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Ashland Inc. (NYSE:ASH)

F2Q2012 Earnings Conference Call

April 24, 2012, 09:00 a.m. ET

Executives

David Neuberger - Director, IR

Jim O’Brien - Chairman and CEO

Lamar Chambers - SVP and CFO

Sam Mitchell Jr. - SVP and President, Ashland Consumer Markets

Analysts

David Begleiter - Deutsche Bank

Laurence Alexander - Jefferies

Mike Sison - Keybanc

Jeff Zekauskas - J.P. Morgan

John McNulty - Credit Suisse

Mike Harrison - First Analysis

Dmitry Silversteyn - Longbow Research

Operator

Good day ladies and gentlemen and welcome to the Ashland Inc. Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder this conference call is being recorded.

I would now like to turn the conference over to David Neuberger, Director of Investor Relations. Please begin.

David Neuberger

Thank you, Lithia. Good morning and welcome Ashland second quarter fiscal 2012 conference call and webcast. We released results for the quarter ended March 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-Q in May.

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 Sam Mitchell, President of Ashland Consumer Markets.

Before we get started, let me note that 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 and pro forma results. We believe these adjusted and pro forma results enhance understanding of our performance by more accurately reflecting our ongoing business. In addition, we are providing ISPs historical financial contribution representing Ashland’s best estimate of the appropriate cost allocation and shared resource cost. Reporting results in this manner has inherent limitations, and we do not represent that these financial results were calculated using the same methodology used by ISP.

Please turn to Slide 3 for our second quarter highlights. Reported earnings per share from continuing operations were $1.13 in the March 2012 quarter. When adjusted for key items which I will cover shortly, EPS was $1.52 as compared with $0.97 in a year ago quarter. Let me note that the $0.97 in the prior year does not include the results of ISP or the related financing cost. This is the only time this morning that we will present data in this manner. For the rest of the presentation and to aide in your analysis we will present results on a pro forma basis which includes the results of ISP in prior periods.

Sales totaled $2.1 billion a 2% increase over the prior year on a pro forma basis. Operating margin was consistent between all periods roughly 10.5% of sales. Our adjusted EBITDA was $329 million 2% above the $322 million of pro forma adjusted EBITDA in the prior year quarter. EBITDA as a percent of sales was nearly 16%.

Once again Specialty Ingredients turned in the strongest performance during the quarter increasing earnings by more than 10% on a pro forma basis.

We generated $141 million of free cash flow during the quarter due to a combination of good business performance and improvement in our trade working capital as a percent of sales.

Slide 4 details our key items. In total three key items had a net unfavorable EPS impact on continuing operations of $0.39 in the March 2012 quarter. The first key item is a $3 million after-tax charge or a negative $0.03 per share related to stepped up inventory values from the ISP acquisition. This key item arose from a refinement of our original purchase accounting calculations.

The second key item is a $12 million after-tax charge or a negative $0.16 per share related to the ISP integration and cost restructuring efforts we previously described. The majority of this charge stem from the consolidation of facilities in the Wilmington, Delaware area. The resultant savings now complete the strategic cost portion of our overall cost reduction program. This key item also included a small benefit related to an update for our Water Technologies severance accrual. But previously described 6 to $7 million cost reduction project in Water Technologies has been completed with the cost to achieve these savings being somewhat reduced.

The last key item is a $16 million after-tax charge or a negative $0.20 per share related to a write-off of pre-construction cost for a previously planned Greenfield manufacturing facility in the north of China. This write-off includes cost associated with upfront planning and design, initial engineering and land. This project has been suspended since 2008 as we evaluated the projects benefits and the projected returns. The decision to write-off this upfront cost will allow us to avoid an estimated $35 million in additional cost while shipping our capital investment focused to higher return projects.

In year ago quarter four key items combined for a net favorable impact on earnings of $1.29 per share. With the largest item being the call out of our actuarial gain on pension and [no PEP] expenses, while pension adjustments will typically occur only in the fourth quarter, the sale of Ashland distribution led to a pension re-measurement in the year ago quarter and to the callout item shown here, to aide in your analysis first that the peer group, Ashland’s results included $29 million of intangible amortization expense during the March 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 $1.77 per share.

Please turn to Slide 5 for Ashland’s adjusted pro forma results. As a reminder results are presented on a pro forma basis which includes a full quarter of ISP in the March 2011 quarter. The year ago quarter also includes stepped up depreciation and amortization related to purchase accounting. As such Ashland’s March quarter sales increased 2% over the prior year to $2.1 billion, excluding currency sales would have been up roughly 3%.

Sales increased 8% sequentially primarily due to normal seasonal trends. Gross profit as a percent of sales was approximately 28%, consistent with both the prior year period and the first quarter of 2012. Gross profit was stable due to strong pricing in each of our businesses which more than covered roughly $130 million of higher raw material cost year-over-year.

Selling, general, administrative and research and development expenses collectively referred to as SG&A rose slightly to $374 million. EBITDA of $329 million grew 2% over the prior year and 9% sequentially, while EBITDA as a percent of sales was 15.8%.

Now turn to Slide 6 to review our volume trends. This chart shows underlying volume trends on a normalized and rolling four quarter basis. By totaling the trailing four quarter 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 Specialty Ingredients, our largest and most profitable business has also been our strongest growth vehicle averaging roughly 10% annual volume growth over the past two years. Specialty Ingredients has proven to be less economically sensitive, demonstrating its resilience regardless of the macroeconomic climate. Over this period all of Specialty Ingredients major markets were up with the strongest growth coming in energy and construction.

Performance Materials has been growing at a similar pace but it's recently turned negative, primarily due to reduced demand in both Europe and the emerging regions. Water Technologies continues to experience volume declines particularly in the mature economies. Ashland Consumer Markets has also decline partially due to the loss of a low margin tolling account which we previously described as well as market softness in North America.

