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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
Commission file number 1-2918
ASHLAND INC.
(a Kentucky corporation)
I.R.S. No. 61-0122250
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 checkmark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). [x]
At April 30, 2004, there were 70,373,118 shares of Registrant's Common
Stock outstanding. One Right to purchase one-thousandth of a share of
Series A Participating Cumulative Preferred Stock accompanies each
outstanding share of Registrant's Common Stock.
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PART I - FINANCIAL STATEMENTS
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
----------------------- ------------------------
(In millions except per share data) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------- ------------------------
REVENUES
Sales and operating revenues $ 1,812 $ 1,644 $ 3,735 $ 3,382
Equity income 18 29 56 64
Other income 9 10 22 28
---------- ---------- ----------- ----------
1,839 1,683 3,813 3,474
COSTS AND EXPENSES
Cost of sales and operating expenses 1,453 1,322 2,971 2,695
Selling, general and administrative expenses 328 334 643 668
Depreciation, depletion and amortization 48 51 97 103
---------- ---------- ----------- ----------
1,829 1,707 3,711 3,466
---------- ---------- ----------- ----------
OPERATING INCOME (LOSS) 10 (24) 102 8
Net interest and other financial costs (29) (32) (59) (65)
---------- ---------- ----------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES (19) (56) 43 (57)
Income taxes 8 19 (16) 19
---------- ---------- ----------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS (11) (37) 27 (38)
Results from discontinued operations (net of income taxes) - Note B (5) (2) (10) (93)
---------- ---------- ----------- ----------
NET INCOME (LOSS) $ (16) $ (39) $ 17 $ (131)
========== ========== =========== ==========
BASIC EARNINGS (LOSS) PER SHARE - Note A
Income (loss) from continuing operations $ (.16) $ (.54) $ .39 $ (.56)
Results from discontinued operations (.07) (.03) (.14) (1.35)
---------- ---------- ----------- ----------
Net income (loss) $ (.23) $ (.57) $ .25 $ (1.91)
========== ========== =========== ==========
DILUTED EARNINGS (LOSS) PER SHARE - Note A
Income (loss) from continuing operations $ (.16) $ (.54) $ .39 $ (.56)
Results from discontinued operations (.07) (.03) (.14) (1.35)
---------- ---------- ----------- ----------
Net income (loss) $ (.23) $ (.57) $ .25 $ (1.91)
========== ========== =========== ==========
DIVIDENDS PAID PER COMMON SHARE $ .275 $ .275 $ .55 $ .55
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
2
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------------------------
March 31 September 30 March 31
(In millions) 2004 2003 2003
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ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $ 180 $ 223 $ 106
Accounts receivable 1,180 1,170 1,073
Allowance for doubtful accounts (39) (35) (38)
Inventories - Note A 475 441 484
Deferred income taxes 114 142 85
Assets of discontinued operations held for sale - - 201
Other current assets 137 144 145
-------------- -------------- --------------
2,047 2,085 2,056
INVESTMENTS AND OTHER ASSETS
Investment in Marathon Ashland Petroleum LLC (MAP) 2,349 2,448 2,315
Goodwill 524 523 514
Asbestos insurance receivable (noncurrent portion) 396 399 394
Other noncurrent assets 390 340 342
-------------- -------------- --------------
3,659 3,710 3,565
PROPERTY, PLANT AND EQUIPMENT
Cost 2,988 2,959 2,931
Accumulated depreciation, depletion and amortization (1,792) (1,748) (1,683)
-------------- -------------- --------------
1,196 1,211 1,248
-------------- -------------- --------------
$ 6,902 $ 7,006 $ 6,869
============== ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Debt due within one year $ 206 $ 102 $ 243
Trade and other payables 1,262 1,371 1,236
Liabilities of discontinued operations held for sale - - 34
Income taxes 17 11 15
-------------- -------------- --------------
1,485 1,484 1,528
NONCURRENT LIABILITIES
Long-term debt (less current portion) 1,353 1,512 1,568
Employee benefit obligations 402 385 480
Deferred income taxes 221 291 170
Reserves of captive insurance companies 192 168 186
Asbestos litigation reserve (noncurrent portion) 565 560 530
Other long-term liabilities and deferred credits 354 353 351
Commitments and contingencies - Notes D and F
-------------- -------------- --------------
3,087 3,269 3,285
COMMON STOCKHOLDERS' EQUITY 2,330 2,253 2,056
-------------- -------------- --------------
$ 6,902 $ 7,006 $ 6,869
============== ============== ==============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
STATEMENTS OF CONSOLIDATED COMMON STOCKHOLDERS' EQUITY
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Accumulated
other
Common Paid-in Retained comprehensive
(In millions) stock capital earnings loss Total
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BALANCE AT OCTOBER 1, 2002 $ 68 $ 338 $ 1,961 $ (194) $ 2,173
Total comprehensive income (loss) (1) (131) 44 (87)
Cash dividends (37) (37)
Issued common stock under stock
incentive and other plans 7 7
--------- --------- --------- -------------- ---------
BALANCE AT MARCH 31, 2003 $ 68 $ 345 $ 1,793 $ (150) $ 2,056
========= ========= ========= ============== =========
BALANCE AT OCTOBER 1, 2003 $ 68 $ 350 $ 1,961 $ (126) $ 2,253
Total comprehensive income (1) 17 35 52
Cash dividends (38) (38)
Issued common stock under stock
incentive and other plans 2 61 63
--------- --------- --------- -------------- ---------
BALANCE AT MARCH 31, 2004 $ 70 $ 411 $ 1,940 $ (91) $ 2,330
========= ========= ========= ============== =========
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(1) Reconciliations of net income (loss) to total comprehensive income
(loss) follow.
Three months ended Six months ended
March 31 March 31
-------------------------------- ---------------------------------
(In millions) 2004 2003 2004 2003
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Net income (loss) $ (16) $ (39) $ 17 $ (131)
Minimum pension liability adjustment - 19 - 19
Related tax expense - (7) - (7)
Unrealized translation adjustments 4 24 34 32
Related tax benefits - - 1 -
--------- --------- --------- ---------
Total comprehensive income (loss) $ (12) $ (3) $ 52 $ (87)
========= ========= ========= =========
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At March 31, 2004, the accumulated other comprehensive loss of $91
million (after tax) was comprised of net unrealized translation gains
of $25 million and a minimum pension liability of $116 million.
