Ashland Global Holdings Inc.
ASHLAND INC. (Form: 10-Q, Received: 01/30/2012 16:06:25)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 
 
 

 
FORM 10-Q

 
 
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the quarterly period ended December 31,  2011
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
EXCHANGE ACT OF 1934
 
For the transition period from _________ to ___________
 
 
Commission file number 1-32532
 
ASHLAND INC.
 
(a Kentucky corporation)
I.R.S. No. 20-0865835
 
50 E. RiverCenter Boulevard
P.O. Box 391
Covington, Kentucky 41012-0391
Telephone Number (859) 815-3333
 

 
 
Indicate by check mark whether the Registrant : (1)  has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days .  Yes  þ    No  o     
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).      Yes þ   No ¨
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.   See the definitions of  “large accelerated filer,” “accelerated filer” and “smaller reporting company”  in Rule 12b-2 of the Exchange Act.  (Check One):
 
 Large Accelerated Filer þ  Accelerated Filer o   
  Non- Accelerated Filer o   Smaller Reporting Company o
  (Do not check if a smaller reporting company.)
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes ¨   No þ 
 
At December 31, 2011, there were 78,305,729 shares of Registrant’s Common Stock outstanding.
 
 


 
 
 
 
PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS
 
             
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
           
STATEMENTS OF CONSOLIDATED INCOME
           
             
   
Three months ended
 
   
December 31
 
(In millions except per share data - unaudited)
 
2011
   
2010
 
             
SALES
  $ 1,930     $ 1,433  
                 
COSTS AND EXPENSES
               
Cost of sales (a)
    1,408       1,035  
Selling, general and administrative expense (b)
    362       276  
Research and development expense
    30       20  
      1,800       1,331  
EQUITY AND OTHER INCOME
    14       12  
                 
OPERATING INCOME
    144       114  
Net interest and other financing expense
    (57 )     (27 )
Net gain (loss) on acquisitions and divestitures (c)
    (4 )     21  
INCOME FROM CONTINUING OPERATIONS
               
BEFORE INCOME TAXES
    83       108  
Income tax expense - Note J
    23       37  
INCOME FROM CONTINUING OPERATIONS
    60       71  
Income from discontinued operations (net of income taxes) - Note D (d)
    1       28  
NET INCOME
  $ 61     $ 99  
                 
BASIC EARNINGS PER SHARE - Note M
               
Income from continuing operations
  $ .77     $ .92  
Income from discontinued operations
    .01       .35  
Net income
  $ .78     $ 1.27  
                 
DILUTED EARNINGS PER SHARE - Note M
               
Income from continuing operations
  $ .76     $ .91  
Income from discontinued operations
    .01       .34  
Net income
  $ .77     $ 1.25  
                 
DIVIDENDS PAID PER COMMON SHARE
  $ .175     $ .15  
                 
(a)
Includes a non-cash charge of $25 million for the three months ended December 31, 2011 related to the fair value assessment of inventory acquired from ISP at the date of acquisition.
(b)
Includes a restructuring charge of $28 million for the three months ended December 31, 2011 related to the ongoing efforts to reduce stranded costs resulting from the divestiture of Distribution, the contribution of the Casting Solutions business to the expanded global joint venture with Süd-Chemie AG and integration activities related to the acquisition of ISP.
(c)
Includes a gain of $19 million for the three months ended December 31, 2010 related to the formation of an expanded global joint venture with Süd-Chemie AG.  The gain is primarily attributable to the fair value remeasurement of the net assets contributed to the joint venture exceeding the recorded values.
(d)
Includes income of $26 million for the three months ended December 31, 2010 related to direct results of the Distribution business that was divested on March 31, 2011.  Due to the sale qualifying for discontinued operation treatment, the direct results of this business have been presented within this caption.
 
 
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
 
2
 
 
             
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
           
CONDENSED CONSOLIDATED BALANCE SHEETS
           
             
   
December 31
   
September 30
 
(In millions - unaudited)
 
2011
   
2011
 
             
ASSETS
           
             
CURRENT ASSETS
           
Cash and cash equivalents
  $ 466     $ 737  
Accounts receivable   (a)
    1,369       1,482  
Inventories - Note G
    981       925  
Deferred income taxes
    163       163  
Other assets
    84       80  
      3,063       3,387  
NONCURRENT ASSETS
               
Goodwill - Note H
    3,294       3,291  
Intangibles - Note H
    2,088       2,134  
Asbestos insurance receivable (noncurrent portion) - Note L
    440       448  
Deferred income taxes
    11       11  
Other assets
    759       781  
      6,592       6,665  
PROPERTY, PLANT AND EQUIPMENT
               
Cost
    4,308       4,306  
Accumulated depreciation and amortization
    (1,450 )     (1,392 )
      2,858       2,914  
                 
TOTAL ASSETS
  $ 12,513     $ 12,966  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
CURRENT LIABILITIES
               
Short-term debt - Note I
  $ 76     $ 83  
Current portion of long-term debt - Note I
    121       101  
Trade and other payables
    770       911  
Accrued expenses and other liabilities
    497       644  
      1,464       1,739  
NONCURRENT LIABILITIES
               
Long-term debt (noncurrent portion) - Note I
    3,607       3,648  
Employee benefit obligations - Note K
    1,546       1,566  
Asbestos litigation reserve (noncurrent portion) - Note L
    766       783  
Deferred income taxes
    403       404  
Other liabilities
    662       691  
      6,984       7,092  
                 
STOCKHOLDERS’ EQUITY
    4,065       4,135  
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 12,513     $ 12,966  
                 
(a)
Accounts receivable includes an allowance for doubtful accounts of $31 million and $37 million at December 31, 2011 and September 30, 2011, respectively.
 
 
 
 
 
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
 

 
3
 
 
                                 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
                           
STATEMENTS OF CONSOLIDATED STOCKHOLDERS’ EQUITY
                     
                                 
                     
Accumulated
         
                     
other
         
   
Common
   
Paid-in
   
Retained
   
comprehensive
         
(In millions - unaudited)
 
stock
   
capital
   
earnings
   
income
 
(a)
 
Total
 
                                 
BALANCE AT SEPTEMBER 30, 2011
  $ 1     $ 627     $ 3,200     $ 307       $ 4,135  
Total comprehensive income (loss) (b)
                    61       (116 )       (55 )
Dividend on common stock, $.175 per share
                    (14 )               (14 )
Common shares issued under stock
                                         
   incentive and other plans (c)
            (1 )                       (1 )
BALANCE AT DECEMBER 31, 2011
  $ 1     $ 626     $ 3,247     $ 191       $ 4,065  
                                           
(a)
At December 31, 2011, the after-tax accumulated other comprehensive income of $191 million was comprised of unrecognized prior service credits as a result of certain employee benefit plan amendments of $61 million, net unrealized translation gains of $147 million, and net unrealized losses on interest rate hedges of $17 million.
(b)
Reconciliations of net income to total comprehensive income (loss) follow.
 
     
Three months ended
 
   
December 31
 
(In millions)
 
2011
   
2010
 
             
Net income
  $ 61     $ 99  
Unrealized translation loss, net of tax
    (111 )     (18 )
Net unrealized loss on interest rate hedges, net of tax
    (5 )     -  
Total comprehensive income (loss)
  $ (55 )   $ 81  
                 
(c)  
Common shares issued were 220,180 for the three months ended December 31, 2011.

