Jan 27, 2009
Executives
James O'Brien – Chairman, CEO Lamar Chambers – Senior Vice President, CFO
Analysts
[James Sheehan – Deutsche Bank] Laurence Alexander – Jefferies & Co Mike Harrison – First Analysis Robert Felice – Gabelli & Company Dmitry Silversteyn – Longbow Research [Douglas Shoody – Keybanc Capital Markets]. Steve Velgot– SIG
Operator
Good day everyone, and welcome to today's Ashland Incorporated first quarter earnings conference call. (Operator Instructions) At this time for opening remarks, I would like to turn the call over to Eric Boni.
Eric Boni
Good morning and welcome to Ashland's first quarter fiscal 2009 conference call and web cast. We released our fiscal first quarter results for the period ended December 31, 2008 as 6:00 eastern time today.
These results are preliminary until we file our 10-Q in February. With me here today are Jim O'Brien, Ashland's Chairman and Chief Executive Officer and Lamar Chambers, Senior Vice President and CFO.
Before we get started let me remind you and review our cautionary language regarding forward-looking statements on Slide 2. Statements may be made during the course of this presentation that constitute forward-looking statements as that term is defined in relevant securities laws.
We believe our expectations are based on reasonable assumptions but cannot assure that those assumptions will be achieved. Therefore, any forward-looking statements may prove to be inaccurate.
Please turn to the agenda on Slide 3. Now I will give you an outline for the call.
First, I'll review the quarter's highlights followed by key items as well as pro forma and conforming adjustments to get you to our reported results, and get you from our reported results to our adjusted pro forma results for the first fiscal quarter. We believe these adjusted pro forma results enhance understanding of our current and future performance particularly so for this past quarter which reflected only partial quarter results for the Hercules business and certain large effects related to accounting for the acquisition.
Then, I'll discuss our debt covenant status. Lamar will discuss our performance and outlook by commercial unit, and then present potential cash flow scenarios that may help you with your financial models.
Jim will cover our $265 million of cost savings initiatives, including Hercules integration and other identified opportunities. After that, we will take your questions.
Please turn to Slide 4. Clearly the acquisition of Hercules completed November 13, 2008 was a significant event in Ashland's history, transforming Ashland into a specialty chemicals company.
Of course, as we all know, this transaction closed at a time when the global economy was in a steep decline which affected corporate performance in most industries. Against this backdrop, our newly combined company saw volumes across all of our business segments decrease anywhere from the mid single digits to the low 20's on an adjusted pro forma percentage basis.
That said, Ashland's overall revenue was down 9% as average selling prices were higher versus a year ago, helping to partially offset larger volume declines. During the first quarter, we generated $147 million of adjusted pro forma EBITDA, down 14% versus the December quarter last year, with Ashland Distribution being a bright spot, up 50%.
Reductions in selling, general and administrative expenses, along with a focus on active price management helped lessen the impact of lower volumes. Ashland's performance on the debt financial covenants is slightly improved since we closed the Hercules transaction.
In that time, we paid down $100 million of debt. At December 31, our consolidated debt to EBITDA ratio for covenant purposes was 3.1 times and about 17% favorable to the maximum threshold.
Meanwhile, our fixed charge coverage was 2.3 times which is significantly better than our minimum threshold. Now, I'd ask that you bear with me for a few minutes as I walk you through a number of key items on Slide 5, primarily related to the acquisition of Hercules that obscure Ashland's underlying financial performance.
Starting with the items that affect operating income, the largest impact comes from purchase accounting adjustments. Purchase accounting requires that inventory acquired at closing is stepped up to its market value, rather than the cost of manufactured goods typically used to value inventory.
Thus, the sales of all goods on hand as of the closing would create a reduction in earnings sold. The total pre tax impact from inventory adjustments in the quarter was $21 million or $0.23 per share after tax.
There was a total of $17 million of additional inventory adjustments. We expect these adjustments to flow through the income statement in the second quarter.
As with the other purchase accounting items, these are non-cash charges. The in process R&D expense relates to the current purchase accounting requirement to write up any ongoing research and development activities to a computed fair market value and then immediately expense them.