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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Six months ended
March 31
------------------------
(In millions) 2004 2003
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CASH FLOWS FROM OPERATIONS
Income (loss) from continuing operations $ 27 $ (38)
Expense (income) not affecting cash
Depreciation, depletion and amortization 97 103
Deferred income taxes (1) 22
Equity income from affiliates (56) (64)
Distributions from equity affiliates 153 98
Other items 1 (1)
Change in operating assets and liabilities (1) (163) (22)
------- --------
58 98
CASH FLOWS FROM FINANCING
Proceeds from issuance of common stock 54 1
Repayment of long-term debt (70) (161)
Increase in short-term debt 17 165
Dividends paid (38) (37)
------- --------
(37) (32)
CASH FLOWS FROM INVESTMENT
Additions to property, plant and equipment (86) (52)
Purchase of operations - net of cash acquired (4) (5)
Proceeds from sale of operations 10 6
Other - net 21 (7)
------- --------
(59) (58)
------- --------
CASH PROVIDED (USED) BY CONTINUING OPERATIONS (38) 8
Cash provided (used) by discontinued operations (5) 8
------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (43) 16
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 223 90
------- --------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 180 $ 106
======= ========
- ------------------------------------------------------------------------------------------------------------------------------------
(1) 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 - SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL REPORTING
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with 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 for
the fiscal year ended September 30, 2003 (as amended to include the audited
financial statements of Marathon Ashland Petroleum LLC for the year ended
December 31, 2003). Results of operations for the periods ended March 31,
2004, are not necessarily indicative of results to be expected for
Ashland's fiscal year ending September 30, 2004.
INVENTORIES
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March 31 September 30 March 31
(In millions) 2004 2003 2003
- --------------------------------------------------------------------------------------------------------------------
Chemicals and plastics $ 366 $ 333 $ 360
Construction materials 70 67 78
Petroleum products 67 66 64
Other products 48 48 47
Supplies 5 5 5
Excess of replacement costs over LIFO carrying values (81) (78) (70)
-------------- -------------- --------------
$ 475 $ 441 $ 484
============== ============== ==============
EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings (loss) per share (EPS) from continuing operations.
- ------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
------------------------ -----------------------
(In millions except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
NUMERATOR
Numerator for basic and diluted EPS - Income (loss)
from continuing operations $ (11) $ (37) $ 27 $ (38)
========== =========== ========== ==========
DENOMINATOR
Denominator for basic EPS - Weighted average
common shares outstanding 69 68 69 68
Common shares issuable upon exercise of stock options - - 1 -
---------- ----------- ---------- ----------
Denominator for diluted EPS - Adjusted weighted
average shares and assumed conversions 69 68 70 68
========== =========== ========== ==========
EARNINGS (LOSS) PER SHARE FROM CONTINUING OPERATIONS
Basic $ (.16) $ (.54) $ .39 $ (.56)
Diluted $ (.16) $ (.54) $ .39 $ (.56)
6
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE B - DISCONTINUED OPERATIONS
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, a former subsidiary. During the quarter ended
December 31, 2002, Ashland increased its reserve for asbestos claims by
$390 million to cover litigation defense and claim settlement costs
expected to be paid through December 2012. Because insurance provides
reimbursements for most of these costs and coverage-in-place agreements
exist with the insurance companies that provide substantially all of the
coverage being accessed, the increase in the asbestos reserve was offset in
part by probable insurance recoveries valued at $235 million. The resulting
$155 million pretax charge to income, net of deferred income tax benefits
of $60 million, was reflected as an after-tax loss from discontinued
operations of $95 million in the Statement of Consolidated Income for the
three months ended December 31, 2002. Additional reserves have been
provided since then to maintain the reserve to cover the expected costs on
a rolling ten-year basis. See Note F for further discussion of Ashland's
asbestos-related litigation.
On August 29, 2003, Ashland sold the net assets of its Electronic Chemicals
business and certain related subsidiaries in a transaction valued at
approximately $300 million before tax. Electronic Chemicals was a part of
Ashland Specialty Chemical, providing ultra pure chemicals and other
products and services to the worldwide semiconductor industry, with
revenues of $215 million in 2003, $217 million in 2002 and $212 million in
2001. The sale reflects Ashland's strategy to optimize its business mix and
focus greater attention on the remaining chemical and transportation
construction operations where it can achieve strategic advantage. Ashland's
after-tax proceeds were used primarily to reduce debt. All assets and
liabilities of Electronic Chemicals are classified as current in the March
31, 2003 balance sheet. Assets of $201 million were composed of current
assets of $52 million, investments and other assets of $27 million, and
property, plant and equipment of $122 million. Liabilities of $34 million
were composed of current liabilities of $21 million and noncurrent
liabilities of $13 million.
Components of amounts reflected in the income statements related to
discontinued operations are presented in the following table.
- -------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
------------------------ -----------------------
(In millions) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------------
PRETAX INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Reserves for asbestos-related litigation $ (7) $ (7) $ (15) $ (162)
Electronic Chemicals
Results of operations - 3 - 7
Loss on disposal - - (1) -
INCOME TAXES
Reserves for asbestos-related litigation 2 3 6 63
Electronic Chemicals
Results of operations - (1) - (1)
Loss on disposal - - - -
---------- ----------- ---------- ----------
RESULTS FROM DISCONTINUED OPERATIONS (NET OF INCOME TAXES) $ (5) $ (2) $ (10) $ (93)
========== =========== ========== ==========
7
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE C - UNCONSOLIDATED AFFILIATES
Under Rule 3-09 of Regulation S-X, Ashland filed audited financial
statements for Marathon Ashland Petroleum LLC (MAP) for the year ended
December 31, 2003, on a Form 10-K/A on March 19, 2004. Unaudited income
statement information for MAP is shown below.
MAP is organized as a limited liability company that has elected to be
taxed as a partnership. Therefore, the parents are responsible for income
taxes applicable to their share of MAP's taxable income. The net income
reflected below for MAP does not include any provision for income taxes
that will be incurred by its parents.
- ------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
------------------------ ------------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
Sales and operating revenues $ 9,060 $ 8,254 $ 18,618 $ 15,333
Income from operations 49 82 149 176
Net income 46 77 142 169
Ashland's equity income 13 25 45 56
On March 19, 2004, Ashland announced the signing of an agreement under
which it would transfer its 38% interest in MAP and two wholly-owned
businesses to Marathon in a transaction structured to be generally tax free
and valued at approximately $3.0 billion. The two other businesses are
Ashland's maleic anhydride business and 61 Valvoline Instant Oil Change
(VIOC) centers. The transaction is subject to several previously disclosed
conditions, including approval by Ashland's shareholders, customary
antitrust review, consent from public debt holders and receipt of a
favorable private letter ruling from the Internal Revenue Service with
respect to the tax treatment. While there is meaningful risk that the
transaction will not receive the favorable ruling from the IRS, in which
case the transaction would not close, Ashland believes it is more likely
than not that this transaction will receive a favorable ruling. If the
conditions are met, the transaction is expected to close by the end of the
2004 calendar year.