Now let’s turn to Slide 7 for Ashland’s overall EBITDA Bridge. This chart shows what led to the March quarters performance as compared with the year ago period on a pro forma basis. Improvements in margin were by far the largest contributor to the year-over-year increase in EBITDA. As compared to the prior year quarter, each of our commercial units has now pushed through enough pricing to more than recover their increased raw material cost.

In total volume had a slightly negative effect on EBITDA with volume gains in Specialty Ingredients being offset by volume declines in the other commercial units. SG&A which is adjusted for recent divestitures and currency translation negatively affected EBITDA by $13 million. Currency translation had a negligible effect on EBITDA. All together EBITDA increased by $7 million compared to a year ago.

Now let’s turn to Slide 8 for a liquidity and net debt. As noted on the highlight slide, we did generate a fair amount of free cash during the quarter. This increase to our cash balances by $133 million taking your total cash at the end of March to approximately $600 million.

Total liquidity which is cash plus revolver capacity increased to $1.5 billion at the March quarter end. As we continue to generate free cash, we are focused on building liquidity so that we are in a position to call our nine and one-eighth notes in June 2013. As most of you know this is our highest rate debt and it carries about $60 million of annual interest expense. At the end of March our gross debt was essentially unchanged at $3.8 billion and our net debt was $3.2 billion down $185 million sequentially.

With that Sam Mitchell will now discuss Ashland Consumer Markets beginning on Slide 9. Sam?

Sam Mitchell Jr.

As expected Consumer Markets achieved improved performance sequentially due to the combination of higher volumes, increased pricing and lower cost. Lubricant volumes rose 11% sequentially in line with normal seasonal trends but declined 9% from the prior March quarter. Roughly one-third of the volume decline versus the prior year is attributable to the previously disclosed loss of a low margin tolling account. I will discuss the remaining volume decline shortly.

Sales increased 6% over the prior year quarter and rose 9% sequentially. Our gross profit was down 290 basis points versus the prior year and improved 110 basis points sequentially to 26.4% of sales.

During our first quarter earnings call, we noted that January’s gross profit was running at 28%. However, as we moved through the quarter the combination of higher trade promotion activity and reduced volumes in our higher margin DIY channel negatively affected gross profit.

Trade promotion typically refers to reduced pricing offered in support of short-term retail activities, this practice is common throughout the industry and takes place at selected times throughout the year to drive volume and increased brand awareness. However, in the second quarter many retailers were focused on reducing inventory thus negating the volume risk we would have expected.

SG&A was even with prior year, but up 8% sequentially in line with normal seasonal trends ahead of the summer driving season. Overall Consumer Markets generated EBITDA of $66 million with an EBITDA margin of 12.7% for the March 2012 quarter.

Now please turn to Slide 10 for Consumer Markets EBITDA Bridge. Our bridge shows that higher margins were more than offset by reduced volumes lead into the decline in EBITDA versus the year ago quarter. The reduced volumes led to $13 million of the EBITDA decline. These volume effects were concentrated in North America particularly in the do-it-yourself market channel. This channel has been weak due to overall market softness and retailers reducing their inventories thus negatively affecting our shipment. Despite our volume declines our market share has improved over this period based on point of sales data.

Our international business continues to perform well with volumes rising 4% over the prior year. Higher margins contributed $6 million to EBITDA with price increases more than recovering our higher raw material cost. While we recover these costs in a dollar basis versus the prior year, the denominator effect of higher sales does have a compressing effect on our gross profit as a percent of sales. In total EBITDA declined by $7 million from the March 2011 quarter.

Let’s go to the next slide. As most of you have probably realized Group II base oils suppliers recently announced a $0.24 increase per gallon. You will recall that Group II base oils are the largest raw material cost for Consumer Markets. In addition Group III base oils will be increasing by a similar amount. The affected dates of these increases vary we estimate the impact to our business at approximately $3 million in the third quarter. We expect to pass along these cost increases through higher pricing and we recently announced a price increase of up to 5% to our customers. We anticipate we are roughly three month lag for full price implementation. This coupled with the promotional spending we have already committed to will continue to pressure margins in the back half of the fiscal year.

Longer-term base oil cost will continue to be affected by the overall crude market. However, due to the significant increases in base oil supply currently planned over the next few years, the volatility of base oil should be reduced.

To remind you and as we detailed at our Analyst Day in New York last November, by 2014 Group II base oil capacity is expected to expand by roughly 20%, while the capacity for Group III is expected to nearly double. This should lead to more consistent earnings growth in consumer markets.

Please turn to Slide 12 and I will share some comments on our business outlook. Looking out over the rest of the year, we do see volumes improving while the North American motor oil market has been challenging, volume should improve sequentially due to a pickup in seasonal demand. Meanwhile Valvoline with no change has held up well despite fuel prices in the $4 per gallon range. We are encouraged by these results and continue to focus on expanding our service penetration and overall store base. Last month we expanded in the Southern California market following the acquisition of 72 EZ Lube stores by our largest franchisee.

On the international front, we expect continued strength as we focus on some compelling opportunities in selected markets. Last week we announced the five year distribution agreement with TNK-BP Russia’s third largest oil company to distribute Valvoline products in Russia. TNK-BP provides us with access to 15,000 installer and retail outlets in Russia which ranks as the largest market for passenger car, motor oil in Europe. This partnership should allow us to build our share in this growing region.

In closing we have one of the strongest and most trusted brands in the business and despite the recent declines, our share has remained stable. We remain committed to our 2014 target and fully expect that the strategy that we haven’t placed will lead to improved results overtime.

Now I will turn the presentation over to Lamar for a discussion on the other commercial units beginning on Slide 13.

