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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 JUNE 30, 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 July 31, 2004, there were 71,066,675 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 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) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------- --------------------
REVENUES
Sales and operating revenues $ 2,192 $ 2,006 $ 5,928 $ 5,388
Equity income 221 104 277 169
Other income 12 15 34 43
---------- ---------- ----------- ----------
2,425 2,125 6,239 5,600
COSTS AND EXPENSES
Cost of sales and operating expenses 1,756 1,602 4,727 4,296
Selling, general and administrative expenses 330 336 974 1,004
Depreciation, depletion and amortization 47 49 144 153
---------- ---------- ----------- ----------
2,133 1,987 5,845 5,453
---------- ---------- ----------- ----------
OPERATING INCOME 292 138 394 147
Net interest and other financial costs (29) (31) (88) (97)
---------- ---------- ----------- ----------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 263 107 306 50
Income taxes (96) (36) (111) (17)
---------- ---------- ----------- ----------
INCOME FROM CONTINUING OPERATIONS 167 71 195 33
Results from discontinued operations (net of income taxes) - Note B (6) (1) (16) (94)
---------- ---------- ----------- ----------
NET INCOME (LOSS) $ 161 $ 70 $ 179 $ (61)
========== ========== =========== ==========
BASIC EARNINGS (LOSS) PER SHARE - Note A
Income from continuing operations $ 2.38 $ 1.04 $ 2.80 $ .48
Results from discontinued operations (.09) (.02) (.23) (1.38)
---------- ---------- ----------- ----------
Net income (loss) $ 2.29 $ 1.02 $ 2.57 $ (.90)
========== ========== =========== ==========
DILUTED EARNINGS (LOSS) PER SHARE - Note A
Income from continuing operations $ 2.35 $ 1.03 $ 2.75 $ .48
Results from discontinued operations (.09) (.02) (.22) (1.37)
---------- ---------- ----------- ----------
Net income (loss) $ 2.26 $ 1.01 $ 2.53 $ (.89)
========== ========== =========== ==========
DIVIDENDS PAID PER COMMON SHARE $ .275 $ .275 $ .825 $ .825
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) 2004 2003 2003
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ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $ 183 $ 223 $ 112
Accounts receivable 1,256 1,170 1,085
Allowance for doubtful accounts (39) (35) (40)
Inventories - Note A 510 441 512
Deferred income taxes 115 142 98
Assets of discontinued operations held for sale - - 198
Other current assets 204 144 186
---------- ---------- ----------
2,229 2,085 2,151
INVESTMENTS AND OTHER ASSETS
Investment in Marathon Ashland Petroleum LLC (MAP) 2,568 2,448 2,401
Goodwill 513 523 519
Asbestos insurance receivable (noncurrent portion) 400 399 398
Other noncurrent assets 393 340 345
---------- ---------- ----------
3,874 3,710 3,663
PROPERTY, PLANT AND EQUIPMENT
Cost 2,955 2,959 2,949
Accumulated depreciation, depletion and amortization (1,791) (1,748) (1,725)
---------- ----------- ----------
1,164 1,211 1,224
---------- ----------- ----------
$ 7,267 $ 7,006 $ 7,038
========== =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Debt due within one year $ 204 $ 102 $ 296
Trade and other payables 1,384 1,371 1,235
Liabilities of discontinued operations held for sale - - 28
Income taxes 15 11 16
---------- ---------- ----------
1,603 1,484 1,575
NONCURRENT LIABILITIES
Long-term debt (less current portion) 1,338 1,512 1,564
Employee benefit obligations 394 385 493
Deferred income taxes 313 291 201
Reserves of captive insurance companies 196 168 184
Asbestos litigation reserve (noncurrent portion) 565 560 535
Other long-term liabilities and deferred credits 358 353 346
Commitments and contingencies - Notes D and F
---------- ----------- ----------
3,164 3,269 3,323
COMMON STOCKHOLDERS' EQUITY 2,500 2,253 2,140
---------- ----------- ----------
$ 7,267 $ 7,006 $ 7,038
========== =========== ==========
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 (1) (61) 76 15
Cash dividends (56) (56)
Issued 64,370 common shares under
stock incentive and other plans 8 8
---------- -------------- -------------- -------------- -------------
BALANCE AT JUNE 30, 2003 $ 68 $ 346 $ 1,844 $ (118) $ 2,140
========== ============== ============== ============== =============
BALANCE AT OCTOBER 1, 2003 $ 68 $ 350 $ 1,961 $ (126) $ 2,253
Total comprehensive income (1) 179 22 201
Cash dividends (57) (57)
Issued 2,698,722 common shares under
stock incentive and other plans 3 100 103
---------- -------------- -------------- -------------- -------------
BALANCE AT JUNE 30, 2004 $ 71 $ 450 $ 2,083 $ (104) $ 2,500
========== ============== ============== ============== =============
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(1) Reconciliations of net income (loss) to total comprehensive income follow.
