Ashland Inc. and Subsidiaries
Management's Discussion and Analysis
Years Ended September 30
(In millions) 1997 1996 1995
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SALES AND OPERATING REVENUES
Refining and Marketing(1) $ 6,719 $ 6,485 $ 5,891
Valvoline 1,099 1,199 1,113
Chemical 4,047 3,695 3,551
APAC 1,257 1,235 1,123
Coal(2) 1,367 580 610
Intersegment sales (289) (302) (316)
- ------------------------------------------------------------------------------------------------------------------------
$ 14,200 $12,892 $11,972
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OPERATING INCOME
Refining and Marketing(1) $ 189 $ 89 $ (1)
Valvoline 67 82 (4)
Chemical 144 169 159
APAC 82 83 75
Coal(2) 68 36 66
General corporate expenses (60) (97) (91)
- ------------------------------------------------------------------------------------------------------------------------
$ 490 $ 362 $ 204
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EQUITY INCOME
Arch Mineral Corporation(2) $ - $ 13 $ (4)
Other 15 11 11
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$ 15 $ 24 $ 7
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Operating information
Refining and Marketing(1)
Refining inputs (thousand barrels per day)(3) 358.5 368.5 349.5
Value of products manufactured per barrel $ 26.43 $ 24.64 $ 22.49
Input cost per barrel 21.39 20.50 18.28
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Refining margin per barrel $ 5.04 $ 4.14 $ 4.21
Refined product sales (thousand barrels per day)
Wholesale sales to
Ashland brand retail jobbers 23.0 17.6 1.0
Other wholesale customers(4) 295.3 303.5 309.4
SuperAmerica retail system 76.1 74.2 71.5
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Total refined product sales 394.4 395.3 381.9
SuperAmerica merchandise sales (millions) $ 600 $ 583 $ 548
Valvoline lubricant sales (thousand barrels per day)(4) 19.1 19.5 19.1
APAC construction backlog at September 30 (millions) $ 693 $ 647 $ 672
Coal(5)
Tons sold (millions) 53.7 50.6 49.2
Sales price per ton $ 25.46 $ 25.85 $ 26.93
Major revenue sources (percent of sales)
Gasoline 17% 18% 17%
Coal 10% 5% 6%
========================================================================================================================
(1) Segments formerly identified as Petroleum and SuperAmerica were
combined effective October 1, 1996. Prior years amounts have been
restated.
(2) Ashland Coal and Arch Mineral merged effective July 1, 1997, into
Arch Coal, Inc. Prior interim periods of fiscal 1997 were restated to
consolidate Ashland's interest in Arch Mineral for the entire year.
Prior years were not restated, reflecting Ashland's interest in
Ashland Coal on a consolidated basis and Ashland's interest in Arch
Mineral on the equity method of accounting. See Note C to the
consolidated financial statements.
(3) Includes crude oil and other purchased feedstocks.
(4) Includes intersegment sales.
(5) Amounts are reported on a 100% basis and prior amounts have been
restated to show pro forma information for Arch Coal prior to the
merger.
RESULTS OF OPERATIONS
Ashland's net income amounted to $279 million in 1997, $211 million in 1996
and $24 million in 1995. However, such earnings include the results of
discontinued operations, as well as various unusual items which had a
significant effect on the comparisons. The following table shows the
effects of unusual items on operating income and income from continuing
operations for the three years ended September 30, 1997.
Income from
Operating income continuing operations
----------------------------- ----------------------------------
(In millions) 1997 1996 1995 1997 1996 1995
==============================================================================================================================
Income before unusual items $544 $362 $320 $220 $136 $91
Costs related to coal merger (39) - - (13) - -
Asset impairment write-downs (26) - (79) (22) - (52)
Early retirement and restructuring programs - - (37) - - (25)
LIFO inventory liquidation gain 11 - - 7 - -
- ------------------------------------------------------------------------------------------------------------------------------
Income as reported $490 $362 $204 $192 $136 $14
==============================================================================================================================
During 1997, Ashland reached a decision to sell Blazer Energy, its
exploration and production subsidiary. Ashland sold Blazer's domestic
operations for $566 million during July 1997, resulting in an after tax
gain of $71 million. In addition, Ashland has reached an agreement in
principle to sell its Nigerian operations, subject to the approval of the
Nigerian government and other conditions. As a result, Exploration was
reclassified as a discontinued operation in Ashland's income statements and
its investment in the Nigerian operations is carried on Ashland's
consolidated balance sheet as net assets of discontinued operations held
for sale at September 30, 1997. For comparison purposes, prior year income
statements and balance sheets have been restated.
Also during July 1997, Ashland Coal and Arch Mineral merged to form Arch
Coal, Inc., in which Ashland has a 54% ownership interest. Previously,
Ashland consolidated its investment in Ashland Coal (in which it owned 57%)
and accounted for its investment in Arch Mineral (in which it owned 50%) on
the equity method. Due to the merger, the results of Arch Mineral were
consolidated in fiscal 1997, but its results for prior years remain on the
equity method. Many synergistic opportunities are being pursued as a result
of the merger, some of which led to the charge of $39 million to write-off
duplicate facilities previously owned by Arch Mineral and to provide for
severance and other costs related to the merger.
Other unusual items in 1997 included goodwill write-downs of $26 million by
Valvoline and Ashland Chemical and a gain of $11 million from the
liquidation of certain inventories of Refining and Marketing. While Ashland
remains committed to expanding Valvoline and Ashland Chemical on a global
basis, results from certain of their European operations have been well
below the levels which were expected when they were acquired, necessitating
write-downs of the related goodwill. The inventory gain resulted from
reductions in the crude oil and petroleum product inventories of Refining
and Marketing that were accounted for on the last-in, first-out (LIFO)
method. LIFO inventories are valued at their costs in the years acquired,
and such costs were well below the current replacement costs of the
liquidated inventories.
Effective September 30, 1995, Ashland adopted Financial Accounting
Standards Board Statement No. 121 (FAS 121), "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." As a
result, Ashland recorded charges of $79 million in 1995 to write down
various assets to their fair values, including an idle unit at Ashland
Petroleum's Catlettsburg refinery, certain unused crude oil gathering
pipelines of Scurlock Permian and petroleum product marketing properties
which were being sold or shut down. Fair values were based upon appraisals
or estimates of discounted future cash flows. In addition, charges of $37
million related to early retirement and restructuring programs were
incurred, reflecting efforts by Ashland Petroleum and several other
divisions to reduce their costs and improve their competitive positions.
Excluding unusual items, income from continuing operations amounted to $220
million in 1997, compared to $136 million in 1996. Refining and Marketing
results were up considerably, as were earnings from Ashland's coal
investments. Results from Valvoline, Ashland Chemical and APAC would have
exceeded their record levels achieved in 1996 if they had not incurred
higher allocations of general corporate expenses. Ashland began allocating
more of these expenses in 1997 to the segments to better reflect their
costs of doing business. Income from continuing operations of $136 million
for 1996 was up from $91 million in 1995 before unusual items. Record
results were achieved in 1996 by Valvoline, Ashland Chemical and APAC,
combined with increased earnings from Refining and Marketing and Arch
Mineral. Such improvements more than offset the reduced earnings from
Ashland Coal.
The following table compares operating income before unusual items by
segment for the three years ended September 30, 1997. The consolidation of
Arch Mineral's results significantly affects the comparability of operating
income from Coal for 1997. In addition, the increased allocations of
general corporate expenses reduced the operating results of the segments on
a comparative basis by $39 million, but did not have a significant impact
on overall operating income.
Ashland Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
(In millions) 1997 1996 1995
=======================================================================================================
Operating income
Refining and Marketing $178 $89 $101
Valvoline 77 82 1
Chemical 160 169 164
APAC 82 83 75
Coal 107 36 66
General corporate expenses (60) (97) (87)
- -------------------------------------------------------------------------------------------------------
$544 $362 $320
=======================================================================================================
(Bar graph appears in the left margin comparing Ashland Inc. operating
income for fiscal 1995, 1996 and 1997. The graph shows the breakdown
between Ashland's Coal, Refining and Marketing, and growth businesses
composed of Valvoline, Chemical and APAC.)
REFINING AND MARKETING
Operating income from Refining and Marketing before unusual items doubled
from $89 million in 1996 to $178 million in 1997. Principal factors leading
to the improved results included better refining margins, reduced refining
expenses and increased retail margins for both gasoline and merchandise.
However, these improvements were partially offset by lower earnings from
Scurlock Permian and an additional $19 million allocation of general
corporate expenses.
During the first half of fiscal 1997, Refining operated at near break-even
levels reflecting refining margins which averaged $3.89 a barrel. Crude oil
costs increased rapidly in the December quarter and wholesale product
prices were slow to respond. Although margins began improving during the
March quarter as crude oil costs softened, heavy flooding in the Ohio
Valley limited Ashland's ability to ship products on the river systems.
Refining margins increased dramatically in the last half of the year,
averaging $6.01 a barrel excluding LIFO inventory gains, reflecting strong
gasoline and asphalt demand. In addition, refining expenses for 1997 were
reduced by 25 cents a barrel, despite lower throughputs, reflecting
continuing efforts by Ashland Petroleum to reduce its costs and improve its
competitive position.
(Bar graph appears in the left margin comparing operating income from
Refining and Marketing for fiscal 1995, 1996 and 1997.)
In other areas, results from Scurlock Permian were down $12 million due to
lower margins on crude oil sales, reflecting increased competition for the
declining production in many of its gathering areas. Earnings from
SuperAmerica increased $10 million due to increased gasoline and
merchandise margins. Sales volumes were also higher, reflecting an
increased number of locations, but the effect was largely offset by
increased operating and occupancy costs. At September 30, 1997, 766 retail
locations were operating, compared to 742 locations in 1996 and 704
locations in 1995. Included in these totals are 641 SuperAmerica stores in
1997, 624 stores in 1996 and 609 stores in 1995, with the remainder being
Rich Oil outlets.
Operating income from Refining and Marketing amounted to $89 million in
1996, compared to $101 million in 1995 before unusual items. Although
earnings from Refining increased, SuperAmerica's results were adversely
affected by an extremely competitive environment. A $7 million improvement
in earnings from Refining was achieved even though rapidly rising crude oil
prices late in 1996 led to severe margin compression and a weak September
1996 quarter. Despite the modest improvement, results for 1996 were still
disappointing given the progress Ashland Petroleum made in improving its
competitive position. Refinery runs averaged 368,500 barrels a day, up 5%
from 1995 and refining expenses (other than fuel consumed in the refining
process) were reduced by 26 cents a barrel, due to the higher level of
throughputs and ongoing efforts to reduce costs and increase efficiency.
The effects of these improvements, however, were largely offset by higher
average crude oil costs, which could not be fully passed through in product
prices, and associated increases in fuel costs. For the year, input costs
increased $2.22 a barrel, peaking in the September 1996 quarter with an
increase of $4.58 a barrel compared to the September 1995 quarter. As a
result, refining margins were compressed during what is normally the strong
summer driving season.
On the other hand, results from SuperAmerica declined $19 million compared
to 1995. While gasoline and merchandise volumes were both up on a per store
basis, the effect was more than offset by a decline in gasoline margins of
1.5 cents a gallon and increased operating costs. Higher labor and
occupancy costs resulted from a continued tight labor market, the ongoing
roll-out of the co-branding partnership program with fast-food chains,
initial costs associated with the opening of new stores and rebuilds, and
the ongoing operation of additional stores.
