONTINUING OPERATIONS
Proceeds from issuance of common stock 17 100
Excess tax benefits from share-based payment arrangements 6 17
Repayment of long-term debt (7) (1,477)
Repurchase of common stock (138) -
Decrease in short-term debt - (40)
Cash dividends paid (59) (60)
--------- ---------
(181) (1,460)
CASH FLOWS FROM INVESTMENT ACTIVITIES FROM CONTINUING OPERATIONS
Additions to property, plant and equipment (189) (285)
Purchase of operations - net of cash acquired (177) (152)
Proceeds from sale of operations 12 2,397
Purchases of available-for-sale securities (645) -
Proceeds from sales and maturities of available-for-sale securities 437 -
Purchase of accounts receivable (revised - see Note A) - (150)
Other - net 11 9
--------- ---------
(551) 1,819
--------- ---------
CASH (USED) PROVIDED BY CONTINUING OPERATIONS (617) 475
Cash used by discontinued operations (revised - see Note A)
Operating cash flows (5) (26)
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(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (622) 449
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 985 243
--------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 363 $ 692
========= =========
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(a) Excludes changes resulting from operations acquired or sold.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with U.S. generally accepted accounting
principles for interim financial reporting and Securities and Exchange
Commission regulations. Although such statements are subject to any
year-end audit adjustments which may be necessary, in the opinion of
management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. These
financial statements should be read in conjunction with Ashland's Annual
Report on Form 10-K, as amended, for the fiscal year ended September 30,
2005. Results of operations for the periods ended June 30, 2006, are not
necessarily indicative of results to be expected for the year ending
September 30, 2006. Certain prior period data has been reclassified in
the consolidated financial statements and accompanying footnotes to
conform to current period presentation.
Ashland has separately disclosed in the Statements of Consolidated Cash
Flows the operating portion of the cash flows attributable to its
discontinued operations, which in prior periods were reported on a
combined basis as a single amount. There were no financing or investing
cash flows related to discontinued operations for the reported periods.
In addition, for the nine month period ended June 30, 2005, the
presentation of Ashland's repurchase of accounts receivable previously
sold under its sale of receivables facility has been revised. The
Investment section contains a new caption entitled "Purchase of accounts
receivable" for the $150 million cash outflow in the period. The "Change
in operating assets and liabilities" caption in the Operating section
has been increased by $150 million. As a result, the repurchase is
reflected as an investing cash outflow in the June 2005 period.
Collections of these receivables will be reflected as an investing cash
inflow in the September 2005 cash flow statement.
In the June 2006 quarter, Ashland redefined its reporting segments as it
continues to evolve into a diversified chemical company. Performance
Materials and Water Technologies, formerly combined under Ashland
Specialty Chemical have now been separately disclosed since these
businesses serve different markets and recent acquisitions have made
Water Technologies a much larger and more distinct part of Ashland.
Performance Materials includes three related business groups: Composite
Polymers, Casting Solutions, and Specialty Polymers and Adhesives. Water
Technologies also includes three related business groups: Drew
Industrial, Drew Marine, and Environmental and Process Solutions (which
is the business acquired from Degussa AG in May 2006). Disclosing
Performance Materials and Water Technologies separately provides greater
visibility to Ashland's strategy of expanding its products, services and
geographical reach in key market segments where it competes. For further
information on this revised disclosure see "Information by Industry
Segment" immediately following the Notes to Condensed Consolidated
Financial Statements on pages 17 and 18 of this document. Prior periods
have been conformed to the current period presentation.
The preparation of Ashland's condensed consolidated financial statements
requires management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses, and the
disclosures of contingent assets and liabilities. Significant items that
are subject to such estimates and assumptions include long-lived assets,
employee benefit obligations, income taxes, reserves and associated
receivables for asbestos litigation, environmental remediation, and
income recognized under construction contracts. Although management
bases its estimates on historical experience and various other
assumptions that are believed to be reasonable under the circumstances,
actual results could differ significantly from the estimates under
different assumptions or conditions.
6
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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NOTE B - NEW ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 123R (FAS 123R), which revised FAS 123, "Accounting for
Stock-Based Compensation," by requiring the expensing of share-based
compensation based on the grant-date fair value of the award. FAS 123
had provided companies the option of expensing such awards or merely
disclosing the pro forma effects of such expensing in the notes to
financial statements. As of October 1, 2002, Ashland began expensing
employee stock options in accordance with FAS 123 and its related
amendments. Ashland elected the modified prospective method of adoption,
under which compensation costs recorded in the year ended September 30,
2003 were the same as that which would have been recorded had the
recognition provisions of FAS 123 been applied from its original
effective date. Results for prior periods were not restated. FAS 123R
also required an additional caption in the financing section of the
Statements of Consolidated Cash Flows to present separately the excess
tax benefits from share based-payment arrangements. The adoption of FAS
123R during the December 2005 quarter did not have a material effect on
Ashland's financial position, results of operations or cash flows.
In June 2006, the FASB issued Interpretation No. 48 (FIN 48),
"Accounting for Uncertainty in Income Taxes" which clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with Financial Accounting Standard
No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be
taken in a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. FIN 48 becomes effective for Ashland on
October 1, 2007 and is currently being evaluated by Ashland to determine
the effect on the condensed consolidated financial statements.
NOTE C - ACQUISITIONS AND DIVESTITURES
ACQUISITIONS
In May 2006, Ashland acquired the water treatment business of Degussa
AG, branded under the Stockhausen name, with five manufacturing
facilities operating in Germany, China, Brazil, Russia and the United
States. The acquisition allows Ashland's Water Technologies division to
expand its technology base, product line and service levels while
continuing to develop its presence in key emerging international
markets. The transaction, denominated in Euros, was valued at $162
million at the exchange rate on the acquisition date. A summary of the
preliminary purchase price allocation follows.
-----------------------------------------------------------------
Assets
(In millions) (liabilities)
-----------------------------------------------------------------
Accounts receivable $ 65
Inventories 31
Property, plant and equipment 61
Goodwill and other intangibles 55
Trade and other payables (20)
Other noncurrent assets (liabilities) - net (30)
--------
$ 162
========
7
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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NOTE C - ACQUISITIONS AND DIVESTITURES (CONTINUED)
Also during 2006, three small acquisitions were made by Water
Technologies and Valvoline. All acquisitions are accounted for under the
purchase method of accounting. Ashland is currently in the process of
finalizing its valuation of the assets acquired and liabilities assumed
for several acquisitions to assist it in allocating the purchase price
to the individual assets acquired and liabilities assumed. The
preliminary allocation of purchase price included in the current period
balance sheet is based on Ashland's current best estimate and is subject
to revision based on final determination of fair value. Ashland
anticipates that the valuations will be completed prior to the first
anniversary of the acquisitions.
DIVESTITURES - MAP TRANSACTION
On June 30, 2005, Ashland completed its previously announced agreement
with Marathon to transfer Ashland's 38% interest in MAP and two other
businesses to Marathon in a transaction valued at approximately
$3.7 billion (the "MAP Transaction"). The two other businesses were
Ashland's maleic anhydride business and 60 Valvoline Instant Oil Change
centers in Michigan and northwest Ohio.
As a result of the transaction, Old Ashland shareholders of record as of
the close of business on June 30, 2005 received .2364 Marathon shares
and one Ashland share per Old Ashland share. In total, Ashland's
shareholders received 17,538,815 shares of Marathon common stock with an
aggregate value of $936 million based upon the June 30 closing price of
Marathon stock. Additionally, the transaction resulted in Ashland's
receipt of $2.4 billion in cash and MAP accounts receivable of
$913 million, which totaled $3.3 billion. This amount was comprised of
$2.8 billion of cash and accounts receivable, which amount was included
in the $3.7 billion transaction value, and $518 million of additional
cash and accounts receivable representing 38% of MAP's distributable
cash and other adjustments as of June 30, 2005.
Proceeds net of expenses of $26 million exceeded the book investment and
resulted in a pretax gain of $1,295 million recorded in the periods
ended June 30, 2005. Even though the Marathon common stock distribution
went directly to Ashland shareholders, for financial reporting purposes
the Marathon stock is reflected as non-cash proceeds from the
transaction, included in the gain computation, and then shown as a
distribution to shareholders out of retained earnings in Ashland's
stockholders' equity progression. The pretax gain is shown on a separate
line caption on the Statements of Consolidated Income below operating
income and labeled "Gain on the MAP Transaction." Because none of the
businesses qualify as discontinued operations under FASB Statement
No. 144 (FAS 144), "Accounting for the Impairment or Disposal of
Long-Lived Assets," the gain is reported in income from continuing
operations, with no restatement of prior results.
The MAP Transaction was structured to be generally tax-free to Ashland
shareholders and tax-efficient to Ashland. Ashland and Marathon entered
into a closing agreement with the Internal Revenue Service (IRS) with
respect to various tax consequences of the transaction. Pursuant to a
Tax Matters Agreement (TMA) with Marathon, any tax payable under Section
355(e) of the Internal Revenue Code on the transaction up to $200
million will be borne by Marathon, with the next $175 million being
borne by Ashland, and any tax over $375 million being split equally
between the two companies. Ashland has incurred approximately $14
million of Section 355(e) tax which has been borne by Marathon.