 
 
 
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
 
 
 
4
 
 
 
             
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
           
STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
           
             
   
Three months ended
 
   
December 31
 
(In millions - unaudited)
 
2011
   
2010
 
CASH FLOWS (USED) PROVIDED BY OPERATING ACTIVITIES FROM
           
CONTINUING OPERATIONS
           
Net income
  $ 61     $ 99  
Income from discontinued operations (net of income taxes)
    (1 )     (28 )
Adjustments to reconcile income from continuing operations to
               
  cash flows from operating activities
               
Depreciation and amortization
    104       73  
Debt issuance cost amortization
    6       4  
Deferred income taxes
    2       10  
Equity income from affiliates
    (7 )     (3 )
Distributions from equity affiliates
    1       2  
Gain from sale of property and equipment
    -       (3 )
Stock based compensation expense
    6       4  
Stock contributions to qualified savings plans
    -       12  
Net (gain) loss on acquisitions and divestitures
    2       (21 )
Inventory fair value adjustment related to ISP acquisition
    25       -  
Change in operating assets and liabilities   (a)
    (380 )     (187 )
      (181 )     (38 )
CASH FLOWS (USED) PROVIDED BY INVESTING ACTIVITIES FROM
               
CONTINUING OPERATIONS
               
Additions to property, plant and equipment
    (44 )     (22 )
Proceeds from disposal of property, plant and equipment
    1       4  
Purchase of operations - net of cash acquired
    -       (5 )
Proceeds from sale of operations or equity investments
    -       21  
      (43 )     (2 )
CASH FLOWS (USED) PROVIDED BY FINANCING ACTIVITIES FROM
               
CONTINUING OPERATIONS
               
Proceeds from issuance of long-term debt
    -       11  
Repayment of long-term debt
    (23 )     (10 )
(Repayment of)/proceeds from short-term debt
    (7 )     6  
Cash dividends paid
    (14 )     (12 )
Proceeds from exercise of stock options
    1       1  
Excess tax benefits related to share-based payments
    -       1  
      (43 )     (3 )
CASH (USED) PROVIDED BY CONTINUING OPERATIONS
    (267 )     (43 )
Cash (used) provided by discontinued operations
               
Operating cash flows
    (3 )     -  
Investing cash flows
    -       (1 )
Effect of currency exchange rate changes on cash and cash equivalents
    (1 )     1  
DECREASE IN CASH AND CASH EQUIVALENTS
    (271 )     (43 )
                 
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR
    737       417  
                 
CASH AND CASH EQUIVALENTS - END OF PERIOD
  $ 466     $ 374  
                 
(a) 
Excludes changes resulting from operations acquired or sold.

 
 
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
 
 
 
5
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE A   SIGNIFICANT ACCOUNTING POLICIES
 
Basis of presentation  
 
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission regulations.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  These statements omit certain information and footnote disclosures required for complete annual financial statements and, therefore, should be read in conjunction with Ashland’s Annual Report on Form 10-K for the fiscal year ended September 30, 2011.  Results of operations for the period ended December 31, 2011 are not necessarily indicative of results to be expected for the year ending September 30, 2012.  Certain prior period data has been reclassified in the Condensed Consolidated Financial Statements and accompanying footnotes to conform to current period presentation.
 
Ashland is composed of four reporting segments:  Ashland Specialty Ingredients (Specialty Ingredients), which in previous periods had been named Functional Ingredients, Ashland Water Technologies (Water Technologies), Ashland Performance Materials (Performance Materials) and Ashland Consumer Markets (Consumer Markets).
 
On August 23, 2011, Ashland completed the acquisition of International Specialty Products Inc. (ISP).  ISP’s operating results are included in the Specialty Ingredients reporting segment, with the exception of ISP’s Elastomers business, which is included within the Performance Materials reporting segment.  See Note B for additional information on the ISP acquisition.  On March 31, 2011, Ashland completed the sale of substantially all of the assets and certain liabilities of Ashland Distribution (Distribution).  As a result of this sale, the prior period operating results and cash flows related to Distribution have been reflected as discontinued operations.  See Notes C, D and P for additional information on the Distribution divestiture and reporting segment results.
 
Use of estimates, risk and uncertainties
 
The preparation of Ashland’s Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities as well as qualifying subsequent events.  Significant items that are subject to such estimates and assumptions include, but are not limited to, long-lived assets (including goodwill and intangible assets), employee benefit obligations, income taxes, and liabilities and receivables associated with asbestos litigation, environmental remediation and asset retirement obligations.  Although management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, actual results could differ significantly from the estimates under different assumptions or conditions.
 
Ashland’s results are affected by domestic and international economic, political, legislative, regulatory and legal actions.  Economic conditions, such as recessionary trends, inflation, interest and monetary exchange rates, government fiscal policies, and changes in the prices of hydrocarbon-based products and other raw materials, can have a significant effect on operations.  While Ashland maintains reserves for anticipated liabilities and carries various levels of insurance, Ashland could be affected by civil, criminal, regulatory or administrative actions, claims or proceedings relating to asbestos, environmental remediation or other matters.
 
Change in accounting policy regarding pension and other postretirement benefits
 
During the September quarter in 2011, Ashland elected to change its method of recognizing actuarial gains and losses for its defined benefit pension and other postretirement benefit plans.  Previously, Ashland recognized the actuarial gains and losses as a component of Stockholders’ Equity within the Condensed Consolidated Balance Sheet on an annual basis and amortized the gains and losses into operating results over the average future service period of active employees within the related plans.  Ashland has elected to immediately recognize the change in the fair value of plan assets and net actuarial gains and losses annually in the fourth quarter of each year and whenever a plan is determined to qualify for a remeasurement during a year.  The remaining components of pension and other postretirement benefits expense will be recorded on a quarterly basis.  While Ashland’s historical policy of recognizing pension and other postretirement benefit expense is considered acceptable under U.S. GAAP,
 
 
6
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 


NOTE A   SIGNIFICANT ACCOUNTING POLICIES (continued)
 
Ashland believes that the new policy is preferable as it eliminates the delay in recognizing gains and losses within operating results.  This change will also improve transparency within Ashland’s operating results by immediately recognizing the effects of economic and interest rate trends on plan investments and assumptions in the year these gains and losses are actually incurred.  This change in accounting policy has been applied retrospectively, adjusting all prior periods presented.
 
In conjunction with this change in accounting policy for pension and other postretirement benefits, Ashland also elected to change its method of accounting for certain costs included in inventory.  Ashland has elected to exclude the amount of its pension and other postretirement benefit costs applicable to inactive participants from inventoriable costs and charge them directly to cost of sales.  While Ashland’s historical policy of including all pension and other postretirement benefit costs as a component of inventoriable costs was acceptable, Ashland believes that the new policy is preferable, as inventoriable costs will only include costs that are directly attributable to current manufacturing employees.  Applying this change retrospectively, in connection with the change in accounting for pension and other postretirement benefit costs, did not have a significant impact on previously reported inventory, cost of sales or segment reported results in any of the prior period financial statements.
 
The effect of the accounting policy changes on the previously reported results for the three months ended December 31, 2010 resulted in a $12 million increase in net income and a $0.16 increase in diluted earnings per share from net income.
 
New accounting standards
 
The adoption of new accounting standards and new accounting standards issued during the current year are included in interim financial reporting.  A detailed listing of all new accounting standards relevant to Ashland is included in the Annual Report on Form 10-K for the fiscal year ended September 30, 2011.
 
In December 2011, the FASB issued accounting guidance related to the offsetting of assets and liabilities on the balance sheet (ASC 210 Balance Sheet).  The new guidance requires disclosures to provide information to help reconcile differences in the offsetting requirements under U.S. GAAP.  This guidance will become effective for Ashland on October 1, 2013.  The adoption of this guidance is not expected to have a material impact on the Condensed Consolidated Financial Statements.
 