VALVOLINE
Excluding unusual items, Valvoline's operating income amounted to $77
million in 1997, compared to a record $82 million in 1996. Gross profits
from Valvoline's core lubricant and antifreeze businesses combined were up
nearly 20%, reflecting improved margins. However, this improvement was more
than offset by an increase of $5 million in general corporate expense
allocations and by a reduction in gross profits from R-12, an automotive
refrigerant. Due to cool summer weather which shortened the peak season,
sales volumes of R-12 were down significantly in 1997. In addition, the
used oil collection business operated profitably, while earnings from
Valvoline Instant Oil Change (VIOC) declined slightly due to higher
operating expenses. At September 30, 1997, VIOC operated 382 company-owned
outlets, compared to 374 outlets in 1996 and 365 outlets in 1995. In
addition, the VIOC franchising program continued to expand with 137 outlets
open in 1997, compared to 100 outlets in 1996 and 90 outlets in 1995.
(Bar graph appears in the left margin comparing operating income from
Valvoline for fiscal 1995, 1996 and 1997.)
Operating income from Valvoline was $82 million in 1996, compared to near
break-even results before unusual items for 1995. The record earnings
reflected improved results from nearly all of Valvoline's business units,
including a significant earnings boost from the sale of R-12. Prices for
R-12 escalated rapidly during 1996, as shortages developed within the
market. Due to its ozone-depleting characteristics, the U.S. Environmental
Protection Agency banned the production of R-12 at the end of 1995, but
sales of existing inventories of this refrigerant are still permitted. Even
aside from R-12 earnings, however, Valvoline's results would still have
been up significantly. Results from its lubricant business improved,
reflecting increased volumes, higher margins on both branded and private
label sales and reduced advertising and promotional costs. In addition,
results from VIOC nearly doubled, while the used oil collection business
continued to approach profitability.
CHEMICAL
Ashland Chemical's operating income before unusual items amounted to $160
million in 1997, compared to a record $169 million in 1996. Earnings from
petrochemicals were up $13 million, reflecting increased cumene and
methanol sales volumes and margins. Operating income from specialty
chemicals improved $5 million on the strength of higher electronic chemical
sales volumes and margins, but the effect was partially offset by lower
marine chemical sales volumes. Results from the distribution businesses
were down $3 million due to margin declines for industrial chemicals and
solvents. Ashland Chemical also incurred an additional $11 million
allocation of general corporate expenses, as well as charges of $8 million
for environmental remediation and plant shutdown costs.
(Bar graph appears in the right margin comparing operating income from
Ashland Chemical for fiscal 1995, 1996 and 1997.)
Operating income of Ashland Chemical increased from $164 million before
unusual items in 1995 to $169 million in 1996 and represented Ashland
Chemical's fourth straight year of record earnings. Outstanding results
from specialty chemicals, a moderate increase from the distribution
businesses and reduced environmental remediation costs more than offset a
decline from petrochemicals. Results from the distribution businesses were
up 5% on the strength of improved sales volumes, while earnings from
specialty chemicals improved by 56%. The 1995 acquisition of Aristech's
unsaturated polyester resin business was a major contributor to the
improved specialty chemical results, along with higher sales volumes and
margins for electronic chemicals. However, operating income from
petrochemicals declined by $50 million, due largely to reduced prices for
methanol, but also due to increased natural gas prices and higher feedstock
costs for cumene and solvents.
APAC
Operating income from the APAC construction companies amounted to $82
million in 1997, compared to a record $83 million in 1996. Net revenue
(total revenue less subcontract work) was up 4%, while production of hot
mix asphalt and crushed aggregate reached record levels. The effects,
however, were more than offset by an additional $4 million in general
corporate expense allocations.
(Bar graph appears in the right margin comparing operating income from APAC
for fiscal 1995, 1996 and 1997.)
APAC achieved its third straight year of record results in 1996 with
operating income of $83 million, compared to $75 million in 1995. APAC's
results reflected its ongoing efforts in cost control, safety and materials
technology, allowing the highway construction group to take full advantage
of a strong construction economy. Revenues rose 10%, reflecting a higher
level of both public and private sector construction jobs, as well as
increased sales of hot-mix asphalt, crushed aggregate and ready-mix
concrete.
COAL
Operating income for Coal for 1997 reflects the consolidation of Arch
Mineral results as of October 1, 1996, and includes charges of $39 million
for costs related to the merger of Ashland Coal and Arch Mineral. Prior to
1997, Arch Mineral was accounted for on the equity method, creating
comparability problems. If Arch Mineral had been consolidated in all three
years, pro forma operating income from Ashland's coal investments before
unusual items would have amounted to about $100 million for 1995 and $88
million for 1996, compared to $107 million for 1997. Ashland Coal's
contributions to the 1997 results are up from 1996 despite the expiration
of certain of its higher priced sales contracts and price reductions under
certain other sales contracts around the end of December 1995. Ashland Coal
subsequently reduced its average costs per ton to record levels, enabling
it to more than offset the effects of reduced sales prices. Arch Mineral's
contributions to these earnings are also up strongly from 1996, reflecting
increased production and reduced administrative and interest costs.
(Bar graph appears in the right margin comparing operating income from Coal
for fiscal 1995, 1996 and 1997.)
Operating income for 1996 and 1995 reflect only Ashland Coal's results.
Ashland Coal had a difficult year in 1996 due largely to contract
expirations and other price reductions in that year. As a result, operating
income amounted to $36 million in 1996, compared to $66 million in 1995
reflecting the lower sales prices.
Charges for asset impairment and restructuring costs reduced Ashland's
equity earnings from Arch Mineral by $6 million in 1995. Adjusting for
these unusual items, Arch Mineral generated equity income of $13 million in
1996 and $2 million in 1995. Arch's results for 1996 were favorably
affected by increased sales volumes and lower mining costs, as well as the
restructuring completed in 1995.
GENERAL CORPORATE EXPENSES
Excluding unusual items, general corporate expenses were $60 million in
1997, $97 million in 1996 and $87 million in 1995. The reduction in 1997
reflects the allocation of an additional $41 million in costs to the
segments, including $2 million to the discontinued operations of Blazer
Energy. The remaining changes over the three-year period result principally
from fluctuations in incentive and deferred compensation costs.
Ashland Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
DISCONTINUED OPERATIONS
Net income from discontinued operations (excluding the after tax gain of
$71 million on the sale of Blazer Energy's domestic operations in 1997)
amounted to $25 million in 1997, $75 million in 1996 and $10 million in
1995. Results for 1996 included an after tax gain of $48 million from the
settlement of claims against Columbia Gas Transmission involving natural
gas contracts that were abrogated by Columbia in 1991.
FINANCIAL POSITION
LIQUIDITY
Ashland's financial position has enabled it to obtain capital for its
financing needs and to maintain investment grade ratings on its senior debt
of Baa2 from Moody's and BBB from Standard & Poor's. Ashland has a
revolving credit agreement providing for up to $320 million in borrowings,
under which no borrowings were outstanding at September 30, 1997. At that
date, Arch Coal also had revolving credit agreements providing for up to
$500 million in borrowings, of which $240 million was in use. Under a shelf
registration, Ashland can issue an additional $220 million in medium-term
notes should future opportunities or needs arise. Ashland and Arch Coal
also have access to various uncommitted lines of credit and commercial
paper markets, under which Arch Coal had short-term notes of $35 million
outstanding at September 30, 1997. While certain debt agreements contain
covenants limiting new borrowings, Ashland could still have increased its
indebtedness by up to $2.1 billion at September 30, 1997.
Cash flows from continuing operations, a major source of Ashland's
liquidity, amounted to $852 million in 1997, $651 million in 1996 and $442
million in 1995. The significant improvements in cash flows reflects a
higher level of earnings, modest working capital growth and the
consolidation of Arch Coal in 1997. Cash flows from operations exceeded
Ashland's capital requirements for net property additions and dividends
since 1994 by $470 million, providing additional funds for debt repayment
and acquisitions.
(Bar graph appears in the left margin comparing cash flows from continuing
operations for fiscal 1995, 1996 and 1997.)
Property additions amounted to $1.3 billion during the last three years and
are summarized in the Information by Industry Segment on Page 63. While
about 40% of Ashland's capital expenditures during this period were in
Refining and Marketing, its percent of the total expenditures has declined
in each of those three years. Capital expenditures by Valvoline, Ashland
Chemical and APAC, Ashland's growth businesses, also accounted for 40% of
the total expenditures since 1994, increasing from 37% in 1995 to 45% in
1997.
(Bar graph appears in the left margin comparing Ashland Inc. property
additions for fiscal 1995, 1996 and 1997.)
Cash flows used for acquisitions amounted to $478 million during the last
three years. Such acquisitions include $252 million for certain operations
of Aristech Chemical Corporation and numerous smaller chemical companies,
$124 million for additional interests in Ashland Coal, $47 million for
Zerex and $36 million for various construction companies. Of the total
capital invested in acquisitions since 1994, 70% was employed in Valvoline,
Ashland Chemical and APAC.
Long-term borrowings provided cash flows of $573 million during the last
three years, including the issuance of $407 million of medium-term notes,
$75 million of pollution-control bonds and $88 million of Arch Coal debt.
The proceeds from these long-term borrowings were used in part to retire
$778 million of long-term debt (scheduled maturities as well as refundings
to reduce interest costs). Cash flows were supplemented as necessary by the
issuance of short-term notes and commercial paper.
Working capital at September 30, 1997, was $734 million, and liquid assets
(cash, cash equivalents and accounts receivable) amounted to 88% of current
liabilities at that date. Ashland's working capital is significantly
affected by its use of the LIFO method of inventory valuation, which valued
inventories $416 million below their replacement costs at September 30,
1997.
CAPITAL RESOURCES
Ashland's capital employed at September 30, 1997, consisted of debt (43%),
minority interest (7%) and common stockholders' equity (50%). Debt as a
percent of capital employed is down from 50% at the end of 1996, reflecting
strong cash flows from operations during 1997, as well as the sale of the
domestic operations of Blazer Energy. In addition, minority interest
increased from 4% at September 30, 1996, reflecting the consolidation of
Arch Mineral. Common stockholders' equity increased from 38% at the end of
1996, due to the conversion of $290 million of preferred stock into common,
as well as the strong earnings during 1997.
(Bar graph appears in the left margin comparing debt as a percent of
capital employed for fiscal 1995, 1996 and 1997.)
During fiscal 1998, Ashland anticipates capital expenditures of
approximately $560 million. Capital expenditures in Refining and Marketing
are expected to amount to about $170 million, including nearly $40 million
for SuperAmerica. Capital expenditures of Valvoline, Ashland Chemical and
APAC are projected at around $240 million, with most of the remainder
invested by Arch Coal. Both Ashland and Arch Coal anticipate meeting their
1998 capital requirements for property additions and dividends from
internally generated funds.
ENVIRONMENTAL MATTERS
Federal, state and local laws and regulations relating to the protection of
the environment have resulted in higher operating costs and capital
investments by the industries in which Ashland operates. Because of the
continuing trends toward greater environmental awareness and ever
increasing regulations, Ashland believes that expenditures for
environmental compliance will continue to have a significant effect on its
businesses. Although it cannot accurately predict how such trends will
affect future operations and earnings, Ashland believes the nature and
significance of its ongoing compliance costs will be comparable to those of
its competitors in the petroleum, chemical and mining industries.
Capital expenditures for air, water and solid waste control facilities for
continuing operations amounted to $26 million in 1997, $38 million in 1996
and $42 million in 1995. Based on current environmental regulations,
Ashland anticipates such capital expenditures will amount to about $30
million in 1998. Environmental remediation and compliance expenditures
amounted to $155 million in 1997, $153 million in 1996 and $148 million in
1995, and are expected to be in the range of $160 million in 1998. Such
compliance expenditures do not include the costs of additives, such as MTBE
and ethanol, used to meet reformulated gasoline and oxygenated fuel
requirements.
Environmental reserves are subject to considerable uncertainties that
affect Ashland's ability to estimate its share of the ultimate costs of
required remediation efforts. Such uncertainties involve the nature and
extent of contamination at each site, the extent of required cleanup
efforts under existing environmental regulations, widely varying costs of
alternate cleanup methods, changes in environmental regulations, the
potential effect of continuing improvements in remediation technology, and
the number and financial strength of other potentially responsible parties
at multiparty sites.
