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Executives

Jason Thompson - Director, IR

John Panichella - SVP and Group Operating Officer, and President, Ashland Specialty Ingredients

Lamar Chambers - SVP and CFO

Jim O’Brien - Chairman and CEO

Analysts

John McNulty - Credit Suisse

Laurette Alexander - Jefferies

Jeff Zekauskas - JPMorgan

David Begleiter - Deutsche Bank

Mike Sison - KeyBanc

Mike Harrison - First Analysis

Dimitri Silverstein - Longbow Research

Ashland (ASH) Q1 2013 Earnings Call January 29, 2013 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Ashland Inc. First Quarter Earnings Call. (Operator Instructions) As a reminder, this call is being recorded. I would now like to turn the conference over to your host for today, Mr. Jason Thompson, Director of Investor Relations. Sir, you may begin.

Jason Thompson

Thank you, Ben. Good morning, and welcome to Ashland’s first quarter fiscal 2013 conference call and webcast. We released results for the quarter ended December 31, 2012 at approximately 6 a.m. Eastern Time today and this presentation should be viewed in conjunction with the earnings release. These results are preliminary until we file our 10-K.

On the call today are Ashland’s Chairman and Chief Executive Officer, Jim O’Brien; Lamar Chambers, Senior Vice President and Chief Financial Officer; and John Panichella, Senior Vice President and Group Operating Officer responsible for Ashland Specialty Ingredients and Ashland Water Technologies.

As shown on Slide 2, our remarks today will include forward-looking statements as that term is defined in securities laws. We believe any such statements are based on reasonable assumptions but cannot assure that such expectations will be achieved.

Please also note that during this presentation, we will be discussing adjusted results. We believe this will enhance understanding of our performance by more accurately reflecting our ongoing business.

Please turn to slide 3 for our first quarter highlights. In the December 2012 quarter, we reported earnings of $1.27 per share from continuing operations. On adjusted for key items, EPS was $1.12 as compared with $1.20 in the year ago quarter.

We acquired ISP on August 23, 2011 and the prior year includes a full quarter of the ISP results and related financing. Sales during the quarter were $1.9 billion. When we normalize for currency and adjust for divestitures and joint ventures, sales would have flat with the prior year quarter.

I will note that our fiscal first quarter is our seasonally weakest, coupled with this typical seasonality was a very soft month of December impacting Specialty Ingredients. Our adjusted EBITDA was $268 million which was a 11% below the prior year.

During the quarter, we took about $31 million loss on straight guar, $6 million higher than the $25 million loss we previously described at our Analyst Day in early December. This includes an inventory write down as well as some transactional losses on a higher cost inventory.

Total after-tax guar EPS impact was $0.25 per share, excluding this effect adjusted EPS would have been up 14% versus prior year. We have addressed the Straight-guar issue and it is behind us. Outside of guar we experienced reduced demand and energy, coatings and construction most notably during the latter half of December. For the remainder of our business we have mixed results.

Water Technology saw year-over-year decline in sales and volume offset by an increase and gross profit margin due to a stronger business mix. Performance Materials was negatively affected by reduced margins in the Elastomers business and weakness in the European economy. Consumer market's EBITDA increased by 34% year-over-year due to lower raw material cost and a strong quarter for the international business. Slide 4 details are key items.

In total three key items had a net favorable EPS impact on continuing operations of $0.15 in the December 2012 quarter. First key item is an insurance settlement resulting in a $22 million game or a positive $0.16 per share due to a business interruption insurance. We expect to receive the cash for this in the second quarter. This is related to a supply disruption and our Specialty Ingredients site in Calvert City that occurred in 2011. The settlement was for damages incurred while the normal source of a key raw material was disrupted. The supply chain and associated cost structure was back to normal for the full December quarter.

The second key item is a $5 million after tax charge or a negative $0.06 per share related to various cost restructuring efforts. Roughly 1/3 of this charge steamed from plant rationalization projects which when completely should lead to better utilization rates and improved fixed cost absorption. The remaining two-third is related to the ISP integration.

Lastly, we had a tax benefit of $4 million or a positive $0.05 per share due a deferred tax adjustment related to foreign corporate income tax rate changes. In the year ago quarter, two key items combined for a net unfavorable impact on earnings of $0.44 per share. To aid in your analysis, versus the peer group Ashland’s results included $29 million of intangible amortization expense during the December 2012 quarter. We carry higher than average amortization due to our corporate transformation and prior acquisitions. Without this amortization, earnings would be roughly $0.25 higher or $1.37 per share.

Please turn to slide 5 for Ashland’s adjusted results. Ashland’s December quarter sales decreased 3% over the prior year to $1.9 billion. We did not achieve the sales growth we were expecting due to softness across three of the four business units. Sales declined 9% sequentially. December is our seasonally weakest quarter which accounts for some of this decline.

We continue to experience weakness in our more commoditized products including straight guar, solvents, and elastomers but we also had volume declines in our coatings and construction segments during the month of December.

Gross profit as a percent of sales was 27.6% excluding the loss on straight guar in the quarter, gross profit margins would have been up 100 basis points to 29.3%. Selling, general, administrative, and research and development expenses collectively referred to as SG&A was up slightly to $368 million.