NOTE D - LEASES AND OTHER COMMITMENTS
LEASES
Under various operating leases, Ashland has made guarantees with respect to
the residual value of the underlying property. If Ashland had cancelled
those leases at March 31, 2004, its maximum obligations under the residual
value guarantees would have amounted to $95 million. Ashland does not
expect to incur any significant charge to earnings under these guarantees,
$22 million of which relates to real estate. These lease agreements are
with unrelated third party lessors and Ashland has no additional
contractual or other commitments to any party to the leases.
OTHER COMMITMENTS
Ashland has guaranteed 38% of MAP's payments for certain crude oil
purchases, up to a maximum guarantee of $95 million. At March 31, 2004,
Ashland's contingent liability under this guarantee amounted to $73
million. Although Ashland has not made and does not expect to make any
payments under this guarantee, it has recorded the fair value of the
guarantee obligation, which is not significant.
8
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE E - EMPLOYEE BENEFIT PLANS
On January 12, 2004, the Financial Accounting Standards Board issued Staff
Position No. FAS 106-1, "Accounting and Disclosure Requirements Related to
the Medicare Prescription Drug, Improvement and Modernization Act of 2003."
In accordance with that Staff Position, Ashland has elected to defer the
impact of the Medicare Prescription Drug, Improvement and Modernization Act
of 2003 (Act) until authoritative guidance on the accounting is issued. As
a result, the accumulated postretirement benefit obligation or net periodic
postretirement benefit costs in the financial statements or accompanying
notes do not reflect the effects of the Act, which are not yet reasonably
determinable.
Presently, Ashland anticipates contributing $128 million to its pension
plans during fiscal 2004. As of March 31, 2004, $64 million of
contributions have been made.
The following tables detail the components of pension and other
postretirement benefit costs.
- ------------------------------------------------------------------------------------------------------------------------
Other postretirement
Pension benefits benefits
------------------------ -------------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
Service cost $ 12 $ 11 $ 3 $ 3
Interest cost 17 16 6 6
Expected return on plan assets (15) (13) - -
Other amortization and deferral 7 8 (4) (2)
---------- ---------- ----------- -----------
$ 21 $ 22 $ 5 $ 7
========== ========== =========== ===========
SIX MONTHS ENDED MARCH 31
Service cost $ 24 $ 20 $ 7 $ 6
Interest cost 33 31 12 12
Expected return on plan assets (30) (24) - -
Other amortization and deferral 15 14 (8) (3)
---------- ---------- ----------- -----------
$ 42 $ 41 $ 11 $ 15
========== ========== =========== ===========
NOTE F - 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, as well as the number of open claims, can fluctuate
significantly from period to period.
9
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE F - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------
Six months ended
March 31 Years ended September 30
--------------------------- ------------------------------------------
(In thousands) 2004 2003 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Open claims - beginning of period 198 160 160 167 118
New claims filed 16 35 66 45 52
Claims settled (3) (4) (7) (15) (2)
Claims dismissed (11) (13) (21) (37) (1)
----------- ----------- ----------- ----------- -----------
Open claims - end of period 200 178 198 160 167
=========== =========== =========== =========== ===========
Since October 1, 2000, Riley has been dismissed as a defendant in 72% of
the resolved claims. Amounts spent on litigation defense and claim
settlements totaled $24 million for the six months ended March 31, 2004,
compared to $26 million for the six months ended March 31, 2003, and annual
costs of $45 million in 2003, $38 million in 2002 and $15 million in 2001.
During the December 2002 quarter, Ashland increased its reserve for
litigation defense and claim settlement costs related to asbestos claims by
$390 million. After that increase, Ashland's asbestos reserve covered the
costs expected to be paid through December 2012, and additional reserves
have been provided since then to maintain the reserve to cover the expected
costs on a rolling ten-year basis. Prior to December 31, 2002, the asbestos
reserve was based on the estimated costs that would be incurred to settle
open claims. The estimates of future asbestos claims and related costs were
developed with the assistance of Hamilton, Rabinovitz & Alschuler, Inc.
(HR&A), nationally recognized experts in that field. Ashland's reserve for
asbestos claims on an undiscounted basis amounted to $615 million at March
31, 2004, compared to $580 million at March 31, 2003.
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 the number of future claims that would be filed, as well as the
related costs that would be incurred in resolving those claims.
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 that ten years is
the most reasonable period for recognizing a reserve for future costs, and
that costs that might be incurred after that period are not reasonably
estimable.
10
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE F - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
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 are generally
due from insurers that are insolvent, rather than as a result of uninsured
claims or the exhaustion of Ashland's insurance coverage.
Ashland retained the services of Tillinghast-Towers Perrin to assist
management in the estimation of probable insurance recoveries. Such
recoveries are based on assumptions and estimates surrounding the available
insurance coverage; one assumption of which 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 is a disagreement with these
companies over the timing of recoveries. The resolution of this
disagreement could have a material effect on the value of insurance
recoveries from those companies. In estimating the value of future
recoveries, Ashland has used the least favorable interpretation of this
agreement, which results in a significant discount being applied to value
those recoveries. Ashland will continue to apply this methodology until
such time as the disagreement is resolved.
At March 31, 2004, Ashland's receivable for recoveries of litigation
defense and claim settlement costs from its insurers amounted to $426
million, of which $29 million relates to costs previously paid. Receivables
from insurance companies amounted to $419 million at March 31, 2003. About
35% of the estimated receivables from insurance companies at March 31,
2004, are expected to be due from Equitas and other London companies. Of
the remainder, over 90% is expected to come from companies or groups that
are rated A or higher by A. M. Best.
ENVIRONMENTAL PROCEEDINGS
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
March 31, 2004, 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, approximately 130 current and former
operating facilities (including certain operating facilities conveyed to
MAP) and about 1,220 service station properties. Ashland's reserves for
environmental remediation amounted to $169 million at March 31, 2004, and
$174 million at March 31, 2003. Such amounts 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.
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. Ashland regularly adjusts its reserves as environmental remediation
continues.
11
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE F - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
No individual remediation location is material to Ashland as its largest
reserve for any site is less than 10% of the remediation reserve. As a
result, Ashland's exposure to adverse developments with respect to any
individual site is not expected to be material, and these sites are in
various stages of ongoing remediation. Although environmental remediation
could have a material effect on results of operations if a series of
adverse developments occurs in a particular quarter or fiscal year, Ashland
believes that the chance of such developments occurring in the same quarter
or fiscal year is remote.
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.