Three months ended Nine months ended
June 30 June 30
---------------------------- -------------------------------
(In millions) 2004 2003 2004 2003
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Net income (loss) $ 161 $ 70 $ 179 $ (61)
Minimum pension liability adjustment - - - 19
Related tax expense - - - (7)
Unrealized translation adjustments (12) 32 22 64
Related tax benefits - - - -
---------- -------------- -------------- -------------
Total comprehensive income $ 149 $ 102 $ 201 $ 15
========== ============== ============== =============
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At June 30, 2004, the accumulated other comprehensive loss of $104
million (after tax) was comprised of net unrealized translation gains
of $12 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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Nine months ended
June 30
------------------------
(In millions) 2004 2003
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CASH FLOWS FROM OPERATIONS
Income from continuing operations $ 195 $ 33
Expense (income) not affecting cash
Depreciation, depletion and amortization 144 153
Deferred income taxes 70 43
Equity income from affiliates (277) (169)
Distributions from equity affiliates 156 114
Other items 2 (1)
Change in operating assets and liabilities (1) (213) (62)
----------- ----------
77 111
CASH FLOWS FROM FINANCING
Proceeds from issuance of common stock 86 1
Repayment of long-term debt (75) (191)
Increase in short-term debt 8 243
Dividends paid (57) (56)
----------- ----------
(38) (3)
CASH FLOWS FROM INVESTMENT
Additions to property, plant and equipment (121) (84)
Purchase of operations - net of cash acquired (5) (5)
Proceeds from sale of operations 48 5
Other - net 13 (6)
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(65) (90)
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CASH PROVIDED (USED) BY CONTINUING OPERATIONS (26) 18
Cash provided (used) by discontinued operations (14) 4
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INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (40) 22
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 223 90
----------- ----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 183 $ 112
=========== ==========
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(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. All adjustments (consisting of normal recurring accruals)
considered necessary by management for a fair presentation have been
included, although such statements are subject to any year-end audit
adjustments which may be necessary. 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 June 30,
2004, are not necessarily indicative of results to be expected for
Ashland's fiscal year ending September 30, 2004.
INVENTORIES
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June 30 September 30 June 30
(In millions) 2004 2003 2003
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Chemicals and plastics $ 390 $ 333 $ 364
Construction materials 76 67 82
Petroleum products 73 66 75
Other products 50 48 60
Supplies 6 5 5
Excess of replacement costs over LIFO carrying values (85) (78) (74)
------------- -------------- --------------
$ 510 $ 441 $ 512
============= ============== ==============
EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share (EPS) from continuing operations.
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Three months ended Nine months ended
June 30 June 30
------------------------ -----------------------
(In millions except per share data) 2004 2003 2004 2003
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NUMERATOR
Numerator for basic and diluted EPS - Income
from continuing operations $ 167 $ 71 $ 195 $ 33
========== =========== ========== ==========
DENOMINATOR
Denominator for basic EPS - Weighted average
common shares outstanding 70 68 70 68
Common shares issuable upon exercise of stock options 1 1 1 1
---------- ----------- ---------- ----------
Denominator for diluted EPS - Adjusted weighted
average shares and assumed conversions 71 69 71 69
========== =========== ========== ==========
EARNINGS PER SHARE FROM CONTINUING OPERATIONS
Basic $ 2.38 $ 1.04 $ 2.80 $ .48
Diluted $ 2.35 $ 1.03 $ 2.75 $ .48
6
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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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 reflect updates in the estimate of potential
payments for litigation defense and claim settlement costs during the next
ten years. 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 June
30, 2003 balance sheet. Assets of $198 million were composed of current
assets of $52 million, investments and other assets of $26 million, and
property, plant and equipment of $120 million. Liabilities of $28 million
were composed of current liabilities of $15 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.