Due to the structure of the transaction, Marathon is entitled to the tax
deductions for Ashland's future payments of certain contingent
liabilities related to previously owned businesses of Ashland. However,
pursuant to the terms of the TMA, Marathon has agreed to compensate
Ashland for these tax deductions. At June 30, 2005, Ashland recorded a
discounted receivable of $65 million for the estimated present value of
8
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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NOTE C - ACQUISITIONS AND DIVESTITURES (CONTINUED)
probable recoveries from Marathon for the portion of these future tax
deductions which is not dependent upon Marathon's ability to utilize
these deductions. This receivable is included in the total pretax gain
on the transaction and is included in other noncurrent assets on
Ashland's balance sheet. Deferred tax assets previously recorded on
these contingent liabilities were reversed through the income tax
provision for the transaction. Adjustments to the receivable resulting
from changes in the liability estimates have been and will continue to
be recorded in the "Gain on the MAP Transaction" line caption on the
income statement, while the accretion of the discount will be reflected
in interest income. As of June 30, 2006, this receivable had been
reduced to $56 million.
Net deferred tax liabilities totaling $328 million were reversed through
the income tax provision for the transaction as of June 30, 2005. The
reversal of deferred taxes, including those deferred tax assets related
to the contingent liabilities discussed above, reflects the fact that
Marathon assumes Ashland's tax basis in these net assets as a result of
the MAP Transaction.
Ashland used a substantial portion of the proceeds of the MAP
Transaction to retire most of its debt and certain other financial
obligations. In addition to the repurchase of accounts receivable
previously sold under its sale of receivables facility and the purchase
of $101 million of assets that were formerly leased under operating
leases, Ashland retired approximately $1.54 billion of balance sheet
debt as of June 30, 2005 and incurred a loss on the early retirement of
debt of $143 million during the quarter and $145 million during the nine
months ended June 30, 2005. The loss consisted of debt repayment
premiums of $139 million, a tender fee of $3 million and the write-off
of deferred debt issuance costs of $3 million. A tax benefit of $56
million during the quarter and $57 million during the nine months ended
June 30, 2005 was recorded for the loss on early retirement of debt.
Ashland has and will continue to retire additional debt and other
financial obligations in subsequent quarters.
The gain on the MAP Transaction and the loss on early retirement of
debt, net of their respective tax effects, increased net income by
$1,536 million, or $20.56 per share, for the third quarter ended
June 30, 2005. In addition, the operating income earned from the
businesses sold during this quarter added $173 million of net income or
$2.31 per share. Due to the continuing nature of certain tax issues, the
gain has been adjusted in subsequent quarters, and may continue to be
adjusted in future periods, primarily in the tax area due to the unique
and complicated tax aspects of the transaction. Adjustments to the gain
in subsequent periods will be reflected in the quarter they are
determined.
DIVESTITURES - OTHER
In January 2006, APAC sold its operations in the Richmond, Virginia and
Shawnee, Oklahoma market areas. Both of these businesses were
unprofitable in 2005 and were part of APAC's "fix or exit" team analysis
that was completed in the second quarter of the current fiscal year.
These two transactions did not have a significant effect on Ashland's
condensed consolidated financial statements.
NOTE D - DEBT DEFEASANCE
During the December 2005 quarter Ashland entered into an in-substance
defeasance of approximately $49 million to repay current and long-term
debt that had a carrying value of $44 million on the balance sheet as of
December 31, 2005. Because the transaction was not a legal defeasance
the investment has been placed into a trust and will be exclusively
restricted to future obligations and repayments related to these debt
instruments. The investments have been classified on the balance sheet
as other current assets or other noncurrent assets based on the
contractual debt repayment schedule. At June 30, 2006, the carrying
value of the investments to defease debt, including other defeasements
accomplished in fiscal 2005, was $56 million and the carrying value of
the debt was $49 million.
9
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE E - INVENTORIES
Inventories are carried at the lower of cost or market. Certain
chemicals, plastics and lubricants are valued at cost using the last-in,
first-out (LIFO) method. The remaining inventories are stated at cost
using the first-in, first-out (FIFO) method or average cost method
(which approximates FIFO). The following table summarizes Ashland's
inventories as of the reported balance sheet dates.
----------------------------------------------------------------------------------------------------------------
June 30 September 30 June 30
(In millions) 2006 2005 2005
----------------------------------------------------------------------------------------------------------------
Chemicals and plastics $ 518 $ 429 $ 449
Construction materials 97 80 85
Lubricants 83 68 76
Other products 59 67 70
Supplies 12 9 8
Excess of replacement costs over LIFO carrying values (144) (126) (121)
----------- ------------ ------------
$ 625 $ 527 $ 567
=========== ============ ============
NOTE F - UNCONSOLIDATED AFFILIATES
On June 30, 2005, Ashland completed the MAP Transaction. For further
detailed information on this transaction see Note C within this document
or Note D of Notes to Consolidated Financial Statements in Ashland's
Annual Report on Form 10-K, as amended, for the fiscal year ended
September 30, 2005. Separate audited financial statements for MAP
required by Rule 3-09 of Regulation S-X were filed on a Form 10-K/A on
March 30, 2006. Income statement information for MAP during the period
of ownership is shown below.
MAP was organized as a limited liability company that had elected to be
taxed as a partnership. Therefore, the parents were responsible for
income taxes applicable to their share of MAP's taxable income. The net
income reflected below for MAP did not include any provision for income
taxes that would have been incurred by its parents.
---------------------------------------------------------------------------
Three months ended Nine months ended
June 30 June 30
------------------- -------------------
(In millions) 2006 2005 2006 2005
---------------------------------------------------------------------------
Sales and operating revenues $ - $ 14,282 $ - $ 38,195
Income from operations - 823 - 1,408
Net income - 823 - 1,396
Ashland's equity income - 309 - 518
NOTE G - GOODWILL AND OTHER INTANGIBLES
In accordance with FASB Statement No. 142 (FAS 142), "Goodwill and Other
Intangible Assets," Ashland has discontinued the practice of amortizing
goodwill and other intangible assets with indefinite lives and initiated
an annual review for impairment. Impairment is to be examined more
frequently if certain indicators are encountered. Ashland has completed
its most recent annual goodwill impairment test required by FAS 142 as
of July 1, 2005 and has determined that no impairment exists.
The following is a progression of goodwill by segment for the nine
months ended June 30, 2006 and 2005.
10
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE G - GOODWILL AND OTHER INTANGIBLES (CONTINUED)
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Performance Water
(In millions) APAC Materials Distribution Valvoline Technologies Total
-----------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2004 $ 411 $ 57 $ - $ 6 $ 39 $ 513
Acquisitions 2 43 1 17 - 63
----------- ----------- ----------- ------------ ------------ -----------
Balance at June 30, 2005 $ 413 $ 100 $ 1 $ 23 $ 39 $ 576
=========== =========== =========== ============ ============ ===========
Balance at September 30, 2005 $ 413 $ 100 $ 1 $ 24 $ 39 $ 577
Divestitures (4) - - - - (4)
Acquisitions - 2 - 5 32 39
Currency translation adjustment - 2 - - 1 3
----------- ----------- ----------- ------------ ------------ -----------
Balance at June 30, 2006 $ 409 $ 104 $ 1 $ 29 $ 72 $ 615
=========== =========== =========== ============ ============ ===========
Other intangible assets consist of trademarks, patents and licenses,
non-compete agreements, sale contracts, customer lists and intellectual
property. Intangibles are amortized on a straight-line basis over their
estimated useful lives. The cost of trademarks is amortized principally
over 10 to 25 years and patents and other intangibles over 3 to 17
years. Ashland reviews intangible assets for possible impairment
whenever events or changes in circumstances indicate that carrying
amounts may not be recoverable.
Other intangible assets were comprised of the following as of June 30,
2006 and 2005.
-----------------------------------------------------------------------------------------------------------
2006 2005
--------------------------------- ----------------------------------
Gross Net Gross Net
carrying Accumulated carrying carrying Accumulated carrying
(In millions) amount amortization amount amount amortization amount
-------------------------------------------------------------------- ---------------------------------
Trademarks $ 66 $ (19) $ 47 $ 56 $ (18) $ 38
Patents and other intangibles 66 (18) 48 49 (14) 35
-------- --------- -------- -------- --------- --------
Total intangible assets $ 132 $ (37) $ 95 $ 105 $ (32) $ 73
======== ========= ======== ======== ========= ========
As of June 30, 2006, all of Ashland's other intangible assets that had a
carrying value were being amortized. Amortization expense recognized on
intangible assets for the three months ended June 30 was $1 million for
2006 and $2 million for 2005. Amortization expense recognized on
intangible assets for the nine months ended June 30 was $4 million for
2006 and $5 million for 2005. Estimated amortization expense for future
periods is $7 million in 2006 (includes nine months actual and three
months estimated), $9 million in 2007, $8 million in 2008, $7 million in
2009 and $5 million in 2010.
NOTE H - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (EPS) from continuing operations.
11
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE H - EARNINGS PER SHARE (CONTINUED)
-----------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
June 30 June 30
------------------------ -----------------------
(In millions except per share data) 2006 2005 2006 2005
-----------------------------------------------------------------------------------------------------------------------
NUMERATOR
Numerator for basic and diluted EPS - Income
from continuing operations $ 93 $ 1,767 $ 208 $ 1,893
========== =========== ========== ==========
DENOMINATOR
Denominator for basic EPS - Weighted average
common shares outstanding 71 73 71 72
Common shares issuable upon exercise of stock options 1 2 1 2
---------- ----------- ---------- ----------
Denominator for diluted EPS - Adjusted weighted
average shares and assumed conversions 72 75 72 74
========== =========== ========== ==========
EPS FROM CONTINUING OPERATIONS
Basic $ 1.31 $ 24.13 $ 2.91 $ 26.11
Diluted $ 1.29 $ 23.65 $ 2.87 $ 25.48
NOTE I - EMPLOYEE BENEFIT PLANS
As of June 30, 2006, Ashland has made contributions of $75 million to
its U.S. pension plans and $8 million to its non-U.S. pension plans.