12
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
INFORMATION BY INDUSTRY SEGMENT
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
------------------------ -----------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
REVENUES
Sales and operating revenues
APAC $ 408 $ 374 $ 1,058 $ 932
Ashland Distribution 785 712 1,482 1,348
Ashland Specialty Chemical 318 278 629 562
Valvoline 324 301 614 582
Intersegment sales
Ashland Distribution (4) (5) (9) (10)
Ashland Specialty Chemical (19) (16) (38) (31)
Valvoline - - (1) (1)
---------- ----------- ---------- ----------
1,812 1,644 3,735 3,382
Equity income
APAC 3 2 8 4
Ashland Specialty Chemical 2 2 4 4
Valvoline - - (1) -
Refining and Marketing 13 25 45 56
---------- ----------- ---------- ----------
18 29 56 64
Other income
APAC 7 (1) 11 2
Ashland Distribution 2 4 7 14
Ashland Specialty Chemical 3 3 5 6
Valvoline - 1 1 2
Refining and Marketing (4) 1 (5) 1
Corporate 1 2 3 3
---------- ----------- ---------- ----------
9 10 22 28
---------- ----------- ---------- ----------
$ 1,839 $ 1,683 $ 3,813 $ 3,474
========== =========== ========== ==========
OPERATING INCOME
APAC $ (33) $ (57) $ (2) $ (56)
Ashland Distribution 19 7 32 15
Ashland Specialty Chemical 19 5 42 18
Valvoline 24 18 45 32
Refining and Marketing (1) 2 21 27 45
Corporate (21) (18) (42) (46)
---------- ----------- ---------- ----------
$ 10 $ (24) $ 102 $ 8
========== =========== ========== ==========
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Includes Ashland's equity income from MAP, amortization related to
Ashland's excess investment in MAP, and other activities
associated with refining and marketing.
13
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
INFORMATION BY INDUSTRY SEGMENT
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
----------------------- --------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INFORMATION
APAC
Construction backlog at March 31 (millions) (1) $ 1,897 $ 1,800
Net construction job revenues (millions) (2) $ 207 $ 198 $ 573 $ 503
Hot-mix asphalt production (million tons) 4.4 4.1 12.9 11.2
Aggregate production (million tons) 6.1 5.0 12.9 12.1
Ready-mix concrete production (million cubic yards) 0.5 0.4 0.9 0.9
Ashland Distribution (3)
Sales per shipping day (millions) $ 12.3 $ 11.3 $ 11.8 $ 10.8
Gross profit as a percent of sales 14.6% 15.0% 14.7% 15.4%
Ashland Specialty Chemical (3)
Sales per shipping day (millions) $ 4.7 $ 4.4 $ 4.8 $ 4.5
Gross profit as a percent of sales 33.0% 33.4% 33.2% 34.2%
Valvoline
Lubricant sales (million gallons) 47.5 48.6 91.9 92.9
Premium lubricants (percent of U.S. branded volumes) 21.4% 18.8% 20.4% 17.9%
Refining and Marketing (4)
Refinery runs (thousand barrels per day)
Crude oil refined 789 853 844 842
Other charge and blend stocks 196 96 190 130
Refined product yields (thousand barrels per day)
Gasoline 552 483 582 525
Distillates 235 257 266 268
Asphalt 57 66 63 65
Other 155 143 135 115
-------- -------- -------- --------
Total 999 949 1,046 973
Refined product sales (thousand barrels per day) (5) 1,307 1,280 1,331 1,293
Refining and wholesale marketing margin (per barrel) (6) $ 1.44 $ 1.71 $ 1.58 $ 1.82
Speedway SuperAmerica (SSA)
Retail outlets at March 31 1,773 2,005
Gasoline and distillate sales (million gallons) 763 829 1,569 1,726
Gross margin - gasoline and distillates (per gallon) $ .1145 $ .1166 $ .1145 $ .1085
Merchandise sales (millions) (7) $ 521 $ 522 $ 1,068 $ 1,105
Merchandise margin (as a percent of sales) 25.3% 25.5% 25.1% 24.8%
- ------------------------------------------------------------------------------------------------------------------------------------
(1) Includes APAC's proportionate share of the backlog of
unconsolidated joint ventures.
(2) Total construction job revenues, less subcontract costs.
(3) Sales are defined as sales and operating revenues. Gross profit is
defined as sales and operating revenues, less cost of sales and
operating expenses, and depreciation and amortization relative to
manufacturing assets.
(4) Amounts represent 100% of MAP's operations, in which Ashland owns
a 38% interest.
(5) Total average daily volume of all refined product sales to MAP's
wholesale, branded and retail (SSA) customers.
(6) Sales revenue less cost of refinery inputs, purchased products and
manufacturing expenses, including depreciation.
(7) Effective January 1, 2003, SSA adopted EITF 02-16, "Accounting by
a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor," which requires rebates from vendors to be
recorded as reductions to cost of sales. Rebates from vendors
recorded in SSA merchandise sales for periods prior to January 1,
2003 have not been restated and included $46 million in the six
months ended March 31, 2003.
14
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 a net loss of $16 million for the
quarter ended March 31, 2004, compared to a net loss of $39 million for the
quarter ended March 31, 2003. Ashland reported a loss from continuing
operations of $11 million for the quarter ended March 31, 2004, compared to
a loss of $37 million for the quarter ended March 31, 2003. Results from
discontinued operations, consisting primarily of charges for asbestos
liabilities, accounted for the difference in net income and income from
continuing operations.
A 10% increase in sales revenues and a lower overall cost structure
contributed to improved operating income from wholly-owned businesses
compared to the previous winter quarter, which is typically Ashland's
weakest due to the seasonality of its businesses. Combined operating income
for the Chemicals sector (which includes Ashland Distribution, Ashland
Specialty Chemical and Valvoline) totaled $62 million in the March 2004
quarter, compared to $30 million for the March 2003 quarter. Each of the
Chemicals sector divisions achieved record March quarters - results from
Ashland Distribution nearly tripled, Ashland Specialty Chemical nearly
quadrupled and Valvoline was up 33 percent. In the Transportation
Construction sector, Ashland Paving And Construction, Inc. (APAC) reduced
its quarter-over-quarter operating loss by 42%. Higher manufacturing and
crude oil costs resulted in lower profits from refining and marketing.
YEAR-TO-DATE - Ashland reported net income of $17 million for the six
months ended March 31, 2004, compared to a net loss of $131 million for the
six months ended March 31, 2003. Ashland reported income from continuing
operations of $27 million for the six months ended March 31, 2004, compared
to a loss of $38 million for the six months ended March 31, 2003. Results
from discontinued operations, consisting primarily of charges for asbestos
liabilities, accounted for the difference in net income and income from
continuing operations.
Management was pleased by Ashland's performance during the first six months
of fiscal 2004. Chemicals sector operating income totaled $119 million for
the first six months of fiscal 2004, compared to $65 million for the 2003
period. Record March quarter results from Ashland Distribution, Ashland
Specialty Chemical and Valvoline indicate that the plan to drive
efficiency, manage capital and grow value-creating businesses is working.