During 1997, the U. S. Environmental Protection Agency (EPA) completed
comprehensive inspections of compliance with federal environmental laws and
regulations at Ashland's three refineries. Ashland continues to cooperate
and hold discussions with the EPA concerning these inspections, as well as
what additional remediation actions may be required or costs may be
incurred.
Ashland does not believe that any liability resulting from environmental
matters, after taking into consideration its insurance coverages and
amounts already provided for, will have a material adverse effect on its
consolidated financial position, cash flows or liquidity.
DERIVATIVE INSTRUMENTS
Ashland is exposed to various market risks, including changes in certain
commodity prices, foreign currency rates and interest rates. To manage the
volatility relating to these natural business exposures, Ashland enters
into various derivative transactions in accordance with its established
policies. Ashland does not hold or issue derivative instruments for trading
purposes.
Ashland selectively uses commodity futures contracts to reduce its exposure
to certain risks inherent within its refining business. Such contracts are
used principally to hedge the value of intransit crude oil cargoes, hedge
exposure under fixed-price petroleum product sales contracts, obtain higher
prices for crude oil sales, protect against margin compression caused by
increasing crude oil prices, take advantage of attractive refining margins
and lock in costs on a portion of the natural gas fuel needs of the
refineries. Ashland also uses forward exchange contracts to hedge certain
foreign currency transaction exposures of its operations. The potential
loss from a hypothetical 10% adverse change in commodity prices or foreign
currency rates on Ashland's open commodity futures and foreign exchange
contracts at September 30, 1997, would not materially affect Ashland's
consolidated financial position, results of operations or cash flows.
Ashland uses interest rate swap agreements to obtain greater access to the
lower borrowing costs normally available on floating-rate debt, while
minimizing refunding risk through the issuance of long-term, fixed-rate
debt. Long-term debt at September 30, 1997, included about $280 million of
floating-rate debt, and the interest rates on an additional $370 million of
fixed-rate debt were converted to LIBOR floating rates through unleveraged
interest rate swap agreements. As a result, Ashland's annual interest costs
in 1998 will fluctuate based on short-term interest rates on about $650
million of Ashland's consolidated long-term debt outstanding at September
30, 1997, as well as on any short-term notes and commercial paper.
OUTLOOK
Ashland Chemical will continue to pursue growth through internal efforts
and selective acquisitions. Ashland Chemical will emphasize integrated
products and services, targeting its North American customers and a growing
international sales base with existing offerings and extensions into
untapped markets, such as its recent entry into the distribution market for
nutritional products. With market globalization favoring producers that
have a worldwide presence, investments in acquisitions will also continue
as attractive opportunities to add volume, technologies or market coverage
are identified.
APAC will pursue growth through geographic expansion, enhanced materials
production capabilities and product line extensions, such as concrete
paving and greater site development services. Continued federal
infrastructure funding and an expanding economy should continue to benefit
APAC's efforts to build market position in existing markets and reduce
costs. APAC's construction backlog amounted to a record year end level of
$693 million at September 30, 1997. Such backlog includes a modest increase
in the public sector and a slight decrease in the private sector, and is
expected to contain margins comparable to those included in last year's
backlog.
Valvoline will focus on extending and leveraging its brand franchise to
related products, while pursuing international growth through aggressive
marketing, joint ventures and application of domestic competencies. R-12
margins are expected to remain strong, although the level of annual demand
is uncertain. Domestic sales volumes of higher-margin packaged lubricants
serving
Ashland Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION AND ANALYSIS
the "do-it-yourself" market are expected to continue to give ground to
lower-margin bulk sales to the "do-it-for-me" market. However, sales of
automotive chemicals and international sales of lubricants are expected to
provide continued growth opportunities.
Although margins are expected to remain volatile, key external factors look
promising for the refining and marketing industry. The economy is
reasonably strong, inflation appears to be under control, and economic
growth continues at a modest pace. In addition, petroleum product demand is
expected to continue increasing over 1% annually for the rest of the
decade. Such increases reflect a leveling of fuel efficiency in the
passenger car fleet, increasing sales of light-truck and sport-utility
vehicles which average fewer miles per gallon than passenger cars, and an
increasing number of vehicle miles traveled. Refinery utilization rates are
strong, which should be beneficial for refining margins.
Ashland Petroleum continues to strengthen its position in refining by
enhancing its production of higher-value products, reducing its operating
expenses and increasing its volumes sold under company brands. While
SuperAmerica continues to expand its retail network, Ashland Petroleum is
also increasing controlled gasoline sales through its branded
jobber/distributor marketing program. Under that program, 601 retail
locations were operating at September 30, 1997, compared to 485 locations
at the end of 1996. Controlled sales volumes are up 21% since 1994,
accounting for over 47% of refinery gasoline production in 1997, providing
deeper market penetration in key Midwest markets, strengthening margins and
reducing Ashland Petroleum's dependence on wholesale markets.
During 1997, Ashland and Marathon Oil Company signed a letter of intent to
combine the petroleum refining and marketing and most transportation assets
of the two companies. Ashland and Marathon have resolved all material
matters concerning valuation and due diligence, and anticipate signing
definitive agreements in December 1997. Ashland would have a 38% ownership
interest in the proposed joint venture. Ashland expects that the proposed
venture will be able to achieve substantial synergies beginning in 1998 by
pursuing operational efficiencies and integrating the strengths of the
business processes, management systems and administrative support functions
of the two companies.
Arch Coal's results for 1998 are expected to benefit from numerous steps
which have been taken or are underway to capture synergies resulting from
the merger of Ashland Coal and Arch Mineral. Arch Coal's low debt and high
cash flow provide the financial strength to support continued operational
improvements, acquisitions and internal expansion.
Ashland's debt at the end of 1997 was down by $255 million from the prior
year, despite the addition of $236 million in debt resulting from the
consolidation of Arch Coal as of October 1, 1996. As a result, net interest
costs are expected to be significantly lower in 1998, given the reduction
in Ashland's debt during 1997. Annualizing the interest cost on outstanding
debt at September 30, 1997, would result in net interest expense of about
$125 million during 1998, compared to $170 million in 1997. Such debt
reduction also provides Ashland with greater financial flexibility to
pursue its growth goals.
EFFECTS OF INFLATION AND CHANGING PRICES
Ashland's financial statements are prepared on the historical cost method
of accounting and, as a result, do not reflect changes in the dollar's
purchasing power. Although annual inflation rates have been low in recent
years, Ashland's results are still affected by the cumulative inflationary
trend from prior years.
In the capital-intensive industries in which Ashland operates, replacement
costs for its properties would generally exceed their historical costs.
Accordingly, depreciation, depletion and amortization expense would be
greater if it were based on current replacement costs. However, since
replacement facilities would reflect technological improvements and changes
in business strategies, such facilities would be expected to be more
productive than existing facilities, mitigating the increased expense.
Ashland uses the last-in, first-out (LIFO) method to value a substantial
portion of its inventories to provide a better matching of revenues with
current costs. However, LIFO values such inventories below their
replacement costs.
Monetary assets (such as cash, cash equivalents and accounts receivable)
lose purchasing power as a result of inflation, while monetary liabilities
(such as accounts payable and indebtedness) result in a gain, because they
can be settled with dollars of diminished purchasing power. Ashland's
monetary liabilities exceed its monetary assets, which results in net
purchasing power gains and provides a hedge against the effects of future
inflation.
FORWARD-LOOKING STATEMENTS
Management's Discussion and Analysis contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934, including various information
within the Capital Resources, Derivative Instruments and Outlook sections.
Although Ashland believes that its expectations are based on reasonable
assumptions, it cannot assure that the expectations contained in such
statements will be achieved. Important factors which could cause actual
results to differ materially from those contained in such statements are
discussed in Note A to the Consoldiated Financial Statements under risks
and uncertainties. Other factors and risks affecting Ashland's revenues and
operations are contained in Ashland's Form 10-K for the fiscal year ended
September 30, 1997, which is on file with the Securities and Exchange
Commission.
ASHLAND INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
YEARS ENDED SEPTEMBER 30
(In millions except per share data) 1997 1996 1995
===================================================================================================================================
REVENUES
Sales and operating revenues (including excise taxes) $14,200 $12,892 $11,972
Other 119 76 66
- -----------------------------------------------------------------------------------------------------------------------------------
14,319 12,968 12,038
COSTS AND EXPENSES
Cost of sales and operating expenses 10,860 9,975 9,130
Excise taxes on products and merchandise 992 985 988
Selling, general and administrative expenses 1,405 1,275 1,269
Depreciation, depletion and amortization 572 371 447
- -----------------------------------------------------------------------------------------------------------------------------------
13,829 12,606 11,834
- -----------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME 490 362 204
OTHER INCOME (EXPENSE)
Interest expense (net of interest income) (170) (169) (171)
Equity income - Note D 15 24 7
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST 335 217 40
Income taxes - Note E (119) (73) (3)
Minority interest in earnings of subsidiaries (24) (8) (23)
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 192 136 14
Income from discontinued operations (net of income taxes) - Note B 25 75 10
Gain on sale of discontinued operations (net of income taxes) - Note B 71 - -
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE EXTRAORDINARY LOSS 288 211 24
Extraordinary loss on early retirement of debt (net of income taxes) - Note F (9) - -
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME 279 211 24
Dividends on convertible preferred stock (9) (19) (19)
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME AVAILABLE TO COMMON SHARES $ 270 $ 192 $ 5
===================================================================================================================================
EARNINGS PER SHARE - Note A
Primary
Income (loss) from continuing operations $ 2.57 $ 1.81 $ (.08)
Income from discontinued operations .36 1.16 .16
Gain on sale of discontinued operations 1.00 - -
Extraordinary loss (.13) - -
---------------------------------------------------
Net income $ 3.80 $ 2.97 $ .08
Assuming full dilution
Income (loss) from continuing operations $ 2.52 $ 1.84 $ (.08)
Income from discontinued operations .33 .98 .16
Gain on sale of discontinued operations .94 - -
Extraordinary loss (.12) - -
---------------------------------------------------
Net income $ 3.67 $ 2.82 $ .08
AVERAGE COMMON SHARES AND EQUIVALENTS OUTSTANDING
Primary 71 65 62
Assuming full dilution 76 77 63
===================================================================================================================================
See Notes to Consolidated Financial Statements.
ASHLAND INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30
(In millions) 1997 1996
===================================================================================================================
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 268 $ 77
Accounts receivable (less allowances for doubtful accounts of
$24 million in 1997 and $27 million in 1996) 1,730 1,621
Inventories - Note A 729 708
Other current assets 268 259
- -------------------------------------------------------------------------------------------------------------------
2,995 2,665
INVESTMENTS AND OTHER ASSETS
Investments in and advances to unconsolidated affiliates - Note D 86 157
Investments of captive insurance companies 189 178
Cost in excess of net assets of companies acquired (less accumulated
amortization of $70 million in 1997 and $43 million in 1996) 120 120
Coal supply agreements (less accumulated amortization of
$53 million in 1997 and $44 million in 1996) 195 44
Net assets of discontinued operations held for sale - Note B 18 326
Other noncurrent assets 283 314
- -------------------------------------------------------------------------------------------------------------------
891 1,139
PROPERTY, PLANT AND EQUIPMENT
Cost
Refining and Marketing 3,497 3,395
Valvoline 328 312
Chemical 904 818
APAC 671 626
Coal 1,904 980
Corporate 167 154
- -------------------------------------------------------------------------------------------------------------------
7,471 6,285
Accumulated depreciation, depletion and amortization (3,580) (3,000)
- -------------------------------------------------------------------------------------------------------------------
3,891 3,285
- -------------------------------------------------------------------------------------------------------------------
$7,777 $7,089
===================================================================================================================
See Notes to Consolidated Financial Statements.