 
NOTE B – ACQUISITIONS
 
International Specialty Products
 
Background and financing
 
On August 23, 2011, Ashland completed its acquisition of ISP, a global specialty chemical manufacturer of innovative functional ingredients and technologies, in a transaction valued at $3.2 billion.  ISP reported sales of $1.9 billion for the twelve month period ended September 30, 2011.  The purchase price was an all cash transaction, reduced by the amount of ISP’s net indebtedness at closing, and is subject to post-closing adjustments based on changes in ISP’s net working capital as well as adjustments to the extent that certain change in control payments, termination costs for interest rate swaps, and accrued pension and other post-employment benefit liabilities of ISP exceed specified amounts.  Ashland has included ISP within the Specialty Ingredients reportable segment, with the exception of ISP’s Elastomers business line, a business with $410 million of sales for the twelve month period ended September 30, 2011, which has been included within the Performance Materials reportable segment.  The acquisition was recorded by Ashland using the acquisition method of accounting in accordance with applicable U.S. GAAP whereby the total purchase price was allocated to tangible and intangible assets and liabilities acquired based on respective fair values.
 
On August 23, 2011, in conjunction with the ISP acquisition closing, Ashland entered into a $3.9 billion senior secured credit facility with a group of lenders (Senior Credit Facility).  The Senior Credit Facility is comprised of
 
 
 
7
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE B – ACQUISITIONS (continued)
 
(i) a $1.5 billion term loan A facility, (ii) a $1.4 billion term loan B facility and (iii) a $1.0 billion revolving credit facility.  Proceeds from borrowings under the term loan A facility and the term loan B facility were used, together with cash on hand, to finance the cash consideration paid for the ISP acquisition, as well as to finance the repayment of existing indebtedness of ISP in connection with the acquisition.
 
Purchase price allocation
 
The all-cash purchase price of ISP was $2,177 million.  The following table summarizes the values of the assets acquired and liabilities assumed at the date of acquisition.
 
   
At
 
Purchase price allocation (in millions)
  August 23, 2011  
Assets:
     
Cash
  $ 186  
Accounts receivable
    286  
Inventory
    381  
Other current assets
    51  
Intangible assets
    1,101  
Goodwill
    1,234  
Property, plant and equipment
    1,140  
Other noncurrent assets
    85  
Liabilities:
       
Accounts payable
    (175 )
Accrued expenses
    (211 )
Debt
    (1,196 )
Deferred tax - net
    (570 )
Employee benefit obligations
    (72 )
Other noncurrent liabilities
    (63 )
Total purchase price
  $ 2,177  
         
 
As of December 31, 2011, the purchase price allocation for the acquisition was preliminary and subject to completion.  Adjustments to the current fair value estimates in the above table may occur as the process conducted for various valuations and assessments is finalized.  Goodwill is calculated as the excess of the consideration transferred over the net assets recognized and represents the estimated future economic benefits arising from other assets acquired that could not be individually identified and separately recognized.
 
Intangible assets identified
 
Ashland has identified $135 million of in-process research and development (IPR&D) projects within the acquired ISP business that, as of the date of acquisition, had not been established in the market place.  These projects consist of various enhancements of existing products or new potential applications for products.  Ashland used various valuation models based on discounted probable future cash flows on a project-by-project basis in identifying 23 projects as distinct assets.  With the adoption of ASC Topic 805, “Business Combinations,” on October 1, 2009, identified IPR&D acquired in a business combination is capitalized and tested for impairment annually and when events and circumstances indicate an impairment may have occurred.  As such, these assets have and will continue to be subjected to future impairment or amortization as the individual projects continue through the various stages of the feasibility assessment process.
 
Ashland has also identified approximately $174 million of certain product trade names, within the Specialty Ingredients business, that have been designated as indefinite-lived assets.  Ashland’s designation of an indefinite life for these assets took many factors into consideration, including the current market leadership position of the brands as well as their recognition worldwide in the industry.  The remaining $792 million of identified finite-lived
 
 
8
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE B – ACQUISITIONS (continued)
 
intangible assets are being amortized over the estimated useful life in proportion to the economic benefits consumed.  Ashland considered the useful lives of the customer relationships and developed technology to be 18 years and 8 to 15 years, respectively.  The determination of the useful lives is based upon various industry studies, historical acquisition experience, economic factors, and future cash flows of the combined company.  In addition, Ashland reviewed certain technological trends and also considered the relative stability in the current ISP customer base.
 
The following details the total intangible assets identified.
 
         
Life
Intangible asset type (in millions)
 
Value
   
(years)
Customer relationships - Specialty Ingredients
  $ 266       18  
Developed technology - Specialty Ingredients
    498       8 - 15  
Developed technology - Performance Materials
    19       8 - 15  
IPR&D - Specialty Ingredients
    135    
Indefinite
Product trade names - Specialty Ingredients
    174    
Indefinite
Product trade names - Specialty Ingredients
    3       4  
Product trade names - Performance Materials
    6       4  
Total
  $ 1,101          
                 
 
NOTE C– DIVESTITURES
 
Synlubes business divestiture
 
In November 2011, Ashland announced that it had entered into a definitive agreement to sell its aviation and refrigerant lubricants business, a polyol/ester-based synlubes (synlubes) business included within the Water Technologies business segment to Monument Chemical Inc., a Heritage Group Company.  Annual sales of the business are approximately $50 million.  Total net assets related to this business totaled $21 million as of December 31, 2011 and primarily consisted of property, plant and equipment.  The transaction was closed in January 2012 and is expected to have a nominal gain that will be recognized in the March 2012 quarter.  
 
PVAc business divestiture
 
In November 2011, Ashland announced that it had entered into a definitive agreement to sell its polyvinyl acetate homopolymer and copolymer (PVAc) business included within the Performance Materials business segment to Celanese Corporation.  Annual sales of the business are approximately $45 million.  Total net assets related to this business totaled $23 million as of December 31, 2011 and primarily consisted of property, plant and equipment.  The sale agreement includes the transfer of the PVAc business, inventory and related technology, but does not include any real estate or manufacturing facilities.  Ashland’s PVAc business includes two brands, Flexbond™ and Vinac™ emulsions.  To support the transition, the products will be temporarily toll manufactured by Ashland for the Celanese Corporation.  The transaction was closed in January 2012 and is expected to have a nominal gain that will be recognized in the March 2012 quarter.  
 
Ashland Distribution
 
On March 31, 2011, Ashland completed the sale to Nexeo Solutions, LLC (Nexeo) of substantially all of the assets and certain liabilities of its global distribution business which previously comprised the Ashland Distribution (Distribution) segment.  The transaction was an asset sale with the total post-closing adjusted cash proceeds received by Ashland of $972 million, before transaction fees and taxes.  Ashland recognized an after-tax gain of $271 million during 2011.  Because this transaction signified Ashland’s exit from the distribution business, the results of operations and cash flows of Distribution have been classified as discontinued operations for all periods
 
 
 
9
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE C – DIVESTITURES (continued)
 
presented.  Certain indirect corporate costs included within selling, general and administrative expense that were previously allocated to the Distribution reporting segment that do not qualify for discontinued operations accounting classification are now reported as costs within the Unallocated and other section of continuing operations, and for the three months ended December 31, 2011 and 2010 were $5 million and $7 million, respectively.  Ashland is currently implementing plans to reduce these stranded costs.
 
Ashland will retain and has agreed to indemnify Nexeo for certain liabilities of the Distribution business arising prior to the closing of the sale.  This includes pension and other postretirement benefits, as well as certain other liabilities, including certain litigation and environmental liabilities relating to the pre-closing period, as described in the definitive agreement.  The ongoing effects of the pension and postretirement plans for former Distribution employees are reported within the Unallocated and other section of continuing operations.
 