Lamar Chambers

Thank you, Sam. Good morning everyone. Specialty Ingredients had another strong quarter, but each of our business units doing very well. We achieved particularly impressive results in our energy, construction, and specialty performance businesses. Including ISP, volumes were up 2% over the prior year, affecting this comparison versus the prior year is a demand trend toward more concentrated forms of our liquid products. We are seeing increased interest in these higher priced products from customers who like the [convene] us, ease of use and lower shipping cost. Adjusting for these effects volume would have been up 4% on a more comparable basis.

Going forward and beginning with the April business fundamentals we will be using this for wise methodology for reporting volumes. Volumes improved 15% sequentially due to normal seasonal trends.

Sales of $723 million were up 11% over the prior year with significant pricing across all of our business units. These pricing actions has enabled us which will recover increased raw material cost but also to maintain margins at the historical levels. Actions such as these has historically made Specialty Ingredients our most consistent and most predictable commercial unit, the strong sales growth and extremely stable margins.

Gross profit was 33.5% in the March 2012 quarter consistent between all periods. SG&A of $123 million was in line with our expectations but up versus a prior year. Overall EBITDA grew 12% over the prior year to $186 million. EBITDA as a percent of sales was 25.7%.

Slide 14 shows Specialty Ingredients EBITDA Bridge. Improved volumes and mix were the primary drivers of the year-over-year increase in EBITDA. Volume gains related by another strong quarter in the construction and energy markets. Energy has benefited significantly from increased demand for hydraulic fracturing (inaudible) continue to gain share in construction markets. We are pleased with the pricing actions of these commercial units and we have been able to move more than offset $45 million and higher raw material cost versus a prior quarter. In total margin contributed $9 million to the EBITDA increase.

As I mentioned on the previous slide SG&A was up versus a prior year lading to a $12 million (inaudible). In total EBITDA was up $20 million over the year ago March quarter.

Now please turn to Slide 15 and I will review our performance in Water Technologies. Water Technologies sales were $428 million down 9% from a year ago quarter. However, when we adjust for recent divestitures sales were down 4%. The 4% sales decline was composed of 3% increase in pricing which was more than offset by roughly 7% decline in volume.

As compared to the prior year, sales were up in both our paper and industrial markets. Paper actually performed reasonably well in light of the overall market conditions with sales declining 3%.

Tissue and towel and packaging were both up versus a prior year, while printing and writing was up about 10%. Printing and writing demand has suffered due to accelerated mill closures and extended outages North America and Europe. While some of this demand should return overtime, we estimate the effect from the permanent closures to represent roughly half of the 10% decline.

Sales declines within our industrial markets were primarily attributable to the loss of certain low margin accounts and product applications such as waste water polymers, where we have been rationalizing our portfolio to focus on higher margin opportunities. Industrial markets did improve sequentially and we expect this trend to continue going forward.

Gross profit as a percent of sales was up 80 basis points from the prior year, and 130 basis points sequentially. These increases were primarily tied to the sale of the low margins synthetic lubricates business.

SG&A was unchanged versus the prior year at $120 million. At $39 million EBITDA declined 24% versus a prior year quarter and our EBITDA as a percent of sales was 9.1%.

Now let’s turn to Water Technologies EBITDA Bridge on Slide 15. As you can see negative volumes were the primary drivers of the EBITDA declines versus a prior year. The volumes issues within North America and Europe that will be described last quarter have largely continued. However, I will note that volumes in both regions have improved somewhat sequentially. This growth was partially offset by a recent market weakness in Asia Pacific paper markets.

Pricing has improved as we not only recovered our cost, but also increased margin dollars versus a prior year. Margins excluding the effect of recent divestitures captured in the other category contributed $4 million to our year-over-year EBITDA. Excluding currency translation, SG&A expenses were at slight headwind to EBITDA.

In total EBITDA decreased $12 million from the year ago quarter. Clearly our results in Water Technologies have been below our expectations. In response we have taken a number of steps over the past years to refocus this business on higher growth, higher margin opportunities. This test includes the divestiture of our syn lubes business and the repositioning of our middle market commercial business through a well established distributor. The latter decision announced just last week will eliminate 6 to $7 million of cost associated with servicing approximately 5,000 customer locations that together generated only $15 million in annualized sales. Going forward we will continue to focus on improving the business to generate results and are more in line with our expectations.

Please turn to Slide 17 for a review of our Performance Materials business. Performance Materials had a good quarter with strong results in the composites and adhesive offsetting the sequentially decline in elastomers we described last quarter.

Before we get into the actual results, I will note there were a number of items affecting comparisons between [peers]. First we sold our relatively high volume PVAc and adhesive business in early January. Next we made some changes to our tolling arrangement with the Casting Solutions joint venture as compared to the prior year which reduced volumes and sales but had no significant effect on earnings.

Lastly the results shown here are on a pro forma basis and include the elastomers business in the year ago quarter. Thus while Performance Materials reported volume was down 16% from the year ago quarter when we exclude the effects of Casting Solutions and the PVAc business, volumes were up 2% sequentially and on the same basis volumes were up 13% due to normal seasonal trends. Our reported pro forma sales were down 4% from the prior year, they were up 4% when we exclude Casting Solutions and the PVAc business.

Gross profit of 14.6% of sales grew by 100 basis points over the prior March quarter. We are particularly pleased with the margin improvements in both our composites and the adhesives business. In both cases pricing has improved conservatively and we have recovered our increased raw material cost.

Within composites, we have also benefited from the capacity in fixed cost reductions, we implemented last year. This has allowed us to better rationalize our product portfolio, improving the mix within composites. Significant gains in these businesses were offset by higher cost within our elastomers business. These higher costs were the biggest reason for the sequential decline in profitability.