This one time non-cash charge was about $10 million pre tax or $0.14 per share after tax. Ashland incurred $26 million of restructuring costs in the quarter, primarily as a result of the integration activities related to the Hercules acquisition.
This has a $0.29 EPS impact. Moving on to our other expenses, as we previously stated, Ashland entered into cross currency swaps several weeks before closing that in essence, neutralized future value changes in existing Hercules swaps.
Based on the exchange rate at the closing of the transaction, the new Ashland swaps generated a book loss of approximately $54 million while the Hercules swaps gained about the same amount from an economic value standpoint. Since our businesses were not consolidated prior to closing, Ashland is just reporting the $54 million one time expense for accounting purposes.
The EPS impact is $0.51. Also during the quarter, we recognized a $32 million expense related to the previous temporary impairment of our student loan option rate securities.
Given Ashland's new debt structure with the Hercules transaction, we no longer have the intent to hold these instruments to maturity. This item amounted to an EPS impact of $0.45.
During the December quarter, Ashland had discrete income taxes effects from items such as FIN 48, reserve increases and changes in earnings repatriation expectations totaling $25 million with an EPS impact of $0.36. Also, as we've discussed in prior calls, the revaluation of other intangible assets such as trademarks, customer lists, etc., and property plant and equipment is generating about $120 million of annualized D&A or $30 million per quarter.
Since we only owned the Hercules business just over one-half of the quarter, the charge in the first quarter was only $17 million. This charge as opposed to all of the others I just mentioned is an ongoing charge.
Please turn to Slide 6. Slide 6 helps you bridge from the reported numbers in this morning's release to the adjusted pro forma numbers we will be discussing for the remainder of this call.
Starting with the Ashland GAP results, we add the Hercules business results in the second column, not consolidated into Ashland's earnings. This consists of the full three months of Heritage Hercules results from the last fiscal year and the Hercules results from the beginning of October 2008 through the closing of the transaction on November 13.
Our pro forma results also adjust for purchase accounting and other key items noted on the previous chart to arrive at the adjusted pro forma results. We've not attempted to conform all expenses and we acknowledge that there may be some difference in the analysis, but directionally, we believe the total adjusted pro forma results provide a reasonable comparison between the December 2007 and December 2008 results.
In Appendix Eight of this presentation, we provide similar pro forma reconciliations for each of our business segments starting with Slide 39. We strongly encourage you to review these slides which are integral to this presentation to enhance your understanding of the adjustments made.
Please turn to Slide 7 to look at our progress in generating cash. As we previously stated, we are actively engaged in seeking further opportunities to generate cash to enhance liquidity and provide financial flexibility.
During the December quarter, we reduced selling, general and administrative expenses by roughly $30 million on an adjusted pro forma basis excluding currency translation. We also began our process of reducing capital expenditures in the quarter.
This resulted in $57 million of adjusted pro forma capital expenditures in the December 2008 quarter versus $83 million in the December 2007 quarter, a $26 million reduction. We reduced the quarterly dividend by 73% to $0.75 per share.
Another opportunity to generate cash is through the divestiture of non core assets, particularly small and medium sized lines of business. Towards this end, during the December quarter, we completed the divestiture of Fiber Visions which generated proceeds of $7 million.
While this had no book impact, it generated a capital loss for tax purposes in excess of $200 million which we would be able to use to offset future capital gains. We continue to actively pursue small to medium sized divestitures from within several of our segments.
We will remain disciplined in achieving an appropriate value for any assets that may be sold. Also during the quarter we sold approximately $20 million of auction rate securities.
Please turn to Slide 8 to review our adjusted pro forma EBITDA for the first quarter. As I noted earlier, our pro forma sales and operating revenue declined 9% for the quarter to $2.2 billion.
Operating income declined 23% to $74 million, partially due to the increase in depreciation and amortization as a result of the purchase accounting I mentioned at the beginning of the presentation. Improvements in distribution's EBITDA were unable to offset reductions in our other segments.