As part of this sale, Ashland is receiving transition service fees for ongoing administrative and other services being provided to Nexeo.  During the three months ended December 31, 2011, Ashland recognized transition service fees of $8 million, which offset costs of providing transition services and are classified within the selling, general and administrative expense caption of the Statements of Consolidated Income.  While the transition service agreements vary in duration depending upon the type of service provided, Ashland is implementing plans to reduce costs as the transition services are phased out.
 
Casting Solutions Joint Venture
 
In July 2010, Ashland and Süd-Chemie AG (Süd-Chemie) signed an agreement for the formation of an expanded global joint venture serving the foundry chemical sector.  The transaction closed on November 30, 2010 and combined three businesses:  (i) Ashland’s Casting Solutions business group, (ii) Süd-Chemie’s Foundry-Products and Specialty Resins business unit, and (iii) Ashland-Südchemie-Kernfest GmbH (ASK), the then existing 50% owned European-based joint venture between Ashland and Süd-Chemie, for which Ashland historically only recognized equity income of the joint venture within its consolidated results.   Ashland recognized a pretax gain of $23 million during 2011, of which $19 million was recognized during the December 2010 period, attributable to the fair market value of the net assets contributed to the joint venture.
 
Ashland’s equity interest in the expanded joint venture qualifies for equity method accounting treatment under U.S. GAAP.  As a result, beginning on December 1, 2010, the results of the Performance Materials segment no longer include the sales, cost of sales, selling, general and administrative expense and corresponding taxes related to the Casting Solutions business; however, Ashland includes the financial results of the joint venture within operating income of the Performance Materials segment and in the equity and other income caption of the Statements of Consolidated Income.
 
 
NOTE D – DISCONTINUED OPERATIONS
 
As previously described in Note C, on March 31, 2011 Ashland completed the sale of substantially all of the assets and certain liabilities of Distribution.  Ashland has determined that this sale qualifies as a discontinued operation, in accordance with U.S. GAAP, since Ashland does not have significant continuing involvement in the distribution business.  As a result, operating results and cash flows related to Distribution have been reflected as discontinued operations in the Statement of Consolidated Income and Statement of Condensed Consolidated Cash Flows.  Sales for the three months ended December 31, 2010 were $856 million.  The results of operations for the three months ended December 31, 2010 are included in the table below.  Ashland has made subsequent adjustments to the gain on sale of Distribution, primarily relating to the tax effects of the sale, during the three months ended December 31, 2011.
 
Ashland’s divestiture of Ashland Paving And Construction (APAC) during 2006 qualified as a discontinued operation.  As a result, the previous operating results, assets and liabilities related to APAC have been reflected as discontinued operations in the Condensed Consolidated Financial Statements.  Ashland has made subsequent
 
 
10
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE D – DISCONTINUED OPERATIONS (continued)
 
adjustments to the gain on the sale of APAC, primarily relating to the tax effects of the sale, during the three month period ended December 31, 2010.  Such adjustments to these and other divested businesses may continue to occur in future periods and are reflected in the period they are determined and recorded in the discontinued operations caption in the Statements of Consolidated Income.
 
Ashland is subject to liabilities from claims alleging personal injury caused by exposure to asbestos.  Such claims result primarily from indemnification obligations undertaken in 1990 in connection with the sale of Riley Stoker Corporation (Riley), a former subsidiary of Ashland, and from the acquisition of Hercules during 2009, a wholly-owned subsidiary of Ashland.  Adjustments to the recorded litigation reserves and related insurance receivables are recorded within discontinued operations and continue periodically, primarily reflecting updates to the original estimates.  See Note L for more information related to the adjustments on asbestos liabilities and receivables.
 
Components of amounts reflected in the Statements of Consolidated Income related to discontinued operations are presented in the following table for the three months ended December 31, 2011 and 2010.

   
Three months ended
 
   
December 31
 
(In millions)
 
2011
   
2010
 
Income (loss) from discontinued operations (net of tax)
           
Distribution (a)
  $ (1 )   $ 26  
Asbestos-related litigation reserves and receivables
    6       1  
Gain (loss) on disposal of discontinued operations (net of tax)
               
Distribution
    (4 )     -  
APAC
    -       1  
Total income from discontinued operations (net of tax)
  $ 1     $ 28  
                 
(a)  
For the three months ended December 31, 2010, the pretax income reported for Distribution was $36 million.
 
NOTE E – RESTRUCTURING ACTIVITIES
 
Ashland periodically implements restructuring programs related to acquisitions, divestitures or other cost reduction programs in order to enhance profitability through streamlined operations and an improved overall cost structure for each business.
 
During 2011, Ashland announced steps to reduce stranded costs resulting from the divestiture of Distribution and the contribution of the Casting Solutions business to the expanded global joint venture with Süd-Chemie.  In addition, Ashland is currently taking action to integrate ISP subsequent its purchase in August 2011.  As a first step to address cost reduction opportunities resulting from these transactions, Ashland announced a voluntary severance offer (VSO) in June 2011 to approximately 1,500 regular, full-time, non-union, U.S.-based employees, primarily within various shared resource groups as well as certain positions within the Specialty Ingredients business, ultimately resulting in 150 employees being formally approved for the VSO.  An involuntary program was also initiated as a further step to capture targeted saving levels from these transactions and other business cost saving initiatives.  The VSO and involuntary program resulted in a severance charge of $34 million during the September 2011 quarter.  The involuntary program continued during the December 2011 quarter and resulted in an additional severance charge of $28 million classified within the selling, general and administrative expense caption of the Statement of Consolidated Income for the three months ended December 31, 2011.  Additional charges related to the involuntary program may be incurred in subsequent periods from ongoing efforts to maximize operational efficiencies as a result of these transactions.  As of December 31, 2011, the restructuring reserve for these programs totaled $56 million.
 
As of December 31, 2011 and 2010, the $8 million and $21 million, respectively, in remaining restructuring reserves for previously announced programs consisted of severance payments from the 2009 Hercules Integration Plan, which resulted in 12 permanent facility closings and a reduction in the global workforce of over 2,000
 
 
11
 
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE E – RESTRUCTURING ACTIVITIES (continued)
 
employees from 2008 through 2010 and the Performance Materials restructuring, which consisted of several plant closings and an operational redesign to eliminate excess capacity that was announced during 2010.
 
The following table details, at December 31, 2011 and 2010, the amount of restructuring reserves related to the programs discussed above, and the related activity in these reserves for the three months ended December 31, 2011 and 2010.  The reserves are included in accrued expenses and other liabilities in the Condensed Consolidated Balance Sheet.
 
 
(In millions)
 
Severance
 
Balance as of September 30, 2011
  $ 45  
Restructuring reserve
    28  
Utilization (cash paid or otherwise settled)
    (9 )
Balance at December 31, 2011
  $ 64  
         
Balance as of September 30, 2010
  $ 26  
Utilization (cash paid or otherwise settled)
    (5 )
Balance at December 31, 2010
  $ 21  
         
 
NOTE F – FAIR VALUE MEASUREMENTS
 
As required by U.S. GAAP, Ashland uses applicable guidance for defining fair value, the initial recording and periodic remeasurement of certain assets and liabilities measured at fair value and related disclosures for instruments measured at fair value.  Fair value accounting guidance establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.  The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).  An instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement.  The three levels within the fair value hierarchy are described as follows:
 
Level 1  — Observable inputs such as unadjusted quoted prices in active markets for identical assets or liabilities.
 
Level 2  — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.  These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
 
Level 3  — Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date.  Unobservable inputs reflect Ashland’s own assumptions about what market participants would use to price the asset or liability.  The inputs are developed based on the best information available in the circumstances, which might include occasional market quotes or sales of similar instruments or Ashland’s own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.
 