In the first quarter, and as described on our call elastomers benefited 10 to $12 million due to lower butadiene cost. However, butadiene reverse course in January and increased $0.50 over the course of the March quarter. This increase in cost reduced our earnings in the quarter by 3 to $4 million. Elastomers pricing is highly indexed, and we pushed through our costs with a 4 to 6 week lag. Butadiene cost have continued to decline in April by appears to be flattening out.

SG&A was $43 million in the March quarter roughly in line with the year ago quarter and our expectations. EBITDA grew 9% over the prior year to $35 million and EBITDA as a percent of sales was 8.6%.

Now let’s turn to Performance Materials EBITDA Bridge on Slide 18. The effect of the ASK Chemicals joint venture and the divested PVAc business are captured in the other category. Excluding those effects, increased margins in our adhesives and composites business were the primary drives of EBITDA growth.

The 2% decline in volume that I mentioned on the previous slide led to a $1 million reduction in EBITDA. All volumes were up in both the emerging regions and Europe. North American markets rose roughly 4% due to meaningful increases in industrial and residential construction.

We are very encouraged by this growth in the domestic market and we are optimistic about the remainder of the year. In addition, we believe demand will improve in Asia and Latin America albeit slowly. Europe remains soft but does appear to be stabilized.

SG&A excluding currency translation was a $2 million headwind to EBITDA. Other accounted for $2 million of the EBITDA increase. Within this item our reasonably strong performance from ASK Chemicals more than offset the loss of EBITDA from the sale of PVAc business. In total EBITDA grew about $3 million to $35 million in the March 2012 quarter.

Now let’s take a look at our corporate cost reduction program on Slide 19. We continue to make progress against our $90 million cost reduction program. This program is intended to eliminate the stranded cost associated with the divestiture of Ashland distribution and the formation of the ASK Chemicals joint venture as well as to achieve anticipated cost synergies from the ISP acquisition.

As of the end of March we will achieve roughly $65 million of annualized run rate savings. Approximately half of these savings were achieved toward the end of the March quarter and we will see their full effect beginning in April. This completes a $40 million reduction program of our stranded cost and they includes approximately $25 million of ISP related cost synergies.

The integration of ISP continues to perceive very well and these reductions were completed ahead of schedule. We are pleased with the price of the integration and the last major step would be the implementation of the unified ERP platform in the first half of calendar 2013. The remaining $25 million of savings will come primarily from reductions in back-office support and supply chain. We expect roughly $10 million of these savings by the end of this fiscal year of the remaining $15 million achieved by the end of fiscal 2013.

Now let’s look at some corporate items on Slide 20. Capital expenditures were $55 million for the March 2012 quarter bringing our year-to-date spending to approximately $100 million. Given the capital avoidance related to the project in China that Dave mentioned as well as other miscellaneous adjustments, we now expect CapEx for the year to be in the 300 to $325 million range.

Interest expense is $56 million for the March quarter. We expect this interest expense to be relatively stable until the anticipated call of our nine and one-eighth notes in June of next year. Our effective tax rate for the quarter was 27% excluding the effect of key items somewhat below our previous guidance. Let’s take our tax rate for the first half of the year, slightly more than 28%. Given our on-going work in this area and a refinement of some of our initial assumptions, we now expect our tax rate for the full-year to be in the range of 28 to 30%. As expected trade working capital has begun to improve and now stands 17.6% of annualized sales. This represents a 100 basis points decline since the end of December.

Now I will turn the presentation over to Jim O’Brien for his closing comments starting on Slide 21.

Jim O’Brien

Thanks Lamar, and good morning everyone. As you heard this morning our overall business continues to perform well. We achieved increased sales, stable margins, and improved cash flow during the quarter despite some market weakness in certain commercial units.

Specialty Ingredients led the way with another great quarter. But in this commercial unit we achieved double-digits sales and earnings increases over the prior year, with good sales growth in all regions of the world.

Due to a strong performance over the past two quarters, Specialty Ingredients represents 56% of Ashland’s consolidated EBITDA for the trailing 12 months. This improved business mix should lead to more predictable results for Ashland. Performance Materials increased pro forma EBITDA by 9% due to on-going pricing actions and a strengthening North American market which has helped offset some of the recent weakness overseas.

Consumer markets was down versus the prior year due to reduced demand for motor oil in North America, which offsets a stronger international performance. Within water Technologies lower volumes have offset the benefit of improved pricing. On average a normalizing for the effects of acquisitions, divestitures and joint ventures, Ashland’s volumes declined 4% versus the prior year. Despite volumes declines, sales grew 2% to $2.1 billion. This reflects a significant pricing actions taken by our commercial units.

We achieved EBITDA of $329 million a 2% increase over the prior year and 9% increase sequentially. Free cash flow for the quarter was $141 million more in lined with our expectations again is back on-track state our goal for the year.

Now let’s turn to our outlook on Slide 22. Looking ahead to the third quarter, we have a lot to be excited about. Specialty Ingredients to continue its historical growth pattern and also enjoy a strong seasonal pickup in the construction and energy markets. Consumer markets Performance Materials should improve with seasonal demand. While raw material cost in each of these commercial units appear to be rising, our leadership teams have demonstrated a strong ability to effectively manage these challenges in a timely manner.

Water Technologies have taken a number of steps over the past year to refocus our business on higher margin, higher growth opportunities. This includes the divestiture of our syn lubes business and more recently the repositioning of our middle market commercial business through a well established distributors.

We also have made the strategic decision to rationalize certain low margin products and applications. These are the right steps to take, that I’m confident that our actions will lead to improved results overtime.

As you heard from Lamar, we have made great progress on our cost reduction program. The entire $40 million of trended cost have been removed, achieving the goal we laid out shortly after the sale of Ashland distributions. In addition we have already captured roughly $25 million of ISP cost synergies on a run rate basis. These synergies were achieved ahead of schedule as we combine with our on-going business performance provide clear evidence that the integration is progressing largely as expected.