(In millions) 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Debt due within one year
Notes payable to financial institutions $ 35 $ 117
Current portion of long-term debt 58 86
Trade and other payables 2,045 1,973
Income taxes 123 22
- ----------------------------------------------------------------------------------------------------------------------
2,261 2,198
NONCURRENT LIABILITIES
Long-term debt (less current portion) - Notes F and G 1,639 1,784
Employee benefit obligations - Note M 854 613
Reserves of captive insurance companies 161 166
Other long-term liabilities and deferred credits 565 340
Commitments and contingencies - Notes G, I and L
- ----------------------------------------------------------------------------------------------------------------------
3,219 2,903
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES 273 174
STOCKHOLDERS' EQUITY - Notes F, J and K
Preferred stock, no par value, 30 million shares authorized
Convertible preferred stock, 6 million shares issued in 1996,
$300 million liquidation value - 293
Common stockholders' equity
Common stock, par value $1.00 per share
Authorized - 150 million shares
Issued - 75 million shares in 1997 and 64 million shares in 1996 75 64
Paid-in capital 605 280
Retained earnings 1,379 1,185
Other (35) (8)
- ----------------------------------------------------------------------------------------------------------------------
Total common stockholders' equity 2,024 1,521
- ----------------------------------------------------------------------------------------------------------------------
2,024 1,814
- ----------------------------------------------------------------------------------------------------------------------
$7,777 $7,089
======================================================================================================================
ASHLAND INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
Preferred Common Paid-in Retained Loan to
(In millions) stock stock capital earnings LESOP Other Total
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE AT OCTOBER 1, 1994 $293 $61 $159 $1,126 $(33) $(11) $1,595
Net income 24 24
Dividends
Preferred stock (19) (19)
Common stock, $1.10 a share (68) (68)
Issued common stock under
Share offering program 2 49 51
Acquisition of operations
of other companies 1 40 41
Stock incentive plans 7 7
LESOP loan repayments 22 22
Other changes 1 1 2
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1995 293 64 256 1,063 (11) (10) 1,655
Net income 211 211
Dividends
Preferred stock (19) (19)
Common stock, $1.10 a share (70) (70)
Issued common stock under
Stock incentive plans 18 18
Employee savings plan 6 6
LESOP loan repayments 11 11
Other changes 2 2
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1996 293 64 280 1,185 - (8) 1,814
Net income 279 279
Dividends
Preferred stock (9) (9)
Common stock, $1.10 a share (76) (76)
Issued common stock under
Preferred stock conversion (290) 9 281 -
Stock incentive plans 2 44 46
Employee savings plan 1 1
Preferred stock redemption (3) (3)
Other changes (1) (27) (28)
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1997 $ - $75 $605 $1,379 $ - $(35) $2,024
- ------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
Ashland Inc. and Subsidiaries
STATEMENTS OF CONSOLIDATED CASH FLOWS
Years Ended September 30
(In millions) 1997 1996 1995
===============================================================================================================================
CASH FLOWS FROM CONTINUING OPERATIONS
Income from continuing operations $192 $136 $ 14
Expense (income) not affecting cash
Depreciation, depletion and amortization 572 371 447
Deferred income taxes 3 (11) (71)
Other noncash items 45 1 43
Change in operating assets and liabilities(1) 40 154 9
- -------------------------------------------------------------------------------------------------------------------------------
852 651 442
CASH FLOWS FROM FINANCING
Proceeds from issuance of long-term debt 175 68 330
Proceeds from issuance of capital stock 35 16 55
Repayment of long-term debt (621) (97) (60)
Increase (decrease) in short-term debt (57) (84) 38
Dividends paid (97) (93) (92)
- -------------------------------------------------------------------------------------------------------------------------------
(565) (190) 271
CASH FLOWS FROM INVESTMENT
Additions to property, plant and equipment (431) (430) (399)
Purchase of operations - net of cash acquired (96) (83) (299)
Investment purchases(2) (248) (455) (725)
Investment sales and maturities(2) 216 491 704
Other - net - 6 32
- -------------------------------------------------------------------------------------------------------------------------------
(559) (471) (687)
- -------------------------------------------------------------------------------------------------------------------------------
CASH PROVIDED (USED) BY CONTINUING OPERATIONS (272) (10) 26
Cash provided (used) by discontinued operations - Note B 436 35 (14)
- -------------------------------------------------------------------------------------------------------------------------------
INCREASE IN CASH AND CASH EQUIVALENTS 164 25 12
Cash and cash equivalents - beginning of year 104 (3) 52 40
- -------------------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF YEAR $268 $ 77 $ 52
===============================================================================================================================
DECREASE (INCREASE) IN OPERATING ASSETS(1)
Accounts receivable $ 1 $ (52) $ (126)
Inventories 17 2 (60)
Other current assets (6) (6) 11
Investments and other assets (3) 10 31
INCREASE (DECREASE) IN OPERATING LIABILITIES(1)
Trade and other payables (143) 216 176
Income taxes 80 (12) (2)
Noncurrent liabilities 94 (4) (21)
- -------------------------------------------------------------------------------------------------------------------------------
CHANGE IN OPERATING ASSETS AND LIABILITIES $ 40 $ 154 $ 9
===============================================================================================================================
(1) Excludes changes resulting from operations acquired or sold.
(2) Represents primarily investment transactions of captive insurance
companies.
(3) Includes $27 million of cash and cash equivalents of Arch Mineral
Corporation that was presented on a consolidated basis effective
October 1, 1996 (see Note A).
See Notes to Consolidated Financial Statements.
ASHLAND INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Ashland and
its majority-owned subsidiaries. Investments in joint ventures and 20% to
50% owned affiliates are accounted for on the equity method. Ashland Coal,
Inc. and Arch Mineral Corporation merged on July 1, 1997, into a new
corporation known as Arch Coal, Inc., in which Ashland has a 54% ownership
interest. Beginning in the September 1997 quarter, Arch Coal was
consolidated in Ashland's financial statements. Prior interim quarters in
1997 were restated to reflect Arch Mineral on a consolidated basis for
comparison purposes. Since Arch Mineral was previously accounted for on the
equity method, the comparability of various amounts included in Ashland's
consolidated financial statements and the accompanying notes are affected.
RISKS AND UNCERTAINTIES
The preparation of Ashland's consolidated financial statements in
conformity with generally accepted accounting principles requires Ashland's
management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses, and the disclosures
of contingent assets and liabilities. Significant items subject to such
estimates and assumptions include the carrying value of long-lived assets,
environmental reserves, employee benefit obligations, income recognized
under construction contracts, and the ultimate realization of deferred tax
assets. Actual results could differ from the estimates and assumptions
used.
Ashland's operations are affected by domestic and international political,
legislative, regulatory and legal actions. Such actions may include changes
in the policies of the Organization of Petroleum Exporting Countries or
other developments involving or affecting oil-producing countries,
including military conflict, embargoes, internal instability or actions or
reactions of the government of the United States in anticipation of, or in
response to, such actions.
Domestic and international economic conditions, such as recessionary
trends, inflation, interest and monetary exchange rates, as well as changes
in the availability or prices of crude oil and petroleum products, can have
a significant effect on Ashland's 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 environmental or
other matters. In addition, climate and weather can significantly affect
Ashland in several of its operations, such as its construction, heating oil
and coal businesses.
INVENTORIES
(In millions) 1997 1996
=================================================================================================
Crude oil $277 $316
Petroleum products 289 323
Chemicals 341 342
Other products 174 146
Materials and supplies 64 55
Excess of replacement costs over LIFO carrying values (416) (474)
- --------------------------------------------------------------------------------------------------
$729 $708
==================================================================================================
Crude oil, petroleum products, chemicals and other products with a
replacement cost of $751 million at September 30, 1997, and $834 million at
September 30, 1996, are valued using the last-in, first-out (LIFO) method.
The remaining inventories are stated generally at the lower of cost (using
the first-in, first-out [FIFO] or average cost method) or market.
Ashland decreased certain LIFO inventories in 1997 for operating reasons.
Cost of sales and operating expenses include costs for these inventories
based on prior years' LIFO carrying values which were less than current
replacement costs. As a result of LIFO inventory liquidations, net income
was increased by $7 million ($.09 per share) in 1997. The effects of LIFO
inventory liquidations during 1996 and 1995 were not significant.
PROPERTY, PLANT AND EQUIPMENT
The cost of plant and equipment (other than the costs of purchasing rights
to coal reserves and mine development costs) is principally depreciated by
the straight-line method over the estimated useful lives of the assets.
Costs of purchasing rights to coal reserves and mine development costs are
depleted by the units-of-production method over the estimated recoverable
reserves. Coal exploration costs are expensed as incurred.
Estimated costs of major refinery turnarounds are accrued, while other
maintenance and repair costs are expensed as incurred. Maintenance and
repair expense amounted to $463 million in 1997, $355 million in 1996 and
$341 million in 1995.
ENVIRONMENTAL COSTS
Accruals for environmental costs are recognized when it is probable that a
liability has been incurred and the amount of that liability can be
reasonably estimated. Such costs are charged to expense if they relate to
the remediation of conditions caused by past operations or are not expected
to mitigate or prevent contamination from future operations. Accruals are
recorded at undiscounted amounts based on experience, assessments and
current technology without regard to any third-party recoveries and are
regularly adjusted as environmental assessments and remediation efforts
proceed.
EARNINGS PER SHARE
Primary earnings per share is based on net income less preferred dividends
divided by the average number of common shares and equivalents outstanding
during the respective years. Shares of common stock issuable under stock
options are treated as common stock equivalents when dilutive.
Earnings per share assuming full dilution begins with the primary earnings
per share computation. Prior to 1997, shares issuable upon conversion of
the preferred stock and 6.75% subordinated debentures were added to average
common shares and equivalents when dilutive. In such cases, net income was
further adjusted by adding back preferred dividends and interest expense
(net of tax) on these debentures.
In the computation of earnings per share assuming full dilution for 1997,
the preferred shares which were converted in March 1997 (see Note J) were
assumed to be converted to common shares as of the beginning of the year,
in accordance with generally accepted accounting principles. If the shares
had been assumed converted as of the beginning of the year for the primary
computation, the resulting primary earnings per share would have amounted
to $3.70. The 6.75% convertible subordinated debentures were retired in
July 1997 (see Note F) and, therefore, were not assumed converted for the
1997 computation.
DERIVATIVE INSTRUMENTS
Ashland selectively uses commodity futures contracts to reduce its exposure
to certain risks inherent within its refining business. Such contracts are
used principally to hedge the value of intransit crude oil cargoes, hedge
exposure under fixed-price sales contracts, obtain higher prices for crude
oil sales, protect against margin compression caused by increasing crude
oil prices, take advantage of attractive refining margins and lock in
prices on a portion of the natural gas fuel needs of the refineries.
Realized gains and losses on these contracts are included in cost of sales
in the original contract month, with amounts paid or received on early
terminations deferred on the balance sheet in other current assets or trade
and other payables, as appropriate (the deferral method). In addition,
commodity futures contracts are used as an alternate method of obtaining or
selling crude oil and petroleum products to balance physical barrel
activity. These contracts are marked-to-market each month and included in
accounts receivable, with the offsetting unrealized gain or loss included
in cost of sales (the fair value method).
Ashland uses forward exchange contracts to hedge foreign currency
transaction exposures of its operations. These contracts are
marked-to-market each month and included in trade and other payables, with
the offsetting gain or loss included in other revenues (the fair value
method).