EBITDA of $268 million was 11% below the prior year and down 23% sequentially. EBITDA margin was 14.3% compared to 15.6% in the prior year.

Now turn to Slide 6 to review our volume trends. This chart shows underlying volume trends on a normalized and rolling four quarters basis. By totaling the trailing four quarters for each period, we are eliminating seasonality and showing yearly growth. The data have been normalized for acquisitions, divestitures, and joint ventures.

As shown here, volumes and Specialty Ingredients flattened out in recent quarters. We believe this is in part due to temporary issues. John will elaborate on this later. Performance Materials had been trending downwards primarily due to reduced demand in Europe and the emerging regions. The trend has recently reversed due to a strengthening North American environment.

Water Technologies and consumer markets have started to show improvement with new leadership in place in the Water Technologies business, we are focused on improving volumes over the next few quarters.

Now let’s turn to slide 7 for Ashland’s overall EBITDA Bridge. This chart shows what led to the December quarter's performance as compared with the year ago period. Margin declines in Specialty Ingredients and performance materials drove the year-over-year decrease in EBITDA.

The margin decline in Specialty Ingredients was primarily concentrated in our straight guar and in our intermediates and solvents business. Performance Materials had a tough comp to the prior year quarter where elastomers benefited $10 to $12 due to pricing. SG&A which is adjusted for currency translation negatively affected EBITDA by $6 million, currency translation represented $5 million headwind to EBITDA. Altogether, EBITDA decreased by $33 million compared to a year ago.

Now let's turn to slide eight. All liquidity, which is cash plus available revolver and AR capacity, was $1.4 billion at quarter end. We paid down roughly $40 million of debt during the quarter, reducing our cash balance to $488 million. Our gross debt remained at $3.6 billion and our net debt remained at $3.1 billion. I'll remind everyone that we have a long term targeted gross debt to EBITDA ratio of two times. As we generate cash throughout the year we expect to progress toward meeting this goal.

I'll now turn the presentation over to John Panichella and ask you to turn to slide nine.

John Panichella

Thank you, Jason, good morning everyone. Our fiscal first quarter results did not meet our expectations, this underperformance was due to a volume issue not a margin issue. We experienced lower than expected volumes in our energy, coatings, and construction businesses, particularly during the last two weeks of December. In addition, we had a higher than anticipated loss on straight guar for the quarter, we will go into detail on guar and energy in a few minutes. Specialty ingredients sales decreased 1% to $622 million versus the prior year, there were several factors contributing to this sales decline. Coatings and construction sale and volumes were both down year over year. Both businesses experienced destocking among several large distributors and customers, primarily within emerging markets.

We typically see modest declines in these businesses at this time of the year; however this year was significantly lower as a result of year end order patterns. We also saw sales decline in our intermediates and solvents business, primarily in emerging markets. The drop in sales was due to pricing and is consistent with what we have communicated on previous earnings calls. In addition the year ago quarter includes $6 million in sales from a facility in Jinmen, China, that we closed during the year. We are disappointed with the overall results during the quarter which were below our growth expectations.

On a positive note we saw year over year sales and gross profits increases in our pharmaceutical, oral and hair care, non-energy, non-guar energy and specialties businesses. Gross profits as a percent of sales was 27.5%, 590 basis points below the prior year. This year over year drop is due almost exclusively to loss on straight guar and intermediates and solvents pricing. SG&A was $121 million in the quarter which is down sequentially by $6 million. Overall, EBITDA fell 28% versus the prior year to $116 million and EBITDA as a percent of sales was 18.6%. Excluding the loss, the straight guar losses, EBITDA margins would have been about 24% which is roughly in line with our near term expectations.

Slide 10 shows Specialty Ingredients EBITDA Bridge. The $31 million loss on straight guar was the largest contributor to the year-over-year decline in EBITDA which is captured in the margin category on the slide.

Gross profit in the year ago period for our straight guar product line was $7 million. The net effect to EBITDA on a year-over-year basis due to straight guar is $38 million. Hurricane Sandy affected operations at our East Coast plans which reduced the EBITDA by $2 million.

Improved business mix largely offset the effect of lower overall volumes. Several of our higher margin businesses did well. But we saw compression in our low margin intermediates and solvents product lines.

Excluding the loss on straight guar and intermediates and solvents pricing EBITDA would have been flat. SG&A adjusted for currency was a $5 million headwind to EBITDA. In addition currency translation negatively affected EBITDA by $4 million. In total, EBITDA was down $44 million over the year ago December quarter.

Please turn to slide 11. We mentioned during our December 4th analyst day that we expected to incur a $25 million loss on straight guar in the first quarter. This estimate was based on market conditions at that time. Through the month of December, price continued to move against us ultimately increasing the loss to $31 million.

As of today, we have orders for all remaining material and expect two thirds to be shipped by the end of the month with the remainder shipped by the end of the quarter. To make it clear, because of the lower cost or market adjustment we expect to generate no margin from straight guar sales during the second quarter. We have taken several steps to significantly reduce risk associated with the straight guar business.