As I described last quarter we are focused on building our liquidity in order to call our highest interest rate debt in June of next year. In line with that goal we build our cash balances during the quarter and we expect this trend to continue as we approach the call date for the notes.

On the next slide let me close with some final thoughts. I’m very pleased with our year-to-date performance. This is only our second full quarter of running ISP which you are beginning to see what Ashland has become. We are now a more consistent, more predictable company with the Specialty Ingredients commercial unit generating 56% of our EBITDA.

We have a margin profile that better reflects our Specialty Chemical focus with a 16% EBITDA margin in the quarter. And we have greater opportunities for organic growth, than at any time in our history. Most of these opportunities are concentrated within Specialty Ingredients, where the incremental capital investment is expected to generate returns in excess of 20%.

In closing, you recall that last November we laid out Ashland’s 2014 financial targets at our Analyst Day in New York. These targets include EBITDA of $1.7 billion and earnings in the range of $9.50 to $01.50 per share. We are well on track for the year and remain confident in our ability to deliver these targets and generate significant value for our shareholders.

With that we will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from David Begleiter of Deutsche Bank. Your line is open.

David Begleiter - Deutsche Bank

Jim just in Valvoline, can you comment on some of the trends you are seeing in motor oil and any potential secular structural decline in volume trends in North America?

Jim O’Brien

Go ahead Sam.

Sam Mitchell Jr.

Yes, regarding North America, we have reported that the category demand has been soft this past year. We saw that drive 2011 with declines of about 5% and yet we don’t see it getting any worse, it's tracked closely to miles driven being off, and as we look at our outlook for the next six months and the forecast, the business is holding up pretty well despite cash prices approaching $4. And one particular area I look at is Valvoline with no change where our car counts have actually improved over the last one to two months. So, we see some good signs there. When I look at do-it-yourself market, we have a strong promotional slate moving forward, and so I think as we look forward we are not going to see overall category demand worsen and hopefully it can perform quite well for us. I think the consumer is beginning to adjust to the higher gas prices and hopefully we are seeing a peak right now in the $4 range.

David Begleiter - Deutsche Bank

And Sam, are you still confident in your 2014 margin targets in this segment?

Sam Mitchell Jr.

We reported our margin targets in the high 20%, and EBITDA in the 14 to 15% range and we are confident in those forecast.

David Begleiter - Deutsche Bank

And lastly Jim, in 2014 now what percent will Specialty Ingredients fee of that $1.7 billion in EBITDA in 2014?

Jim O’Brien

It's about 50%, if you work through the math for 2014.

Lamar Chambers

Right and as we tell you work on the growth aspects and we look at our invested capital, I’d expect that Specialty Ingredients overtime will become a larger percent into the mix. So, the basis of the assumption is 50%, but I’d expect to buy 40 to be much higher than that.

Operator

Thank you. Our next question is from Laurence Alexander of Jefferies. Your line is open.

Laurence Alexander - Jefferies

First can you discuss how you think pricing will do versus raw materials excluding consumer markets in the back half of the year?

Jim O’Brien

When you look at the pricing activities in Europe, Specialty Ingredients done very well with their pricing because types of activities are participating which are more around the consumption of middle class products, hair care, oil care and skin care and the like. So they've been very successful in passing things through because a lot of what they are introducing a new products may have the opportunity to reposition pricing at that time. Our Performance Materials their activity has been the strongest in Eastern Europe so really the activity that they want in Europe is not really western in nature it's more Eastern Europe. Where they had more success so that’s really mitigated some of the effects that you read in the paper about Western Europe and the issues that they are having although it's not a much cleaner in Eastern Europe but at least they're growing and construction is doing much better there. So, they’ve had success in that area.

Water has been the most challenged because it's more heavily centered in Western Europe and I’d say that the challenge is there reflected the environment that you read about. So, I’d say water has been the most challenged and then of course Valvoline with their TNK announcement in growth and other aspects of the market there. They have done very well, despite weakening European market. So, as you look at our forecast going into next quarter and the rest of the year, water is the one is probably the most challenged here in the rest of them, we fully expect to meet their objectives and meet their pricing needs.

Laurence Alexander - Jefferies

And within consumers markets, the issue was with do-it-yourself market. Are you seeing any signs yet of consumers pushing back on your own price increases?

Sam Mitchell Jr.

No our pricing and promotion and the volume that they are delivering is held up well. In fact based on the point of sale that we have believe our market share has actually improved in the recent months. The one area of softness that we had is in our premium mix where our [Max Life] sales have been softer and we would like and that have to do with the price increases that we did take in 2011. The price gap versus conventional oils grew and that’s something that we are addressing with our promotion strategy moving forward because [Max Life] we feel so has a lot of room for growth.

Operator

Thank you. Our next question is from Mike Sison of Keybanc. Your line is open.

Mike Sison - Keybanc

Can you give us a little bit of feel in Specialty Ingredients, how the Aqualon businesses versus ISP performed? Were they pretty much in line in terms of the growth and possibly the improvement that you saw in the quarter?

Jim O’Brien

When you look at Specialty Ingredients probably the strongest growth was in the energy piece, so the guar-based materials and things that were around down hole fracturing and down hole drilling on horizontal drilling did very, very well. We anticipate the next six months to be no different even though the wells that are being tapped are fewer the horizontal drilling that we really participate in are advancing. So, that part is doing very well, we expect it to continue.