Ashland does not anticipate contributing additional funds to its U.S.
and non-U.S. pension plans during the last quarter of fiscal year 2006.
The following table details the components of pension and other
postretirement benefit costs.
-----------------------------------------------------------------------------------------------------------------------
Other postretirement
Pension benefits benefits
------------------------- -------------------------
(In millions) 2006 2005 2006 2005
-----------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30
Service cost $ 15 $ 13 $ 2 $ 2
Interest cost 23 20 5 4
Expected return on plan assets (27) (21) - -
Amortization of prior service credit - - (3) (2)
Amortization of net actuarial loss 12 8 - -
----------- ----------- ----------- -----------
$ 23 $ 20 $ 4 $ 4
=========== =========== =========== ===========
NINE MONTHS ENDED JUNE 30
Service cost $ 44 $ 40 $ 6 $ 7
Interest cost 65 59 11 12
Expected return on plan assets (76) (59) - -
Amortization of prior service credit - - (7) (7)
Amortization of net actuarial loss 32 24 1 3
----------- ----------- ----------- -----------
$ 65 $ 64 $ 11 $ 15
=========== =========== =========== ===========
12
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE J - LITIGATION, CLAIMS AND CONTINGENCIES
ASBESTOS-RELATED LITIGATION
Ashland is subject to liabilities from claims alleging personal injury
caused by exposure to asbestos. Such claims result primarily from
indemnification obligations undertaken in 1990 in connection with the
sale of Riley Stoker Corporation (Riley), a former subsidiary. Although
Riley was neither a producer nor a manufacturer of asbestos, its
industrial boilers contained some asbestos-containing components
provided by other companies.
A summary of asbestos claims activity follows. Because claims are
frequently filed and settled in large groups, the amount and timing of
settlements and number of open claims can fluctuate significantly from
period to period.
----------------------------------------------------------------------------------------------------------------------
Nine months ended
June 30 Years ended September 30
--------------------------- ------------------------------------------
(In thousands) 2006 2005 2005 2004 2003
----------------------------------------------------------------------------------------------------------------------
Open claims - beginning of period 184 196 196 198 160
New claims filed 4 10 12 29 66
Claims settled (3) (5) (6) (7) (7)
Claims dismissed (16) (16) (18) (24) (21)
----------- ----------- ----------- ----------- -----------
Open claims - end of period 169 185 184 196 198
=========== =========== =========== =========== ===========
Since October 1, 2002, Riley has been dismissed as a defendant in 77% of
the resolved claims. Amounts spent on litigation defense and claim
settlements averaged $1,655 per claim resolved in the nine months ended
June 30, 2006, compared to $1,675 in the nine months ended June 30,
2005, and annual averages of $1,985 in 2005, $1,655 in 2004 and $1,610
in 2003. A progression of activity in the asbestos reserve is presented
in the following table.
-----------------------------------------------------------------------------------------------------------------------
Nine months ended
June 30 Years ended September 30
--------------------------- -------------------------------------------
(In millions) 2006 2005 2005 2004 2003
-----------------------------------------------------------------------------------------------------------------------
Asbestos reserve - beginning of period $ 571 $ 618 $ 618 $ 610 $ 202
Expense incurred 104 - - 59 453
Amounts paid (32) (34) (47) (51) (45)
----------- ----------- ----------- ----------- ------------
Asbestos reserve - end of period $ 643 $ 584 $ 571 $ 618 $ 610
=========== =========== =========== =========== ============
During the December 2002 quarter, Ashland increased its reserve for
asbestos claims by $390 million to cover the litigation defense and
claim settlement costs for probable and reasonably estimable future
payments related to existing open claims, as well as an estimate of
those that may be filed in the future. Prior to December 31, 2002, the
asbestos reserve was based on the estimated costs that would be incurred
to settle existing open claims. A range of estimates of future asbestos
claims and related costs using various assumptions was developed with
the assistance of Hamilton, Rabinovitz & Alschuler, Inc. (HR&A). The
methodology used by HR&A to project future asbestos costs was based
largely on Ashland's recent experience, including claim-filing and
settlement rates, disease mix, open claims, and litigation defense and
claim settlement costs. Ashland's claim experience was compared to the
results of previously conducted epidemiological studies estimating the
number of people likely to develop asbestos-related diseases. Those
studies were undertaken in connection with national analyses of the
population expected to have been exposed to asbestos. Using that
information, HR&A estimated a range of the number of future claims that
may be filed, as well as the related costs that may be incurred in
resolving those claims.
13
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE J - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
From the range of estimates, Ashland recorded the amount it believed to
be the best estimate, which represented the expected payments for
litigation defense and claim settlement costs during the next ten years.
Subsequent updates to this estimate have been made, with the assistance
of HR&A, based on a combination of a number of factors including the
actual volume of new claims, recent settlement costs, changes in the mix
of alleged disease, enacted legislative changes, the number of years
over which the costs extend, and other developments impacting Ashland's
estimate of future payments. The number of years of future costs
represented by Ashland's reserves has varied since 2002 from ten to 29
years, depending on the model selected. During the most recent update of
this estimate completed during the June 2006 quarter it was determined
that the reserves for asbestos claims should be increased by $104
million. This increase in the reserves is based on the results of a
non-inflated, non-discounted 51-year model developed with the assistance
of HR&A, based on recent claims experience, which represents Ashland's
current best estimate of future costs. This increase resulted in total
reserves for asbestos claims of $643 million at June 30, 2006, compared
to $571 million at September 30, 2005 and $584 million at June 30, 2005.
Projecting future asbestos costs is subject to numerous variables that
are extremely difficult to predict. In addition to the significant
uncertainties surrounding the number of claims that might be received,
other variables include the type and severity of the disease alleged by
each claimant, the long latency period associated with asbestos
exposure, dismissal rates, costs of medical treatment, the impact of
bankruptcies of other companies that are co-defendants in claims,
uncertainties surrounding the litigation process from jurisdiction to
jurisdiction and from case to case, and the impact of potential changes
in legislative or judicial standards. Furthermore, any predictions with
respect to these variables are subject to even greater uncertainty as
the projection period lengthens. In light of these inherent
uncertainties, Ashland believes its asbestos reserve represents the best
estimate within a range of possible outcomes. As a part of the process
to develop Ashland's estimates of future asbestos costs, a range of
long-term cost models is developed that assumes a run-out of claims
through 2057. These models are based on national studies that predict
the number of people likely to develop asbestos-related diseases and are
heavily influenced by assumptions regarding long-term inflation rates
for indemnity payments and legal defense costs, as well as other
variables mentioned previously. Ashland has estimated that it is
reasonably possible that total future litigation defense and claim
settlement costs on an inflated and undiscounted basis could range as
high as approximately $1.9 billion, depending on the combination of
assumptions selected in the various models. If actual experience is
worse than projected relative to the number of claims filed, the
severity of alleged disease associated with those claims or costs
incurred to resolve those claims, Ashland may need to increase further
the estimates of the costs associated with asbestos claims and these
increases could potentially be material over time.
Ashland has insurance coverage for most of the litigation defense and
claim settlement costs incurred in connection with its asbestos claims,
and coverage-in-place agreements exist with the insurance companies that
provide substantially all of the coverage currently being accessed. As a
result, increases in the asbestos reserve have been largely offset by
probable insurance recoveries. The amounts not recoverable generally are
due from insurers that are insolvent, rather than as a result of
uninsured claims or the exhaustion of Ashland's insurance coverage.
Ashland's management has estimated the value of probable insurance
recoveries associated with Ashland's estimate of its asbestos
liabilities. Such recoveries are based on management's assumptions and
estimates surrounding the available or applicable insurance coverage.
One such assumption is that all solvent insurance carriers remain
solvent. Although coverage limits are resolved in the coverage-in-place
agreement with Equitas Limited (Equitas) and other London companies,
which collectively provide a significant portion of Ashland's insurance
coverage for asbestos claims, there was a disagreement with
14
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE J - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
these companies over the timing of recoveries. In estimating the value
of future recoveries, Ashland has historically used the least favorable
interpretation of this agreement under which the ultimate recoveries are
extended for many years, resulting in a significant discount being
applied to value those recoveries. On June 16, 2006 an arbitrator
reached a decision essentially confirming that interpretation. Ashland
will continue to apply this methodology based on this arbitration
decision.
At June 30, 2006, Ashland's receivable for recoveries of litigation
defense and claim settlement costs from insurers amounted to $476
million, of which $60 million relates to costs previously paid.
Receivables from insurance companies amounted to $400 million at
September 30, 2005 and $404 million at June 30, 2005. The receivable was
increased by $104 million during the June 2006 quarter, reflecting the
updated model used for purposes of valuing the reserve described above,
and its impact on the valuation of future recoveries from insurers.
About 40% of the estimated receivables from insurance companies at June
30, 2006 are expected to be due from Equitas and other London companies.
Of the remainder, approximately 90% is expected to come from companies
or groups that are rated A or higher by A. M. Best.