First, we worked directly with our suppliers and customers to improve supplying commercial agreements. This enables us to mitigate the inherent risk in this volatile market. Second, we affirmed up our supply chain processes to optimize inventory levels. As a result, we have reduced inventory levels from three months to one month and expect to manage at this level going forward. We feel these measures will dramatically reduce earnings volatility in this business.

I would like to remind you that the guar dynamics differ by end product. We sell two main types of guar. Our straight guar product lines are more commoditized and experience dramatic declines in volume over the prior year quarter. We expected this and have discussed it in previous calls. The second type is derivatized guar which are highly differentiated, more technically advanced products.

Volumes on derivatives were down relative to the prior year but profitability was up on strong pricing. We expect underline demand for these products to return to normal levels towards the end of the second quarter as our customers received 2013 project funding.

Please turn to slide 12 and I’ll give you an outlook on the other parts of our business. These are the key areas of our strategy that will support growth. We described each of these in detail at our analyst day. Despite the difficult quarter, we remain on track in most of these areas. Our top line strategy is to grow within key segments, strategic accounts, new products and emerging regions. We continue to improve both the top line and profitability on a year-over-year basis in our pharmaceutical and personal care businesses.

Coatings and other key segment for growth experienced some softness in the quarter due primarily to emerging markets. The broader HEC market for coatings have experienced over the past few quarters. This market does exhibit some volatility from quarter-to-quarter but historically, it has grown 4 to 5% annually. We expect the market will return to the historical trend but we are cautious about demand for our coatings HEC products in the second quarter.

We saw solid growth in our top 40 strategic accounts and new products during the quarter with sales up 11% and 12% respectively. We are pleased with this performance. Emerging markets is an area where we failed to meet growth expectations especially during the month of December. One example is with our HEC product line sold into the emerging regions of Latin America, Eastern Europe and Middle East Africa where we saw significant declines. We did see sales growth in North America.

Our construction business was also affected by weak demand in the emerging markets. We did not anticipate weakness in these regions in either of these product lines and do not expect that it reflects any long term trend. We remain confident in the underline trends that support growth in the emerging markets but do expect some volatility as these trends play out. In the near term, we anticipate two headwinds affecting Specialty Ingredients. The first is continued weakness in emerging markets in Europe; the second is related to the intermediates and solvents product lines. We have seen reduced price in these commodities, due to softer demand in capacity expansion by our competitors. This was discussed at both our 2012 fiscal fourth quarter earnings call and previous analyst days. For the most part, this continues to play out as expected. As a result of these near term headwinds and strict guar sales generating no margin, we expect our overall second quarter sales to be relatively flat with the prior year quarter.

We continue to expect a differentiated more technically advance businesses such as pharmaceutical and personal care will remain strong. We do expect continued weakness in our more commoditized product line. I'll now turn the presentation over to Lamar who will covers the Water Technologies business on slide 13.

Lamar Chambers

Thank you John and good morning everyone. Whilst still weak versus the prior year, Water Technologies performance slightly improved over the September quarter. Volumes were down 1% versus the prior year and sales $421 million were down 6% from the prior year. Normalizing for currency effect divestitures of sales and volumes would have been roughly flat year over year.

Gross product increased 100 basis point from the prior quarter due to strong pricing and mix. SG&A of $125 million was essentially flat for the September quarter. At $34 million, EBITDA increased 3% sequentially but was down 15% versus the prior year. EBITDA as a percent of sales was 8.1%. In total, (inaudible) performance and Water Technology has stabilized.

Geographically, Latin America remains strong and all other regions remain soft. We have new leadership in place and actions are being taken today to improve this business. Among these are improving sales efficiency, increasing focus on large multinational customers, incorporating strict contract management procedures and pricing management.

We expect to see benefits from these actions over the next few quarters. The new management in place were examining our longer term strategy including our operating model and cost structure and we expect to share a more details during our March quarter earnings presentation.

Now let`s turn to the bridge on slide 14. Excluding divestitures volumes were slightly higher versus prior year. Margin was a tail wind in the quarter driven by price and normalized for currency; higher SG&A expenses more than offset this benefit. Currency translation negatively affected EBITDA by $2 million. The other consists of our divested North American moves and commercial businesses. In total, EBITDA decreased $6 million from the year ago quarter.

Please turn to slide 15. Performance Materials reported volume of sales were both down 9% from the year ago quarter. When we exclude the effect for the divested PVAc business, volumes were flat year over year. Sequentially, volumes were down 6%, roughly in line with normal seasonality. Overall, sales were $345 million. Normalizing for currency and adjusting for business divestitures, sales would have been down 4% from the prior year.

We achieved gross profit as a percent of sales of 15.7%, a 350 basis point decline from the prior year. For Performance Materials in total, we view normalized gross profit at current demand levels as being roughly in line with these results. This level varies to some degree based on normal seasonality.

I will remind you that the year ago quarter does include a $10 million to $12 million benefit from elastomers due to declining butadiene cost.

Going forward, we expect the elastomers business to be affected by three different drivers. First we expect Butadiene’s cost to continue ticking up. As we have mentioned before, we have about four to six week lag on price which we would expect to impact margin slightly. Second, the replacement tire remains weak. And third, low cost imports continue to influence the market. As a result, we expect second quarter elastomers volume to be roughly in line with Q1.