When you compare the historical ISP products against the cellulosics business both did well, and in the construction side of the cellulosics, it's done extraordinary well compared to what it did going 18 months ago. We reposition that business and worked hard on getting into the right markets and especially Eastern Europe, China continues to perform well, and the paints and coatings business did well for us. So, as we look at that all aspects of ASI they all seem to be running on target and as expected with limited weakness. So, I’m really even pleased with how the two teams come together and how they focused on markets together, and that’s the other aspect that’s working well. The top line synergies that we have hoped for bringing aspects of the cellulosics with the other products that ISP had to our customer mix seem to be being received well and we have received some opportunities that we otherwise being have garnered without this combination. So, everything that I have seen about the new ASI is as advertised in and that team is performing very, very well. And John Panichello as its leader is working very hard and putting a lot of time and effort into it it's paying off.

Mike Sison - Keybanc

Okay. Sam in terms of Valvoline as I recall when you look at the 2014 goals, I think the plan there was to grow sales mid to high single-digit something to that degree. Given where you are seeing the markets, do you still think that’s a reasonable outlook as we move on to the next couple of years?

Sam Mitchell Jr.

It is, we are expecting to see a lot of our growth from the international side of the business and that’s where we continue to make excellent progress in building our channels to market. We are expecting Valvoline it's no change to be a major contributed to those targets too, and our quick lube business continues to perform well. Our same-store sales continue to be up this year and longer-term we expect to add more units as noted by the acquisition it was made by one of our largest franchisees, so that’s going to create some good opportunities. And the do-it-yourself market where we have seen the softness recently in 2011, we do see some signs of stabilization as we move through 2012 and the biggest part of our growth strategy there is to grow our market share and so we believe we have got good plans in place to drive share growth over this time period too, but the do-it-yourself market certainly an important market for us and it's one that we are going to keep a close eye on, but that share growth and stabilization in demand is going to be key to our success there.

Mike Sison - Keybanc

Okay. And one quick one for Lamar, if this tax rate that you guided for the rest of ‘12 likely the same rate we will see in ‘13 and ‘14.

Lamar Chambers

On a book basis we would expect maybe our book tax rate will longer term to be gravitating down, based on some of the planning actions we have underway now. I would want to give you a specific 2013 and ’14 target at this point at this point I we will have time but it's reasonable to expect 2 to 3% decrease in our book effective rate, and we go into other way our tax rate right now we are enjoying a rather low tax rate in the 18 to 20% range. It will gravitate up by 2 to 3 percentage points based on our best estimate. So, that’s how that longer term outlook is for taxes.

Operator

Thank you. Our next question is from Jeff Zekauskas of J.P. Morgan. Your line is open.

Jeff Zekauskas - J.P. Morgan

Can you talk about the effects of TNK-BP vintage, so if you will sell through 15,000 outlets in Russia. What’s that mean in terms of gallonage and how much does quote of motor oil sell for in Russia?

Sam Mitchell Jr.

Comparative basis answering that last question regarding price in Russia, the prices are actually higher on a per unit basis in Russia than we would experience in North America. As far as the forecast for the business, we are excited about this new partnership, it's substantially strengthens our distribution in Russia. And we have a partner in TNK-BP that really understands that local market too, so we are going to be working very close to with them to develop those marketing plans for not only getting distribution but then driving sales. So, at this point we are not ready to share any of our targets, but we do think it creates good upside for our European business and it's part of our overall international strategy which is just strengthening in our distribution partners throughout the world and especially in developing markets like Russia.

Jeff Zekauskas - J.P. Morgan

Okay. When do you start to ship to BP?

Sam Mitchell Jr.

That will start in the fourth quarter shipping to TNK-BP.

Jeff Zekauskas - J.P. Morgan

Can you talk about your Specialty Ingredients volumes in China and in the U.S. that is what were the rates of growth. And given your prospective on China, how do you see that market evolving for you this year?

Jim O’Brien

I’ll speak to the last part of your question let Dave give you the actual numbers. But China has been challenging for many companies and ours included because of the shift in focus. But the area of ASI’s participation is not is effected by the government plans as per se like Performance Materials of the wind blade market that was impacted highly in the first half and is just not picking up in the second half. Because we are really focused on the middle class primarily with the ASI products it's around construction, painting and in the skin care and oil care and the middle class consumer type products which have not been affected highly by the government growth programs, so as the consumer continues to evolve their and consumption rose, our businesses have done very, very well. So, ASI as a team advanced it's products and advanced it's sales in that area.

David Neuberger

North America was up a couple of points per volume in terms of sales versus prior year it was up a little over 20%. Asia was down slightly but there we have done some product rationalization as well, but likely drove those declines. I think if you excluded that you’d be relatively flat.

Jeff Zekauskas - J.P. Morgan

And then lastly for Lamar. Are you really going to reach 300 million in CapEx given that you have got two quarters to go, and [100] a quarter seems a lot?

Lamar Chambers

If you look back historically at our spending patterns on CapEx, you will find we are more heavily weighted towards the end of the year, just way this project roll in and checks are actually written. So, we think the $300 million range is a pretty solid estimate at this stage. We have pulled that back some as you may recall our initial guidance on this year’s spending was expected to pick up 350 million and with the refinement of timing on similar projects as well as the cancellation of some one of which we talked about today in North China. We think $300 million is a pretty middle of the road estimate.

Jeff Zekauskas - J.P. Morgan

And then lastly in your tax rate, where exactly is your tax rate going down, which geography and which business what did you do?

Lamar Chambers

Well, it's really a result of our global planning efforts around with ISP now in the portfolio better leveraging the opportunity to combine legal entities, locate our businesses and attractive tax rate jurisdictions and really as appose to any particular country contributing heavily to the decrease is more of the global realignment and repositioning of our entities.

Operator

Thank you. Our next question is from John McNulty of Credit Suisse. Your line is open.

John McNulty - Credit Suisse

Just a few quick questions. First of all with regard to your water business, it sounds like the shifting over to the distributable, I think you said would can save you about $6 million that would be 3 to 4%, it looks like on a margin impact in terms of on an annual basis. When does that effectively hit, is it hitting kind of immediately now or does it kind of gradually trickle in, like when should we see that margin impact?