For assets that are measured using quoted prices in active markets (Level 1), the total fair value is the published market price per unit multiplied by the number of units held without consideration of transaction costs.  Assets and liabilities that are measured using significant other observable inputs (Level 2) are primarily valued by reference to quoted prices of similar assets or liabilities in active markets (market approach), adjusted for any terms specific to that asset or liability.  For all other assets and liabilities for which unobservable inputs are used (Level 3), fair value is derived through the use of fair value models, such as a discounted cash flow model or other standard pricing models that Ashland deems reasonable.
 
The following table summarizes financial asset instruments subject to recurring fair value measurements as of December 31, 2011.
 
 
 
12
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE F – FAIR VALUE MEASUREMENTS (continued)
 
               
Quoted prices
             
               
in active
   
Significant
       
               
markets for
   
other
   
Significant
 
         
Total
   
identical
   
observable
   
unobservable
 
   
Carrying
   
fair
   
assets
   
inputs
   
inputs
 
(In millions)
 
value
   
value
   
Level 1
   
Level 2
   
Level 3
 
Assets
                             
Cash and cash equivalents
  $ 466     $ 466     $ 466     $ -     $ -  
Auction rate securities
    10       10       -       -       10  
Deferred compensation investments (a)
  173       173       60       113       -  
Investments of captive insurance company (a)
  2       2       2       -       -  
Total assets at fair value
  $ 651     $ 651     $ 528     $ 113     $ 10  
                                         
Liabilities
                                       
Interest rate swap derivatives
  $ 29     $ 29     $ -     $ 29     $ -  
                                         
(a)   
Included in other noncurrent assets in the Condensed Consolidated Balance Sheets.
 
The following table summarizes financial asset instruments subject to recurring fair value measurements as of September 30, 2011.
 
               
Quoted prices
             
               
in active
   
Significant
       
               
markets for
   
other
   
Significant
 
         
Total
   
identical
   
observable
   
unobservable
 
   
Carrying
   
fair
   
assets
   
inputs
   
inputs
 
(In millions)
 
value
   
value
   
Level 1
   
Level 2
   
Level 3
 
Assets
                             
Cash and cash equivalents
  $ 737     $ 737     $ 737     $ -     $ -  
Auction rate securities
    10       10       -       -       10  
Deferred compensation investments (a)
    185       185       76       109       -  
Investments of captive insurance company (a)
  2       2       2       -       -  
Foreign currency derivatives
    1       1       -       1       -  
Total assets at fair value
  $ 935     $ 935     $ 815     $ 110     $ 10  
                                         
Liabilities
                                       
Interest rate swap derivatives
  $ 20     $ 20     $ -     $ 20     $ -  
                                         
(a)   Included in other noncurrent assets in the Condensed Consolidated Balance Sheets.
 
Level 3 instruments
 
Auction rate securities
 
At December 31, 2011 and September 30, 2011, Ashland held at par value $12 million of student loan auction rate securities for which there was not an active market with consistent observable inputs.  In February 2008, the auction rate securities market became largely illiquid, as there was not enough demand to purchase all of the securities that holders desired to sell at par value during certain auctions.  Since this time, the market for auction rate securities has failed to achieve equilibrium.  Due to the uncertainty as to when active trading will resume in the auction rate securities market, Ashland believes the recovery period for certain of these securities may extend beyond a twelve-month period.  As a result, these instruments have been classified as noncurrent assets in the Condensed Consolidated Balance Sheet.
 
 
13
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE F – FAIR VALUE MEASUREMENTS (continued)
 
During the three months ended December 31, 2011 and 2010, there was no activity related to Ashland’s auction rate securities.
 
Derivative and hedging activities
 
Currency hedges
 
Ashland conducts business in a variety of foreign currencies.  Accordingly, Ashland regularly uses foreign currency derivative instruments to manage exposure on certain transactions denominated in foreign currencies to curtail the earnings volatility effects of short-term assets and liabilities denominated in currencies other than the functional currency of an entity.
 
Ashland contracts with counter-parties to buy and sell foreign currencies to offset the impact of exchange rate changes on transactions denominated in non-functional currencies, including short-term inter-company loans.  These contracts generally require exchange of one foreign currency for another at a fixed rate at a future date and generally have maturities of less than twelve months.  All contracts are marked-to-market with net changes in fair value recorded within the selling, general and administrative expense caption.  The impacts of these contracts were largely offset by gains and losses resulting from the impact of changes in exchange rates on transactions denominated in non-functional currencies.  The following table summarizes the losses recognized during the three months ended December 31, 2011 and 2010 within the Statement of Consolidated Income.
 
 
Three months ended
 
 
December 31
 
(In millions)
 
2011
   
2010
 
Foreign currency derivative gain
  $ 1     $ -  
                 
 
The following table summarizes the fair values of the outstanding foreign currency derivatives as of December 31, 2011 and September 30, 2011 included in other current assets and trade and other payables of the Condensed Consolidated Balance Sheet.
 
   
December 31
   
September 30
 
(In millions)
 
2011
   
2011
 
Foreign currency derivative assets
  $ -     $ 1  
Notional contract values
    52       62  
                 
Foreign currency derivative liabilities
  $ -     $ -  
Notional contract values
    45       35  
                 
 
Interest rate hedges
 
During 2011, Ashland entered into interest rate swap agreements in order to manage the variable interest rate risk associated with term loans A and B that were borrowed in conjunction with the ISP acquisition.  As of December 31, 2011 and September 30, 2011, the total notional value of interest rate swaps related to term loans A and B equaled $1.5 billion and $650 million, respectively.  These instruments qualify for hedge accounting treatment and are designated as cash flow hedges whereby Ashland records these hedges at fair value, with the effective portion of the gain or loss reported as a component of accumulated other comprehensive income (AOCI) and subsequently recognized in the Statements of Consolidated Income when the hedged item affects net income.  There was no hedge ineffectiveness with these instruments during the three months ended December 31, 2011.
 
The fair value of Ashland’s interest rate swap assets and liabilities are calculated using standard pricing models.  These models utilize inputs derived from observable market data such as interest rate spot rates and forward rates, and are deemed to be Level 2 measurements within the fair value hierarchy.  Counterparties to these interest rate
 
 
14
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE F – FAIR VALUE MEASUREMENTS (continued)
 
swap agreements are highly rated financial institutions which Ashland believes carry only a minimal risk of nonperformance.  The following table summarizes the fair values of the outstanding interest rate swap instruments as of December 31, 2011 and September 30, 2011.

     
December 31
   
September 30
 
(In millions)
Consolidated balance sheet caption
 
2011
   
2011
 
Interest rate swap liabilities
Accrued expenses and other liabilities
  $ 17     $ 17  
Interest rate swap liabilities
Other noncurrent liabilities
    12       3  
 
The following table summarizes the unrealized loss on interest rate hedges recognized in AOCI during the three months ended December 31, 2011, as well as the loss reclassified from AOCI to income during the three months ended December 31, 2011.  The loss reclassified to income was recorded in the net interest and other financing expense caption within the Statement of Consolidated Income.
 
   
Change in
    Loss reclassified  
    unrealized loss    
from AOCI
 
(In millions)
 
in AOCI
   
to income
 
Interest rate hedges
  $ 14     $ 5  
                 
 
During 2009, Ashland purchased a three year interest rate cap on a notional amount of $300 million of variable rate debt.  This interest rate cap fixes Ashland’s interest rate on that outstanding variable interest rate debt when LIBOR interest rates equal or exceed 7% on a reset date.  This instrument does not qualify for hedge accounting and therefore gains or losses reflecting changes in fair value, along with the amortization of the upfront premium paid by Ashland to purchase the instrument, are reported in the Statements of Consolidated Income within the net interest and other financing expense caption.  As of December 31, 2011 and September 30, 2011, the fair value on the interest rate cap was less than $1 million and recorded within the other noncurrent assets caption of the Condensed Consolidated Balance Sheet.
 