Our composites business continues to be impacted by weakness in Europe, China and Brazil. This was somewhat offset by year-over-year improvement in North America, due to the improving construction market.

SG&A was $44 million or 2% below the year ago quarter and in line with expectations. While not explicitly shown on this slide, we had roughly $2 million year-over-year decline in equity income from a casting solutions joint venture. This shows up within performance materials operating income. Most of this decline is due to the significantly reduced demand in the European transportation market and actions are currently being taken to out realign the joint venture’s cost structure with existing demand levels.

In total, Performance Materials EBITDA was $28 million during the December quarter with EBITDA margins of 8.1%.

Now, let’s turn to slide 16. On this bridge the effects for the ASK Chemicals joint venture and the divested PVAc business are captured in the other category. Other was a $3 million headwind of EBITDA. Excluding those effects, decreased elastomer margins accounted for essentially all of decline in EBITDA year-over-year, which was due to Butadiene effects. The volume declines in Europe led to a $3 million reduction to EBITDA. SG&A adjusted for currency was down $1 million. In total, EBITDA fell $17 million during the quarter, most of which was attributed to the usually high earnings generated by the elastomers business in the year ago quarter.

Now let’s go consumer markets on slide 17. Consumer markets had a strong quarter with significant expansion in earnings due to volume increases in our international business and lower material cost. Lubricant volumes were up 1% versus the prior year and down 8% sequentially (inaudible) normal seasonal declines.

Our international business had a record first quarter with volume increases of 30% over the prior year. This business was seeing consistent earnings growth over the past several quarters, most notably in Asia and Latin America. Sales of $481 million were up 1% versus prior year. Gross profit as a percent of sales increased 480 basis points to 30.1%. Gross profit has improved due to a number of raw material decreases announced over the past eight months. The most recent announcements was in early January and the effects will begin to take place in the March quarter. Some of this benefit will be eroded through competitive pricing adjustments. As we have said in the past, we expect gross profit percent to be in the high 20% range. SG&A were up $6 million for 8% from the prior year.

I will remind everyone that our advertising spend during the December quarter is typically our lowest and that we would expect an increases on a dollar basis (inaudible) to the summer driving season. Overall, consumer markets generated EBITDA of $75 million, a 34% increase over the prior year. We achieved EBITDA margins of 15.6%.

Now please turn to slide 18 for consumer markets EBITDA Bridge. Our margins were the primary driver the year over increase in EBITDA accounting for $19 million of EBITDA growth. This was driven by falling input costs as previously discussed. Volume and mix added $4 million to EBITDA, primarily due to strong international volumes. The other category captures equity income from our joint ventures and contributed $1 million of the EBITDA increase for the quarter. In total, it was a strong quarter for consumer markets for the EBITDA increasing by $90 million from the prior year.

Please turn to slide 19 for a few comments on corporate items. Capital expenditure for $51 million for the December 2012 quarter and our 2013 forecast remains $385 million. We expect to spend a little over half of this in Specialty Ingredients with most of the growth capital concentrated there.

Net interest expense for the quarter was $44 million. This is in line with $180 million annual run rate we mentioned at our Analyst Day in early December.

Our effective tax rate for the quarter was 24% excluding the effects of key items. This is slightly below our fiscal 2013 estimate of 26-28% which remains unchanged for the full year.

Trade working capital for the quarter averaged 17.3% of annualized sales. This is roughly in line with our target of 17% and 100 basis point improvement from the year ago quarter.

We generated $30 million of free cash flow which is unusually high for the December quarter. For example, we had use of cash of $133 million in the prior year quarter. Now, I will turn the presentation over to Jim O’Brien for the closing comments starting on Slide 20.

Jim O’Brien

Thanks Lamar and good morning every one. As you heard this morning, Ashland had a challenging quarter. Our financial results came in below our expectations due to weak demand in some key markets and the loss on straight guar. Three of our four commercial units experienced year-over-year decline in sales. Most of this was in the more commoditized product lines including straight guar, solvents, and elastomers.

We also saw volume declines in two of our more growth oriented businesses, coatings and construction. During the last two weeks of December, a number of our customers curtailed purchasing particularly in the emerging markets. They have returned to more normal purchasing patterns in January.

Sales for the quarter declined slightly to $1.9 billion down 3% from the prior year. However, when we normalize for currency divestitures, sales would have been flat. Specialty ingredients had a weak December and a quarter that did not meet our expectations. Performance in the quarter was a volume issue and not a margin issue. The loss on straight guar was more than we anticipated and volumes in our coatings and construction businesses declined dramatically in the latter half of the month. We did see year over year improvement in sales and profitability in key segments, such as pharmaceutical, oral and hair care. Within Water Technologies, both sales and volumes declined compared to the prior year. These were concentrated primarily in our low margin product lines. Gross profit margin in this unit improved both year over year and sequentially. And we saw year over year growth in our North American packaging and tissue and towel business. We believe the floor has been set for this business and have confidence that Luis and his leadership team can return it to growth.