David Neuberger

That comment was around the SG&A load and it will save somewhere around that $6 million range. I’d say you should see a piece of that next quarter and then the majority of it during Q4, just because the run rate type basis. But bear in mind you are also losing $15 million of annual sales with reasonable gross profit across that part of the business. So, I’d say it's a net effect at the EBITDA line or the earnings line is going to be relatively neutral for that. So, more as you heard from Jim, that’s about refocusing that business and some of the higher margin opportunities.

John McNulty - Credit Suisse

And then the Valvoline, I believe you said it was a $3 million hit in the third quarter ties to the price hike or the raw material hike. How is the math working that, what are the puts and takes, it seems like with 48 million gallons or 46 million gallons a $0.25 hike will be higher than that?

Sam Mitchell Jr.

The calculation it has to do with the timing in which it's going to hit us, so that’s primarily the difference and probably using a little bit lower volumes too, this is primarily first a North American market where we behave with this.

John McNulty - Credit Suisse

So, will some of this drag into their fourth quarter as well in terms of how we should be modeling this out?

Sam Mitchell Jr.

Not so fully hit us during the third quarter, and the fourth quarter then the price increases will begin to take effect.

John McNulty - Credit Suisse

And then just the last question, Jim maybe this is for you, with regard to your 2014 target, you clearly have a lot of revenue growth baked in and I guess when we see a quarter like this where the revenue growth is relatively modest. And that you are claiming is still on track. I guess how should we think about the volumes and the revenue growth over the next year and half or so, and what do you view is some of the major levers that will get you to your target?

Jim O’Brien

The area that we really have most control over is some of the organic growth that we see in the projects we see in ASI. So, we still anticipate to fund those projects going into the next two years as the consumer continues to evolve and grow throughout the world. We see that as a trend that those volumes will be there and that growth will be sustained and we will be able to feed into that with our investment strategy to continue to grow ASI.

To your point on Valvoline and Performance Materials and water, that’s going to be more tied to industrial production and the growth in Europe and Asia and South America. And right now that appears to have stalled to some extent. So if that continues to stall and be difficult over the period that’s going to have downward pressure on those estimates. And there is no question we cannot fight through a trend that is going to be that series of a headwind. So, as we sit here and communicate today, we think our earnings growth will continue this year and we will be able to meet our expectations for the pricing and maintaining volumes that we see, because we are going through a seasonal growth pattern that we always have more volume will come through this third quarter for us that’s significant just by the weather patterns of the world, we are going into northern hemisphere this summer. We always have a much better seasonal pattern, and we fully expect to have that again this year despite some of the headwinds in the economies. So, that’s going to help us get through this year and as we go in the next we anticipate that these problems will be resolved and growth will resume to some extent over that period. If it doesn’t it's going to be more difficult.

David Neuberger

Just one thing to add to that on the sales growth commentary. While reported GAAP sales growth was 2% when you exclude some of the recent divestitures when you adjust for currency would have been up closer to 5%. So, a little bit higher sales growth when you exclude for some of the unusual.

Operator

Thank you. And our next question is from Mike Harrison of First Analysis. Your line is open.

Mike Harrison - First Analysis

I had a few questions around the energy or oil field side of Specialty Ingredients. My understanding is that there is greater need for guar in oily shell as compared to gas shells. With the shift that’s occurred in drilling, are you guys able to get all the guar that you need right now in order to meet that demand?

Jim O’Brien

That’s our biggest problem, we have more orders than we have supply. So, right now we are off trying to have contracts and to acquire as much guars we can, and that’s been part of our working capital issue as we have maintained extensive inventories of this because of the backlog of demand and plus the price of this material is more than doubled over the last six months. So, the pricing effect this has had on our inventories has been impactful as well. So, your question is a good one and that gets us confidence because the orders that we have we are desperately trying to find more of this product to process for that market because we can sell all we can find.

Mike Harrison - First Analysis

Have you been able to pass n those higher cost to the customer and to some extent are you able to use this as an opportunity to maybe shift some customers toward other cellulosics or other is modifiers that might be higher margin for you, but a better value to the customer, (inaudible) the only thing that works in this application?

Jim O’Brien

There are other cellulosics they can work, they do carry actually a higher price compared against and the effectiveness that you have with guar. So, you are kind of approaching that equilibrium point where people can have this substitution perhaps. And they are interested in that only because they are looking for more material. It's not so much that they are looking for substitute because of price, looking for a substitute because they just can’t meet the demand. So, we are looking at trying to create some substitution that you are using some of our products, but primarily it's still a guar demand products and that’s where kind of sits right now.

Mike Harrison - First Analysis

And you have been able to pass through the higher guar cost to the customer?

Jim O’Brien

Yes, matter of fact we have shorten the time of pricing sometimes we are on a weekly pricing on this is that the price is going up so dramatically so quickly, you really can’t hold your price it's pretty much order to order as far as that the prices for this product.

Mike Harrison - First Analysis

Okay Jim, on the ISP synergies you said that you are running ahead of schedule in terms of this $50 million target. Given that how much higher could be eventual cost synergies be, I know for example when you acquire Hercules, you heavily overshot your target. Is a $100 million a more reasonable target when all is said and done here?

Jim O’Brien

I think we will be able to give a more reasonable expectation once we get into the Global One launch and that’s going to take effect next year and right it's either going to be April-May or June-July timeframe, we are still working on when we can actually get it done. One or more after we launch Global One to see some of these back room synergies that we can bring to the efficiency of that systems and processes that we put in place. That’s where we gained a lot of when we put Hercules and Ashland first time as we get them on the same systems. And then we learned a lot how we could run the company differently. So, I’d like to hope that we could do better and the number you are throwing out I have no idea we can reach that number. We are going to squeeze out as much as we can to make the company as efficient as possible.