Other financial instruments
 
At December 31, 2011 and September 30, 2011, Ashland’s long-term debt had a carrying value of $3,728 million and $3,749 million, respectively, compared to a fair value of $3,969 million and $3,953 million, respectively.  The fair values of long-term debt are based on quoted market prices or, if market prices are not available, the present values of the underlying cash flows discounted at Ashland’s incremental borrowing rate.
 
 
NOTE G – INVENTORIES
 
Inventories are carried at the lower of cost or market.  Certain chemicals, plastics and lubricants are valued at cost using the last-in, first-out (LIFO) method.  The remaining inventories are stated at cost using the weighted-average cost method or the first-in, first-out method.  The following table summarizes Ashland’s inventories as of the reported Condensed Consolidated Balance Sheet dates.
 
   
December 31
   
September 30
 
(In millions)
 
2011
   
2011
 
Finished products
  $ 661     $ 620  
Raw materials, supplies and work in process
    370       364  
LIFO reserve
    (50 )     (59 )
    $ 981     $ 925  
                 
 
 
15
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE H – GOODWILL AND OTHER INTANGIBLES
 
In accordance with U.S. GAAP, Ashland reviews goodwill and indefinite-lived intangible assets for impairment annually and when events and circumstances indicate an impairment may have occurred.  The annual assessment is performed as of July 1 and consists of Ashland determining each reporting unit’s current fair value compared to its current carrying value.  Ashland has determined that its reporting units for allocation of goodwill include the Specialty Ingredients, Water Technologies and Consumer Markets reportable segments and the Composite Polymers/Specialty Polymers and Adhesives reporting unit within the Performance Materials reportable segment.  Prior to its sale to Nexeo, Distribution was treated as a separate reporting unit for allocation of goodwill.  Ashland performed its most recent annual goodwill impairment test as of July 1, 2011, and determined at that time that no impairment existed.
 
The following is a progression of goodwill by segment for the period ended December 31, 2011.

   
Specialty
   
Water
   
Performance
   
Consumer
       
(In millions)
 
Ingredients
   
Technologies
   
Materials
   
Markets
   
Total
 
Balance at September 30, 2011
  $ 2,092     $ 676     $ 357     $ 166     $ 3,291  
Acquisitions (a)
    49       -       -       -       49  
Currency translation adjustment
    (25 )     (12 )     (9 )     -       (46 )
Balance at December 31, 2011
  $ 2,116     $ 664     $ 348     $ 166     $ 3,294  
                                         
 
( a)  The adjustment primarily relates to updates to the post-closing adjustments from the ISP acquisition.
 
Intangible assets principally consist of trademarks and trade names, intellectual property, customer lists, IPR&D and sale contracts and those classified as finite are amortized on a straight-line basis over their estimated useful lives.  The cost of definite-lived trademarks and trade names is amortized principally over 4 to 25 years, intellectual property over 5 to 20 years, customer relationships over 3 to 24 years and other intangibles over 2 to 50 years.
 
IPR&D and certain intangible assets within trademarks and trade names have been classified as indefinite-lived and had a balance of $599 million as of December 31, 2011 and September 30, 2011.  In accordance with U.S. GAAP, Ashland annually reviews these intangible assets for possible impairment or whenever events or changes in circumstances indicate that carrying amounts may not be recoverable.  In conjunction with the July 1, 2011 annual assessment of indefinite-lived intangible assets, Ashland’s models did not indicate any impairment.  Intangible assets were comprised of the following as of December 31, 2011 and September 30, 2011.
 
   
December 31, 2011
 
   
Gross
         
Net
 
   
carrying
   
Accumulated
   
carrying
 
(In millions)
 
amount
   
amortization
   
amount
 
Trademarks and trade names
  $ 536     $ (33 )   $ 503  
Intellectual property
    845       (100 )     745  
Customer relationships
    833       (129 )     704  
IPR&D
    135       -       135  
Other intangibles
    35       (34 )     1  
Total intangible assets
  $ 2,384     $ (296 )   $ 2,088  
                         
 
 
16
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE H – GOODWILL AND OTHER INTANGIBLES (continued)

   
September 30, 2011
 
   
Gross
         
Net
 
   
carrying
   
Accumulated
   
carrying
 
(In millions)
 
amount
   
amortization
   
amount
 
Trademarks and trade names
  $ 536     $ (31 )   $ 505  
Intellectual property
    848       (87 )     761  
Customer relationships
    846       (116 )     730  
IPR&D
    135       -       135  
Other intangibles
    35       (32 )     3  
Total intangible assets
  $ 2,400     $ (266 )   $ 2,134  
                         
 
Amortization expense recognized on intangible assets for the three months ended December 31 was $30 million for 2011 and $17 million for 2010 and is primarily included in the selling, general and administrative expense caption of the Statements of Consolidated Income.  Estimated amortization expense for future periods is $119 million in 2012 (includes three months actual and nine months estimated), $117 million in 2013, $115 million in 2014, $114 million in 2015 and $111 million in 2016.
 
 
NOTE I – DEBT
 
The following table summarizes Ashland’s current and long-term debt as of the reported Condensed Consolidated Balance Sheet dates.
 
   
December 31
   
September 30
 
(In millions)
 
2011
   
2011
 
Term Loan A, due 2016 (a)
  $ 1,481     $ 1,500  
Term Loan B, due 2018 (a)
    1,396       1,400  
9.125% notes, due 2017
    633       633  
6.50% junior subordinated notes, due 2029 (b)
    128       128  
6.60% notes, due 2027 (b)
    12       12  
Medium-term notes, due 2013-2019, interest at a weighted-
               
average rate of 8.4% at December 31, 2011 (7.7% to 9.4%)
    21       21  
8.80% debentures, due 2012
    20       20  
Hercules Nanjing - term notes, due 2013
    36       35  
Other international loans, interest at a weighted-average
               
rate of  7.0% at December 31, 2011 (2.0% to 11.8%)
    76       81  
Other
    1       2  
Total debt
    3,804       3,832  
Short-term debt
    (76 )     (83 )
Current portion of long-term debt
    (121 )     (101 )
Long-term debt (less current portion)
  $ 3,607     $ 3,648  
                 
(a)  
Senior credit facilities.
(b)  
Retained instrument from the Hercules acquisition.
 
 
The scheduled aggregate maturities of debt by year are as follows:  $146 million remaining in 2012, $137 million in 2013, $176 million in 2014, $172 million in 2015, $1,064 million in 2016 and $664 million in 2017.  Total borrowing capacity remaining under the $1 billion revolving credit facility was $916 million, representing a reduction of $84 million for letters of credit outstanding at December 31, 2011.
 
 
17
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE I – DEBT (continued)
 
Covenant restrictions
 
The Senior Credit Facility (Term Loan A, Term Loan B and revolving credit facility) contains usual and customary representations, warranties and affirmative and negative covenants, including financial covenants for leverage and fixed charge coverage ratios, limitations on liens, additional indebtedness, further negative pledges, investments, payment of dividends, mergers, sale of assets and restricted payments, and other customary limitations.   As of December 31, 2011, Ashland is in compliance with all debt agreement covenants.
 