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Three months ended Nine months ended
June 30 June 30
------------------------ -----------------------
(In millions) 2004 2003 2004 2003
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PRETAX INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Reserves for asbestos-related litigation $ (7) $ (8) $ (22) $ (171)
Electronic Chemicals
Results of operations - 5 - 12
Loss on disposal (2) - (3) -
INCOME TAXES
Reserves for asbestos-related litigation 3 3 9 67
Electronic Chemicals
Results of operations - (1) - (2)
Loss on disposal - - - -
---------- ----------- ---------- ----------
RESULTS FROM DISCONTINUED OPERATIONS (NET OF INCOME TAXES) $ (6) $ (1) $ (16) $ (94)
========== =========== ========== ==========
7
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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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.
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Three months ended Nine months ended
June 30 June 30
------------------------ ------------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------
Sales and operating revenues $ 11,155 $ 8,005 $ 29,773 $ 23,338
Income from operations 585 281 734 457
Net income 583 276 725 446
Ashland's equity income 216 101 261 157
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, 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 June 30, 2004, its maximum obligations under the residual
value guarantees would have amounted to $102 million. Ashland does not
expect to incur any significant charge to earnings under these guarantees,
$24 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 June 30, 2004,
Ashland's contingent liability under this guarantee amounted to $83
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
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE E - EMPLOYEE BENEFIT PLANS
In May 2004, the Financial Accounting Standards Board issued Staff Position
No. FAS 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the
Act)." Among other things, the Act will expand Medicare to include an
outpatient prescription drug benefit beginning in 2006, as well as provide
a subsidy for sponsors of retiree health care plans that provide a benefit
that is at least actuarially equivalent to the new Medicare drug benefit.
The Staff Position is effective July 1, 2004. Ashland is currently
evaluating the impact of the Act on its postretirement benefit plans and
has not determined the effect of the Act on its financial statements.
Presently, Ashland anticipates contributing $128 million to its pension
plans during fiscal 2004. As of June 30, 2004, $89 million of contributions
have been made.
The following tables detail the components of pension and other
postretirement benefit costs.
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Other postretirement
Pension benefits benefits
------------------------ -------------------------
(In millions) 2004 2003 2004 2003
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THREE MONTHS ENDED JUNE 30
Service cost $ 12 $ 13 $ 1 $ 3
Interest cost 19 19 4 5
Expected return on plan assets (18) (15) - -
Other amortization and deferral 9 9 (2) (2)
---------- ---------- ----------- -----------
$ 22 $ 26 $ 3 $ 6
========== ========== =========== ===========
NINE MONTHS ENDED JUNE 30
Service cost $ 35 $ 33 $ 8 $ 8
Interest cost 53 50 15 18
Expected return on plan assets (48) (39) - -
Other amortization and deferral 24 23 (10) (5)
---------- ---------- ----------- -----------
$ 64 $ 67 $ 13 $ 21
========== ========== =========== ===========
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
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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NOTE F - LITIGATION, CLAIMS AND CONTINGENCIES (continued)
- ----------------------------------------------------------------------------------------------------------------------
Nine months ended
June 30 Years ended September 30
--------------------------- ------------------------------------------
(In thousands) 2004 2003 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Open claims - beginning of period 198 160 160 167 118
New claims filed 24 58 66 45 52
Claims settled (6) (5) (7) (15) (2)
Claims dismissed (17) (17) (21) (37) (1)
----------- ----------- ----------- ----------- -----------
Open claims - end of period 199 196 198 160 167
=========== =========== =========== =========== ===========
Since October 1, 2000, Riley has been dismissed as a defendant in 72% of
the resolved claims. For the nine months ended June 30, 2004, amounts spent
on litigation defense and claim settlements amounted to $1,736 per claim
resolved, compared to $1,593 for the nine months ended June 30, 2003, and
annual costs of $1,610 in 2003, $723 in 2002 and $4,445 in 2001. A
progression of activity in the asbestos reserve is presented in the
following table.
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Nine months ended
June 30 Years ended September 30
--------------------------- -------------------------------------------
(In millions) 2004 2003 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Asbestos reserve - beginning of period $ 610 $ 202 $ 202 $ 199 $ 57
Expense incurred 44 419 453 41 157
Amounts paid (39) (36) (45) (38) (15)
----------- ----------- ----------- ----------- ------------
Asbestos reserve - end of period $ 615 $ 585 $ 610 $ 202 $ 199
=========== =========== =========== =========== ============
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), nationally recognized
experts in that field. 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.