Ashland uses interest rate swap agreements to obtain greater access to the
lower borrowing costs normally available on floating-rate debt, while
minimizing refunding risk through the issuance of long-term, fixed-rate
debt. Each interest rate swap agreement is designated with all or a portion
of the principal balance and term of a specific debt obligation. These
agreements involve the exchange of amounts based on a fixed interest rate
for amounts based on variable interest rates over the life of the
agreement, without an exchange of the notional amount upon which the
payments are based. The differential to be paid or received as interest
rates change is accrued and recognized as an adjustment of interest expense
related to the debt (the accrual method). The related amount payable to or
receivable from counterparties is included in trade and other payables. The
fair values of the swap agreements are not recognized in the financial
statements. Gains and losses on terminations of interest rate swap
agreements are deferred on the balance sheet (in other long-term
liabilities) and amortized as an adjustment to interest expense related to
the debt over the remaining term of the original contract life of the
terminated swap agreement.
STOCK INCENTIVE PLANS
Effective October 1, 1996, Ashland adopted the disclosure requirements of
Financial Accounting Standards Board Statement No. 123 (FAS 123),
"Accounting for Stock-Based Compensation." With respect to accounting for
its stock options, as permitted under FAS 123, Ashland has retained the
intrinsic value method prescribed by Accounting Principles Board Opinion
No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related
Interpretations (see Note K).
ACCOUNTING CHANGES
Effective September 30, 1995, Ashland adopted Financial Accounting
Standards Board Statement No. 121 (FAS 121), "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." As a
result, Ashland recorded charges of $83 million ($79 million included in
depreciation, depletion and amortization and $4 million charged to
discontinued operations) to write down certain assets to their estimated
fair values. These assets included an idle unit at Ashland Petroleum's
Catlettsburg refinery, certain unused crude oil gathering pipelines of
Scurlock Permian, and petroleum product marketing properties which were
being sold or shut down. Fair values were based upon appraisals or
estimates of discounted future cash flows. Operating income was reduced for
each of the affected segments as follows: Refining and Marketing ($68
million); Valvoline ($3 million); Chemical ($4 million); and general
corporate expenses ($4 million). In addition, Arch Mineral adopted FAS 121
and recorded a charge to write down certain idle facilities, decreasing
Ashland's equity income by $3 million. The adoption of FAS 121 reduced
Ashland's net income for 1995 by $54 million or $.86 per share.
NOTE A - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER
Cash equivalents include highly liquid investments maturing within three
months after purchase. Investments of captive insurance companies
(primarily foreign corporate and government debt obligations) are carried
at market value plus accrued interest.
Income related to construction contracts is generally recognized by the
units-of-production method, which is a variation of the
percentage-of-completion method. Any anticipated losses on such contracts
are charged against operations as soon as such losses are estimable.
Costs in excess of net assets of companies acquired are amortized by the
straight-line method over periods generally ranging from 10 to 40 years,
with an average remaining life of 13 years. Costs of acquired coal supply
agreements are capitalized and amortized over the contract sales tonnage.
Research and development costs are expensed as incurred ($29 million in
1997, $28 million in 1996 and $24 million in 1995).
Certain prior year amounts have been reclassified in the consolidated
financial statements and accompanying notes to conform with 1997
classifications.
NOTE B - DISCONTINUED OPERATIONS
On July 1, 1997, Ashland sold the domestic exploration and production
operations of Blazer Energy Corporation, realizing cash proceeds of $566
million. The sale resulted in a pretax gain of $138 million which, net of
$67 million of income taxes, produced a gain on sale of discontinued
operations of $71 million. Ashland has reached an agreement in principle to
sell its exploration and production operations in Nigeria, subject to the
approval of the Nigerian government and other conditions. Accordingly,
results from the Exploration segment are shown as discontinued operations
with prior years restated. Components of amounts reflected in the income
statements, balance sheets and cash flow statements are presented in the
following table.
(In millions) 1997 1996 1995
======================================================================================================================
INCOME STATEMENT DATA
Revenues $240 $320(1) $204
Costs and expenses (215) (226) (210)
- ----------------------------------------------------------------------------------------------------------------------
Operating income (loss) 25 94 (6)
Income tax benefit (expense) - (19) 16
- ----------------------------------------------------------------------------------------------------------------------
Income from discontinued operations $ 25 $ 75(1) $ 10
======================================================================================================================
BALANCE SHEET DATA
Current assets $ 59 $ 76
Investments and other assets 1 1
Property, plant and equipment - net 57 430
Current liabilities (41) (81)
Noncurrent liabilities (58) (100)
- ----------------------------------------------------------------------------------------------------------------------
Net assets of discontinued operations held for sale $ 18 $326
======================================================================================================================
CASH FLOW DATA
Cash flows from operations $(90) $115 $ 58
Cash flows from investment (including sales proceeds) 526 (80) (72)
- ----------------------------------------------------------------------------------------------------------------------
Cash provided (used) by discontinued operations $436 $ 35 $(14)
======================================================================================================================
(1) Includes a gain of $73 million ($48 million after income taxes)
resulting from the settlement of claims in the bankruptcy
reorganization of Columbia Gas Transmission and Columbia Gas
Systems.
NOTE C - INFORMATION BY INDUSTRY SEGMENT
Ashland's operations are conducted primarily in the United States and are
managed along industry segments, which include Refining and Marketing,
Valvoline, Chemical, APAC and Coal. Information by industry segment is
shown on Pages 62 and 63.
Refining and Marketing operations are conducted by Ashland Petroleum and
SuperAmerica. Ashland Petroleum is a leading regional refiner and marketer
in the Midwest. In addition to supplying petroleum products to
SuperAmerica, Valvoline, Ashland Chemical and APAC, Ashland Petroleum is a
leading supplier of petroleum products to the transportation and commercial
fleet industries, other industrial customers and independent marketers
(including marketers operating under the Ashland brand name). Ashland
Petroleum also transports crude oil and petroleum products in connection
with its refining and wholesale marketing operations and gathers and
markets crude oil through Scurlock Permian. SuperAmerica includes Ashland's
retail gasoline and merchandise marketing operations, including the
SuperAmerica chain of high-volume retail stores. Gasoline and merchandise
are also sold from outlets operated by SuperAmerica under the Rich brand
name. Operations are conducted primarily in the Ohio Valley and Upper
Midwest.
During 1997, Ashland and Marathon Oil Company signed a letter of intent to
combine the petroleum refining and marketing and most transportation assets
of the two companies. Ashland would have a 38% ownership interest in the
proposed joint venture. On October 30, 1997, Ashland and Marathon announced
that the two firms had resolved all material matters concerning valuation
and due diligence, and anticipate signing definitive agreements in December
1997.
Valvoline is a marketer of automotive and industrial oils, automotive
chemicals, antifreeze, filters, rust preventives and coolants, with sales
in more than 140 countries. In addition, Valvoline is engaged in the "fast
oil change" business through outlets operating under the Valvoline Instant
Oil Change and Valvoline Rapid Oil Change names and provides environmental
services for the collection of used oil, antifreeze and filters.
Chemical businesses are managed by Ashland Chemical, which distributes
industrial chemicals, solvents, thermoplastics and resins, fiberglass
materials and fine ingredients. Ashland Chemical also manufactures a wide
variety of specialty chemicals and certain petrochemicals. Major specialty
chemicals include foundry products, water treatment and marine service
chemicals, specialty polymers and adhesives, unsaturated polyester resins,
and high-purity electronic and laboratory chemicals. Ashland Chemical's
petrochemicals division manufactures and markets maleic anhydride and
methanol, and markets cumene, aromatic and aliphatic solvents, and
propylene manufactured by Ashland Petroleum. Marketing of the
petrochemicals manufactured by Ashland Petroleum will be transferred to
Refining and Marketing in fiscal 1998.
The APAC group of companies, which are located in 13 southern and
midwestern states, perform contract construction work including paving,
repair and resurfacing highways, streets, airports, residential and
commercial developments, sidewalks, and driveways; grading and base work;
and excavation and related activities in the construction of bridges and
structures, drainage facilities and underground utilities. APAC also
produces and sells construction materials, such as asphaltic and ready-mix
concrete, crushed stone and other aggregate and, in certain markets,
concrete block and specialized construction materials, such as
architectural block.
Coal operations are conducted by 54% owned, publicly traded Arch Coal,
Inc., which was created on July 1, 1997, by the merger of Ashland Coal,
Inc. and Arch Mineral Corporation. Beginning in the September 1997 quarter,
Arch Coal was consolidated in Ashland's financial statements. Prior interim
quarters in 1997 were restated to reflect Arch Mineral on a consolidated
basis for comparison purposes. Arch Mineral was previously accounted for on
the equity method. Arch Coal is the largest producer of bituminous,
low-sulfur coal in the eastern United States. Arch markets coal to electric
utilities and industrial customers throughout the United States, Europe and
Japan. Coal is produced from surface and deep mines located in Illinois,
Kentucky, Virginia, West Virginia and Wyoming. Arch also markets coal mined
by independent producers.
On July 1, 1997, Ashland sold the domestic exploration and production
operations of Blazer Energy Corporation. Ashland has reached an agreement
in principle to sell its exploration and production operations in Nigeria,
subject to the approval of the Nigerian government and other conditions.
Accordingly, results from the Exploration segment are shown as discontinued
operations with prior years restated (see Note B).
Certain information with respect to continuing foreign operations follows.
Income from continuing operations
Total assets before income taxes
------------------------ -----------------------------------------------
(In millions) 1997 1996 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------------
Foreign operations
Refining and Marketing $ 63 $ 70 $ 2 $ 3 $ 4
Valvoline 103 127 (7)(1) 4 3
Chemical 363 327 26(1) 41 42
- ---------------------------------------------------------------------------------------------------------------------------------
$529 $ 524 $21 $ 48 $49
=================================================================================================================================
(1) Includes charges of $10 million for Valvoline and $16 million for
Chemical to write down goodwill related to certain European
operations.
NOTE D - UNCONSOLIDATED AFFILIATES
Affiliated companies accounted for on the equity method include LOOP LLC
and LOCAP INC. (18.6% and 21.4% owned corporate joint ventures operating a
deepwater offshore port and related pipeline facilities in the Gulf of
Mexico) and various other companies. Prior to 1997, Arch Mineral
Corporation was 50% owned and accounted for on the equity method (see Notes
A and C). Summarized financial information reported by these affiliates and
a summary of the amounts recorded in Ashland's consolidated financial
statements follow. At September 30, 1997, Ashland's retained earnings
include $55 million of undistributed earnings from unconsolidated
affiliates accounted for on the equity method.
Arch Mineral LOOP LLC and
(In millions) Corporation LOCAP INC. Other Total
==============================================================================================================================
SEPTEMBER 30, 1997
Financial position
Current assets $ 30 $ 311
Current liabilities (81) (161)
--------------------------------
Working capital (51) 150
Noncurrent assets 586 149
Noncurrent liabilities (438) (104)
--------------------------------
Stockholders' equity $ 97 $ 195
================================
Results of operations
Sales and operating revenues $ 123 $ 994
Gross profit 40 238
Net income 27 38
Amounts recorded by Ashland
Investments and advances 18 68 $ 86
Equity income 2 13 15
Dividends received - 9 9
==============================================================================================================================
SEPTEMBER 30, 1996
Financial position
Current assets $ 165 $ 28 $ 265
Current liabilities (142) (82) (151)
--------------------------------------------------------
Working capital 23 (54) 114
Noncurrent assets 752 613 225
Noncurrent liabilities (646) (489) (107)
--------------------------------------------------------
Stockholders' equity $ 129 $ 70 $ 232
========================================================
Results of operations
Sales and operating revenues $ 727 $ 117 $ 846
Gross profit 98 38 214
Net income 27 8 28
Amounts recorded by Ashland
Investments and advances 73 13 71 $ 157
Equity income 13 2 9 24
Dividends received - - 7 7
==============================================================================================================================
SEPTEMBER 30, 1995
Results of operations
Sales and operating revenues $ 714 $ 119 $ 775
Gross profit 50 36 193
Net income (loss) (8)(1) 4 29
Amounts recorded by Ashland
Equity income (loss) (4) 1 10 $ 7
Dividends received 3 1 8 12
==============================================================================================================================
(1) Includes a charge of $12 million resulting from asset impairment
write-downs under FAS 121 and provisions for early retirement and
restructuring programs.