Financial covenants
 
The maximum consolidated leverage ratios permitted under the Senior Credit Facility are as follows:  4.00 from the period December 31, 2011 through March 31, 2012, 3.75 as of June 30, 2012, 3.50 as of September 30, 2012, 3.00 from the period December 31, 2012 through September 30, 2013 and 2.75 as of December 31, 2013 and each quarter thereafter.  At December 31, 2011, Ashland’s calculation of the consolidated leverage ratio was 3.0 compared to the maximum consolidated leverage ratio permitted under the Senior Credit Facility of 4.00.
 
The minimum required consolidated fixed charge coverage ratios under the Senior Credit Facility are 1.50 from the period December 31, 2011 through June 30, 2012, 1.75 as of September 30, 2012 and 2.00 as of December 31, 2012 and each quarter thereafter.  At December 31, 2011, Ashland’s calculation of the fixed charge coverage ratio was 3.3 compared to the minimum required consolidated ratio of 1.50.
 
 
NOTE J – INCOME TAXES
 
Ashland’s effective tax rate is generally subjected to adjustments related to discrete items and changes within foreign effective tax rates resulting from income or loss fluctuations.  The overall effective tax rate was 27.7% for the three months ended December 31, 2011 and included two discrete tax benefits of $9 million for both the $28 million severance and restructuring charge and the $25 million fair value assessment of inventory charge recorded during the current quarter.
 
The overall effective tax rate was 34.3% for the three months ended December 31, 2010 and included certain discrete items such as a $16 million tax expense from the $19 million pretax gain associated with the fair market value of the Casting Solutions contribution and a $4 million tax benefit associated with research and development tax credits for 2010.  In addition, the effective tax rate during this period was favorably impacted by $3 million from other miscellaneous discrete tax items.
 
Changes in unrecognized tax benefits are summarized as follows for the three months ended December 31, 2011.
 
 
(In millions)
     
Balance at October 1, 2011
  $ 160  
Increases related to positions taken on items from prior years
    4  
Decreases related to positions taken on items from prior years
    (14 )
Increases related to positions taken in the current year
    1  
Balance at December 31, 2011
  $ 151  
         
 
Ashland expects to conclude certain audits during the year ending September 30, 2012.  As a result, it is reasonably possible that the amount of the unrecognized tax benefits may increase or decrease within the next twelve months which may have a material effect on the Condensed Consolidated Financial Statements.  However, an estimate of the range of possible change cannot be made at this time due to the uncertainty of the resolution of the open audits.
 
 
18
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE K – EMPLOYEE BENEFIT PLANS
 
As discussed in Notes A and P, Ashland elected during 2011 to change its method of recognizing actuarial gains and losses for its defined benefit pension and postretirement benefit plans.  This accounting change was applied retrospectively, adjusting all prior periods presented.
 
For the three months ended December 31, 2011, Ashland contributed $3 million to the U.S. benefit plans and $9 million to the non-U.S. benefit plans.  Ashland expects to make additional contributions to the U.S. plans of approximately $92 million and to the non-U.S. plans of $18 million during the remainder of 2012.  The following table details the components of pension and other postretirement benefit costs.
 
               
Other postretirement
 
   
Pension benefits
   
benefits
 
(In millions)
 
2011
   
2010
   
2011
   
2010
 
Three months ended December 31
                       
Service cost
  $ 10     $ 13     $ 1     $ 1  
Interest cost
    49       50       3       4  
Expected return on plan assets
    (57 )     (57 )     -       -  
Amortization of prior service credit
    (1 )     (1 )     (4 )     (1 )
    $ 1     $ 5     $ -     $ 4  
                                 
 
NOTE L – LITIGATION, CLAIMS AND CONTINGENCIES
 
Asbestos litigation
 
Ashland and Hercules, a wholly-owned subsidiary of Ashland, have liabilities from claims alleging personal injury caused by exposure to asbestos.  To assist in developing and annually updating independent reserve estimates for future asbestos claims and related costs given various assumptions, Ashland retained Hamilton, Rabinovitz & Associates, Inc. (HR&A).  The methodology used by HR&A to project future asbestos costs is based largely on recent experience, including claim-filing and settlement rates, disease mix, enacted legislation, open claims, and litigation defense.  The claim experience of Ashland and Hercules are separately compared to the results of previously conducted third party epidemiological studies estimating the number of people likely to develop asbestos-related diseases.  Those studies were undertaken in connection with national analyses of the population expected to have been exposed to asbestos.  Using that information, HR&A estimates a range of the number of future claims that may be filed, as well as the related costs that may be incurred in resolving those claims.
 
Ashland asbestos-related litigation
 
The claims alleging personal injury caused by exposure to asbestos asserted against Ashland result primarily from indemnification obligations undertaken in 1990 in connection with the sale of Riley Stoker Corporation, a former subsidiary.  The amount and timing of settlements and number of open claims can fluctuate significantly from period to period.  A summary of Ashland asbestos claims activity, excluding those related to Hercules, follows.

   
Three months ended
                   
   
December 31
   
Years ended September 30
 
(In thousands)
 
2011
   
2010
   
2011
   
2010
   
2009
 
Open claims - beginning of period
  72     83     83     100     115  
New claims filed
  1     -     2     2     2  
Claims settled
  -     -     (1 )   (1 )   (1 )
Claims dismissed
  (3 )   (4 )   (12 )   (18 )   (16 )
Open claims - end of period
  70     79     72     83     100  
                               
 
19
 
 


 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE L – LITIGATION, CLAIMS AND CONTINGENCIES (continued)
 
Ashland asbestos-related liability
 
From the range of estimates, Ashland records the amount it believes to be the best estimate of future payments for litigation defense and claim settlement costs, which generally approximates the mid-point of the estimated range of exposure from model results.  Ashland reviews this estimate and related assumptions quarterly and annually updates the results of a non-inflated, non-discounted approximate 50-year model developed with the assistance of HR&A.  During the most recent annual update of this estimate, completed during the June 2011 quarter, it was determined that the liability for asbestos claims should be increased by $41 million.  Total reserves for asbestos claims were $533 million at December 31, 2011 compared to $543 million at September 30, 2011.
 
A progression of activity in the asbestos reserve is presented in the following table.

   
Three months ended
                   
   
December 31
   
Years ended September 30
 
(In millions)
 
2011
   
2010
   
2011
   
2010
   
2009
 
Asbestos reserve - beginning of period
  $ 543     $ 537     $ 537     $ 543     $ 572  
Reserve adjustment
    -       -       41       28       5  
Amounts paid
    (10 )     (11 )     (35 )     (34 )     (34 )
Asbestos reserve - end of period
  $ 533     $ 526     $ 543     $ 537     $ 543  
                                         
 
Ashland asbestos-related receivables
 
Excluding the Hercules asbestos claims further described below, Ashland has insurance coverage for most of the litigation defense and claim settlement costs incurred in connection with its asbestos claims, and coverage-in-place agreements exist with the insurance companies that provide most of the coverage currently being accessed.  As a result, increases in the asbestos reserve have been largely offset by probable insurance recoveries.  The amounts not recoverable generally are due from insurers that are insolvent, rather than as a result of uninsured claims or the exhaustion of Ashland’s insurance coverage.
 
For the Ashland asbestos-related obligations, Ashland has estimated the value of probable insurance recoveries associated with its asbestos reserve based on management’s interpretations and estimates surrounding the available or applicable insurance coverage, including an assumption that all solvent insurance carriers remain solvent.  Approximately 72% of the estimated receivables from insurance companies are expected to be due from domestic insurers, of which approximately 85% have a credit rating of B+ or higher by A. M. Best, as of December 31, 2011.  The remainder of the insurance receivable is due from London insurance companies, which generally have lower credit quality ratings, and from Underwriters at Lloyd’s, whose insurance policy obligations have been transferred to a Berkshire Hathaway entity.  Ashland discounts this piece of the receivable based upon the projected timing of the receipt of cash from those insurers unless likely settlement amounts can be determined.
 