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 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
and other developments impacting Ashland's estimate of potential payments
during the next ten years. In addition, at least annually, more formal
estimates are developed with the assistance of HR&A. Ashland's reserve for
asbestos claims on an undiscounted basis amounted to $615 million at June
30, 2004, compared to $585 million at June 30, 2003.
10
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ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE F - LITIGATION, CLAIMS AND CONTINGENCIES (continued)
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,
and even though it is reasonably possible that additional costs might be
incurred, they are not reasonably estimable at this time. 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 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 under which the ultimate recoveries are extended for many years,
resulting 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. On July 21, 2004, Ashland filed a demand
for arbitration to resolve the dispute concerning the interpretation of
this agreement.
At June 30, 2004, Ashland's receivable for recoveries of litigation defense
and claim settlement costs from its insurers amounted to $430 million, of
which $39 million relates to costs previously paid. Receivables from
insurance companies amounted to $423 million at June 30, 2003. About 35% of
the estimated receivables from insurance companies at June 30, 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.
11
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE F - LITIGATION, CLAIMS AND CONTINGENCIES (CONTINUED)
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
June 30, 2004, such locations included 95 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 June 30, 2004, and
$167 million at June 30, 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.
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 Nine months ended
June 30 June 30
------------------------ -------------------
(In millions) 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
REVENUES
Sales and operating revenues
APAC $ 698 $ 683 $ 1,755 $ 1,615
Ashland Distribution 838 733 2,320 2,081
Ashland Specialty Chemical 354 308 983 870
Valvoline 330 307 945 889
Intersegment sales
Ashland Distribution (5) (6) (13) (16)
Ashland Specialty Chemical (23) (19) (61) (50)
Valvoline - - (1) (1)
--------- --------- ---------- --------
2,192 2,006 5,928 5,388
Equity income
APAC 3 2 11 6
Ashland Specialty Chemical 2 1 5 5
Valvoline - - - 1
Refining and Marketing 216 101 261 157
---------- ----------- ---------- --------
221 104 277 169
Other income
APAC 9 3 20 5
Ashland Distribution 1 3 8 17
Ashland Specialty Chemical 3 3 8 8
Valvoline 2 1 3 4
Refining and Marketing (2) 4 (7) 4
Corporate (1) 1 2 5
---------- ----------- ---------- --------
12 15 34 43
---------- ----------- ---------- --------
$ 2,425 $ 2,125 $ 6,239 $ 5,600
========== =========== ========== ========
OPERATING INCOME
APAC $ 43 $ 17 $ 41 $ (39)
Ashland Distribution 23 11 56 27
Ashland Specialty Chemical 22 3 63 21
Valvoline 30 24 75 56
Refining and Marketing (1) 205 100 232 145
Corporate (31) (17) (73) (63)
---------- ----------- --------- --------
$ 292 $ 138 $ 394 $ 147
========== =========== ========== ========
- --------------------------------------------------------------------------------
(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
- ------------------------------------------------------------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
INFORMATION BY INDUSTRY SEGMENT
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended Nine months ended
June 30 June 30
----------------------- --------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INFORMATION
APAC
Construction backlog at June 30 (millions) (1) $ 1,869 $ 1,824
Net construction job revenues (millions) (2) $ 409 $ 402 $ 982 $ 904
Hot-mix asphalt production (million tons) 9.9 9.8 22.7 21.0
Aggregate production (million tons) 8.1 7.6 21.0 19.7
Ready-mix concrete production (million cubic yards) 0.4 0.6 1.4 1.5
Ashland Distribution (3)
Sales per shipping day (millions) $ 13.3 $ 11.6 $ 12.3 $ 11.1
Gross profit as a percent of sales 14.4% 15.1% 14.6% 15.3%
Ashland Specialty Chemical (3)
Sales per shipping day (millions) $ 5.6 $ 4.9 $ 5.1 $ 4.6
Gross profit as a percent of sales 30.7% 33.1% 32.3% 33.8%
Valvoline
Lubricant sales (million gallons) 50.0 49.2 141.3 142.2
Premium lubricants (percent of U.S. branded volumes) 22.0% 19.8% 21.0% 18.5%
Refining and Marketing (4)
Refinery runs (thousand barrels per day)
Crude oil refined 1,013 951 900 878
Other charge and blend stocks 142 129 174 130
Refined product yields (thousand barrels per day)
Gasoline 623 582 596 544
Distillates 323 292 285 276
Asphalt 85 76 70 69
Other 138 138 136 123
--------- ---------- --------- --------
Total 1,169 1,088 1,087 1,012
Refined product sales (thousand barrels per day) (5) 1,440 1,346 1,367 1,311
Refining and wholesale marketing margin (per barrel) (6) $ 5.27 $ 2.94 $ 2.87 $ 2.21
Speedway SuperAmerica (SSA)
Retail outlets at June 30 1,746 1,802
Gasoline and distillate sales (million gallons) 802 882 2,371 2,608
Gross margin - gasoline and distillates (per gallon) $ .1192 $ .1229 $ .1161 $ .1134
Merchandise sales (millions) (7) $ 600 $ 590 $ 1,668 $ 1,695
Merchandise margin (as a percent of sales) 23.4% 23.9% 24.4% 24.4%
- ------------------------------------------------------------------------------------------------------------------------------------
(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 nine
months ended June 30, 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 net income of $161 million for the
quarter ended June 30, 2004, compared to $70 million for the quarter ended
June 30, 2003. Ashland reported income from continuing operations of $167
million for the quarter ended June 30, 2004, compared to $71 million for
the quarter ended June 30, 2003. Ashland's results from discontinued
operations, consisting of 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, accounted
for the difference in net income and income from continuing operations.