ENVIRONMENTAL REMEDIATION
Ashland is subject to various federal, state and local environmental
laws and regulations that require environmental assessment or
remediation efforts (collectively environmental remediation) at multiple
locations. At June 30, 2006, such locations included 99 waste treatment
or disposal sites where Ashland has been identified as a potentially
responsible party under Superfund or similar state laws, 101 current and
former operating facilities (including certain operating facilities
conveyed to MAP) and about 1,220 service station properties, of which
214 are being actively remediated. Ashland's reserves for environmental
remediation amounted to $176 million at June 30, 2006, compared to $178
million at September 30, 2005 and $177 million at June 30, 2005, of
which $144 million at June 30, 2006, $145 million at September 30, 2005
and $145 million at June 30, 2005 were classified in noncurrent
liabilities on the Condensed Consolidated Balance Sheets. The total
reserves for environmental remediation reflect Ashland's estimates of
the most likely costs that will be incurred over an extended period to
remediate identified conditions for which the costs are reasonably
estimable, without regard to any third-party recoveries. Engineering
studies, probability techniques, historical experience and other factors
are used to identify and evaluate remediation alternatives and their
related costs in determining the estimated reserves for environmental
remediation. Ashland regularly adjusts its reserves as environmental
remediation continues. Environmental remediation expense amounted to $20
million for the nine months ended June 30, 2006, compared to $39 million
for the nine months ended June 30, 2005, and annual expense of
$47 million in 2005, $2 million in 2004 and $22 million in 2003.
Environmental remediation reserves are subject to numerous inherent
uncertainties that affect Ashland's ability to estimate its share of the
costs. Such uncertainties involve the nature and extent of contamination
at each site, the extent of required cleanup efforts under existing
environmental regulations, widely varying costs of alternate cleanup
methods, changes in environmental regulations, the potential effect of
continuing improvements in remediation technology, and the number and
financial strength of other potentially responsible parties at
multiparty sites. Although it is not possible to predict with certainty
the ultimate costs of environmental remediation, Ashland currently
estimates that the upper end of the reasonably possible range of future
costs for identified sites could be as high as approximately $300
million. No individual remediation location is material to Ashland, as
its largest reserve for any site is less than 10% of the remediation
reserve.
15
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------------------------------------------------
NOTE J - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
OTHER LEGAL PROCEEDINGS
In addition to the matters described above, there are various claims,
lawsuits and administrative proceedings pending or threatened against
Ashland and its current and former subsidiaries. Such actions are with
respect to commercial matters, product liability, toxic tort liability,
and other environmental matters, which seek remedies or damages, some of
which are for substantial amounts. While these actions are being
contested, their outcome is not predictable.
16
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
INFORMATION BY INDUSTRY SEGMENT
------------------------------------------------------------------------------------------
Three months ended Nine months ended
June 30 June 30
----------------------- -----------------------
(In millions - unaudited) 2006 2005 2006 2005
------------------------------------------------------------------------------------------
REVENUES
Sales and operating revenues
APAC $ 838 $ 713 $ 2,053 $ 1,713
Performance Materials (a) 370 383 1,068 1,028
Distribution 1,050 987 3,046 2,837
Valvoline 366 354 1,030 987
Water Technologies (a) 113 101 310 290
Intersegment sales
Performance Materials (a) (38) (40) (108) (105)
Distribution (6) (5) (17) (17)
Valvoline (1) (1) (3) (1)
Water Technologies (a) (1) - (1) (1)
----------- ---------- ---------- ----------
2,691 2,492 7,378 6,731
Equity income
APAC 1 3 1 6
Performance Materials (a) 2 2 7 6
Valvoline 1 1 - -
Water Technologies (a) - - 1 -
Refining and Marketing - 309 - 518
----------- ---------- ---------- ----------
4 315 9 530
Other income
APAC 7 7 30 11
Performance Materials (a) 1 1 2 17
Distribution 1 2 3 7
Valvoline - 2 5 5
Water Technologies (a) 1 1 3 3
Refining and Marketing - - - 2
Unallocated and other 3 1 6 4
----------- ---------- ---------- ----------
13 14 49 49
----------- ---------- ---------- ----------
$ 2,708 $ 2,821 $ 7,436 $ 7,310
=========== ========== ========== ==========
OPERATING INCOME (b)
APAC $ 68 $ 41 $ 95 $ (6)
Performance Materials (a) 41 33 94 73
Distribution 30 31 95 80
Valvoline (10) 19 (6) 49
Water Technologies (a) 9 2 9 9
Refining and Marketing (c) - 290 - 486
Unallocated and other (11) (6) (16) (16)
----------- ---------- ---------- ----------
$ 127 $ 410 $ 271 $ 675
=========== ========== ========== ==========
---------------------------------------------------------------------------
(a) In the June 2006 quarter, Ashland redefined its reporting segments as
it continues to evolve into a diversified chemical company.
Performance Materials and Water Technologies were formerly combined
under Ashland Specialty Chemical. Prior periods have been conformed to
the current period presentation.
(b) In October 2005, Ashland refined its segment reporting to allocate
substantially all corporate expenses to Ashland's five operating
divisions, with the exception of certain legacy costs or items clearly
not associated with the operating divisions. Prior periods have been
conformed to the current period presentation.
(c) Includes Ashland's equity income from MAP, amortization related to
Ashland's excess investment in MAP and other activities associated
with refining and marketing through June 30, 2005.
17
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
INFORMATION BY INDUSTRY SEGMENT
--------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
June 30 June 30
---------------------- -----------------------
(In millions) 2006 2005 2006 2005
--------------------------------------------------------------------------------------------------------------
OPERATING INFORMATION
APAC
Construction backlog at June 30 (a) $ 1,951 $ 2,100
Net construction job revenues (b) $ 509 $ 424 $ 1,189 $ 966
Hot-mix asphalt production (tons) 8.7 9.5 20.7 21.0
Aggregate production (tons) 8.7 8.3 23.7 22.6
Performance Materials (c) (d)
Sales per shipping day $ 5.9 $ 6.0 $ 5.7 $ 5.5
Pounds sold per shipping day 5.1 5.9 5.0 5.6
Gross profit as a percent of sales 25.0% 22.6% 23.2% 20.2%
Distribution (c)
Sales per shipping day $ 16.7 $ 15.4 $ 16.2 $ 15.1
Pounds sold per shipping day 19.6 19.1 19.0 19.2
Gross profit as a percent of sales 9.3% 10.0% 9.7% 9.8%
Valvoline (c)
Lubricant sales (gallons) 45.1 48.1 127.8 131.4
Premium lubricants (percent of U.S. branded volumes) 22.4% 24.3% 23.2% 23.5%
Gross profit as a percent of sales 20.2% 25.9% 21.4% 27.0%
Water Technologies (c) (d)
Sales per shipping day $ 1.8 $ 1.6 $ 1.6 $ 1.5
Gross profit as a percent of sales 45.5% 46.9% 47.0% 48.1%
--------------------------------------------------------------------------------------------------------------
(a) Includes APAC's proportionate share of the backlog of unconsolidated
joint ventures.
(b) Total construction job revenues, less subcontract costs.
(c) Sales are defined as sales and operating revenues. Gross profit is
defined as sales and operating revenues, less cost of sales and
operating expenses.
(d) In the June 2006 quarter, Ashland redefined its reporting segments as
it continues to evolve into a diversified chemical company.
Performance Materials and Water Technologies were formerly combined
under Ashland Specialty Chemical. Prior periods have been conformed to
the current period presentation.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
---------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
---------------------------------------------------------------------------
RESULTS OF OPERATIONS
Current Quarter - Ashland reported net income of $93 million, or $1.29
per share, for the quarter ended June 30, 2006, compared to
$1,767 million, or $23.65 per share, for the quarter ended June 30,
2005. The net income comparison is affected by the $1,536 million, or
$20.56 per share, gain from the June 2005 transfer of Ashland's former
38-percent interest in Marathon Ashland Petroleum LLC (MAP) to Marathon
Oil Corporation (Marathon), as described in Note C to the Condensed
Consolidated Financial Statements, and subsequent retirement of most of
Ashland's debt. The 2005 quarter also included $173 million of net
income, or $2.31 per share, from the businesses sold (which consisted
primarily of Ashland's equity income from MAP) and interest expense
eliminated from the debt retirement. Total impact in the 2005 June
quarter of the gain on the sale, operating income from businesses sold
and interest eliminated equaled $1,709 million, or $22.87 per share. The
2006 quarter included $6 million, or $.08 per share of net, after-tax
interest income.
In the June 2006 quarter, Ashland redefined its reporting segments as it
continues to evolve into a diversified chemical company. Performance
Materials and Water Technologies, formerly combined under Ashland
Specialty Chemical have now been separately disclosed since these
businesses serve different markets and recent acquisitions have made
Water Technologies a much larger and more distinct part of Ashland.
Performance Materials and APAC performed exceptionally well during the
quarter both benefiting from improved margins as well as favorable
weather for APAC. Distribution delivered another solid quarter earning
just slightly less than the prior year's record third quarter results.
Valvoline and Water Technologies continued to struggle with rising raw
material costs and the lag in passing through price increases, causing
gross profit margin erosion.
Year-to-Date - Ashland reported net income of $207 million, or $2.90 per
share, for the nine months ended June 30, 2006, compared to
$1,893 million, or $25.48 per share, for the nine months ended June 30,
2005. The comparison is affected by the $1,535 million, or $20.66 per
share, gain from the June 2005 transfer of Ashland's former 38-percent
interest in MAP to Marathon and subsequent retirement of most of
Ashland's debt. The nine months ended June 30, 2005 included
$269 million of net income, or $3.62 per share, from the businesses sold
and interest expense eliminated. The nine months ended June 30, 2006
included $17 million, or $.24 per share of net, after-tax interest
income.