NOTE E - INCOME TAXES
A summary of the provision for income taxes related to continuing
operations follows.
(In millions) 1997 1996 1995
===================================================================================================================================
Current(1)
Federal $ 92 $ 60 $ 52
State 7 7 10
Foreign 17 17 12
- -----------------------------------------------------------------------------------------------------------------------------------
116 84 74
Deferred 3 (11) (71)
- -----------------------------------------------------------------------------------------------------------------------------------
$119 $ 73 $ 3
===================================================================================================================================
(1) Income tax payments amounted to $82 million in 1997, $110 million in
1996 and $54 million in 1995.
Deferred income taxes are provided for significant income and expense items
recognized in different years for tax and financial reporting purposes.
Temporary differences which give rise to significant deferred tax assets
(liabilities) follow. These amounts are recorded in various asset and
liability accounts on Ashland's consolidated balance sheets.
(In millions) 1997 1996
===================================================================================================================================
Employee benefit obligations $365 $ 251
Environmental, insurance and litigation reserves 148 118
Alternative minimum tax credit carryforwards 76(1) 77
Uncollectible accounts receivable 18 19
Compensated absences 16 16
Other items 89 58
- -----------------------------------------------------------------------------------------------------------------------------------
Total deferred tax assets 712 539
- -----------------------------------------------------------------------------------------------------------------------------------
Property, plant and equipment (523) (405)
Coal supply agreements (38) (9)
Undistributed equity income (19) (18)
Prepaid royalties 2 (18)
- -----------------------------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities (578) (450)
- -----------------------------------------------------------------------------------------------------------------------------------
Net deferred tax asset $134 $ 89
===================================================================================================================================
(1) Alternative minimum tax credit carryforwards at September 30, 1997,
relate entirely to Arch Coal, Inc.
The U.S. and foreign components of income from continuing operations before
income taxes and a reconciliation of the normal statutory federal income
tax with the provision for income taxes follow.
(In millions) 1997 1996 1995
===================================================================================================================================
Income from continuing operations before income taxes and minority interest
United States $314 $169 $ (9)
Foreign 21 48 49
- -----------------------------------------------------------------------------------------------------------------------------------
$335 $217 $ 40
===================================================================================================================================
Income taxes computed at U.S. statutory rates $117 $ 76 $ 14
Increase (decrease) in amount computed resulting from
Equity income (4) (5) -
State income taxes 7 4 5
Net impact of foreign results 10 - (4)
Percentage depletion allowance (22) (6) (14)
Other items 11 4 2
- -----------------------------------------------------------------------------------------------------------------------------------
Income taxes $119 $ 73 $ 3
===================================================================================================================================
The Internal Revenue Service (IRS) has examined Ashland's consolidated U.S.
income tax returns through 1993. As a result of its examinations, the IRS
has proposed adjustments, certain of which are being contested by Ashland.
Ashland believes it has adequately provided for any income taxes and
related interest which may ultimately be paid on contested issues.
NOTE F - LONG-TERM DEBT
(In millions) 1997 1996
================================================================================================================================
Senior debt of Ashland
Medium-term notes, due 1998-2025, interest at an average rate
of 8.3% at September 30, 1997 (5.8% to 10.4%) $ 936 $ 909
8.80% debentures, due 2012 250 250
11.125% sinking fund debentures, due 2017 - 200
Pollution control and industrial revenue bonds, due
1998-2022, interest at an average rate of 6.4%
at September 30, 1997 (3.5% to 7.4%) 217 227
Other 2 3
- -------------------------------------------------------------------------------------------------------------------------------
1,405 1,589
6.75% convertible subordinated debentures, due 2014,
convertible into common stock at $51.34 per share - 124
Debt of Arch Coal, Inc. not guaranteed by Ashland
9.78% senior notes, due 1997-2000 - 101
9.66% senior notes, due 2001-2006 - 54
7.79% senior notes, due 1998-2003 43 -
Revolving credit agreement, due 2002, variable interest rate
based on LIBOR, interest rate of 5.9% at September 30, 1997 240 -
Other 9 2
- -------------------------------------------------------------------------------------------------------------------------------
1,697 1,870
Current portion of long-term debt (58) (86)
- -------------------------------------------------------------------------------------------------------------------------------
$1,639 $1,784
================================================================================================================================
Aggregate maturities of long-term debt are $58 million in 1998, $48 million
in 1999, $41 million in 2000, $79 million in 2001 and $328 million in 2002.
Excluded from such maturities are $38 million of floating-rate pollution
control and industrial revenue bonds, due between 2003 and 2009. These
bonds are subject to early redemptions at the bondholders' option, but
generally not before October 1, 1998.
Ashland has a revolving credit agreement which expires on February 9, 2000,
providing for up to $320 million in borrowings, under which no borrowings
were outstanding at September 30, 1997. In addition, Arch Coal has
revolving credit agreements which expire on June 30, 2002, providing for up
to $500 million in borrowings, of which $240 million was in use at
September 30, 1997.
Certain debt agreements contain covenants restricting dividends, share
repurchases and other distributions with respect to Ashland's capital
stock, as well as covenants limiting new borrowings. At September 30, 1997,
distributions with respect to Ashland's capital stock were restricted to $1
billion and additional debt was limited to $2.1 billion.
Interest payments on all indebtedness amounted to $191 million in 1997,
$175 million in 1996, and $163 million in 1995. The weighted average
interest rate on short-term borrowings outstanding was 6.7% at September
30, 1997, and 5.9% at September 30, 1996.
EXTRAORDINARY LOSS
On June 3, 1997, Ashland called for redemption all of its outstanding 6.75%
Convertible Subordinated Debentures. On July 3, 1997, $123 million of the
Debentures were redeemed for 101.35% of the principal amount, plus accrued
interest, thereby eliminating an associated 2.4 million shares of Ashland
Common Stock that had been reserved for conversion. On September 3, 1997,
Ashland announced its intention to redeem its 11.125% Sinking Fund
Debentures on October 15, 1997. The principal amount outstanding of $200
million had a redemption price of 105.562%, plus accrued interest to the
redemption date. On September 23, 1997, Ashland delivered to the trustee
U.S. Treasury securities maturing on October 15, 1997, sufficient to cover
the redemption price and accrued interest in accordance with the indenture
agreement, thereby relieving Ashland of any further obligations under the
Debentures. The redemption premium and writeoff of unamortized deferred
debt issuance expenses related to these two transactions resulted in pretax
charges totaling $15 million which, net of income tax benefits of $6
million, resulted in an extraordinary loss of $9 million on the early
retirement of debt.
NOTE G - FINANCIAL INSTRUMENTS
COMMODITY AND FOREIGN CURRENCY HEDGES
Ashland uses commodity futures contracts and forward exchange contracts to
reduce its exposure to certain risks inherent within its businesses as
described in Note A. The fair value of open commodity and foreign exchange
contracts was not significant at September 30, 1997, and 1996.
INTEREST RATE SWAPS
Ashland uses interest rate swap agreements to obtain greater access to the
lower borrowing costs normally available on floating-rate debt, while
minimizing refunding risk through the issuance of long-term, fixed-rate
debt. At September 30, 1997, Ashland had unleveraged swap agreements with a
notional principal amount of $370 million. These agreements were used to
convert fixed rates on certain debt, including the 8.80% debentures and
various medium-term notes, to variable rates. The variable rates are
generally adjusted quarterly or semiannually based on London Interbank
Offered Rates (LIBOR), but may be fixed for longer terms using forward rate
agreements. Notional amounts do not quantify risk or represent assets or
liabilities of Ashland, but are used in the determination of cash
settlements under the agreements. Ashland is exposed to credit losses from
counterparty nonperformance, but does not anticipate any losses from its
agreements, all of which are with major financial institutions.
At September 30, 1997, Ashland was receiving a weighted-average fixed
interest rate of 6.0% and paying a weighted-average variable interest rate
of 5.9%, calculated on the notional amount. Interest expense was reduced by
$2 million in 1997 and 1996 and an insignificant amount in 1995 resulting
from settlements under these agreements. Under its current swap agreements,
Ashland's annual interest expense in 1998 will change by about $4 million
for each 1% change in LIBOR. The terms remaining on Ashland's swaps range
from 4 to 80 months, with a weighted-average remaining life of 27 months.
The carrying amounts and fair values of Ashland's significant financial
instruments, including interest rate swaps, at September 30, 1997, and
1996, are shown below. The fair values of cash and cash equivalents and
notes payable to financial institutions approximate their carrying amounts.
The fair values of investments of captive insurance companies are based on
quoted market prices plus accrued interest. 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 rates. The fair values of interest rate
swaps are based on quoted market prices, which reflect the present values
of the difference between estimated future variable-rate payments and
future fixed-rate receipts.
1997 1996
--------------------- --------------------------
Carrying Fair Carrying Fair
(In millions) amount value amount value
===================================================================================================================
Assets
Cash and cash equivalents $ 268 $ 268 $ 77 $ 77
Investments of captive insurance companies 189 189 178 178
Interest rate swaps - 1
Liabilities
Notes payable to financial institutions 35 35 117 117
Long-term debt (including current portion) 1,697 1,864 1,870 2,024
Interest rate swaps - 4
===================================================================================================================
NOTE H - ACQUISITIONS AND DIVESTITURES
ACQUISITIONS
In February 1995, Ashland purchased all of Ashland Coal's Class B Preferred
Stock for $110 million. The purchase increased Ashland's ownership of
Ashland Coal from 39% to 54%. As a result of this transaction, Ashland Coal
was consolidated into Ashland's financial statements retroactive to October
1, 1994. Ashland continued to reinvest dividends from Ashland Coal in
additional shares of its common stock, increasing its ownership in Ashland
Coal to 57% as of July 1, 1997, when Ashland Coal and Arch Mineral
Corporation merged (see Notes A and C).
Also during 1995, Ashland acquired the unsaturated polyester resins,
polyester distribution and maleic anhydride businesses of Aristech Chemical
Corporation, the Zerex antifreeze product line, the northern West Virginia
assets of two natural gas producers, and various other chemical and
construction businesses. These and several smaller acquisitions completed
in various segments during the last three years were generally accounted
for as purchases and did not have a significant effect on Ashland's
consolidated financial statements.
DIVESTITURES
Ashland completed several small divestitures in various segments during the
last three years which did not have a significant effect on Ashland's
consolidated financial statements. In 1997, Ashland completed the sale of
the domestic operations of Blazer Energy Corporation. See Note B for a
description of this transaction and its impact on Ashland's consolidated
financial statements.
NOTE I - LEASES AND OTHER COMMITMENTS
LEASES
Ashland and its subsidiaries are lessees in noncancelable leasing
agreements for office buildings, warehouses, pipelines, transportation and
marine equipment, storage facilities, retail outlets, manufacturing
facilities and other equipment and properties which expire at various
dates. Capitalized lease obligations are not significant and are included
in long-term debt. Future minimum rental payments at September 30, 1997,
and rental expense under operating leases follow.
(In millions)
- -----------------------------------------------------------------------------------------------------------------------------------
Future minimum rental payments Rental expense 1997 1996 1995
========================================== ==================================================================================
1998 $ 84
1999 74 Minimum rentals
2000 66 (including rentals under
2001 52 short-term leases) $166 $146 $129
2002 36 Contingent rentals 13 14 11
Later years 174 Sublease rental income (13) (16) (18)
- ------------------------------------------ ----------------------------------------------------------------------------------
$486 $166 $144 $122
===================================================================================================================================
In addition, Arch Coal has entered into various noncancelable royalty lease
agreements under which future minimum payments are approximately $31
million annually through 2002 and $253 million in the aggregate thereafter.