In the Transportation Construction sector, APAC lowered its operating loss
to $2 million for the 2004 period, compared to a loss of $56 million in the
2003 period, reflecting closer-to-normal weather and a reduced cost
structure. Higher manufacturing and crude oil costs resulted in lower
profits from refining and marketing. An analysis of operating income by
industry segment follows.
APAC
CURRENT QUARTER - APAC reported an operating loss of $33 million for the
March 2004 quarter, compared to a loss of $57 million for the March 2003
quarter. The improvement reflected more normal weather conditions, a
reduced cost structure and a program instituted to minimize winter losses.
Net construction job revenues (total construction job revenues, less
subcontract costs) increased 5% from the prior year period, while
production of hot-mix asphalt increased 7% and aggregate production
increased 22%. Liquid asphalt costs per ton declined 6%. Lower equipment
costs reflected reorganization and other cost cutting efforts. For the
March quarter, APAC initiated an aggressive program to minimize winter
losses by shutting down certain operations and reducing work crews. Costs
associated with Project PASS, APAC's process
15
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
APAC (CONTINUED)
redesign initiative, were $4 million in the March 2004 quarter, compared to
$6 million in the March 2003 quarter.
YEAR-TO-DATE - APAC reported an operating loss of $2 million for the six
months ended March 31, 2004, compared to a loss of $56 million for the six
months ended March 31, 2003. The improvement reflects the same factors
described in the current quarter comparison. Net construction job revenues
increased 14% from the prior year period, while production of hot-mix
asphalt increased 15% and aggregate production increased 7%. Costs
associated with Project PASS were $8 million in the 2004 period, compared
to $10 million in the 2003 period.
Looking ahead to the summer construction season - during which APAC has
historically reported the majority of its earnings - the division has
continued to increase its construction backlog, or jobs awarded but not yet
completed. APAC increased the backlog by 5% to a record $1.9 billion as of
March 31, 2004. Of this amount, approximately $280 million was bid at lower
energy prices, and income to be recognized on the completion of this work
is expected to be substantially less than originally anticipated. The
completion of Project Pass is on schedule, with about $2 million of
remaining costs expected to be incurred in the June 2004 quarter.
ASHLAND DISTRIBUTION
CURRENT QUARTER - Ashland Distribution reported record March quarter
operating income of $19 million, compared to $7 million for the March 2003
quarter. Improved customer service capabilities, increased operating
efficiency and effective cost management enabled Ashland Distribution to
improve sales per shipping day by 9% (of which 3% resulted from volume
increases) compared to the 2003 quarter. The favorable effects of the
higher sales were partially offset by a lower gross profit percentage,
reflecting lower margins for chemicals, European plastics, environmental
services and methanol. Selling, general and administrative (SG&A) expenses
were down $5 million compared to the prior year period, reflecting the
Top-Quartile Cost Structure (TQCS) initiative.
YEAR-TO-DATE - Ashland Distribution reported record operating income of $32
million for the six months ended March 31, 2004, compared to $15 million
for the six months ended March 31, 2003. The improvement reflects the same
factors described in the current quarter comparison. Sales per shipping day
were up 9%, including 4% from volume increases. The gross profit percentage
declined from 15.4% to 14.7%, reflecting lower margins for all business
units except domestic plastics and composites. SG&A expenses declined $12
million. Income from litigation settlements and asset sales amounted to $4
million in the 2004 period compared to $7 million in the 2003 period.
ASHLAND SPECIALTY CHEMICAL
CURRENT QUARTER - Ashland Specialty Chemical reported record March quarter
operating income of $19 million, compared to $5 million for the March 2003
quarter. Results from the thermoset core businesses (Casting Solutions,
Composite Polymers and Specialty Polymers & Adhesives) increased 143%,
while the water treatment core businesses (Drew Industrial and Drew Marine)
increased 15%. Higher sales revenues and a reduced cost structure led to
the improvement, despite slight margin pressure due to higher raw material
costs. Sales per shipping day increased 7%. Results of the domestic
thermoset businesses included four additional shipping days, reflecting a
move to a calendar month end for revenue recognition, which increased
revenues by $9 million and operating income by $4 million.
16
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
ASHLAND SPECIALTY CHEMICAL (CONTINUED)
YEAR-TO-DATE - Operating income for Ashland Specialty Chemical was $42
million for the six months ended March 31, 2004, compared to $18 million
for the six months ended March 31, 2003. Results from the thermoset core
businesses increased 67%, while the water treatment core businesses
increased 22%. The improvement reflects the same factors described in the
current quarter comparison.
VALVOLINE
CURRENT QUARTER - Valvoline reported record March quarter operating income
of $24 million, a 33% increase from the 2003 quarter. Valvoline's core
lubricant business improved with premium product sales volumes increasing
5%. Valvoline Instant Oil Change (VIOC) increased non-oil change revenues
by 6% and premium lubricant oil changes by 3%. Valvoline's international
operations improved due in large part to a 4% increase in lubricant sales
volumes and strengthening foreign currencies.
YEAR-TO-DATE - Valvoline reported record operating income of $45 million
for the six months ended March 31, 2004, a 41% improvement over the $32
million reported for the same period in 2003. Valvoline's core lubricant
business improved with an 11% increase in sales volumes for premium
products. VIOC reported record earnings due in part to an 8% increase in
non-oil change revenues, and a 5% increase in premium oil changes. In
addition, results from Valvoline's international operations improved due to
a 4% increase in lubricant sales volumes and strengthening foreign
currencies.
REFINING AND MARKETING
CURRENT QUARTER - Operating income from Refining and Marketing, which
consists primarily of equity income from Ashland's 38% ownership interest
in MAP, amounted to $2 million for the quarter ended March 31, 2004,
compared to $21 million for the March 2003 quarter. Equity income from
MAP's refining and wholesale marketing operations declined $13 million,
reflecting a decline of 27 cents per barrel in MAP's refining and wholesale
marketing margin, due to higher manufacturing and crude oil costs. MAP
completed a substantial amount of planned refinery maintenance during the
quarter and expects to run at full capacity moving into the spring driving
season. In addition, MAP completed a number of other projects including a
multi-year improvement project at its Catlettsburg, Ky., refinery and a
13,000 barrels per day (bpd) expansion of the crude oil processing unit at
its Garyville, La., refinery. The latter project increased MAP's overall
crude oil capacity from 935,000 bpd to 948,000 bpd. Equity income from
MAP's retail operations (Speedway SuperAmerica and a 50% interest in the
Pilot Travel Centers joint venture) increased $1 million, reflecting
decreased operating and administrative expenses. Ashland's administrative
and other costs related to Refining and Marketing were unusually high due
to mark-to-market charges of $4 million on margin hedges and transaction
costs of $2 million associated with the proposed transfer of Ashland's 38%
interest in MAP to Marathon Oil Corporation (Marathon).
