Earnings Call Transcript

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Good day ladies and gentlemen and welcome to the Third Quarter 2008Ashland Earnings Conference Call. My name is Eric and I will beyour audio coordinator for today. At this time, all participantsare in a listen-only mode. We will facilitate a question-and-answersession towards the end of the conference. [Operator instructions].
I would now like to turn your presentation over to Mr. Eric Boni,Director of Investor Relations for Ashland. Please proceed.
Eric Boni - Director of Investor Relations
Thank you, Eric. Good morning and welcome to Ashland's thirdquarter fiscal 2008 conference call and webcast. We released ourthird quarter results at 8'o clock Eastern Daylight Time today.These results are preliminary till we file our 10-Q in August. Ourspeakers here today are Jim O'Brien, Ashland's Chairman and ChiefExecutive Officer; Lamar Chambers, Senior Vice president and CFOand Sam Mitchell, President of Ashland Consumer Markets.
On slide two, we provide our cautionary language regardingforward-looking statements. Statements made during the course ofthis presentation that constitute forward-looking statements asthat term is defined in relevant securities law. Ashland believesits expectations regarding its operating performance and theHercules transaction are based on reasonable assumptions, butcannot assure that those expectations will be achieved. Therefore,any forward-looking statements may prove to be inaccurate. You willalso see the mandatory additional information we must provide inconnection with the proposed acquisition of Hercules.
Please turn to slide three. Before we get started, I will give youan outline of the call. First, we will review Ashland's overallresults and then get into the specifics of our businesses,including a more in-depth review of Valvoline by Sam Mitchell.We'll then discuss our progress on cost structure initiatives andconclude our prepared remarks with an update on the Herculestransaction. After that we will take your questions.
Let's go to our third quarter highlights on slide four. Ashland'soverall results for our 2008 third fiscal quarter were solid, withoperating income increasing 19% on an apples-to-apples basis,versus the June 2007 quarter, which included certain key items I'lltalk about shortly. In aggregate, Ashland's volume was down severalpercentage points and we experienced approximately $80 million ofraw material cost increases during the quarter.
We will discuss our plans to recover these costs later in thepresentation. In light of the difficult economic environment, weare encouraged by our performance in the quarter. Ashland'sPerformance Materials was most affected by these macro economicfactors and reported a 44% decline in operating income. Valvoline'sresults were also affected by rapidly rising raw material costs,which outpaced price increases, leading to a 6% decline inoperating income versus the year-ago quarter. On a sequentialbasis, Valvoline's operating income did improve over March quarterearnings, benefiting from the traditionally strong summer drivingseason.
Ashland Water Technologies improved its results for the Junequarter, although they were enhanced by certain items that areunlikely to repeat going forward. We are encouraged by Ashlanddistribution's performance in the quarter and its continued focuson margin improvement led to a 70% increase in operating incomeversus the June 2007 quarter. The quarter descended also marked thethird consecutive quarter in which distribution increased itsincome sequentially. It is particularly worth noting that weincreased our EBITDA by 3% versus the year-ago quarter to $121million. Also, our focus on working capital continues to showresults. We achieved an additional 46 basis point reductionsequentially in our operating segment trade working capital as apercentage of sales excluding the effect of acquisitions.
Now, let's turn to the financial results on slide 5. Revenuesincreased 11% to $2.2 billion in the third quarter of 2008, drivenby significant price increases versus the year-ago quarter, 4percentage points of the increase were attributable to currencytranslation. Cost of sales increased at a slightly faster pacegoing up 12%. Gross profit dollars increased by $17 million or 5%although our gross profit percentage was down 90 basis points.Selling, general and administrative expenses grew 9% versus the 11%increase in sales, resulting in a 20 basis point reduction in SG&Aas a percentage of sales. Approximately 5 percentage points of thisincrease were due to currency translation. We will discuss theincrease in SG&A in more depth shortly. Our reported operatingincome declined 4% versus the year-ago quarter, but as I mentionedearlier, when key items in the June 2007 quarter are excluded,operating income increased 19%.
Please turn to slide 6 to see the key items affecting our operatingincome. This chart summarizes our operating income by segmentversus the same quarter last year and shows the impact of key itemson operating income. In 2007, each of our businesses was impactedto some degree by unusually large environmental reserve andemployee benefit income adjustments. The yellow all other operatingincome line for 2007 therefore represents our underlyingperformance. While we also had these types of items in 2008 theywere at historical levels, and do not warrant specific adjustment.And thus the all other operating income and operating income linesare identical. On a comparable basis all other operating incomeincreased by $13.9 million or 19% versus the year-ago June quarterwith a combined $15.2 million improvement in distribution and WaterTechnologies as well as a $12.2 million improvement in ourunallocated and other line. More than offsetting the $12.8 milliondecline in performance materials. We will discuss the operatingincome performance of each of our businesses in detail later.
Let's move to slide 7 to look at Ashland's income bridge. Operatingincome declined by nearly $4 million to $86.8 million in the June2008 quarter as compared with the year-ago quarter. Currencytranslation contributed positively to the quarter by $5.6 million.Volume had a $1.1 million positive impact to earnings as increasesin the water and Valvoline businesses offset volume declines inPerformance Materials and distribution.