OTHER COMMITMENTS
Under agreements with LOOP and LOCAP (see Note D), Ashland is obligated,
based upon its equity ownership, to provide a portion of the total debt
service and defined operating and administrative costs of these joint
ventures. This annual obligation is reduced by transportation charges paid
by Ashland and by a pro rata portion of transportation charges paid by
third parties who are not equity participants. If, after each obligor's
requirements have been satisfied, the joint ventures are unable to meet
cash requirements, Ashland is obligated to advance its pro rata share of
the deficiency. All funds provided to these joint ventures are used as
advances against future transportation charges. At September 30, 1997,
substantially all advances made to LOOP and LOCAP by Ashland had been
applied against transportation charges. Transportation charges incurred
amounted to $16 million in 1997, $16 million in 1996 and $21 million in
1995. At September 30, 1997, Ashland's contingent liability for its share
of the indebtedness of LOOP and LOCAP secured by throughput and deficiency
agreements amounted to approximately $83 million.
Arch Coal owns 17.5% of a joint venture operating a coal-loading and
storage facility at Newport News, Va. Venture partners are required to pay
their share of the venture's costs in relation to their ownership (for
fixed operating costs and debt service) or facility usage (for variable
operating costs). Arch Coal's share of such payments amounted to
approximately $4 million annually in each of the last three years. Future
payments for fixed operating costs and debt service are estimated to
approximate $3 million annually through 2015 and $26 million in 2016.
Additionally, Ashland is contingently liable for a guarantee relating to an
office building partially occupied by Arch Coal. At September 30, 1997,
such obligation has a present value of approximately $6 million.
NOTE J - CAPITAL STOCK
In March 1997, Ashland called for redemption the 6 million outstanding
shares of its $3.125 Cumulative Convertible Preferred Stock. Each preferred
share was convertible into 1.546 shares of Ashland common stock, plus cash
for fractional shares. Almost 99% of the series was submitted for
conversion to common stock by the March 31 deadline. The remaining
preferred shares were redeemed at a price of $51.88 per share plus 19.1
cents per share of accrued and unpaid dividends.
Under Ashland's Shareholder Rights Plan, each common share is accompanied
by one right to purchase one-thousandth share of preferred stock for $140.
Each one-thousandth share of preferred stock will be entitled to dividends
and to vote on an equivalent basis with one common share. The rights are
neither exercisable nor separately transferable from the common shares
unless a party acquires or tenders for more than 15% of Ashland's common
stock. If any party acquires more than 15% of Ashland's common stock or
acquires Ashland in a business combination, each right (other than those
held by the acquiring party) will entitle the holder to purchase preferred
stock of Ashland or the acquiring company at a substantial discount. The
rights expire on May 16, 2006, and can be redeemed at any time prior to
becoming exercisable.
At September 30, 1997, 500,000 shares of cumulative preferred stock are
reserved for potential issuance under the Shareholder Rights Plan. At
September 30, 1997, 5 million common shares are reserved for issuance under
outstanding stock options.
NOTE K - STOCK INCENTIVE PLANS
Ashland has stock incentive plans under which key employees or directors
can purchase shares of common stock under stock options or restricted stock
awards. Stock options are granted to employees at a price equal to the fair
market value of the stock on the date of grant and become exercisable over
periods of one to three years. Unexercised options lapse 10 years after the
date of grant. Restricted stock awards entitle employees or directors to
purchase shares at a nominal cost, to vote such shares and to receive any
dividends thereon. However, such shares are subject to forfeiture upon
termination of service before the restriction period ends.
Ashland accounts for its stock incentive plans in accordance with APB 25,
as permitted by FAS 123. In accordance with APB 25, Ashland has not
recognized compensation expense for stock options because the exercise
price of the options equals the market price of the underlying stock on the
date of grant, which is the measurement date. If the alternative method of
accounting for stock incentive plans prescribed by FAS 123 had been
followed, the impact on Ashland's net income and earnings per share for
1997 and 1996 would not have been material. A summary of stock options
follows.
1997 1996 1995
-------------------------- ------------------------- -------------------------
Weighted average Weighted average Weighted average
Common option price Common option price Common option price
(In thousands except per share data) shares per share shares per share shares per share
- ---------------------------------------------------------------------------------------------------------------------------------
Outstanding - beginning of year(1) 5,247 $33.97 5,222 $32.72 4,697 $32.50
Granted 814 53.22 823 38.92 839 33.86
Exercised (1,271) 32.94 (747) 30.45 (164) 27.47
Canceled (72) 37.29 (51) 37.35 (150) 38.16
- ---------------------------------------------------------------------------------------------------------------------------------
Outstanding - end of year(1) 4,718 $37.52 5,247 $33.97 5,222 $32.72
=================================================================================================================================
Exercisable - end of year 3,373 $33.78 3,820 $32.81 3,777 $32.17
=================================================================================================================================
(1) Shares of common stock available for future grants of options or
awards amounted to 5,778,000 at September 30, 1997, and 3,403,000 at
September 30, 1996. Exercise prices for options outstanding at
September 30, 1997, ranged from $23.88 to $53.38 per share. The
weighted average remaining contractual life of the options was 7
years.
NOTE L - LITIGATION, CLAIMS AND CONTINGENCIES
Ashland is subject to various federal, state and local environmental laws
and regulations that require remediation efforts at multiple locations,
including operating facilities, previously owned or operated facilities,
and Superfund or other waste sites. Consistent with its accounting policy
for environmental costs, Ashland's reserves for environmental assessments
and remediation efforts amounted to $150 million at September 30, 1997, and
$173 million at September 30, 1996. Such amounts reflect Ashland's most
likely estimates of the costs which will be incurred over an extended
period to remediate identified environmental conditions for which costs are
reasonably estimable.
Environmental reserves are subject to considerable uncertainties that
affect Ashland's ability to estimate its share of the ultimate costs of
required remediation efforts. Such uncertainties involve the nature and
extent of contamination at each site, the extent of required cleanup
efforts under existing environmental regulations, widely varying costs of
alternate cleanup methods, changes in environmental regulations, the
potential effect of continuing improvements in remediation technology, and
the number and financial strength of other potentially responsible parties
at multiparty sites.
During 1997, the U. S. Environmental Protection Agency (EPA) completed
comprehensive inspections of compliance with federal environmental laws and
regulations at Ashland's three refineries. Ashland continues to cooperate
and hold discussions with the EPA concerning these inspections, as well as
what additional remediation actions may be required or costs may be
incurred.
In addition to environmental matters, Ashland and its subsidiaries are
parties to numerous claims and lawsuits, some of which are for substantial
amounts. While these actions are being contested, the outcome of individual
matters is not predictable with assurance.
Ashland does not believe that any liability resulting from these matters,
after taking into consideration its insurance coverages and amounts already
provided for, will have a material adverse effect on its consolidated
financial position.
NOTE M - EMPLOYEE BENEFIT PLANS
PENSION PLANS
Ashland and its subsidiaries sponsor defined benefit pension plans that
cover substantially all employees, other than union employees covered by
multiemployer pension plans under collective bargaining agreements.
Benefits under Ashland's plans generally are based on employees' years of
service and compensation during the years immediately preceding retirement.
For certain plans, such benefits are expected to come in part from one-half
of employees' leveraged employee stock ownership plan (LESOP) accounts.
Ashland determines the level of contributions to pension plans annually and
contributes amounts within allowable limitations imposed by Internal
Revenue Service regulations. The following tables detail the funded status
of the plans and the components of pension expense. A discount rate of
7.25% and an assumed rate of salary increases of 5% were used in
determining the actuarial present value of projected benefit obligations at
September 30, 1997 (8% and 5% at September 30, 1996).
1997 1996
----------------------------------- ---------------------------------
Plans with Plans with Plans with Plans with
assets in excess ABO in excess assets in excess ABO in excess
(In millions) of ABO of assets of ABO of assets
==================================================================================================================================
Plan assets at fair value (primarily listed
stocks and bonds) $433 $ 69 $360 $ -
- ----------------------------------------------------------------------------------------------------------------------------------
Accumulated benefit obligations (ABO)
Vested 317 99 284 29
Nonvested 45 49 35 36
- ----------------------------------------------------------------------------------------------------------------------------------
362 148 319 65
- ----------------------------------------------------------------------------------------------------------------------------------
Plan assets less than (in excess of) ABO (71) 79(1) (41) 65(1)
Provision for future salary increases 173 34 149 17
Deferred pension costs (5) (10) (10) (15)
- ----------------------------------------------------------------------------------------------------------------------------------
Net accrued pension costs(2) $ 97 $103 $ 98 $ 67
==================================================================================================================================
Components of deferred pension costs
Unrecognized transition gain (loss) $ 6 $ (2) $ 10 $ (4)
Unrecognized net loss - (33) (9) (34)
Unrecognized prior service costs (11) (2) (11) (1)
Recognition of minimum liability - 27 - 24
- ----------------------------------------------------------------------------------------------------------------------------------
$ (5) $(10) $(10) $ (15)
==================================================================================================================================
(In millions) 1997 1996 1995
==================================================================================================================================
Components of pension expense
Service cost $ 39 $ 32 $ 23
Interest cost 48 40 34
Actual investment gain on plan assets (86) (34) (51)
Deferred investment gain(3) 50 6 30
Other amortization and deferral 2 3 1
Enhanced retirement program pension cost - - 15
- ----------------------------------------------------------------------------------------------------------------------------------
$ 53 $ 47 $ 52
==================================================================================================================================
(1) Includes unfunded ABO of $77 million in 1997 and $65 million in 1996
for nonqualified defined benefit plans.
(2) Amounts are recorded in various asset and liability accounts on
Ashland's consolidated balance sheets.
(3) The expected long-term rate of return on plan assets was 9%.
OTHER POSTRETIREMENT BENEFIT PLANS
Ashland and its subsidiaries sponsor several unfunded benefit plans, as
well as participate in multiemployer plans sponsored by the United Mine
Workers of America (UMWA), which provide health care and life insurance
benefits for eligible employees who retire from active service or are
disabled. The health care plans are contributory with the exception of the
UMWA plan. Retiree contributions to Ashland's health care plans are
adjusted periodically and contain other cost-sharing features such as
deductibles and coinsurance. Life insurance plans are generally
noncontributory. Ashland currently funds the costs of benefits as they are
paid.
Effective October 1, 1992, Ashland amended nearly all of its retiree health
care plans to place a cap on the company's contributions and to adopt a
cost-sharing method based upon years of service. These amendments reduced
the accumulated postretirement benefit obligation (APBO) for retiree health
care plans at that date by $197 million, which is being amortized to income
over approximately 12 years. The cap limits Ashland's contributions to a
specific base year per capita health care cost, increasing thereafter by up
to 4.5% per year. For those plans not capped, various health care cost
trend rates are assumed. Increasing the assumed health care cost trend
rates by one percentage point in each year for non-capped plans would
increase the APBO as of September 30, 1997, by $49 million and the net
periodic postretirement benefit cost for 1997 by $4 million.
The following tables detail the status of the plans and the components of
postretirement benefit expense. The APBO was determined using a discount
rate of 7.25% at September 30, 1997, and 8% at September 30, 1996.