Consistent growth in sales and operating revenues, an improved cost
structure and a healthier economy contributed to a 97% improvement in
operating income for the Chemical Sector (which includes Ashland
Distribution, Ashland Specialty Chemical and Valvoline). Ashland
Distribution achieved an all-time record for quarterly operating income,
reflecting a 14% increase in sales and operating revenues. Operating income
from Ashland Specialty Chemical improved on the strength of a 15% increase
in sales and operating revenues. Valvoline recorded a 25% increase in
operating income as its premium product strategy contributed to a 7%
increase in sales and operating revenues. In the Transportation
Construction Sector, Ashland Paving And Construction, Inc. (APAC) continued
its profit recovery, recording operating income of $43 million for the June
2004 quarter, compared to $17 million for the June 2003 quarter. Strong
demand, favorable refining margins and improved throughput resulted in $205
million in operating income from Refining and Marketing, compared to $100
million for the June 2003 quarter.
YEAR-TO-DATE - Ashland reported net income of $179 million for the nine
months ended June 30, 2004, compared to a net loss of $61 million for the
nine months ended June 30, 2003. Ashland reported income from continuing
operations of $195 million for the nine months ended June 30, 2004,
compared to income of $33 million for the nine months ended June 30, 2003.
Ashland's results from discontinued operations, consisting of 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, accounted for the
difference in net income and income from continuing operations.
Chemical Sector operating income totaled $194 million for the first nine
months of fiscal 2004, compared to $104 million for the 2003 period.
Ashland Distribution, Ashland Specialty Chemical and Valvoline all showed
significant improvement, reflecting a combined 11% increase in sales and
operating revenues and an improved cost structure. In the Transportation
Construction Sector, APAC recorded operating income of $41 million for the
2004 period, compared to a loss of $39 million in the 2003 period,
reflecting closer-to-normal weather and a reduced cost structure. Higher
refining margins and improved throughput led to an increase in Refining and
Marketing operating income from $145 million for the 2003 period to $232
million for the 2004 period. An analysis of operating income by industry
segment follows.
APAC
CURRENT QUARTER - APAC reported operating income of $43 million for the
June 2004 quarter, compared to $17 million for the June 2003 quarter.
During the quarter, APAC sold a significant portion of its ready-mix
operations, realizing proceeds net of selling expenses of $38 million and a
pre-tax gain of $9 million. Though sales and operating revenues were only
up 2%, overall margin was up, reflecting reduced costs across the business
and increased profits from the sale of hot-mix asphalt and aggregates.
Costs associated
15
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
APAC (CONTINUED)
with Project PASS, APAC's process redesign initiative, were $2 million in
the June 2004 quarter, compared to $6 million in the June 2003 quarter, as
that project is now essentially complete.