Similarly, significant margin increases in distribution were offsetby margin declines in our other businesses. SG&A increased by $10.4million excluding currency impacts. Let's turn to slide 8 for moredetail on the SG&A. Reported 2008 third quarter SG&A increased by$24 million versus the same prior-year-quarter on an as reportedbasis. $5 million of this increase was attributable to adjustmentsto incentive accruals in the Ashland distribution business.Additionally, certain portions of the environmental reserve andemployee benefit adjustments noted on slide 6 were included in theSG&A line and totaled $18 million. When taken into account with the$13 million of currency translation, all other SG&A expensesdeclined by $12 million or about 5% versus the year-ago quarter.
Now please turn to slide 9 for a review of our preliminary earningsper share chart. Looking at this chart, you'll see that netinterest and other financing income for the third quarter declinedby $4 million. This primarily reflects lower interest rates onAshland's cash and securities. Income taxes increased by $12million giving us an effective tax rate of 29.4% in the June 2008quarter versus 15% in the 2007 quarter. The tax rate for bothperiods included the net favorable effect of adjustments to theestimated annual tax expense. In the unusually low 15% effectivetax rate in the year-ago quarter also reflected favorabledevelopments with respect to settlements for certain tax matters.
Discontinued operations in both periods include net favorableadjustments to asbestos reserves, primarily to related insurancereceivables of $6 million in 2008 and $16 million in 2007 as wellas other smaller items. On a reported basis, our earnings per sharefrom continuing operations amounted to $1.03 as compared with $1.35in the year earlier quarter.
Let's go to slide 10 to see our EPS on an adjusted basis. When thepreviously mentioned key items are excluded from the prior period,our diluted earnings per share from continuing operations for theJune 2008 quarter were $1.03 as compared with $1.18 in the June2007 quarter.
Let's turn to slide 11 for a review of our cash flows. Ashlandgenerated positive operating cash flows after capital expendituresat $75 million in the June 2008 quarter, an increase of $20 millionor 36% versus the prior-year quarter. This brings totalyear-to-date cash generated to $216 million versus the use of cashof $94 million through nine months last year. This dramaticincrease of more than $300 million is a direct result of ourincreased focus on working capital management throughout thecompany. EBITDA for the June 2008 quarter increased by $4 millionor 3% over the year-ago quarter.
Please turn to slide 12 for a more in-depth look at our tradeworking capital. Our internal benchmark of operating segment tradeworking capital to sales decreased sequentially by nearly one-halfof 1% of annualized sales in the June quarter, excluding the impactof working capital added through acquisitions. We continue to makeprogress on managing inventories, reducing them by an additional 61basis points versus the end of the March quarter. All of ourbusinesses contributed to this improvement with Water Technologies'especially noteworthy reduction of more than 350 basis points inone quarter. We are starting to realize a reduction in our accountsreceivable as a percentage of sales in all of our businesses mostnotably in the Valvoline organization. However we have not achievedthe hope for progress in increasing our payables as a percentage ofsales. We are continuing to focus on ways to improve this metric.Overall, we are pleased with our progress and look forward toachieving further reductions in the working capital requirements ofour businesses. Now I'd like to turn the presentation over to LamarChambers to discuss the performances of our businesses. Lamar?
Thank you Eric and good morning everyone. Let's turn to slide 13 tolook at the results of our Ashland Performance Materials business.Volume per day declined 4% as compared with the year-ago quarter,including a greater than 10% reduction in volume in the Americasprimarily in our composite polymers business. As you are well awarethe US residential, construction and transportation marketscontinue to struggle, impacting volumes in our largest markets.
Sales of larger vehicles such as SUVs and pickup trucks, justproportionally impact Performance Materials particularly incomposite polymers unit. The precipitous drop-off in large vehiclesales has had a real impact on our recent performance. That said,we continued to experience significant growth in Asia with a nearly30% increase in volume versus the prior year. Asia now representsnearly 9% of Performance Materials total volume. We also continueto achieve some volume growth in Europe albeit at reduced levels,primarily the result of strong growth in our casting solutionsunit.
Additionally, our premium business such as our Derakane and Hetronresins, which are sold into markets such as infrastructure andenergy continues to generate strong margins and provide someunderlying stability for profitability. Sales of operating revenuesincreased by 6% to $425 million as currency translation and priceincreases helped to offset reduced volume. The lag in achievingprice increases is the primary cause of our reduction in grossprofit percentage. We have also been targeting lower marginbusiness to help recover some of the volume lost due to ourcustomers reduced production, which is also contributing to thegross profit percentage reduction.
Selling, General and Administrative Expenses increased 5% versusthe year-ago quarter [inaudible] an adjusted performing currencytranslation, SG&A increased by only approximately 1%, a directresult of severance charges related to our cost structureefficiency initiatives. Overall operating income fell by 44%primarily a result of reduced margins. Increases in castingsolutions income were offset by significant reductions in ourcomposite polymers unit.
Now let's go to slide 14 to review the components of our change inoperating income for performance materials. Volume reductionsaccounted for roughly $6 million of the operating income decline inthe quarter. Margin pressures in the quarter were more pronouncedand accounted for $12 million of the decline in operating income ascompared with the June 2007 quarter.
As raw material costs have increased we've only been able torecover approximately 80% of these increases thus far. However, wehave announced price increases for July and August, but do notexpect to fully recover the raw material increases until about theend of the September quarter. As a result of these factors and thenormal seasonality of business we expect Performance Materialsoperating income to be down significantly versus the June 2008quarter. We do however, expect some upside earnings potential fromthe significant cost structure improvements underway which we willdiscuss further in a few minutes.