During 2010, Ashland entered into a new agreement with a number of London market insurance companies with respect to coverage for asbestos-related insurance claims.  As a result, a $12 million increase to the Ashland asbestos receivable was recorded within the Condensed Consolidated Balance Sheet, which had a $9 million (after-tax) effect on the Statement of Consolidated Income within the discontinued operations caption.  During the December 2011 quarter, Ashland received $7 million   in cash after reaching a settlement with certain insolvent London market insurance companies.  The cash received from this settlement during the current quarter was recognized as an after-tax gain of $6 million within discontinued operations of the Statement of Consolidated Income since Ashland’s policy is to not record asbestos receivables for any carriers that are insolvent.  In addition, Ashland had agreed to arbitrate a dispute regarding whether there is a significant deductible in the London market companies’ policies in three policy periods that must be satisfied before the policies begin providing coverage for Riley Stoker asbestos claims.  The London market companies had contended that Ashland must bear certain self-insured retentions in respect of Riley Stoker asbestos liabilities before the London coverage attaches in these three years, and Ashland disputed that such self-insured retentions must be satisfied.  The parties conducted an arbitration
 
 
 
20
 
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE L – LITIGATION, CLAIMS AND CONTINGENCIES (continued)
 
hearing on this dispute in June 2011, and a decision was rendered by the arbitrator in October 2011 that essentially supported Ashland’s previously stated position on these claims.
 
At December 31, 2011, Ashland’s receivable for recoveries of litigation defense and claim settlement costs from insurers amounted to $423 million (excluding the Hercules receivable for asbestos claims), of which $56 million relates to costs previously paid.  Receivables from insurers amounted to $431 million at September 30, 2011.  During 2011, the model used for purposes of valuing the asbestos reserve described above, and its impact on valuation of future recoveries from insurers, was updated.  This model update along with the potential settlement adjustments resulted in an additional $42 million increase in the receivable for probable insurance recoveries.
 
A progression of activity in the Ashland insurance receivable (excluding Hercules) is presented in the following table.

   
Three months ended
                   
   
December 31
   
Years ended September 30
 
(In millions)
 
2011
   
2010
   
2011
   
2010
   
2009
 
Insurance receivable - beginning of period
  $ 431     $ 421     $ 421     $ 422     $ 458  
Receivable adjustment
    -       -       42       36       8  
Amounts collected
    (8 )     (7 )     (32 )     (37 )     (44 )
Insurance receivable - end of period
  $ 423     $ 414     $ 431     $ 421     $ 422  
                                         
 
Hercules asbestos-related litigation
 
Hercules, a wholly-owned subsidiary of Ashland, has liabilities from claims alleging personal injury caused by exposure to asbestos.  Such claims typically arise from alleged exposure to asbestos fibers from resin encapsulated pipe and tank products which were sold by one of Hercules’ former subsidiaries to a limited industrial market.  The amount and timing of settlements and number of open claims can fluctuate significantly from period to period.  A summary of Hercules’ asbestos claims activity follows.

   
Three months ended
                   
   
December 31
   
Years ended September 30
 
(In thousands)
 
2011
   
2010
   
2011
   
2010
   
2009
(a)
Open claims - beginning of period
  21     20     20     21     27  
New claims filed
  -     2     2     -     1  
Claims dismissed
  -     -     (1 )   (1 )   (7 )
Open claims - end of period
  21     22     21     20     21  
                               
(a)    Beginning of period represents acquisition date of November 13, 2008.
 
Hercules asbestos-related liability
 
From the range of estimates, Ashland records the amount it believes to be the best estimate of future payments for litigation defense and claim settlement costs, which generally approximates the mid-point of the estimated range of exposure from model results.  Ashland reviews this estimate and related assumptions quarterly and annually updates the results of a non-inflated, non-discounted approximate 50-year model developed with the assistance of HR&A.  During the most recent annual update of this estimate, completed during the June 2011 quarter, it was determined that the liability for Hercules asbestos related claims should be decreased by $48 million.  Total reserves for asbestos claims were $305 million at December 31, 2011 compared to $311 million at September 30, 2011.
 
 
 
21
 
 

 
ASHLAND INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

 
NOTE L – LITIGATION, CLAIMS AND CONTINGENCIES (continued)
 
A progression of activity in the asbestos reserve is presented in the following table.

   
Three months ended
                   
   
December 31
   
Years ended September 30
 
(In millions)
 
2011
   
2010
   
2011
   
2010
   
2009
(a)
Asbestos reserve - beginning of period
  $ 311     $ 375     $ 375     $ 484     $ 233  
Reserve adjustment (b)
    -       -       (48 )     (93 )     261  
Amounts paid
    (6 )     (5 )     (16 )     (16 )     (10 )
Asbestos reserve - end of period
  $ 305     $ 370     $ 311     $ 375     $ 484  
                                         
(a) Beginning of period represents acquisition date of November 13, 2008.
(b) 
Includes purchase accounting adjustments recorded during 2010 and 2009 as part of purchase price allocations for the Hercules acquisition.
 
 
Hercules asbestos-related receivables
 
For the Hercules asbestos-related obligations, certain reimbursements pursuant to coverage-in-place agreements with insurance carriers exist.  As a result, increases in the asbestos reserve are partially offset by probable insurance recoveries.  Ashland has estimated the value of probable insurance recoveries associated with its asbestos reserve based on management’s interpretations and estimates surrounding the available or applicable insurance coverage, including an assumption that all solvent insurance carriers remain solvent.  The estimated receivable consists exclusively of domestic insurers, of which approximately 96% have a credit rating of B+ or higher by A. M. Best, as of December 31, 2011.
 
As of December 31, 2011 and September 30, 2011, the receivables from insurers amounted to $48 million.  As previously mentioned, during 2011 the model used for purposes of valuing the asbestos reserve and its impact on valuation of future recoveries from insurers was updated.  This model update along with likely settlement adjustments caused a $20 million reduction in the receivable for probable insurance recoveries.
 
A progression of activity in the Hercules insurance receivable is presented in the following table.

   
Three months ended
                   
   
December 31
   
Years ended September 30
 
(In millions)
 
2011
   
2010
   
2011
   
2010
     
2009
(a)
Insurance receivable - beginning of period
  $ 48     $ 68     $ 68     $ 118     $ 35  
Receivable adjustment
    -       -       (20 )     (50 )     83  
Insurance receivable - end of period
  $ 48     $ 68     $ 48     $ 68     $ 118  
                                         
(a)     Beginning of period represents acquisition date of November 13, 2008.
 
Asbestos litigation cost projection
 
Projecting future asbestos costs is subject to numerous variables that are extremely difficult to predict.  In addition to the significant uncertainties surrounding the number of claims that might be received, other variables include the type and severity of the disease alleged by each claimant, the long latency period associated with asbestos exposure, dismissal rates, costs of medical treatment, the impact of bankruptcies of other companies that are co-defendants in claims, uncertainties surrounding the litigation process from jurisdiction to jurisdiction and from case to case, and the impact of potential changes in legislative or judicial standards.  Furthermore, any predictions with respect to these variables are subject to even greater uncertainty as the projection period lengthens.  In light of these inherent uncertainties, Ashland believes that the asbestos reserves for Ashland and Hercules represent the best estimate within a range of possible outcomes.  As a part of the process to develop these estimates of future asbestos costs, a range of long-term cost models was developed.  These models are based on national studies that predict the number of people likely to develop asbestos-related diseases and are heavily influenced by assumptions regarding long-term
 
 
22
 
 

 
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