YEAR-TO-DATE - APAC reported operating income of $41 million for the nine
months ended June 30, 2004, compared to an operating loss of $39 million
for the nine months ended June 30, 2003. The improvement reflects more
normal weather conditions, a reduced cost structure and a $9 million gain
on the sale of a significant portion of APAC's ready-mix operations in the
June 2004 quarter. Net construction job revenues (total construction job
revenues less subcontract costs) increased 9% from the prior year period,
while production of hot-mix asphalt increased 8% and aggregate production
increased 7%. Costs associated with Project PASS were $10 million in the
2004 period, compared to $15 million in the 2003 period. At June 30, 2004,
APAC's construction backlog, which consists of work awarded and funded but
not yet performed, was $1.87 billion, a record for the June quarter and up
slightly over the same period in 2003.
ASHLAND DISTRIBUTION
CURRENT QUARTER - Ashland Distribution reported operating income of $23
million, an all-time record for quarterly operating income, compared to $11
million for the June 2003 quarter. Sales and operating revenues increased
14%, reflecting a 10% growth in sales volumes due to a healthier economy
and strong customer satisfaction. Ashland Distribution has continued to
build on its leadership positions in logistics and operational excellence.
These factors, coupled with the division's low-cost operational model, have
contributed to its dramatic recovery. The gross profit percentage declined
to 14.4%, compared to 15.1% in the June 2003 quarter, due to lower margins
in chemicals and environmental services. Selling, general and
administrative (SG&A) expenses were down $7 million compared to the prior
year period, reflecting the benefits of the Top-Quartile Cost Structure
(TQCS) initiative.
YEAR-TO-DATE - Ashland Distribution reported record operating income of $56
million for the nine months ended June 30, 2004, compared to $27 million
for the nine months ended June 30, 2003. The improvement reflects the same
factors described in the current quarter comparison. Sales and operating
revenues were up 11%, including 6% from volume increases. The gross profit
percentage declined from 15.3% to 14.6%, due to lower margins in chemicals
and environmental services. SG&A expenses declined $20 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 operating income of
$22 million for the June 2004 quarter, compared to $3 million for the June
2003 quarter, which included an impairment charge of $10 million for a
mothballed maleic anhydride production facility in Neville Island, Pa.
Growth initiatives combined with a lower cost structure led to improved
results despite continued higher raw material costs. Results from the
thermoset resins businesses (Casting Solutions, Composite Polymers and
Specialty Polymers & Adhesives) improved 48%, as sales and operating
revenues were up 18%, reflecting a 15% increase in sales volumes. Results
from the water technologies businesses (Drew Industrial and Drew Marine)
improved 57%, reflecting a 6% increase in sales and operating revenues.
YEAR-TO-DATE - Operating income for Ashland Specialty Chemical was $63
million for the nine months ended June 30, 2004, compared to $21 million
for the nine months ended June 30, 2003. Results from the thermoset resins
businesses increased 60%, while the water technologies businesses increased
34%. The improvement reflects the same factors described in the current
quarter comparison.
16
- --------------------------------------------------------------------------------
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
VALVOLINE
CURRENT QUARTER - Valvoline reported operating income of $30 million for
the June 2004 quarter, a 25% improvement over the $24 million reported for
the June 2003 quarter. Valvoline's core lubricant business improved on the
strength of a 7% increase in branded lubricant sales volumes, aided by a
19% increase in premium lubricant sales volumes. Valvoline's international
operations posted a record June quarter mostly due to a 9% increase in
lubricant sales volumes and stronger foreign currencies. Valvoline Instant
Oil Change (VIOC) earnings were lower as a result of a decline in the
number of oil changes, the impact of which was partially offset by a 3%
improvement in the average ticket price.