On March 19, 2004, Ashland announced the signing of an agreement under
which it would transfer its 38% interest in MAP and two wholly-owned
businesses to Marathon in a transaction structured to be generally tax free
and valued at approximately $3.0 billion. The two other businesses are
Ashland's maleic anhydride business and 61 VIOC centers. The transaction is
subject to several previously disclosed conditions, including approval by
Ashland's shareholders, customary antitrust review, consent from public
debt holders and receipt of a favorable private letter ruling from the
Internal Revenue Service with respect to the tax treatment. While there is
meaningful risk that the transaction will not receive the favorable ruling
from the IRS, in which case the transaction would not close, Ashland
believes it is more likely than not that this transaction will receive a
favorable ruling. If the conditions are met, the transaction is expected to
close by the end of the 2004 calendar year.
17
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
REFINING AND MARKETING (CONTINUED)
YEAR-TO-DATE - Operating income from Refining and Marketing amounted to $27
million for the six months ended March 31, 2004, compared to $45 million
for the 2003 period. Equity income from MAP's refining and wholesale
marketing operations declined $16 million, reflecting a 24 cents per barrel
decline in MAP's refining and wholesale marketing margin, due to the same
factors described in the current quarter comparison. Equity income from
MAP's retail operations increased $2 million, due to the net effects of
higher product and merchandise margins, partially offset by lower volumes
reflecting the sale of SSA's 190 southern stores in May 2003. Equity income
from MAP's transportation operations increased $4 million due to higher
throughput and lower expenses in the December 2003 quarter. Ashland's
administrative and other costs increased $6 million due to the same factors
described in the current quarter comparison.
CORPORATE
Corporate expenses amounted to $21 million in the quarter ended March 31,
2004, compared to $18 million in the March 2003 quarter, reflecting
increased deferred compensation costs. Corporate expenses amounted to $42
million for the six months ended March 31, 2004, compared to $46 million
for the 2003 period. The decrease reflects an $8 million charge in the
December 2002 quarter for severance and other transition costs related to
Ashland's program to reduce general and administrative costs, partially
offset by higher deferred compensation costs in the 2004 period.
NET INTEREST AND OTHER FINANCIAL COSTS
Net interest and other financial costs declined to $29 million in the March
2004 quarter, compared to $32 million in the March 2003 quarter. For the
six months ended March 31, 2004, net interest and other financial costs
amounted to $59 million, compared to $65 million for the 2003 period. The
declines reflect a reduction in the average level of debt outstanding.
DISCONTINUED OPERATIONS
As described in Notes B and F to the Condensed Consolidated Financial
Statements, Ashland's results from discontinued operations include charges
associated with estimated future asbestos liabilities less probable
insurance recoveries, as well as net income from the discontinued
operations of its Electronic Chemicals business. Such amounts are
summarized in the following table.
- -------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
March 31 March 31
------------------------ -----------------------
(In millions) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------------
PRETAX INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Reserves for asbestos-related litigation $ (7) $ (7) $ (15) $ (162)
Electronic Chemicals
Results of operations - 3 - 7
Loss on disposal - - (1) -
INCOME TAXES
Reserves for asbestos-related litigation 2 3 6 63
Electronic Chemicals
Results of operations - (1) - (1)
Loss on disposal - - - -
---------- ----------- ---------- ----------
RESULTS FROM DISCONTINUED OPERATIONS (NET OF INCOME TAXES) $ (5) $ (2) $ (10) $ (93)
========== =========== ========== ==========
18
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
FINANCIAL POSITION
LIQUIDITY
Cash flows from operations, a major source of Ashland's liquidity, amounted
to $58 million for the six months ended March 31, 2004, compared to $98
million for the six months ended March 31, 2003. Cash distributions from
MAP amounted to $146 million in the 2004 period compared to $93 million in
the 2003 period. This increase was more than offset by $64 million in
contributions to Ashland's pension plans in the 2004 period, compared to no
such contributions in the 2003 period, and a $32 million increase in
federal tax payments. Ashland's capital requirements for net property
additions and dividends exceeded cash flows from operations by $50 million
for the six months ended March 31, 2004. Ashland anticipates meeting its
remaining 2004 capital requirements for property additions and dividends
from internally generated funds. Under the terms of the proposed
transaction with Marathon, MAP will not make quarterly cash distributions
to Ashland and Marathon until the closing of the transaction.
Ashland's financial position has enabled it to obtain capital for its
financing needs and to maintain investment grade ratings on its senior debt
of Baa2 from Moody's and BBB from Standard & Poor's (S&P). In August 2003,
S&P revised its outlook on Ashland to negative from stable, and lowered
Ashland's commercial paper rating to A-3 from A-2. In March 2004, Moody's
took a similar action after the announcement of the proposed transaction
with Marathon and lowered Ashland's commercial paper rating to P-3 from
P-2. These actions materially restrict, and could at times eliminate, the
availability of the commercial paper market to Ashland. However, Ashland
was able to utilize such markets in the March 2004 quarter and had $17
million of commercial paper outstanding at March 31, 2004. Ashland has two
revolving credit agreements providing for up to $350 million in borrowings.
Although Ashland borrowed $175 million under these agreements to repay
commercial paper shortly after the S&P downgrade, the revolving credit
agreements were not used during the six months ended March 31, 2004. In
April 2004, Ashland executed an additional $150 million revolving credit
agreement which expires March 31, 2005. Ashland intends to use this
facility to fund currently maturing long-term debt and certain lease
payments. While the revolving credit agreements contain covenants limiting
new borrowings based on Ashland's stockholders' equity, these agreements
would have permitted an additional $1.9 billion of borrowings at March 31,
2004. Additional permissible borrowings are increased (decreased) by 150%
of any increase (decrease) in stockholders' equity.
At March 31, 2004, working capital (excluding debt due within one year)
amounted to $768 million, compared to $703 million at September 30, 2003,
and $771 million at March 31, 2003. The amount at March 31, 2003 included
net assets of $167 million of the discontinued Electronic Chemical
operations held for sale. Ashland's working capital is affected by its use
of the LIFO method of inventory valuation. The LIFO method valued
inventories below their replacement costs by $81 million at March 31, 2004,
compared to $78 million at September 30, 2003, and $70 million at March 31,
2003. Liquid assets (cash, cash equivalents and accounts receivable)
amounted to 89% of current liabilities at March 31, 2004, compared to 92%
at September 30, 2003, and 75% at March 31, 2003. The improvements since
last March reflect a combination of an increase of $98 million in cash
equivalents and a reduction of $158 million in short-term debt that
resulted principally from the sale of the Electronic Chemicals business.