In total, EBITDA declined 14% and EBITDA margins declined by 40 basis points. Slide 9 shows the factors affecting our EBITDA comparisons for the first quarter of fiscal 2008 to 2009.
You will note that throughout our presentation, we are transitions our earnings bridges from operating income to EBITDA in order to provide a clearer comparison due to the significant D&A increased resulting from purchase accounting. We also realize that many of you prefer to focus on EBITDA for a pure measure of underlying performance.
Clearly the economic environment negatively impacted volumes and the effects of this are apparent on the bridge chart. Our focus on price management and actions to cut costs resulted in the improvement in margin and reduction in SG&A expenses you see here.
In fact, these positive factors offset nearly 75% of the volume impact. The SG&A expenses declined in spite of a $10 million increase in pension expense in the quarter versus the prior year.
Currency had a slightly negative impact on current earnings. Please turn to Slide 10 for a look at our cash flow statement.
Ashland utilized $18 million of operating cash flows during the quarter. While revenues declined, inventories were relatively flat on a dollar basis as we were unable to trim production quickly enough to match falling demand.
This represents a potential source of cash in the coming months. The cash flows for financing and investing sections include both the purchase of Hercules and the cash inflows from the issue of stock.
Dividends paid reflect both the new share count and the new $0.7.5 cent per share quarterly rate. Please turn to Slide 11 for the December 31, 2008 balance sheet.
Ashland ended the quarter with $222 million of cash, $225 million in book value of auction rate securities and less than $2.5 billion of current and long term debt. You will note the good will and other intangibles total $3.4 billion.
We recognize that the number of companies who have taken charges for good will impairment in the quarter, we updated our analysis as of December 31, and concluded that we have no good will impairment. Please turn to Slide 12 for further detail on our debt.
This slide details salient statistics about our debt. As of December 31, Ashland repaid the $100 million that was drawn on November 13 from our revolver.
As you can see from the bar chart, other than the accounts receivable securitization which has a 364 day tenure, we have no significant required debt payment until 2014. Ashland's total outstanding debt at December 31 was just under $2.5 billion and net debt was $2.2 billion excluding the student loan auction rate securities with a book value of $225 million.
Now, please turn to Slide 13 for our debt financial covenant calculations. This slide details the calculations for both the debt to EBITDA and fixed charge covered ratios.
The figures presented include a number of adjustments as specified in our credit agreements and thus won't necessarily tie to other publicly available information. The calculations presented are the same that we provide to our banks for our covenant compliance purposes.
As you can see, we are well within our covenant requirements. The credit agreement also specifies a minimum net worth covenant which starts with the December 31 balance sheet.
We will provide you updates on this covenant calculation starting next quarter. Our capital expenditures should decline in the coming quarters as we expect capital expenditures for all of 2009 to be $200 million which is about $100 million below the training fourth quarter.
Conversely, debt amortization and interest expense are expected to increase for the covenant calculation purposes. Lamar will provide some guidance on a number of cash flow items later in the presentation after he covers our businesses results.
Lamar Chambers
Please turn to Slide 14. Ashland Aqualon Functional Ingredients represents former Hercules Aqualon group including its woods rosins business along with a small business transferred from water technologies following the acquisition.
As Eric noted, we are presenting these results on an adjusted pro forma basis. Overall, Functional Ingredients volume dropped by 14% versus the year ago quarter primarily reflecting the world wide decline in the codings and construction markets.
Conversely, sales to the regulated markets grew slightly in the quarter and CMC in China, and the EC product lines exceeded prior year levels although they did negatively impact mix. Overall, revenue declined 7%.
EBITDA declined by 16% to $49 million for the December quarter and as a percent of sales declined 210 basis points to 21.2%. Let's take a look at factors impacting pro forma EBITDA for this segment on Slide 15.
Volume productions drove the decline and adjusted pro forma EBITDA versus the year ago December quarter. Until several months ago, Functional Ingredients was on allocation for three of our primary product lines.
In many cases, we had to turn away orders or could only accept partial orders. As world wide consumption has significantly decreased, we've been able to take these products off allocation but have not yet been successful in replacing the diminished business from our customers.