The increase in Ashland's net income in its remaining operating
businesses for the nine months ended June 30, 2006 compared to the 2005
period, excluding the MAP Transaction impact, was due to improved
operating income from three of Ashland's five segments. APAC showed the
greatest improvement as operating income increased to $95 million
compared to a loss of $6 million in the 2005 period. Performance
Materials reported a 29% increase in operating income and Distribution
increased 19%, while Water Technologies was flat and Valvoline declined
$55 million. An analysis of operating income by industry segment
follows.
19
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
---------------------------------------------------------------------------
Segment operating results reflect new methodology adopted in October
2005 for allocating substantially all corporate expenses to Ashland's
five operating businesses, with the exception of certain legacy costs or
items clearly not associated with the operating divisions. Accordingly,
$20 million in additional corporate expenses for the June 2006 quarter
and $69 million year-to-date were allocated to the divisions. The
remaining $11 million expense for the June 2006 quarter and $16 million
expense for the nine months ended June 30, 2006 is classified as
"Unallocated and other" in Ashland's segment reporting. Results for
previously reported periods have been reclassified to conform with the
new allocation methodology.
APAC
Current Quarter - APAC reported operating income of $68 million for the
June 2006 quarter, a 66% increase compared to the record $41 million
earned in the June 2005 quarter. APAC's performance reflects strong
pricing and favorable weather. Gross profit margin improvement reflected
successful efforts in incorporating higher construction material values
and energy costs into APAC's initial bids. Precipitation was near normal
or below in 11 of the 14 states in which APAC operates and warmer
temperatures allowed construction sites to dry quicker. Sales and
operating revenues were $838 million in the June 2006 quarter, an 18%
increase over the $713 million recorded in the June 2005 quarter. Net
construction job revenues (total construction job revenues less
subcontract costs) increased 20% from $424 million for the June 2005
quarter to $509 million for the June 2006 quarter. Hot-mix asphalt
production decreased 8% to 8.7 million tons versus 9.5 million tons in
the June 2005 quarter, while aggregate production increased 5% to
8.7 million tons from 8.3 million tons in the June 2005 quarter. APAC
continued to roll off older, fixed-price contracts which contained
substantially lower energy and raw material cost estimates. At June 30,
2006, APAC's construction backlog, which consists of work awarded and
funded but not yet performed, was $1,951 million, a 7% decrease compared
to the $2,100 million in the June 2005 quarter. Approximately 60% of the
decline is a result of lower backlog in the Major Projects Group.
Governments, whose road building, repair and maintenance budgets are
generally dollar-denominated, represent the primary customers of APAC.
As asphalt and aggregate prices rise, governments appear to be reducing
their tonnage demand, resulting in a 21% decline in asphalt tonnage in
the backlog.
Year-to-Date - APAC earned operating income of $95 million for the nine
months ended June 30, 2006, compared to a loss of $6 million for the
nine months ended June 30, 2005. The $101 million increase was primarily
the result of the same factors discussed in the current quarter
comparison. Results for the 2006 period included an $18 million gain
from the transfer of property subject to eminent domain and a $2 million
gain from the sale of assets in construction markets exited by APAC. Net
construction job revenues increased 23% to $1,189 million for the nine
months ended June 30, 2006 versus $966 million for the nine months ended
June 30, 2005. Hot-mix asphalt production decreased 1% to 20.7 million
tons versus 21.0 million tons in the 2005 period, while aggregate
production increased 5% to 23.7 million tons versus 22.6 million tons in
the 2005 period. The volume increase for aggregate primarily reflects a
greater use of internally generated materials.
PERFORMANCE MATERIALS
Current Quarter - Performance Materials reported operating income of
$41 million for the June 2006 quarter, an increase of 24% compared to
$33 million for the June 2005 quarter. The gross profit margin improved
from 22.6% in the June 2005 quarter to 25.0% in the June 2006 quarter,
resulting in a $15 million increase in operating income. Pounds per
shipping day decreased 14% to 5.1 million pounds from 5.9 million pounds
in the June 2005 quarter, resulting in a $10 million decrease in
operating income.
20
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
---------------------------------------------------------------------------
PERFORMANCE MATERIALS (CONTINUED)
When these volumes are adjusted for the maleic anhydride business
transferred to Marathon as part of the MAP Transaction in 2005, the
volumes decreased 6%. Both the improved margins and reduced volumes
reflect optimization of the product mix combined with aggressive price
increases as raw material costs continued to rise.
Year-to-Date - Performance Materials earned operating income of $94
million for the nine months ended June 30, 2006, a 29% increase over the
$73 million earned for the nine months ended June 30, 2005. The gross
profit margin increased to 23.2% from 20.2% in the June 2005 period,
resulting in a $55 million increase in operating income. Pounds per
shipping day decreased 11% from 5.6 million pounds for the nine months
ended June 30, 2005 to 5.0 million pounds for the 2006 period resulting
in a $15 million decline in operating income in the current year. When
these volumes are adjusted for the maleic anhydride business transferred
to Marathon as part of the MAP Transaction in 2005 the volumes decreased
3%. Selling, general and administrative expenses increased $6 million in
the 2006 period, while the 2005 period included $11 million in gains
from the sale of an idle plant and the termination of a product supply
contract.
DISTRIBUTION
Current Quarter - Distribution continued its solid performance reporting
operating income of $30 million in the June 2006 quarter, compared with
the record $31 million earned for the June 2005 quarter. Sales and
operating revenues increased to a record $1,050 million, a 6% increase
over the prior year's quarter. Volume increased 3% as pounds per
shipping day increased to 19.6 million pounds from 19.1 million pounds
during the prior year quarter. The increase in volume added $1 million
to operating income and selling, general and administrative expenses
declined $1 million. However, a decrease in gross profit margins to 9.3%
from 10.0% resulted in a $3 million decline in operating income, as
higher costs, primarily in chemicals, outpaced pricing to customers,
causing a short-term margin compression.
Year-to-Date - Distribution earned operating income of $95 million for
the nine months ended June 30, 2006, a 19% increase over the $80 million
recorded for the nine months ended June 30, 2005. Sales and operating
revenues increased 7% from $2,837 million for the nine months ended June
30, 2005 to $3,046 million for the nine months ended June 30, 2006.
Gross profit as a percent of sales decreased from 9.8% to 9.7% compared
to the 2005 period, but increased on a cents per pound basis, resulting
in a $19 million increase in operating income. A 1% decline in volume
reduced operating income by $3 million, while selling, general and
administrative expenses declined $2 million.
VALVOLINE
Current Quarter - Valvoline reported an operating loss of $10 million in
the June 2006 quarter, compared to $19 million of operating income in
the June 2005 quarter. Sales and operating revenues were $366 million
for the current quarter, a 3% increase over the $354 million for the
June 2005 quarter. While revenues increased, continued escalating costs
in base lube stock, additives and packaging further eroded the gross
profit margin as it decreased from 25.9% in the 2005 quarter to 20.2% in
the 2006 quarter, causing a $16 million loss in operating income from
the June 2005 quarter. This lower margin reflects ongoing rapid
increases in lube stock costs, which have not been fully offset by price
increases in the marketplace. In addition, volume levels decreased 6%,
from 48.1 million gallons of lubricant sales in the June 2005 quarter to
45.1 million gallons in the current quarter, resulting in an additional
$3 million of lost operating income compared to the prior year quarter.
Ashland believes this decline in volume is consistent with the weak
demand in its primary markets. Selling, general and administrative
expenses reflected increases of $5 million in advertising and promotion
and $3 million in litigation reserves compared to the prior year
quarter.
21
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
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VALVOLINE (CONTINUED)
Year-to-Date - Valvoline reported an operating loss of $6 million for
the nine months ended June 30, 2006, compared to operating income of $49
million for the nine months ended June 30, 2005. The decline primarily
reflects the gross profit margin compression described in the current
quarter comparison which resulted in a $38 million decrease in operating
income. Sales and operating revenues have increased $43 million or 4%
from $987 million in the 2005 period to $1,030 million in the 2006
period. Despite increased revenues driven by higher prices, lubricant
volumes declined 3%, reflecting a soft market for passenger-car
lubricants. The net impact of volume fluctuations in all product lines
resulted in a $3 million decrease in operating income. Earnings from
Valvoline Instant Oil Change decreased 50% reflecting increased raw
material costs and a decrease in the number of oil changes.
International operating income declined 35% primarily due to higher raw
material costs. Selling, general and administrative costs, including
GlobalOne and litigation reserve expenditures, increased $9 million
compared to the prior year period.
WATER TECHNOLOGIES
Current Quarter - Water Technologies reported operating income of $9
million for the June 2006 quarter compared to $2 million for the June
2005 quarter. The current quarter included an $8 million foreign
currency hedge gain on the Degussa acquisition. Excluding this gain,
operating income declined slightly during the quarter. Sales and
operating revenues increased 12% to $113 million during the June 2006
quarter from $101 million during the June 2005 quarter. This increase
included $5 million from the June operations of the Degussa business,
which is now operating as the Environmental and Process Solutions group
within the Water Technologies business. The primary factor impacting
profitability for this business currently is rising raw material costs
where materials such as propylene, which impacts approximately 50% of
raw material costs for this business, has increased 62% since the prior
year quarter. This rising raw material environment continues to offset
increased pricing, resulting in the decrease in gross profit margin from
46.9% in the June 2005 quarter to 45.5% in the June 2006 quarter.