19
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
CAPITAL RESOURCES
For the six months ended March 31, 2004, property additions amounted to $86
million, compared to $52 million for the 2003 period. The increase reflects
a $33 million buyout of an operating lease for a portion of the buildings
on Ashland's Dublin, Ohio campus.
Ashland's debt level amounted to $1.6 billion at March 31, 2004 and
September 30, 2003, and $1.8 billion at March 31, 2003. Debt as a percent
of capital employed amounted to 40.1% at March 31, 2004, compared to 41.7%
at September 30, 2003, and 46.8% at March 31, 2003. At March 31, 2004,
Ashland's debt included $32 million of floating-rate obligations, and the
interest rates on an additional $183 million of fixed-rate, medium-term
notes were effectively converted to floating rates through interest rate
swap agreements. In addition, Ashland's costs under its sale of receivables
program and various operating leases are based on the floating-rate
interest costs on $184 million of third-party debt underlying those
transactions. As a result, Ashland was exposed to fluctuations in
short-term interest rates on $399 million of debt obligations at March 31,
2004.
ASBESTOS-RELATED LITIGATION AND ENVIRONMENTAL REMEDIATION
For a discussion of Ashland's asbestos-related litigation and environmental
remediation matters, see Note F to the Condensed Consolidated Financial
Statements.
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, with respect to
various information in the Results of Operations, Financial Position, and
Asbestos-Related Litigation and Environmental Remediation sections of this
MD&A. These statements include those that refer to Ashland's operating
performance, earnings and expectations about the MAP transaction. Although
Ashland believes its expectations are based on reasonable assumptions, it
cannot assure the expectations reflected herein will be achieved. These
forward-looking statements are 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) and are subject
to a number of risks, uncertainties, and assumptions that could cause
actual results to differ materially from those described in the
forward-looking statements. The risks, uncertainties, and assumptions
include the possibility that Ashland will be unable to fully realize the
benefits anticipated from the MAP transaction; the possibility of failing
to receive a favorable ruling from the Internal Revenue Service; the
possibility that Ashland fails to obtain the approval of its shareholders;
the possibility that the transaction may not close or that Ashland may be
required to modify some aspect of the transaction to obtain regulatory
approvals. Other factors and risks affecting Ashland are contained in Risks
and Uncertainties in Note A to the Consolidated Financial Statements in
Ashland's Annual Report on Form 10-K, as amended, for the fiscal year ended
September 30, 2003. Ashland undertakes no obligation to subsequently update
or revise these forward-looking statements.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Ashland's market risk exposure at March 31, 2004 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, 2003.
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.
21
PART II - OTHER INFORMATION
---------------------------
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
ASBESTOS-RELATED LITIGATION - For additional information regarding
liabilities arising from asbestos-related litigation, see Note F to the
Condensed Consolidated Financial Statements in this quarterly report on
Form 10-Q.
U.S. DEPARTMENT OF JUSTICE ANTITRUST DIVISION INVESTIGATION - In
November 2003, Ashland received a subpoena relating to a foundry resins
grand jury investigation. Ashland is providing responsive records to the
subpoena. As is frequently the case when such investigations are in
progress, a civil action was filed in federal district court for the
Northern District of Illinois in April 2004. The plaintiff seeks class
action status for a class of customers of foundry resins. Ashland will
vigorously defend this action.
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 March 31, 2004, 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. For additional information regarding environmental matters and
reserves, see Note F to the 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 Environmental
Crimes Section of the U.S. Department of Justice regarding a May 16, 1997
sewer fire at the St. Paul Park, Minnesota refinery, which is now owned by
MAP. As part of the plea agreement, Ashland entered guilty pleas to two
federal 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").
In addition, as part of the plea agreement, Ashland entered into a
deferred prosecution agreement, wherein prosecution of a separate count of
the indictment charging Ashland with violating Subpart QQQ was deferred for
four years. The deferred prosecution agreement provides that if Ashland
satisfies the terms and conditions of the plea agreement and completes the
Refinery Upgrades, the deferred prosecution agreement will terminate and
the United States will dismiss that count with prejudice. If, however, it
is determined by the court that Ashland willfully violated any term or
condition of the plea agreement during the deferral period, the United
States may re-initiate prosecution of the deferred count of the indictment,
using an admission made by Ashland for purposes of the plea agreement that
Ashland knowingly operated the St. Paul Park refinery in violation of
certain Subpart QQQ standards.
As part of its sentence, Ashland was placed on probation for five
years. The primary condition of probation is an obligation not to commit
future federal, state, or local crimes. If Ashland were to commit such a
crime, it would be subject not only to prosecution for that new violation,
but the government could also seek to revoke Ashland's probation. The
probation office has retained an independent environmental consultant to
review and monitor Ashland's compliance with applicable environmental
22
requirements and the terms and conditions of probation. The court also
included other customary terms and restrictions of probation in its
probation order.
(3) Pursuant to a 1988 Resource Conservation and Recovery Act
Administrative Consent Order ("Consent Order"), Ashland is remediating soil
and groundwater at a former chemical distribution facility site in Lansing,
Michigan. The USEPA has asserted that Ashland has not complied with certain
provisions of the Consent Order and, although Ashland disputes this
assertion, Ashland and the USEPA have agreed to resolve the dispute.
Ashland has agreed to payment of a $650,000 penalty, pending agreement on
settlement terms and conditions. Ashland is continuing to work with the
USEPA to define Ashland's continuing obligations under the Consent Order.
No formal penalty proceeding has been initiated.
(4) In 1990, contamination of groundwater at Ashland's former Canton,
Ohio refinery (now owned and operated by MAP) was first identified and
reported to Ohio's Environmental Protection Agency ("OEPA"). Since that
time, Ashland has voluntarily conducted investigation and remediation
activities and regularly communicated with OEPA regarding this matter.
Ashland and the state of Ohio have exchanged Consent Order drafts and have
met to negotiate the terms of such an order. The state filed a complaint in
February 2004, but simultaneously expressed an interest in continuing
Consent Order settlement discussions. Following the filing of the
complaint, Ashland, OEPA and Ohio's Office of the Attorney General have
continued to work to finalize a Consent Order. The state has advised that
it will assess a penalty as part of the overall settlement and has made an
initial request for $650,000.