As a result, the fixed cost impact of lower volumes also reduced margins. Raw material costs were lower sequentially, however the cost of cellulose, which is the most significant raw material used by Functional Ingredients has not dropped as quickly as some other commodities.
Cumulative price increases implemented during the year enabled us to recover 95% of our cumulative increases in raw materials, freight and utility costs during the December quarter. Moving on, let's look at the outlook for Functional Ingredients on Slide 16.
Volumes are clearly under pressure for the first time in recent memory in this business, particularly in the construction market. While we weren't able to anticipate the magnitude of these reductions, we are now taking actions to better position the business should demand continue to be weak.
We have reduced capacity on several lines including one of the dual Belgium MC lines and the CMC lines based on the current demand scenario. We have pursued selective opportunities to increase capacity where appropriate.
We are commissioning a new low molecular wave MC line at Duval and a new Aquaflow line at Kennedy, Texas this quarter. The MC line provides additional capacity primarily into the regulated markets which continue to perform fairly well.
We continue to closely monitor our production requirements to optimize profitability. While our current outlook for the quarter has volumes above Q1 levels, they appear to be much less than recent trends for this business.
Our pricing actions taken to date should provide opportunity for improvement in our gross profit percentage. While we continue to emphasize new product launches, new products represent a 26% of total sales in the quarter, ahead of our targets.
We have a number of opportunities to reduce costs throughout our supply chain and also curtail travel and entertainment expenses. Many other cost control activities are underway.
Let's move on to Aqualon Hercules Water Technologies results on Slide 17. As a reminder, Ashland Hercules Water Technologies represents a combination of the former Ashland Water Technologies and the former Hercules paper technologies and vitreous group minus the small [deformer] business transferred to Functional Ingredients which I mentioned earlier.
This transfer is also recognized in these pro forma numbers. Volume declined 5% on a combined basis as did sales and operating revenue as a 5% unfavorable currency translation was partially offset by price and mix.
The municipal business had relatively flat volumes while the industrial business was down closer to 8%. The paper and marine businesses were roughly in line with that average.
China was particularly weak in many of their units with their modern technologies. EBITDA on a pro forma basis declined $16 million to $34 million in the quarter, representing 7.2% of sales.
Let's move on to the EBITDA grid on Slide 18. While volumes did have a negative impact on EBITDA, the largest source of the EBITDA decline was reduced margin.
Significant production outages at paper mills, especially those making packaging paper began during the late summer and escalated dramatically during the December quarter. Raw materials in the industrial and the municipal businesses were about 10% higher than the same quarter last year while pricing was relatively flat.
Similarly paper gross profit percentages continued to be depressed into October although we did experience increasing gross profit percentages later in the quarter despite decelerating volumes. Year over year however, gross profit percentages remain significantly depressed as you can see on the bridge.
The redesign activities within Ashland's Legacy Water business was off approximately 100 fewer positions. The effects of these changes began to show in the numbers during the quarter.
Additionally, reductions in travel and entertainment and other third party expenses contributed to the favorable SG&A results. Overall, SG&A expenses, excluding currency translation impacts decreased by more than $10 million versus the prior year quarter and more than offset the income impact of volume declines.
Now let's go to Slide 19 for the outlook of this business. We expect that pricing and product mix can provide some positive momentum versus the impact of lower volumes and potential currency headwinds.
We are actively exploring "make" versus "buy" decisions on a number of products. These decisions will likely result in several Ashland plant closures.
We're excited to announce a renewal of our relationship with GE, both on the joint manufacturing agreement and the distribution relationship with Water Technologies. A primary focus of the business during this part of the economic cycle is on cost reduction.
We're focused on the rapid capture of savings from the integration of the Hercules Paper and Ashland Water businesses. While we do not expect significant changes in direct customer pricing roles, the combination of the businesses provides opportunities for cost reductions in a number of other areas.
With that, let's move to Ashland Performance Materials results on Slide 20. Pounds per shipping day declined 7% versus the prior year quarter.