Year-to-Date - Water Technologies reported operating income of $9
million for the nine months ended June 30, 2006 compared to the $9
million for the nine months ended June 30, 2005. Excluding the
aforementioned $8 million foreign currency hedge gain, operating income
decreased $8 million compared to the prior year. Sales and operating
revenues increased 7% to $310 million during 2006 from $290 million
during 2005. However, the revenue increase did not offset the rising raw
material cost environment discussed above as the gross profit margin
decreased from 48.1% in 2005 to 47.0% in 2006.
REFINING AND MARKETING
On June 30, 2005, Ashland completed the transfer of its 38% interest in
MAP as well as its maleic anhydride business and 60 Valvoline Instant
Oil Change centers in Michigan and northwest Ohio to Marathon in a
transaction valued at approximately $3.7 billion (the "MAP
Transaction"). For further detailed information on this transaction see
Note C of Notes to Condensed Consolidated Financial Statements within
this document. Operating income from Refining and Marketing, which
consisted primarily of equity income from MAP, amounted to $290 million
for the June 30, 2005 quarter and $486 million for the nine months ended
June 30, 2005.
UNALLOCATED AND OTHER
Unallocated and other costs, consisting of certain legacy costs or items
clearly not associated with the operating divisions totaled $11 million
for the June 2006 quarter, compared to $6 million in the June 2005
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UNALLOCATED AND OTHER (CONTINUED)
quarter. The June 2006 quarter included $6 million of environmental
expenses and other costs associated with formerly owned businesses in
addition to the ongoing costs that typically occur each quarter.
Unallocated and other costs for the nine months ended June 30, 2006 were
$16 million compared to $16 million for the nine months ended June 30,
2005. The 2006 period included $12 million of environmental expenses,
partially offset by a $5 million favorable adjustment to the previously
estimated withdrawal premium due Oil Insurance Limited (OIL), the
energy-industry mutual insurance consortium in which Ashland
participated and since has terminated participation effective December
31, 2005. The 2005 period included a $7 million charge for estimated
future insurance premiums due OIL.
GAIN (LOSS) ON THE MAP TRANSACTION
See Note C to the Condensed Consolidated Financial Statements for a
discussion of the MAP Transaction and the resulting pretax gain of
$1,295 million recorded in the June 2005 quarter. Ashland recorded a
loss on the MAP Transaction of $2 million in the nine months ended June
30, 2006, as a result of a decrease in the discounted receivable from
Marathon for the estimated present value of future tax deductions. The
loss resulted from a $4 million reclassification of certain tax benefits
related to previously owned businesses of Ashland. The offsetting
benefit was recorded in income taxes as deferred tax benefits. This
decrease in the receivable was partially offset by increases due to tax
benefits recognized on increased environmental reserves in the 2006
period.
LOSS ON EARLY RETIREMENT OF DEBT
Ashland recorded a loss on the early retirement of debt of $143 million
in the June 2005 quarter and $145 million for the nine months ended June
30, 2005. See Note C of Notes to Condensed Consolidated Financial
Statements for a discussion of the early retirement of debt associated
with the MAP Transaction.
NET INTEREST AND OTHER FINANCING INCOME (COSTS)
Ashland recognized net interest and other financing income of $9 million
in the June 2006 quarter and $29 million for the nine months ended June
30, 2006, compared to an expense of $31 million in the June 2005 quarter
and $89 million for the nine months ended June 30, 2005. The comparison
reflects the retirement of most of Ashland's debt from the proceeds of
the MAP Transaction in June 2005 and the temporary investment of the
remaining proceeds in short-term, available-for-sale securities.
INCOME TAXES
Ashland's effective income tax rate for the June 2006 quarter was 31.7%
compared to the tax benefit of $236 million recorded in the June 2005
quarter as a result of the MAP Transaction, which reflected a reversal
of $328 million in net deferred tax liabilities through the income tax
provision. Excluding the pretax gain and the associated deferred tax
benefit, the effective tax rate for the June 2005 quarter was 39.0% and
for the nine months ended June 30, 2005 was 38.8%, both of which are
essentially equal to the combined U.S. federal and state statutory rate.
The June 2006 quarter tax rate included tax benefits of $1 million from
prior-year research and development credits and favorable adjustments to
tax contingency reserves and a $4 million benefit related to the
reestablishment of a deferred tax asset related to a capital lease
obligation. Excluding these adjustments, the effective tax rate for the
quarter was 35.4%. Ashland's effective income tax rate for the nine
months ended June 30, 2006 was 30.1%. This period included tax benefits
of $7 million from prior-year research and development credits and
favorable adjustments to tax contingency reserves, a $4 million
reclassification of certain deferred tax benefits related to previously
23
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INCOME TAXES (CONTINUED)
owned businesses of Ashland and the $4 million benefit from the
reestablishment of the deferred tax asset described above. Excluding
these adjustments, the effective tax rate for the nine months ended June
30, 2006 was 35.4%. The effective income tax rate for the upcoming
September 2006 quarter and fiscal year 2006 is expected to be 32% and
31%, respectively.
DISCONTINUED OPERATIONS
Results of discontinued operations for the three months ended June 30,
2006 included a charge of $104 million to increase the asbestos
litigation reserve and an offsetting credit of $104 million to increase
the asbestos insurance receivable. In addition, results of discontinued
operations for the nine months ended June 30, 2006 included minor
expenses of $1 million (net of income taxes) associated with asbestos
liabilities.
FINANCIAL POSITION
LIQUIDITY
Cash flows from operating activities from continuing operations, a major
source of Ashland's liquidity, amounted to $115 million for the nine
months ended June 30, 2006, compared to $116 million for the nine months
ended June 30, 2005. The cash inflow for the 2006 period is primarily
due to cash generated from operations offset by a $259 million decrease
resulting from the change in operating assets and liabilities, which is
a reflection of working capital caption fluctuations and included a $75
million contribution to Ashland's U.S. pension plan and $63 million in
income tax payments. The cash inflow for the 2005 period included $271
million of cash distributions from MAP and income tax payments of $218
million.
Ashland's financial position has enabled it to obtain capital for its
financing needs. Following shareholder approval of the MAP Transaction
in June 2005, Moody's lowered Ashland's senior debt rating from Baa2 to
Ba1, their highest non-investment grade rating, and also lowered
Ashland's commercial paper rating from P-3 to N-P (Not-Prime), citing
the annual cash flow lost from the operations sold. In September 2005,
Standard & Poor's lowered Ashland's senior debt rating from BBB to BBB-,
its lowest investment grade rating, and lowered Ashland's commercial
paper rating from A-2 to A-3. Ratings downgrades below investment grade
can significantly increase a company's borrowing costs. Ashland has a
revolving credit agreement that expires on March 21, 2010, which
provides for up to $350 million in borrowings. The borrowing capacity
under this facility was reduced by $103 million of letters of credit
outstanding at June 30, 2006. The revolving credit agreement contains a
covenant limiting the total debt Ashland may incur from all sources as a
function of Ashland's stockholders' equity. The covenant's terms would
have permitted Ashland to borrow $5.6 billion at June 30, 2006, in
addition to the actual total debt incurred at that time. Permissible
total Ashland debt under the covenant's terms increases (or decreases)
by 150% of any increase (or decrease) in stockholders' equity.
At June 30, 2006, working capital (excluding debt due within one year)
amounted to $2,149 million, compared to $2,224 million at September 30,
2005 and $2,501 million at June 30, 2005. Ashland's working capital is
affected by its use of the LIFO method of inventory valuation. That
method valued inventories below their replacement costs by $144 million
at June 30, 2006, compared to $126 million at September 30, 2005 and
$121 million at June 30, 2005. Liquid assets (cash, cash equivalents,
available-for-sale securities and accounts receivable) amounted to 185%
of current liabilities at June 30, 2006, compared to 193% at
September 30, 2005 and 207% at June 30, 2005.
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FINANCIAL POSITION (CONTINUED)
CAPITAL RESOURCES
On July 21, 2005, Ashland's Board of Directors authorized the purchase
of $270 million of Ashland common stock in the open market. Through
December 31, 2005, Ashland had repurchased 3.5 million shares at a cost
of $196 million. On January 25, 2006, Ashland's Board of Directors
increased the remaining authorization to $250 million, an increase of
$176 million. During the nine months ended June 30, 2006, Ashland
repurchased 2.4 million shares for $138 million. Through June 30, 2006,
Ashland had repurchased a total of 4.2 million shares at a cost of $237
million with a remaining authorization of $209 million.
For the nine months ended June 30, 2006, property additions amounted to
$189 million, compared to $285 million for the same period last year.
Ashland anticipates meeting its remaining 2006 capital requirements for
property additions and dividends from internally generated funds.
Ashland's debt level amounted to $88 million at June 30, 2006, compared
to $94 million at September 30, 2005, and $168 million at June 30, 2005.
Debt as a percent of capital employed amounted to 2.3% at June 30, 2006,
compared to 2.5% at September 30, 2005, and 4.3% at June 30, 2005. The
low ratios for all periods presented reflect the retirement of most of
Ashland's debt with the proceeds from the MAP Transaction.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
There have been no material changes in the critical accounting policies
described in Management's Discussion and Analysis (MD&A) in Ashland's
Annual Report on Form 10-K, as amended, for the fiscal year ended
September 30, 2005. For a discussion of Ashland's asbestos-related
litigation and environmental remediation matters, see Note J to the
Condensed Consolidated Financial Statements.