Operator

Thank you. Our next question is from Dmitry Silversteyn of Longbow Research. Your line is open.

Dmitry Silversteyn - Longbow Research

Just trying to understand, and I don’t mean to spend a lot of time on Valvoline but you talked about getting pricing, have you announced price increases and when is the effective date in the price increases you announced in Valvoline?

Jim O’Brien

We have announced price increases to the market and they will take effect primarily in the fourth quarter.

Dmitry Silversteyn - Longbow Research

Okay. So you announced at the beginning of the third and there is about a quarter lag that’s the way to think about that?

Jim O’Brien

Yes, the lag varies depending on the channel. So, on the longer side it takes about 90 days for full pricing implementation, some of our channels we can implement faster than that.

Dmitry Silversteyn - Longbow Research

Okay. And far as raw materials base oil price increases. I mean those announcements all came during the March quarter effective dates, either March or April. So, if I’m thinking about sequential raw material increases you are probably not going to see a lot of increases in pricing until you really get into the fourth quarter as well, right?

Jim O’Brien

That’s right.

Dmitry Silversteyn - Longbow Research

Okay. Secondly just, can you provide a little bit more detail, I mean you talked about at the beginning of the presentation but the Chinese plant that you have decided to close in 2008 or suspend a construction in 2008 and have decided to go elsewhere. What are you going to do with that, I mean was that a leased properties, is there a way to recapture some of the value through land sales or through equipment sales or is this a site that can be developed for one of your other businesses?

Jim O’Brien

The site that we relinquished was government owned site, like all the land is in China and you basis by an option on these sites. And you get a lease of 90 years whatever the lease period is, and the decision that we had, we terminated the site this quarter but we suspended it back in 2008 during the financial crisis. And as we continue to evaluate how we would develop that land, and look at how we would position ourselves in China. We felt that we had better opportunities and other parts particularly in ASI to deploy their capital. So, their decision was to take the financial hit on walking away from this opportunity and preserve about $36 million on future opportunities that we think we have that we could earn returns greater than 20%. And this site has designed going back to 2008 with the opportunities we had for the corporation at that time was well below 20%. So, we thought that the best decision for deployment of our capital was to forego this opportunity and redeploy the future opportunities at higher returns.

Dmitry Silversteyn - Longbow Research

And what was the target for this plant, which business was it going to be supporting?

Jim O’Brien

Well it was going to support primarily water and performance and these returns are probably closer to the 14% return.

Dmitry Silversteyn - Longbow Research

And then just a final question on Water Technologies, I mean it's a business that sounds like it's going to take years as appose to quarters to really bring it up to standard that I show you half way in terms of margin and in terms of growth. Can you talk about between now and 2014, what are some of the concrete steps that you are talking that we can hang our head on in believing that this business can improve materially over the next couple of years assuming the economic environment doesn’t change significantly?

Jim O’Brien

Right. I think the way to hold it accountable to this business is the focus we have had the teams like forever, I know for you all. But I think we are getting toward the end of the forever, and it's taking out a lot of the distractions that this business had in it. we had a lot of low margin business that was difficult to manage to the standard that we wanted, so we have been now moving that business out and trying to get it down to a core level where at least the markets that we are in and the customers that we serve, the efficiency of the customer of the sales person in that account, we can get a much higher return. Now we have a volume problem, now if you take a volume out of the business to build that volume back and that where the focus is, you just can’t go to back at low margins, you got to build back higher margins. That takes some time. So, the focus is in the paper side, I think we are winning in pulp or winning in tissue and towel. So, that part I think is going to continue to continue to perform and you will see the business continue to do well. On our water treatment side we still have polyquilamid too much of that is in water treatment for municipalities. That’s a drag on the business. We need to upgrade that to more motions and we have some investments we have made to increase the capacity in Europe for that. The sales people have been more and more successful in motion stalled products that will help that business get better.

When you have our water treatment business and in that one is all around trying to get up more to the heavy industry. We have to win more of the refinery types, the steel mills and more industry because that’s where the money is made in that market and we are putting less and less focus on the middle market and that was why we moved to distributors because that was the high cost to serve, lot of customers, low ticket and you just to get the turnover and you didn’t get the efficiency. So, I think we have the business positioned when we have it organized around that and we want to report to the future is our successes and these true markets on how is the growth going. So, it's all going to be a top line story. How are we winning customers in these markets if we are not winning the customer we are not succeeding. And I guess we will be able to tell you into the future and how that business is performing.

Dmitry Silversteyn - Longbow Research

So, if I can summarize, I mean you are going through or you are about to complete your weeding out process of in which you are talking about taking care of distractions which is removing the low margin business, so the focus is going forward will be to replace the lower margin with the business that a margin that you actually like to see if we can get the overall reported margin moving in the right direction.

Jim O’Brien

Right. I think we have a good business mix right now, we have enough of it. So, we have to win some new business. And so we stripped out the low margin business so that’s why you see the sales decline, and that hurts the business in the near-term, but it's a type of medicine you have to give the business saying, you are not going to participate here. So, now you don’t have this business any longer, now go out and get this other business. So I think we have a good platform, we also have a good funnel of business going through, we just have to close it. So, we work on a lot of different things, we have a lot of opportunities, now the closure rates got to pick up. And that goes back to sales efficiencies and our sales force how good are they. And we are going to soon find out.

Operator

There are no further questions in the queue at this time.

David Neuberger

Thank you for your time this morning and for your interest in Ashland. If you have any additional question please feel free to give me a call at 859-815-3527. Thank you.

Operator

Ladies and gentlemen, this concludes today’s program, you may now disconnect. Good day.

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