However, please remember that Ashland acquired the emulsion polymer assets of adhesives business from Air Products this past summer. Excluding the impact of that acquisition, volume declined 22%.
We believe the U.S. composites market has declined by greater than 25% during this quarter, suggesting that we have significantly increased or slightly increased market share.
Similarly, sales and operating revenues declined 13% and 21% on a comparable basis. Gross profit as a percent of sales declined 230 basis points versus the year ago quarter.
However, as compared to the September 2008 quarter, it increased by 130 basis points as a benefit from lower raw material costs and capacity reduction began to have some impact. Selling and general administrative expenses improved by 12% as a direct result of the cost reduction actions taken during the summer and fall.
Overall EBITDA results reflect $7 million of savings generated from our business model redesign actions which benefited both from the gross profit and SG&A line items. EBITDA declined by $3 million.
Please turn to Slide 21 for more detail as shown on our EBITDA bridge. As you can see on this bridge, the year versus decline in volume more than offset improvements in margin and SG&A expenses.
Volume was severely depressed in all regions as a large number of customers took extended shut downs during the quarter. These volume reductions particularly reflect the weak automotive, construction and recreational marine markets.
Ashland is reducing capacity by approximately 30% to adjust to these market realities. That said, the premium products within composites and adhesives continue to outperform our other product lines, and we have been able to maintain our margin in these specialty applications.
Overall material costs dropped dramatically late in the December quarter. They did not significantly improve our Q1 results.
SG&A improved by roughly $7 million excluding currency translation in the December 2008 quarter largely reflecting head count reductions. Let's turn to the outlook on Slide 22.
We continue to take actions to reduce the cost structure of Performance Materials. During Q2, we are removing an additional $11 million of costs from the business on a run rate basis which will bring our total achieved to $45 million which is greater than our original target.
We now anticipate achieving $60 million in total expected savings from this business. Also, the $11 million will come from capacity reductions in the U.S.
and Europe, cutting total capacity to approximately 70% of previous levels. We are also now getting the benefit from the raw material cost reductions that began in the first quarter.
This should help us maintain margins in this weak economic environment. With that, let's move to Ashland Consumer Markets results on Slide 23.
Lubricant volume for Ashland Consumer Markets or Valvoline declined 17% versus the prior year quarter primarily driven by declines in the "do it for me" markets installer channel which includes car dealerships and independent installers. Meanwhile, sales and operating revenue was up 2% over the prior year due to increased average selling prices.
Gross margins were down 290 basis points in the quarter although they did start to recover in the month of December as base oil costs decreases began to positively impact results. On a per unit basis, gross profit improved versus the prior year quarter, as we stated in our outlook during our September earnings call.
We reduced selling, general and administrative expenses by 9% versus the December 2007 quarter, a result of reduced overhead and lower advertising expenses. EBITDA was flat at $28 million.
Slide 24 shows Consumer Markets EBITDA bridge. Volume declines were offset by improvements in gross margin and decreases in SG&A during the quarter.
Let's turn to Slide 25 for Consumer Markets price and cost trends. Many of you may remember seeing this chart in previous quarters.
It shows the change in Consumer Markets total U.S. branded lubricant cost of sale and the selling prices through December 2008.
U.S. branded lubricant sales volumes account for more than 50% of our total global lubricant sales.
Raw materials costs appear to have peaked during the December quarter. The base oil market has softened significantly during the last 30 to 60 days and thus, we're currently forecasting a decline in raw material costs and as these decreases start to have their full effect while our price decrease announced earlier January will lessen the benefit, we believe that the net impact to margins will bring positive sequential improvement.
Now let's go to Slide 26 for more detail on Consumer Markets outlook. Market demand is likely to strengthen as the fiscal year continues but still remain somewhat below the prior year.
In particular, international demand which has been especially strong during most of fiscal 2008, has now softened, predominantly ion Europe. That said, we expect the overall Consumer Markets business to be solid throughout the balance of 2009 for a number of reasons.
Our Valvoline and oil change business continues to show improvement at the store level, driving same store sales up 9% and increasing the number of franchise units by 7%. We also have significant merchandizing commitments from major retailers who should bolster our "do it yourself" business in the key spring and summer driving season.