1997 1996
----------------------------------- ---------------------------------
Health care Health care
-------------------- -------------------
Ashland UMWA Life Ashland UMWA Life
(In millions) plans plan insurance plans plan insurance
================================================================================================================================
Accumulated postretirement benefit
obligations (APBO)
Retired or disabled employees $132 $124 $26 $113 $17 $25
Fully eligible active plan participants 44 74 5 29 4 5
Other active plan participants 141 59 7 107 20 5
- --------------------------------------------------------------------------------------------------------------------------------
317 257 38 249 41 35
Unrecognized net gain (loss) (21) 1 (4) 4 24 (2)
Unrecognized plan amendment credit 96 - 4 110 2 5
- --------------------------------------------------------------------------------------------------------------------------------
Accrued other postretirement benefit costs $392 $258 $38 $363 $67 $38
================================================================================================================================
1997 1996 1995
------------------- -------------------- ---------------------
Health Life Health Life Health Life
(In millions) care insurance care insurance care Insurance
================================================================================================================================
Components of other postretirement benefit expense
Service cost $ 14 $ 1 $12 $ 1 $12 $ 1
Interest cost 37 3 21 3 20 2
Amortization and deferral
(principally plan amendment credit) (21) - (16) (1) (15) (1)
- --------------------------------------------------------------------------------------------------------------------------------
$ 30 $ 4 $17 $ 3 $17 $ 2
================================================================================================================================
OTHER PLANS
Certain union employees are covered under multiemployer defined benefit
pension plans administered by unions. Amounts charged to pension expense
and contributed to the plans were $5 million in 1997 and $2 million in both
1996 and 1995.
Ashland and its subsidiaries sponsor various savings plans to assist
eligible employees in providing for retirement or other future needs. Under
the principal plans, Ashland contributes up to 4.2% of a participating
employee's earnings (1.2% for LESOP participants prior to March 31, 1996)
and Arch Coal contributes up to 6%. Company contributions amounted to $27
million in 1997, $15 million in 1996 and $9 million in 1995.
Note N - Quarterly Financial Information (Unaudited)
The following table presents quarterly financial information and per share
data relative to Ashland's common stock. Sales and operating revenues and
operating income have been restated effective October 1, 1996, to reflect
the merger of Ashland Coal and Arch Mineral (see Notes A and C) and for all
prior periods to present Blazer Energy as discontinued operations (see Note
B).
Quarters ended December 31 March 31 June 30 September 30
- ------------------------------------------------------------ -------------------- ---------------------- ----------------------
(In millions except per share data) 1996 1995(1) 1997 1996 1997 1996 1997(2) 1996
===================================================================================================================================
Sales and operating revenues $ 3,545 $3,024 $3,346 $3,006 $3,643 $3,429 $3,665 $3,433
Operating income 89 96 65 23 225 146 111 98
Income (loss) from continuing
operations $ 24 $ 32 $ 2 $ (13) $ 119 $ 76 $ 48 $ 41
Income from discontinued operations 12 55 5 11 9 4 71 5
Extraordinary loss - - - - (2) - (8) -
--------------------------------------------------------------------------------------------
Net income (loss) $ 36 $ 87 $ 7 $ (2) $ 126 $ 80 $ 111 $ 46
Primary earnings (loss) per share
Continuing operations $ .30 $ .43 $ (.05) $ (.27) $ 1.57 $ 1.10 $ .62 $ .55
Discontinued operations .17 .86 .08 .16 .11 .06 .94 .09
Extraordinary loss - - - - (.02) - (.10) -
--------------------------------------------------------------------------------------------
Net income (loss) $ .47 $ 1.29 $ .03 $ (.11) $ 1.66 $ 1.16 $ 1.46 $ .64
Common dividends per share .275 .275 .275 .275 .275 .275 .275 .275
Market price per common share
High 48-7/8 36-1/2 45-1/8 39-1/2 48-1/4 44-1/8 54-15/16 40-1/4
Low 39-3/8 30-3/8 39-1/4 34-1/4 40-1/8 38-1/8 46-1/2 35
===================================================================================================================================
(1) A gain resulting from the settlement of claims in the bankruptcy
reorganization of Columbia Gas Transmission and Columbia Gas Systems
increased income from discontinued operations by $48 million, or $.74
per share, in the quarter ended December 31, 1995.
(2) In the quarter ended September 30, 1997, unusual items reduced income
from continuing operations by $28 million, or $.38 per share. See
Management's Discussion and Analysis and Information by Industry
Segment for a discussion of these items. A gain on the sale of the
domestic operations of Blazer Energy increased income from
discontinued operations by $71 million, or $.94 per share (see Note
B).
ASHLAND INC. AND SUBSIDIARIES
FIVE-YEAR SELECTED FINANCIAL INFORMATION
Years Ended September 30
(In millions except per share data) 1997 1996 1995 1994 1993
=================================================================================================================================
SUMMARY OF OPERATIONS
Revenues
Sales and operating revenues (including excise taxes) $14,200 $12,892 $11,972 $10,140 $ 9,958
Other 119 76 66 39 53
Costs and expenses
Cost of sales and operating expenses (10,860) (9,975) (9,130) (7,614) (7,790)
Excise taxes on products and merchandise (992) (985) (988) (877) (645)
Selling, general and administrative expenses (1,405) (1,275) (1,269) (1,074) (1,044)
Depreciation, depletion and amortization (572) (371) (447) (275) (271)
- ---------------------------------------------------------------------------------------------------------------------------------
Operating income 490 362 204 339 261
Other income (expense)
Interest expense (net of interest income) (170) (169) (171) (116) (122)
Equity income 15 24 7 22 26
- ---------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes
and minority interest 335 217 40 245 165
Income taxes (119) (73) (3) (82) (58)
Minority interest in earnings of subsidiaries (24) (8) (23) - -
- ---------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 192 136 14 163 107
Income from discontinued operations 25 75 10 34 35
Gain on sale of discontinued operations 71 - - - -
- ---------------------------------------------------------------------------------------------------------------------------------
Income before extraordinary loss 288 211 24 197 142
Extraordinary loss on early retirement of debt (9) - - - -
- ---------------------------------------------------------------------------------------------------------------------------------
Net income $ 279 $ 211 $ 24 $ 197 $ 142
=================================================================================================================================
BALANCE SHEET INFORMATION
Working capital
Current assets $ 2,995 $ 2,665 $ 2,535 $ 2,109 $ 1,914
Current liabilities 2,261 2,198 2,048 1,641 1,574
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$ 734 $ 467 $ 487 $ 468 $ 340
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Total assets $ 7,777 $ 7,089 $ 6,853 $ 5,662 $ 5,442
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Capital employed
Debt due within one year $ 93 $ 203 $ 272 $ 133 $ 159
Long-term debt (less current portion) 1,639 1,784 1,828 1,391 1,399
Minority interest in consolidated subsidiaries 273 174 179 - -
Convertible preferred stock - 293 293 293 293
Common stockholders' equity 2,024 1,521 1,362 1,302 1,162
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$ 4,029 $ 3,975 $ 3,934 $ 3,119 $ 3,013
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CASH FLOW INFORMATION
Cash flows from continuing operations $ 852 $ 651 $ 442 $ 345 $ 200
Additions to property, plant and equipment 431 430 399 335 390
Dividends 97 93 92 79 66
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Common stock information
Primary earnings per share
Income (loss) from continuing operations $ 2.57 $ 1.81 $ (.08) $ 2.37 $ 1.66
Net income 3.80 2.97 .08 2.94 2.26
Dividends per share 1.10 1.10 1.10 1.00 1.00
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ASHLAND INC. AND SUBSIDIARIES
FIVE-YEAR INFORMATION BY INDUSTRY SEGMENT
YEARS ENDED SEPTEMBER 30
(In millions) 1997 1996 1995 1994 1993
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SALES AND OPERATING REVENUES
Refining and Marketing(1) $ 6,719 $ 6,485 $ 5,891 $ 5,428 $5,594
Valvoline 1,099 1,199 1,113 1,001 938
Chemical 4,047 3,695 3,551 2,885 2,586
APAC 1,257 1,235 1,123 1,101 1,116
Coal(2) 1,367 580 610 - -
Intersegment sales(3)
Refining and Marketing(1) (263) (276) (280) (249) (251)
Other (26) (26) (36) (26) (25)
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$ 14,200 $ 12,892 $ 11,972 $ 10,140 $9,958
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OPERATING INCOME
Refining and Marketing(1) $ 189(4) $ 89 $ (1) $ 172 $ 121(5)
Valvoline 67(6) 82 (4) 52 56
Chemical 144(6) 169 159 125 108
APAC 82 83 75 70 53
Coal(2) 68(7) 36 66 - -
General corporate expenses (60) (97) (91) (80)(8) (77)
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$ 490(9) $ 362 $ 204(10) $ 339 $ 261
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IDENTIFIABLE ASSETS
Refining and Marketing(1) $ 2,669 $ 2,780 $ 2,659 $ 2,657 $2,604
Valvoline 549 557 603 532 430
Chemical 1,558 1,458 1,372 1,122 958
APAC 531 489 433 404 440
Coal(2) 1,719 899 928 - -
Discontinued operations 18 326 285 221 265
Corporate(11) 733 580 573 726 745
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$ 7,777 $ 7,089 $ 6,853 $ 5,662 $5,442
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(In millions) 1997 1996 1995 1994 1993
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ADDITIONS TO PROPERTY, PLANT AND EQUIPMENT
Refining and Marketing(1) $150 $187 $183 $194 $255
Valvoline 29 19 25 25 21
Chemical 101 80 76 61 51
APAC 62 62 47 45 43
Coal(2) 74 58 58 - -
Corporate 15 24 10 10 20
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$431 $430 $399 $335 $390
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DEPRECIATION, DEPLETION AND AMORTIZATION
Refining and Marketing(1) $160 $153 $234 $161 $155
Valvoline 32(6) 23 24 19 18
Chemical 94(6) 67 58 43 42
APAC 49 44 42 40 44
Coal(2) 223(12) 72 72 - -
Corporate 14 12 17 12 12
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$572 $371 $447(13) $275 $271
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(1) Segments formerly identified as Petroleum and SuperAmerica were
combined effective October 1, 1996. Prior year amounts have been
restated.
(2) Ashland Coal and Arch Mineral merged effective July 1, 1997, into
Arch Coal, Inc. Prior interim periods of fiscal 1997 were restated to
consolidate Ashland's interest in Arch Mineral for the entire year.
Prior years were not restated, reflecting Ashland's interest in
Ashland Coal on a consolidated basis (since 1995) and Ashland's
interest in Arch Mineral on the equity method of accounting. Prior to
1995 Ashland Coal was accounted for on the equity method. See Note C
to the financial statements.
(3) Intersegment sales are accounted for at prices which approximate
market value.
(4) Includes a gain of $11 million resulting from LIFO inventory
liquidations.
(5) Includes a gain of $15 million on the sale of TPT, an inland
waterways barge operation.
(6) Includes charges of $10 million for Valvoline and $16 million for
Chemical to write down goodwill related to certain European
operations.
(7) Includes charges of $39 million for duplicate facility write-offs,
severance and other costs resulting from the merger of Ashland Coal
and Arch Mineral into Arch Coal, Inc.
(8) Includes a net gain of $11 million related to litigation matters.
(9) Effective October 1, 1996, the methodology for allocating corporate
general and administrative expenses was changed. For purposes of
comparison to prior year results, segment operating income for the
year ended September 30, 1997, excluding the increased allocations,
amounted to: Refining and Marketing - $208 million; Valvoline - $72
million; Chemical - $155 million; APAC - $86 million; Coal - $68
million; and general corporate expenses - $(101) million.
(10) Includes charges for unusual items totaling $116 million, consisting
of asset impairment write-downs of $79 million under FAS 121 and
provisions of $37 million for early retirement and restructuring
programs. The combined effect of these items reduced operating income
for each of the segments as follows: Refining and Marketing - $102
million; Valvoline - $5 million; Chemical - $5 million; and general
corporate expenses - $4 million.
(11) Includes principally cash, cash equivalents, investments in and
advances to unconsolidated affiliates and investments of captive
insurance companies.
(12) Includes charges of $25 million for duplicate facility write-offs
resulting from the merger of Ashland Coal and Arch Mineral into Arch
Coal, Inc.
(13) Includes charges of $79 million for asset impairment write-downs
which increased depreciation, depletion and amortization for each of
the segments as follows: Refining and Marketing - $68 million;
Valvoline - $3 million; Chemical - $4 million; and Corporate - $4
million.