Performance materials continues to be affected by weak economic activity in Europe. Both our composites business and our casting solutions joint venture were affected by the slow economy in this region. However, performance materials continues to experience strength in North America, due to rebounding construction work. The supermarkets performed well in the quarter. We had year over year improvement in volumes led by strong results in our international business. We also had same store sales growth within Valvoline Instant Oil Change. We continue to maintain more normalized margins in line with our longer term expectations.

We achieved EBITDA of $268 million during the quarter, which included a $31 million loss on straight guar, and an adjusted EPS of $1.12. Excluding the loss on guar, adjusted EPS would have been up 14%, year over year. It was a strong quarter for cash flow, and as you heard from Lamar, we generated $30 million of free cash in a seasonally difficult period. As we mentioned before, we have an insurance settlement and expect to receive the associated cash in the second quarter.

Let's turn to slide 21. January data is showing that Specialty Ingredients is back on track for this second quarter. As order patterns have returned to more normalized levels. I am encouraged by this. But with only one month of data, I am cautiously optimistic about the March quarter.

For Performance materials, we do not expect much improvements in the elastomers business in the second quarter, and anticipate overall margins to remain steady at current demand levels. Water Technologies performance has stabilized. We continue work on the business model and are hopeful for improvement in the coming quarters.

Sequentially, we expect slightly better performance for consumer markets as it continues to improve. At a corporate level, we continue to focus on generating free cash flow which we are currently directing primarily towards debt reduction. Additionally, we routinely analyze growth investments and other value created opportunities.

I would like to reiterate our stance on this straight guar market. I stated at the analyst day in early December that we would not participate in a speculative market. We have taken actions during the quarter to minimize the risk that is inherently volatile segment. And I can say that the inventory and earnings volatility issues we have faced over the past several months are behind this.

To wrap it up, I want to reaffirm our commitment to the 2013 objectives laid out on our September earnings call. Our strategy certainly has not changed because of one challenging quote. We have strong competitive positions in many high growth markets and I firmly believe we can execute to hit our goals. This positions us well to deliver on our overall 2014 financial targets that we presented in analyst day.

With that we'll take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from line of John McNulty from Credit Suisse. Your line is open, please go ahead.

John McNulty - Credit Suisse

A few questions on a the Specialty Ingredients business. I know you don’t normally give overly specific guidance on the business, but just because of all the moving parts, I am trying to think about the base for the second quarter or how we should be thinking about that. in terms of earnings or EBITDA, you didn’t, 116 in first quarter, it looks like about 33-34 million and that was kind of onetime whether it’s write downs or Sandy, so that kind of moves you to a 150 run rate and then it looks like, if I heard you right, you’re looking for flat volumes year-over-year so that’s up call it $80 million. So, should we be thinking about the base for the second quarter in terms of EBITDA in that kind of 170 to 180 range is that kind of right ball park to be thinking about growth going forward?

Lamar Chambers

We’ll not give you a specific number John; I think that the way you’re thinking about is directionally right. The guidance that John gave in you in his presentation was that we expect the second quarter to be in line with last year's second quarter. Now the mix is going to be different because there was a lot of guar in that number and obviously as we said, there won’t be any guar in the second quarter as far as straight guar. Now the derivatized guar will pretty much be in line what we expect for that period.

So, overall the growth that we’re going to get will be in the pharmaceuticals, the hair care and the personal care and as John also stated, we’re expecting the HEC market for coatings to still be a little weak because they haven’t kicked in to the construction season and also we’re seeing some weakness in the emerging markets. So, as those continue to strengthen, we think that we’re here in the second half or open up, fix up but if you’re going to set your expectations for ASI, I would use last year's second quarter as your first guide.

John McNulty - Credit Suisse

Okay. And with regard to the destocking that you saw in the segment. Do you have much color as to where the inventories are at your customers and if there is at any point a need for a restocking phase or are the inventory just too fast to start within they’ve just got them back down to more normal levels. How should we think about that?

John Panichella

Yes, that’s why we commented on January sales. So we were a little bit surprised by the last two weeks of December. We’ve gone out and talked to our top 80 distributors and understand where the inventory levels are. And as Jim said, we’re cautiously optimistic, January looks to be tracking where we expected it and their buying patterns have returned to normal.

John McNulty - Credit Suisse

Okay, fair enough. And then just one last question on the raw material front. It look likes you’ve got a number of moving pieces, on Valvoline coming down a reasonable amount. On the water tech side, you should be seeing propelling, I guess pushing higher. So, can you give us a little color as to how we should think about the incremental hits and benefits on these and how they all together may net out?

Jason Thompson

I think on (inaudible), what you’re seeing as far as the margin expansion because of the pricing is pretty much in line because you have to give some of that back as it rolls through year your own numbers to the market and that’s pretty much takes place.

On the propelling side, as moves through what the pricing actions recover that. So if the (inaudible) does move, as you stated, then the only avenue we have for recovery will be to move it through the market and that only gives us about a one month lag, to get that done. So overall though as we look at products based on crude oil, we're concerned that they crude continues to move that's going to improve upward pricing pressure. But at the same time, it seems to be trading with a certain range, so I really can't predict what we'll see in the second quarter. But if we do a deep sea increases, what they are passing through.

Operator

Thank you, our next question comes from the line of Laurette Alexander of Jefferies, your line is open please go ahead.