SHAREHOLDER DERIVATIVE LITIGATION - On August 16, 2002, Central
Laborers' Pension Fund, derivatively as a shareholder of Ashland,
instituted an action in the Circuit Court of Kentucky in Kenton County
against Ashland's then-serving Board of Directors. On motion of Ashland and
the other defendants, the case was removed to the United States District
Court, Eastern District of Kentucky, Covington Division. The case has been
remanded to the state court. Ashland has filed a Motion to Dismiss the
Complaint. The action is purportedly filed on behalf of Ashland, and
asserts the following causes of action against the Directors: breach of
fiduciary duty, abuse of control, gross mismanagement, and waste of
corporate assets. The suit also names Paul W. Chellgren, the then-serving
Chief Executive Officer and Chairman of the Board, and James R. Boyd,
former Senior Vice President and Group Operating Officer, as individual
defendants, and it seeks to recover an unstated sum from them individually
alleging unjust enrichment from various transactions completed during their
tenure with Ashland. The suit further seeks an unspecified sum from Mr.
Chellgren individually based upon alleged usurpation of corporate
opportunities. The suit also names J. Marvin Quin, Ashland's Chief
Financial Officer, as well as three former employees of Ashland's
wholly-owned subsidiary, APAC, as individual defendants and alleges that
they participated in the preparation and filing of false financial
statements during fiscal years 1999 - 2001. The suit further names Ernst &
Young LLP ("E&Y"), as a defendant, alleging professional accounting
malpractice and negligence in the conduct of its audit of Ashland's 1999
and 2000 financial statements, respectively, as well as alleging that E&Y
aided and abetted the individual defendants in their alleged breach of
duties. The complaint seeks to recover, jointly and severally, from
defendants an unstated sum of compensatory and punitive damages. The
complaint seeks equitable and/or injunctive relief to avoid continuing harm
from alleged ongoing illegal acts, and seeks a disgorgement of defendants'
alleged insider-trading gains, in addition to the reasonable cost and
expenses incurred in bringing the complaint, including attorneys' and
experts' fees.
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.
23
ITEM 5. OTHER INFORMATION
On March 19, 2004, Ashland announced the signing of an agreement under
which it would transfer its 38 percent interest in MAP and two wholly-owned
businesses to Marathon Oil Corporation in a transaction structured to be
generally tax free and valued at approximately $3.0 billion. The two other
businesses are Ashland's maleic anhydride business and 61 Valvoline Instant
Oil Change centers in Michigan and northwest Ohio, which are valued at $94
million.
Under the terms of the agreement, Ashland's shareholders would receive
Marathon common stock with a value of $315 million (or approximately $4.50
per Ashland share based on the number of shares currently outstanding).
Ashland would receive cash and MAP accounts receivable totaling
approximately $2.7 billion. MAP will not make quarterly cash distributions
to Ashland and Marathon between the signing of the agreement and the
closing of the transaction. As a result, the final amount received by
Ashland would be increased by an amount equal to 38 percent of the cash
accumulated from operations during the period prior to closing. Ashland
would use a substantial portion of the transaction proceeds to retire all
or most of the company's outstanding debt and certain other financial
obligations. After payment of these obligations, Ashland would have a
material net cash position.
The transaction is subject to, among other things, approval by
Ashland's shareholders, customary antitrust review, consent from public
debt holders and receipt of a favorable private letter ruling from the
Internal Revenue Service ("IRS") with respect to the tax treatment of the
transaction. There is meaningful risk that the transaction will not receive
the favorable ruling from the IRS, in which case the transaction would not
proceed. However, Ashland believes it is more likely than not that this
transaction will receive a favorable ruling. If these conditions are met,
the transaction is expected to close by the end of the 2004 calendar year.
The foregoing description of the transaction is qualified in its
entirety by reference to the terms of the agreements which were filed as
Exhibits to Ashland's Form 8-K filed on March 22, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
4 Amendment No. 1 dated as of March 18, 2004, to the Rights
Agreement, dated as of May 16, 1996, between Ashland Inc. and the
Rights Agent.
10.1 Amendment No. 2 dated as of March 17, 2004, to the Put/Call,
Registration Rights and Standstill Agreement among Marathon Oil
Company, Ashland Inc. and Marathon Ashland Petroleum LLC.
10.2 Amendment No.1 dated as of March 17, 2004, to the Amended and
Restated Limited Liability Company Agreement of Marathon Ashland
Petroleum LLC.
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,
18 U.S.C. Section 1350.
31.2 Certificate of J. Marvin Quin, Chief Financial Officer of Ashland
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, U.S.C.
Section 1350.
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.
24
(b) Reports on Form 8-K
-------------------
During the quarter ended March 31, 2004, and between such date and
the filing of this quarterly report on Form 10-Q, Ashland
furnished the following reports on Form 8-K:
(1) A report on Form 8-K dated January 7, 2004 announcing that Garry
M. Higdem was elected as Senior Vice President of Ashland and
President of Ashland Paving And Construction, Inc., effective
January 12, 2004.
(2) A report on Form 8-K dated January 26, 2004 reporting Ashland's
first quarter fiscal 2004 results.
(3) A report on Form 8-K dated January 26, 2004 containing a
Regulation FD disclosure.
(4) A report on Form 8-K dated February 24, 2004 containing a
Regulation FD disclosure.
(5) A report on Form 8-K dated March 22, 2004 announcing the signing
of an agreement under which Ashland would transfer its 38 percent
interest in Marathon Ashland Petroleum LLC and two wholly-owned
businesses to Marathon Oil Corporation in a transaction structured
to be generally tax free and valued at approximately $3.0 billion.
The two other businesses are Ashland's maleic anhydride business
and 61 Valvoline Instant Oil Change centers in Michigan and
northwest Ohio.
(6) A report on Form 8-K dated April 7, 2004 containing a Regulation
FD disclosure.
(7) A report on Form 8-K dated April 15, 2004 announcing that Lamar M.
Chambers has been elected Vice President and Controller of
Ashland, effective May 1, 2004.
(8) A report on Form 8-K dated April 26, 2004 containing a Regulation
FD disclosure.
(9) A report on Form 8-K dated April 26, 2004 reporting Ashland's
second quarter fiscal 2004 results.
25
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: May 11, 2004 /s/ J. Marvin Quin
--------------------------------
J. Marvin Quin
Senior Vice President and
Chief Financial Officer (on behalf
of the Registrant as principal
financial officer)
26
EXHIBIT INDEX
Exhibit
No. Description
- ------- ------------------------------------------------------------------
4 Amendment No. 1 dated as of March 18, 2004, to the Rights
Agreement, dated as of May 16, 1996, between Ashland Inc. and the
Rights Agent.
10.1 Amendment No. 2 dated as of March 17, 2004, to the Put/Call,
Registration Rights and Standstill Agreement among Marathon Oil
Company, Ashland Inc. and Marathon Ashland Petroleum LLC.
10.2 Amendment No. 1 dated as of March 17, 2004, to the Amended and
Restated Limited Liability Company Agreement of Marathon Ashland
Petroleum LLC.
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, U.S.C.
Section 1350.
27