YEAR-TO-DATE - Valvoline reported record operating income of $75 million
for the nine months ended June 30, 2004, a 34% improvement over the $56
million reported for the same period in 2003. Valvoline's core lubricant
business improved, reflecting a 14% increase in sales volumes for premium
lubricant products. VIOC reported record earnings due in part to a 3%
increase in non-oil change revenues, and a 3% increase in premium oil
changes, contributing to a 7% increase in the average ticket price. In
addition, Valvoline's international operations posted record results mostly
due to a 3% increase in lubricant sales volumes and stronger 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 $205 million for the quarter ended June 30, 2004,
compared to $100 million for the June 2003 quarter. MAP achieved the
second-highest level of quarterly operating income in the joint venture's
history. High demand in the spring driving season, strong refining margins,
and record throughput at MAP's refineries contributed to a $129 million
increase in equity income from MAP's refining and wholesale marketing
operations. MAP's refining and wholesale marketing margin averaged $5.27
per barrel for the June 2004 quarter, compared to $2.94 per barrel in the
June 2003 quarter. Crude oil throughput during the June 2004 quarter
averaged a record 1.013 million barrels per day, up 7% over the June 2003
quarter. Equity income from MAP's retail operations (Speedway SuperAmerica
(SSA) and a 50% interest in the Pilot Travel Centers joint venture)
decreased $11 million, reflecting an $8 million gain on the sale of 190 SSA
stores in May 2003 and decreased product sales volumes as a result of the
sale. Ashland's administrative and other costs related to Refining and
Marketing increased by $10 million, reflecting mark-to-market losses of $2
million on margin hedges in the June 2004 quarter versus gains of $4
million in the June 2003 quarter, and transaction costs of $5 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. On June 21, 2004,
Ashland filed a preliminary proxy statement with the Securities and
Exchange Commission related to the transaction. The transaction is subject
to several previously disclosed conditions, including approval by Ashland's
shareholders, 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
$232 million for the nine months ended June 30, 2004, compared to $145
million for the 2003 period. Equity income from MAP's refining and
wholesale marketing operations increased $113 million, reflecting a 66
cents per barrel increase in MAP's refining and wholesale marketing margin
and increased throughput, due to the same factors described in the current
quarter comparison. Equity income from MAP's retail operations declined $9
million due to the same factors described in the current quarter
comparison. Ashland's administrative and other costs increased $17 million,
reflecting mark-to-market losses of $7 million on margin hedges in the 2004
period versus gains of $4 million in the 2003 period, and transaction costs
of $8 million associated with the proposed transfer of Ashland's 38%
interest in MAP.
CORPORATE
Corporate expenses amounted to $31 million in the quarter ended June 30,
2004, compared to $17 million in the June 2003 quarter, reflecting
increased incentive compensation costs. Corporate expenses amounted to $73
million for the nine months ended June 30, 2004, compared to $63 million
for the 2003 period. The increase reflects higher incentive and deferred
compensation costs in the 2004 period, partially offset by 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.
NET INTEREST AND OTHER FINANCIAL COSTS
Net interest and other financial costs declined to $29 million in the June
2004 quarter, compared to $31 million in the June 2003 quarter. For the
nine months ended June 30, 2004, net interest and other financial costs
amounted to $88 million, compared to $97 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 Nine months ended
June 30 June 30
------------------------ -----------------------
(In millions) 2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------------------------------
PRETAX INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Reserves for asbestos-related litigation $ (7) $ (8) $ (22) $ (171)
Electronic Chemicals
Results of operations - 5 - 12
Loss on disposal (2) - (3) -
INCOME TAXES
Reserves for asbestos-related litigation 3 3 9 67
Electronic Chemicals
Results of operations - (1) - (2)
Loss on disposal - - - -
---------- ----------- ---------- ----------
RESULTS FROM DISCONTINUED OPERATIONS (NET OF INCOME TAXES) $ (6) $ (1) $ (16) $ (94)
========== =========== ========== ==========
18
- --------------------------------------------------------------------------------
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 $77 million for the nine months ended June 30, 2004, compared to $111
million for the nine months ended June 30, 2003. Cash distributions from
MAP amounted to $146 million in the 2004 period compared to $108 million in
the 2003 period. This increase was more than offset by a $59 million
increase in pension contributions and a $45 million increase in federal tax
payments. Other operating cash flows from Ashland's wholly owned businesses
increased $32 million. Ashland's capital requirements for net property
additions and dividends exceeded cash flows from operations by $83 million
for the nine months ended June 30, 2004. Cash flows from operations for the
nine months ended June 30, 2004 have been supplemented by proceeds of $86
million from the issuance of common stock resulting from stock option
exercises and proceeds of $48 million from the sale of certain APAC
operations. 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. The final amount received by Ashland from the
transaction would be increased by an amount equal to 38% of the cash
accumulated from operations during the period prior to closing.
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 MAP
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.
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 nine months ended June
30, 2004. In the June 2004 quarter, Ashland executed an additional $200
million revolving credit agreement which expires March 31, 2005. Ashland
has utilized this facility to fund currently maturing long-term debt and
certain lease payments, and had $8 million outstanding under this facility
at June 30, 2004. While the revolving credit agreements contain covenants
limiting new borrowings based on Ashland's stockholders' equity, these
agreements would have permitted an additional $2.1 billion of borrowings at
June 30, 2004. Additional permissible borrowings are increased (decreased)
by 150% of any increase (decrease) in stockholders' equity.