Laurette Alexander - Jefferies

Two questions on Specialty Ingredients. First, were you surprised by the degree of cyclicality or volume lumpiness in the cyclical parts of the business?

John Panichella

We predicted the specialty solvents decline. So we weren't very surprised by that. So what we were more surprised by is the coatings construction weakness that we saw towards the last couple of weeks of December. So, the specialty solvents we had anticipated and it was pretty much in line with what we have expected. It's down year over year but pretty much what we had expected.

Laurette Alexander - Jefferies

And then just to clarify the prior comments. So when you say that we should be thinking about Specialty Ingredients as being flat with Q2 last year, that's on the profit level, not just the sales level, is that right?

Lamar Chambers

That's correct, that was the statement that I made.

Laurette Alexander - Jefferies

And then with Valvoline, given the trends that you have been seeing in the last few quarters, what's your sense of your possible peak margins in that business and what kind of conditions would you need to see to get back there?

Lamar Chambers

I think to see peak margins to get back, you need a couple of things, one is a continually falling base stock markets which we don't anticipate. So with that I wouldn't forecast that and at the same time you don't need a strength in consumption, which consumption is staying pretty steady so you don't see a tremendous amount of increasing assumption. Although, our international business is certainly getting additional share in growing with the market. So that's good to see. But when you look at peak margins, it's really driven by a dramatic fall and a base stock and we have not seen that. We only had a couple of price decreases which is difficult of the growth of the base stock of material market but I would not say that we're in line to have a real big large surge of margin at this point.

Operator

Thank you. Our next question is from the line of Jeff Zekauskas from JPMorgan. Your line is open, please go ahead.

Jeff Zekauskas - JPMorgan

Your adjusted tax rate in the first quarter was a little bit more than 24% though you are expecting 26% to 28% for the year. Why was the first quarter adjusted tax rate lower than your expectation for your annual tax rate?

Lamar Chambers

Because as we look at our model for the estimate of our effective tax rate, there is certain, somewhat discreet items that you book in the period that they occur that’s incorporated in that total year estimate. As that happened a couple of significant of those discreet items did occur in the first quarter. So that was built into our expectation around the full year tax guidance in the 26% - 28% range but we benefited from that in the first quarter. So what you should expect to see is the rest of the year will be a little above the first quarter to average out to that mid 20% range.

Jeff Zekauskas - JPMorgan

These were not prior period adjustments, were they?

Lamar Chambers

No-no, these are typical adjustments to various tax reserves domestically and internationally and certain credits that flow through on a discreet basis. So nothing non-recurring I guess I should say but still booked in the discreet period.

Jeff Zekauskas - JPMorgan

Okay and in terms of intermediates and solvents prices, can you give us an idea of sort of where Butadiene prices are and whether the comparisons appear to get worse or they get better as we go into the second quarter.

John Panichella

Yes so I think we said that sales dropped about $9 million primarily due to pricing and going forward in to Q2 we see that about the same. Maybe I would say that you ought to figure on something pretty similar for Q2. We don’t think it will be any worse.

Jeff Zekauskas - JPMorgan

Okay and then lastly you have a very aggressive capital expenditure targets for 2013 though not really very much has been spent this year so far. Does the increase in capital expenditures have any effect on your margins on Specialty Ingredients or is it really completely independent?

Lamar Chambers

Just as a reminder, our total CapEx expectations for this year is $385 million and about just over 50 million in the first quarter. That’s not usual for our typical timing. We usual spend a little not quite on an annual run rate in the first two to three quarters actually of the year. In terms of the impact on margins as we roll in those new projects, it should have very-very minimal impact, nothing really significant enough I don’t think that would impact your models.

Jim O’Brien

Yes Jeff this is Jim. I will just expand a bit on that question. The expenditures we're making both for '13 and first part of '14 is to help build towards our expectations for our '14 plan. So those are critical expansions in our growth markets so that we can beat the demand as we see it going in to '14. So these expenditures are really the lynchpin of how we plan to get to our '14 goal.

Operator

Thank you. Our next question comes from the line of David Begleiter from Deutsche Bank. Your line is open, please go ahead.

David Begleiter - Deutsche Bank

Thank you. Jim and John you mentioned that Water Technology are some of the actions underway including improved self-efficiencies. What exactly is that?

John Panichella

So what we're doing is we're refocusing the business in some of the key markets we think we can grow and we are trying to optimize the resources so we have a pretty big commercial team there and so we are trying to optimize those resources around the model to have them focus on the right segments and really optimize our cost structure around those segments.

David Begleiter - Deutsche Bank

And John can you (inaudible) your near mid-term margin goals in that segment?

John Panichella

So our ‘14 margin goals are I think 10% something like that.

David Begleiter - Deutsche Bank

Very good. And just John, just in the ATC market, anything structural has occurred there to underpin the weakness or is that just some yearend activity?

John Panichella

We saw some really significant declines around the couple large customers and primarily in emerging regions. Now, there has been some consolidations around some large costumers. Sherwin-Williams buying Comex, PPG acquiring Akzo's business, some distributors that brought out some large competitors that have interrupted some of our orders due to the supply restocking on their part. So, we have those kinds of issues but generally some weak performance in Asia that we don’t anticipate will hold for the remainder of the year. We think that will get better.