OUTLOOK
APAC continues to implement its successful five-part improvement program
as it strives to be a consistent low-cost competitor in its markets. The
June 2006 quarter reflects the progress that has been made on an
improved bidding and estimating process as well as capturing increased
margins on materials, whether through third-party sales or through
intra-company sales to its own construction services as it earned the
highest quarterly operating income in its history. In addition, as
older, less profitable jobs roll off, they are being replaced by
contracts with better margins. Approximately 83% of the current backlog
has been awarded since October 2004. In January, APAC sold its Richmond,
Virginia, and Shawnee, Oklahoma, market areas and reported a $2 million
gain in the March 2006 quarter. Both of these businesses were
unprofitable in 2005. APAC's so-called "fix or exit" team's analysis of
75 markets has been completed and while no additional exits of markets
are planned, APAC will continue to evaluate and closely monitor each
market's profitability. APAC has positioned itself for continued
operating income growth, but remains exposed to adverse weather and
commodity pricing.
On June 19, 2006, Ashland announced that it is exploring a possible
separation of APAC, including by means of a spin-off or sale. Ashland
also announced that it has entered into an exclusive negotiating period
with Oldcastle Materials, Inc. regarding the possible sale of APAC.
Ashland said there can be no assurance that any such transaction will
occur. Ashland has retained Credit Suisse Securities (USA) LLC as its
advisor to assist in this process. Ashland also stated that it does not
expect to disclose developments or details with respect to the
exploration of the possible separation of APAC unless and until its
board of directors has approved a definitive transaction or a decision
is made not to proceed with a separation of APAC.
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OUTLOOK (CONTINUED)
In the Chemical Sector, Ashland continues to make significant progress
on its GlobalOne enterprise resource planning (ERP) system. Ashland's
Canadian operations are running under this system, and key learnings
from the "go live" in Canada are being applied to the implementation in
the United States and Mexico, currently scheduled for October of this
year and continuing through the spring of 2007. The scope of GlobalOne
has been expanded from its original design to include new, additional
functionalities in customer and pricing management. As previously
announced, this additional functionality will increase the total cost of
the project by approximately $25 million, bringing the total planned
expenditures for GlobalOne to approximately $115 million. Additional
increases in the cost of GlobalOne are quite possible as the
implementation continues. Through the June 2006 quarter, Ashland has
spent $86 million on this project, with $14 million of that amount being
expensed, and anticipates spending the additional approximately $30
million over the next 18 to 24 months.
Both Performance Materials and Distribution's profitability is a
function of economic growth and their ability to manage raw material
cost increases. These businesses continue to experience strong demand in
Europe and Asia-Pacific, although there appears to be some weakness in
certain North American markets. While marine, primarily small to
mid-sized pleasure boats, and building and construction, primarily new
home builds, have weakened in North America, these businesses continue
to see opportunities for growth in industrial markets, including mining,
power, infrastructure and capital project work in general. Product
changeovers within the automotive industry generally result in a less
profitable September versus June quarter for Performance Materials and
Distribution. However, barring any unforeseen circumstances, both of
these businesses are expected to outperform the September 2005 quarter.
The market environment that has led to Valvoline's poor performance
during the first nine months of fiscal year 2006 continues to exist.
Valvoline continues to pass through price increases; however, in the
face of rising feedstock costs, capturing margin on a timely basis
remains a challenge. Valvoline is continuing to take proactive steps to
manage these market conditions, including the redesign of its business
model. Changes include significant improvements to Valvoline's
Do-It-For-Me installer program to better respond to the growing
influence of this market segment. At the same time, Valvoline has been
challenged to reduce overall expenses by $20 million, to be executed in
fiscal year 2007. The benefits are not likely to be seen for several
months, and Valvoline's results for the September 2006 quarter are
likely to be well below the September 2005 quarter.
Water Technologies continues to battle raw material cost increases as
well, which has lowered its gross profit margin despite increased
revenues. In attempts to capture significant growth in key areas of the
business additional resources have been added to projects such as the
Sonoxide (R) and PathGuard (TM) systems. These resource investments,
along with the sharp increases in raw material costs, have negatively
affected profitability. However, the completed purchase of the water
treatment business of Degussa AG during the quarter is a key part of the
long-term growth strategy for this business. As integration of the
Environmental and Process Solutions operations continues, overall gross
profit margins will likely fall reflecting the lower margins of this
business. In conjunction with this integration a redesign of the Water
Technologies business model is underway, including the challenge to
eliminate $10 million in costs, to be executed in fiscal year 2007, in
attempts to proactively address profitability while maintaining an
aggressive long-term growth strategy in an attractive industry. The
benefits of this cost reduction challenge are likewise not likely to be
seen for several months. For the September 2006 quarter, Water
Technologies should outperform the September 2005 quarter, largely due
to the impact of the Degussa acquisition.
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FORWARD LOOKING STATEMENTS
Management's Discussion and Analysis (MD&A) contains forward-looking
statements, within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934. These
statements include those that refer to Ashland's operating performance,
earnings, and benefits expected to be obtained through the GlobalOne ERP
implementation. These estimates are based upon a number of assumptions,
including those mentioned within MD&A. Such estimates are also based
upon internal forecasts and analyses of current and future market
conditions and trends, management plans and strategies, weather,
operating efficiencies and economic conditions, such as prices, supply
and demand, cost of raw materials, and legal proceedings and claims
(including environmental and asbestos matters). Although Ashland
believes its expectations are based on reasonable assumptions, it cannot
assure the expectations reflected herein will be achieved. This
forward-looking information may prove to be inaccurate and actual
results may differ significantly from those anticipated if one or more
of the underlying assumptions or expectations proves to be inaccurate or
is unrealized or if other unexpected conditions or events occur. Other
factors and risks affecting Ashland are contained in its Annual Report
on Form 10-K, as amended, for the fiscal year ended September 30, 2005.
Ashland undertakes no obligation to subsequently update or revise these
forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Ashland's market risk exposure at June 30, 2006 is generally consistent
with the types and amounts of market risk exposures presented in
Ashland's Annual Report on Form 10-K, as amended, for the fiscal year
ended September 30, 2005.
ITEM 4. CONTROLS AND PROCEDURES
(a) As of the end of the period covered by this quarterly report,
Ashland, under the supervision and with the participation of its
management, including Ashland's Chief Executive Officer and its
Chief Financial Officer, evaluated the effectiveness of Ashland's
disclosure controls and procedures pursuant to Rule 13a-15(b) and
15d-15(b) promulgated under the Securities Exchange Act of 1934, as
amended. Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer have concluded that the disclosure
controls and procedures were effective.
(b) There were no significant changes in Ashland's internal control
over financial reporting, or in other factors, that occurred during
the period covered by this quarterly report that have materially
affected, or are reasonably likely to materially affect, Ashland's
internal control over financial reporting.
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Asbestos-Related Litigation - Ashland is subject to liabilities from
claims alleging personal injury caused by exposure to asbestos. Such claims
result primarily from indemnification obligations undertaken in 1990 in
connection with the sale of Riley Stoker Corporation ("Riley"), a former
subsidiary. Although Riley was neither a producer nor a manufacturer of
asbestos, its industrial boilers contained some asbestos-containing
components provided by other companies.
The majority of lawsuits filed involve multiple plaintiffs and multiple
defendants, with the number of defendants in many cases exceeding 100. The
monetary damages sought in the asbestos-related complaints that have been
filed in state or federal courts vary as a result of jurisdictional
requirements and practices, though the vast majority of these complaints
either do not specify monetary damages sought or merely recite that the
monetary damages sought meet or exceed the required jurisdictional minimum
in which the complaint was filed. Plaintiffs have asserted specific dollar
claims for damages in approximately 5% of the 49,700 active lawsuits
pending as of June 30, 2006. In these active lawsuits, approximately 0.3%
of the active lawsuits involve claims between $0 and $100,000;
approximately 1.6% of the active lawsuits involve claims between $100,000
and $1 million; less than 1% of the active lawsuits involve claims between
$1 million and $5 million; less than 0.2% of the active lawsuits involve
claims between $5 million and $10 million; less than 2% of the active
lawsuits involve claims between $10 million and $15 million; and less than
..02% of the active lawsuits involve claims between $15 million and $100
million. The variability of requested damages, coupled with the actual
experience of resolving claims over an extended period, demonstrates that
damages requested in any particular lawsuit or complaint bear little or no
relevance to the merits or disposition value of a particular case. Rather,
the amount potentially recoverable by a specific plaintiff or group of
plaintiffs is determined by other factors such as product identification or
lack thereof, the type and severity of the disease alleged, the number and
culpability of other defendants, the impact of bankruptcies of other
companies that are co-defendants in claims, specific defenses available to
certain defendants, other potential causative factors and the specific
jurisdiction in which the claim is made.
For additional information regarding liabilities arising from
asbestos-related litigation, see Note J of "Notes to Condensed Consolidated
Financial Statements" in this quarterly report on Form 10-Q.
U.S. Department of Justice ("USDOJ") Antitrust Division Investigation -
In November 2003, Ashland received a subpoena from the USDOJ relating to a
foundry resins grand jury investigation. In January 2006, Ashland was
advised by the USDOJ that this investigation has now been closed. As is
frequently the case when such investigations have been initiated, a number
of civil actions have been filed in multiple jurisdictions, most of which
are seeking class action status for classes of customers of foundry resins.
These cases have been consolidated for pretrial purposes in the United
States District Court, Southern District of Ohio. Ashland will vigorously
defend these civil actions.