At June 30, 2004, working capital (excluding debt due within one year)
amounted to $830 million, compared to $703 million at September 30, 2003,
and $872 million at June 30, 2003. The amount at June 30, 2003 included net
assets of $170 million of the discontinued Electronic Chemical operations.
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 $85 million at June 30, 2004, compared to $78 million
at September 30, 2003, and $74 million at June 30, 2003. Liquid assets
(cash, cash equivalents and accounts receivable) amounted to 87% of current
liabilities at June 30, 2004, compared to 92% at September 30, 2003, and
73% at June 30, 2003. The improvements since last June reflect a
combination of an increase of $104 million in cash equivalents and a
reduction of $245 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 nine months ended June 30, 2004, property additions amounted to
$121 million, compared to $84 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 $1.5 billion at June 30, 2004, $1.6
billion at September 30, 2003, and $1.9 billion at June 30, 2003. Debt as a
percent of capital employed amounted to 38.1% at June 30, 2004, compared to
41.7% at September 30, 2003, and 46.5% at June 30, 2003. At June 30, 2004,
Ashland's debt included $37 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 $186 million of third-party debt underlying those
transactions. As a result, Ashland was exposed to fluctuations in
short-term interest rates on $406 million of debt obligations at June 30,
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 June 30, 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 - 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. As of June 30, 2004, approximately 370,000
asbestos-related claims have been filed against Riley and/or Ashland. Of
this number, approximately 171,000 claims have been disposed of by
settlement or dismissal. The total number of claims pending as of June 30,
2004 is approximately 199,000, compared to 196,000 as of June 30, 2003.
The majority of these claims 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 varies as a result of jurisdictional
requirements and practices, though the overwhelming 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 the jurisdiction in which the complaint was filed. This
variability, coupled with the actual experience of resolving claims over an
extended period, demonstrates that damages requested in any particular
lawsuit or complaint bears 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 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 F to the Condensed Consolidated
Financial Statements in this quarterly report on Form 10-Q.
U.S. DEPARTMENT OF JUSTICE ANTITRUST DIVISION INVESTIGATIONS - (1) In April
2003, APAC-Missouri, Inc., an indirect wholly-owned subsidiary of Ashland,
received a subpoena from the U.S. Department of Justice, Antitrust Division
("USDOJ") in a federal grand jury investigation involving Missouri
Department of Transportation road building projects. On August 11, 2004,
APAC-Missouri, Inc. and one current APAC-Missouri, Inc. employee were each
indicted on a single charge alleging a violation of U.S. federal antitrust
laws in connection with a single project bid by the Central Division of
APAC-Missouri, Inc. in 2000 with revenues less than $8 million.
APAC-Missouri, Inc. will vigorously defend the action.
(2) In November 2003, Ashland received a subpoena from the USDOJ 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 number of civil actions have since been
filed in multiple jurisdictions, most of which are seeking class action
status for classes of customers of foundry resins. Ashland will vigorously
defend the 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, 2004, Ashland had been named a
PRP at 95 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
22
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 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
23
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.1 Amended and Restated Ashland Inc. Incentive Plan.
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.
(B) REPORTS ON FORM 8-K
During the quarter ended June 30, 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 April 7, 2004 containing a Regulation
FD disclosure.
24
(2) 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.
(3) A report on Form 8-K dated April 26, 2004 containing a Regulation
FD disclosure.
(4) A report on Form 8-K dated April 26, 2004 reporting Ashland's
second quarter fiscal 2004 results.
(5) A report on Form 8-K dated May 28, 2004 containing a Regulation FD
disclosure.
(6) A report on Form 8-K dated June 18, 2004 announcing that
APAC-Missouri, an indirect, wholly owned subsidiary of Ashland,
received a subpoena from the U.S. Department of Justice, Antitrust
Division in Missouri, in a road-building grand jury investigation.
(7) A report on Form 8-K dated June 28, 2004 containing a Regulation
FD disclosure.
(8) A report on Form 8-K dated July 14, 2004 announcing that Kathleen
A. Ligocki had been elected to Ashland's Board of Directors.
(9) A report on Form 8-K dated July 26, 2004 containing a Regulation
FD disclosure.
(10) A report on Form 8-K dated July 26, 2004 reporting Ashland's third
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: August 12, 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
- --------------------------------------------------------------------------------
10.1 Amended and Restated Ashland Inc. Incentive Plan.
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