David Begleiter - Deutsche Bank

And just lastly on stock buyback given the drop in today's share price, would you be opportunistic at all in the year medium term on share buybacks?

Lamar Chambers

Well as we stated in our call that we look at every month at ways to improve shareholder value and we do have a stock buyback authorization from the board and that’s something that we consider with the board from time to time and our primary focus is getting our debt down but if we need to do something else, we could always make a different decision.

Operator

Thank you. Our next question is from Mike Sison from KeyBanc. Your line is open. Please go ahead.

Mike Sison - KeyBanc

Hey John when you think about the outlook that you had for fiscal 2013 for Specialty Ingredients heading into the year given the start to the first quarter, how far are you off and given that delta, you know what you need to do to hit sort of the long term growth goal in 2014?

John Panichella

Yes so we feel pretty good about what we talked about in December. We talked about four really primary things that drive the growth. Growth was our large multinational customers. We are pretty on track there. Growth with our new products we're in pretty good shape there. We were surprised by growth in emerging region although we don’t think that’s a long term trend.

We do think that the growth in these emerging regions will return. We just did not have that perform as we wanted in the quarter. And then we had you know our segment growth and we discussed in the call today that we had a couple of segments that were weaker than normal and coatings and construction we saw weakness.

We are somewhat worried about that short term but I don’t think longer term we see any structural issues that will prevent those businesses from growing. So I think the four key things we talked to you about on growth while we did not get the expectation or get the results we expected in the quarter. We think we are pretty much on track on those key initiatives and that they will return over the midterm to kind of the targets we discussed.

Mike Sison - KeyBanc

So in the second half of 2013, the growth in Specialty Ingredients should sort of mirror the optimism that you had thought you would have and then in 2014 we should be back on track as well potentially in terms of year over year growth.

John Panichella

Yes, that's what we're thinking and you got a lot to get through the second quarter as we discussed on the energy, guar, straight guar situation once that kind of plays out, we're thinking the third and fourth quarter, net of energy should be pretty consistent with what we've talked about.

Mike Sison - KeyBanc

Okay, and Lamar I think you noted in Valvoline that there is some competitor pricing that is flowing in, but given the price declines in Basil in January as well as November, would the $19 million plus that you saw in margins sort of expand in the coming quarters?

Lamar Chambers

I think what we would try to guide you to or least share with you our thoughts around return to more of a long term expectations on GP percent which we sized in the high 20% range. So in this past quarter we were slightly above that. But you know in that 28-29% range is more our long term expectation, normal volume levels and that's what we would suggest you'd be thinking about.

Mike Sison - KeyBanc

And that assumes this competitive pricing pressure?

Lamar Chambers

Yes it does.

Operator

Thank you, our next question is from the line of Mike Harrison from First Analysis, your line is open, please go ahead.

Mike Harrison - First Analysis

John I was hoping you could discuss what you see in terms of underlying oil field demand and it sounds like the actions that you're taking in guar to mitigate the risks there, suggest that you think you can manage that straight guar business. Can you talk a little bit about whether it’s still an option to exit the straight guar business and just focus on derivitized guar?

John Panichella

Yes, so, speaking about derivitized guar, we're in a pretty good position there. Those products are very differentiated and we think demand for those products will continue to grow as we anticipated. So we think that that's a pretty good situation and we don't think that will change much. So our expectation is that, that volume will grow and obviously there's been a big change in the raw material cost itself, but our margins will remain healthy in derivitized guar and our volumes should grow. In straight guar as we talked about, we have taken a lot of steps to mitigate our risks. There's still a lot of volatility in the market and we’re not sure, what's going to happen there as customers look at what options they have there around the product and the volatility and the way they buy it. So that’s still a little bit unclear based on the strategy we've taken the mitigate our risk, I think in the next quarter or so that will play out.

Mike Harrison - First Analysis

Jim, I was hoping you could discuss kind of broadly what you are seeing in terms of demand trends. You mentioned emerging from a soft December, may be some additional details on where you have seen improvement in January. In particular I was hoping that may be you could address what you are seeing in construction-related markets and the leverage that Ashland might have to a US housing recovery?

Jim O’Brien

Right, when you take a look at the month of December, two things I think really drove the results. One is the guar write-off was larger than we have hoped. so net standpoint point guar has been written down to the market price is behind us and as John described, we have sales already in place for these remaining inventories so by the end of February, all that inventory should be gone. So that probably behind us 100%. And then you look at the third quarter, the second quarter, the accounting year, that’s when we'll start selling straight guar product again and those profits will start being accrued into our estimates. So, that’s one point.

The second is construction market. The other surprise for us in December was the stocking that took place, the last two weeks of December. and that was primarily in emerging markets like Latin America, the Middle East, Africa, not area that we would primarily have a focus but as a big distributor market for us and basically we got no sales. I mean it just totally got shut off. So as we now look into January, we are seeing those sales come back to more normal pace. So for whatever reason, December they either did it because of their own working capital requirements or whatever reasons they had, but in January we started to see those sales come back.