Environmental Proceedings - (1) Under the federal Comprehensive
Environmental Response Compensation and Liability Act (as amended) and
similar state laws, Ashland may be subject to joint and several liability
for clean-up costs in connection with alleged releases of hazardous
substances at sites where it has been identified as a "potentially
responsible party" ("PRP"). As of June 30, 2006, Ashland had been named a
PRP at 99 waste treatment or disposal sites. These sites are currently
subject to ongoing investigation and remedial activities, overseen by the
United States Environmental Protection Agency ("USEPA") or a state agency,
in which Ashland is typically participating as a member of a PRP group.
Generally, the type of relief sought includes remediation of contaminated
soil and/or groundwater, reimbursement for past costs of site clean-up and
administrative oversight and/or long-term monitoring of environmental
conditions at the sites. The ultimate costs are not predictable with
assurance.
28
For additional information regarding environmental matters and reserves,
see Note J of "Notes to Condensed Consolidated Financial Statements" in
this quarterly report on Form 10-Q.
(2) On May 13, 2002, Ashland entered into a plea agreement with the U.S.
Attorney's Office for the District of Minnesota and the USDOJ regarding a
May 16, 1997, sewer fire at the St. Paul Park, Minnesota refinery, which is
now owned and operated by Marathon Petroleum Company LLC. As part of the
plea agreement, Ashland entered guilty pleas to two misdemeanors, paid a
$3.5 million fine related to violations of the Clean Air Act ("CAA"), paid
$3.55 million as restitution to the employees injured in the fire, and paid
$200,000 as restitution to the responding rescue units. Ashland also agreed
to complete certain upgrades to the St. Paul Park refinery's process
sewers, junction boxes and drains to meet standards established by Subpart
QQQ of the New Source Performance Standards of the CAA (the "Refinery
Upgrades"). The Refinery Upgrades, completed in 2004, have been
acknowledged and accepted by the appropriate agencies. As part of the plea
agreement, Ashland entered into and satisfied the terms and conditions of a
deferred prosecution agreement, and as a result the deferred prosecution
was dismissed by the Court on February 22, 2005.
As part of its sentence, Ashland was placed on probation for five years.
The primary condition of probation was an obligation not to commit future
federal, state, or local crimes. The probation office retained an
independent environmental consultant to review and monitor Ashland's
compliance with applicable environmental requirements and the terms and
conditions of probation. The court also included other customary terms and
restrictions of probation in its probation order.
On December 15, 2005, Ashland filed a motion for Order for Early Release
from probation. Effective June 30, 2006, the Judge granted Ashland's motion
requesting early termination of probation. This Order officially discharges
Ashland from probation.
(3) In March 2006, USEPA issued a proposed Consent Agreement and Final
Order ("CAFO") recommending a penalty of $117,345 and requiring the
performance of an unspecified Supplemental Environmental Project in
connection with alleged violations of record keeping requirements under the
CAA at Ashland's Calumet City, Illinois specialty chemical facility. In May
2006, the parties reached an agreement under which Ashland would pay a
$60,000 penalty and also install equipment which will reduce air emissions
at the facility at an additional cost of approximately $154,000. The CAFO
reflecting those terms was executed on July 28, 2006.
Securities and Exchange Commission ("Commission") Notification - On
April 25, 2006, Ashland was notified by the staff of the Commission of the
staff's intent to seek authorization from the Commission to pursue a civil
action against Ashland relating to adjustments which reduced its
environmental remediation reserves for certain sites for the fiscal years
1999 and 2000. These adjustments to environmental reserves totaled $12.2
million in 1999 and $12.6 million in 2000. The staff advised that it
intends to seek injunctive and/or administrative relief against Ashland and
that it will not recommend any fines, penalties or restatements from
Ashland nor allege any intentional misconduct by Ashland. Ashland has filed
a Wells submission opposing the staff's request that the Commission
authorize a civil action against Ashland.
Lake Belt Third-Party Litigation - APAC-Southeast, Inc.
("APAC-Southeast"), an indirect wholly-owned subsidiary of Ashland, holds
one of several U.S. Army Corps of Engineers (the "Corps") permits granted
in 2002 allowing mining of construction aggregates in the Lake Belt area in
Miami-Dade County, Florida (the "Permit"). Mining under the Permit is
actually performed by a third party, which in turn pays royalties to
APAC-Southeast. The Sierra Club and others filed suit to challenge the
Corps' issuance of the permits alleging that the Corps and other federal
agencies acted capriciously, abused their discretion and failed to comply
with statutory and administrative requirements when issuing the permits.
Although not named as a defendant, APAC-Southeast and other permittees
intervened in the proceedings to protect their interests.
On March 22, 2006, the United States District Court for the Southern
District of Florida ruled that permits at issue, including
APAC-Southeast's, had been improperly issued. The Court remanded the
29
matter to the Corps for further development consistent with the Court's
specific findings. The Court retained jurisdiction to determine the effect,
if any, upon the existing permits and ongoing mining operations.
APAC-Southeast and the other intervenors are actively defending their
interests in the litigation.
If ongoing mining operations are adversely affected, APAC-Southeast
could be impacted both through the negative effect upon royalties paid for
mining under its Permit, and through a general reduction or cessation of
supply of aggregates from the Lake Belt area, which would negatively impact
construction operations in Florida that are highly dependent upon the
availability of the material, including APAC-Southeast's. The proceedings
are continuing and it is not possible to determine at this time the likely
eventual outcome or what impact it will have on APAC-Southeast's
operations.
Other Legal Proceedings - In addition to the matters described above,
there are various claims, lawsuits and administrative proceedings pending
or threatened against Ashland and its current and former subsidiaries. Such
actions are with respect to commercial matters, product liability, toxic
tort liability and other environmental matters, which seek remedies or
damages, some of which are for substantial amounts. While these actions are
being contested, their outcome is not predictable.
ITEM 1A. RISK FACTORS
During the period covered by this report, only one of the risk factors
previously disclosed in Ashland's Form 10-K, as amended, for the year ended
September 30, 2005 materially changed. Ashland's shareholder rights plan
expired pursuant to its terms at the close of business on May 16, 2006. As
a result, Ashland's articles of incorporation were amended to eliminate the
designation of, and all references to, the Series A Participating
Cumulative Preferred Stock. This action affects one of the risk factors
previously disclosed in Ashland's Form 10-K, as amended, for the year ended
September 30, 2005, which is now amended to read in its entirety as
follows:
PROVISIONS OF ASHLAND'S ARTICLES OF INCORPORATION AND BY-LAWS AND KENTUCKY
LAW COULD DETER TAKEOVER ATTEMPTS THAT SOME SHAREHOLDERS MAY CONSIDER
DESIRABLE, WHICH COULD ADVERSELY AFFECT ASHLAND'S STOCK PRICE.
Provisions of Ashland's articles of incorporation and by-laws make
acquiring control of Ashland without the support of its Board of Directors
difficult for a third party, even if the change of control might be
beneficial to Ashland shareholders. Ashland's articles of incorporation and
by-laws contain:
- provisions relating to the classification, nomination and removal of
its directors;
- provisions limiting the right of shareholders to call special
meetings of its Board of Directors and shareholders;
- provisions regulating the ability of its shareholders to bring
matters for action at annual meetings of its shareholders; and
- the authorization given to its Board of Directors to issue and set
the terms of preferred stock.
Ashland's articles of incorporation and the laws of Kentucky impose some
restrictions on mergers and other business combinations between Ashland and
any beneficial owner of 10% or more of the voting power of its outstanding
common stock. The existence of these provisions may deprive shareholders of
any opportunity to sell their shares at a premium over the prevailing
market price for Ashland common stock. The potential inability of Ashland
shareholders to obtain a control premium could adversely affect the market
price for its common stock.
30
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Ashland's stock repurchase program was originally announced on July 21,
2005. The amount of repurchases authorized at that time was $270 million.
After repurchasing $196 million in Ashland Common Stock under the original
authorization, on January 25, 2006, Ashland announced that the
authorization has been increased by an additional $176 million bringing the
total authorization at that time to $250 million. No purchases were made
during the quarter ended June 30, 2006, leaving the dollar value of shares
that may yet be purchased under the repurchase program at approximately
$209 million as of June 30, 2006.
ITEM 6. EXHIBITS
(a) Exhibits
--------
3(i) Third Restated Articles of Incorporation of Ashland Inc. effective
May 17, 2006.
12 Computation of Ratio of Earnings to Fixed Charges.
31.1 Certificate of James J. O'Brien, Chief Executive Officer of Ashland
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of J. Marvin Quin, Chief Financial Officer of Ashland
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certificate of James J. O'Brien, Chief Executive Officer of Ashland,
and J. Marvin Quin, Chief Financial Officer of Ashland pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
31
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ashland Inc.
----------------------------------------------
(Registrant)
Date: August 8, 2006 /s/ J. Marvin Quin
----------------------------------------------
J. Marvin Quin
Senior Vice President and Chief Financial Officer
(on behalf of the Registrant and as principal
financial officer)
32
EXHIBIT INDEX
Exhibit
No. Description
------- ----------------------------------------------------------------
3(i) Third Restated Articles of Incorporation of Ashland Inc.
effective May 17, 2006.
12 Computation of Ratio of Earnings to Fixed Charges.
31.1 Certificate of James J. O'Brien, Chief Executive Officer of
Ashland pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certificate of J. Marvin Quin, Chief Financial Officer of
Ashland pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32 Certificate of James J. O'Brien, Chief Executive Officer of
Ashland, and J. Marvin Quin, Chief Financial Officer of Ashland
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
33