Now, if you would add those two events, more typical for December, we would be talking about it right now. And as I look into the future, the things are going to matter for us for our growth in China and in Latin America, it does have to turn around, in Europe for a big portion of our business wasn’t a problem. So, as a I look at the coming quarters, what we need to see continue to happen is a strengthening in Asia, strengthening in South America, more improvement in Europe but on construction, the form of materials is going to benefit in United States. We saw that already. Performance Materials already has shown some improvement and their composites business because of the US recovery and housing.

HEC, we saw that in our business in the U.S, we had growth in the U.S. where the construction market was strengthening. Well, we have to see improvement but in the emerging regions of the world and I think that will come. And I think as you listen to other people that I have talked in their calls or other economist that have described it, we are starting to see some improvement take place in Asia, hopefully after the Chinese New Year, that will be helpful to us.

And in our month of January we've seen almost all the sales and we are back on track. So as I look in next quarter, I think we have a very good chance of making that estimate we described as being pretty much on track for last year which was not a bad quarter. And the reason why it’s not better is we have no HECs, I mean we have no guar sales. So you put in another full quarter of guar sales on to the mix and you feel better. So that won’t happen till the third quarter.

Mike Harrison - First Analysis

All right, and then last question I had is on Water Technologies. It sounds like your categorized demand as strong in Latin America and sort of weakish elsewhere. Just curious for some more detail on what you are seeing in the paper market in Asia particularly packaging in China which seems like it can be a little bit of a leading indicator. Any signs of improvement there, anything you are willing to hang your head on in terms of pick up in China.

John Panichella

This is John. We have a very small share of that packaging segment in Asia and so we have it as a targeted area. We didn’t see huge growth in the market nor our sales in that category but we do think that it’s upside for us within Water Technology just due to our low share in the segment.

Operator

Thank you. Our next question is from the line of Dimitri Silverstein of Longbow Research. Your line is open, please go ahead.

Dimitri Silverstein - Longbow Research

A lot of my questions has been answered already but I just like kind of reviews a couple of things. Water Technology is part of the business, the reduction in SG&A and all of these strategy around focusing on global customers and doing better job in how you structure contracts and how quickly you best your pricing. What would be by the end of 2014 or 2013 however, whatever timeframe this business has to show you that it can improve, what would be an acceptable level of results from your point of view whether you are talking about EBITDA margins or top line growth or SG&A level. How do we think about the successes and failures of that business as it progress through the year?

Jason Thompson

The one thing that we have seen in this quarter, when Louis came on board, he has focused really on the team at this stage and how they really built a better sales team to try to drive the top line. We have had a couple of critical hires that he has made from the industry which I was pleased to see, so I think that from the senior team we’re starting to see and rebuilt the senior team, I think in a manner that will be (inaudible).

From my standpoint, what I have to see this year is an inflection in the top line. I think they worked very hard on their margins. I think they have a descent mix. They have to drive volume. So the whole focus from my standpoint is, can we grow this business, can we get additional share, and can we drive it in a manner that creates profitability. Now that’s always a very difficult thing to achieve and the only way you can do that is by building a team at a higher performance level to deliver that. So I think that’s being done now. So as I look at the next quarter before that I have to see increase in top line growth.

Dimitri Silverstein - Longbow Research

Okay so top line growth it sounds like a particularly volume growth as well as success in getting pricing, sounds to me like that’s sort of the margin that we have to look at?

Jason Thompson

Yeah that is the measure.

Dimitri Silverstein - Longbow Research

Second question, what was your end of quarter share count on the fully diluted basis?

Lamar Chambers

Yeah just 80 million shares. 80.2 to be more precise.

Dimitri Silverstein - Longbow Research

So slightly higher but that's probably just because of the stocks doing so well. Then finally, you had, I think $50 million unallocated and other benefit, if you will, in the quarter. That's been a pretty volatile number to try to get our hands around. How should we think about that line item going forward? Can you go through a couple of pieces that were a large part of that line item and help us track that a little bit better?

Lamar Chambers

The single biggest piece there with our pension income had reside in the unallocated in other. that was about $19 million. so that reflects the recurrent on our pension assets and that’s in excess of the interest cost was driven by the discount rate, so that’s spread is kind of reset annually by some actuarial updates and so that part is very predictable to the rest of the year. The other kinds of things that flow though that unallocated and other tend to be legacy related items such as occasionally we’ll have some environmental charges et cetera associated with discontinued businesses where we retained obligations and those are a little less predictable frankly, but you should expect to see continued income at the unallocated other level, based on primarily on the pension results.

Dimitri Silverstein - Longbow Research

But is it going to be to the tune of, say, $19 million a quarter benefit, or is that going to diminish?

Lamar Chambers

No, that pension pace will be consistent through the year.

Operator

Thank you, and this does conclude our Q&A session, I would like to turn the conference back over to Mr. Jason Thompson for any final remarks.

Jason Thompson

I'd just like to thank you for your time this morning and for your interest in Ashland, if you have additional questions please give me a call at 859-815-3527 thank you.

Operator

Ladies and gentlemen thank you for your participation in today's conference, this does conclude the program and you may all disconnect, have a great rest of the day.

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