And, we're pleased to announce that we have acquired substantial new national account business, including 685 Goodyear outlets that will help offset the softness in the independent installer business. The Goodyear business will come online in February.
In the economic headwinds notwithstanding, we feel that Consumer Markets is well positioned to increase income versus fiscal 2008. Let's go to Slide 27 for a review of Ashland Distributions results.
Volume per shipping day decreased 17% versus the prior year quarter in the distribution business. Volume in our chemicals line of business declined 12% while our plastics and composite side dropped approximately 25%.
Sales declined 14% to $153 million, mostly from our plastics business with significant increase of gross profit as a percent of sales offset the volume declines and gross profit dollars were flat. Selling and general administrative expenses were favorable to the prior year quarter by about 7% due to currency translation and reduced overhead expenses.
Overall EBITDA increased 50% over the prior year quarter. Now please turn to Slide 28 for a look at Distribution's EBITDA bridge.
As you can see the increase in margin more than offset the 17% decline in volume which reflected declines of roughly 25% in both our European and U.S. plastics business.
Like our other businesses, Distribution saw a weakening demand as customers worked off inventories and delayed re-ordering in the hopes of lower prices and with growing uncertainty in the end market demand. Selling and general administrative expenses were favorable to the prior year quarter by $4 million excluding currency translation primarily as a result of reduced overhead costs.
Our new pricing process was implemented in early 2008 to help protect the margin in this very volatile market. We've shown you the chart on Slide 29 for a number of quarters now.
As this graph shows, both average selling price and product cost dropped about $0.10 per pound or roughly 10% between the September and December quarters. However, gross profit cents per pound did increase over the prior year quarter by more than $0.01 per pound.
Now please turn to Slide 30 for Distribution's outlook. Looking ahead, we continue to see reduced demand in the near term.
Certainly we're seeing customers take a wait and see stance before committing to production and those that are starting up production are doing so at much reduced levels and working through inventories on hand when possible. Our suppliers are also cutting production and overhead to match reduced demand and there is uncertainty about when supply and demand should start to balance.
Start weakness and our finished goods costs coupled with the pricing discipline we've established during the past four quarters may allow margin expansion. As the recession continues, we may very well see consolidation in the distribution marketplace.
Our leadership position and logistics capabilities enable us to provide added value to suppliers as both the sales channel market and potential supply chain partner. With suppliers reducing their sales forces coupled with our broad offering to customers, we believe we are well positioned to capitalize on more opportunities to both customers and suppliers.
Positive trends notwithstanding, our overall performance remains dependent in large part upon the performance of the U.S. manufacturing sector.
Now let's change gears and turn to Slide 31 to discuss some potential cash flow scenarios for Ashland as a whole. As a company policy we do not provide earnings guidance.
It is difficult enough for those who regularly provide guidance to successfully forecast in the current volatile economic environment. However, we thought it might at least be somewhat instructive to show a set of potential scenarios centered around current analyst EBITDA estimates for Ashland of roughly $700 million.
Of course, we are not endorsing or rejecting these analysts' estimates, but merely using them as a starting point. The scenario is intended to be representative of how calculations might be determined on a full year fiscal 2009 basis.
Cash interest expenses for 2009 are forecasted to be about $210 million and are likely to increase when our bridge financing is converted to more permanent financing. Cash taxes are computed at 30% presuming a $350 million depreciation and amortization.
Inherently, lower EBITDA scenarios would presume lower sales volumes and thus lower working capital requirements. When combined with the expectations for lower average selling prices in 2009 it might be reasonable to expect any changes in EBITDA to have an offsetting opposite impact on working capital in the current economic environment.
The combined pension expense of the new Ashland is expected to be about $85 million which is an increase of roughly $50 million of what the combined companies experienced in the 12 months ended December 30, 2008. As we stated in our 10-K we do not expect significant funding to our pension plans, and thus the add back to get from book to cash is expected to be around $50 million.
Environmental and asbestos obligations are both inherent to Ashland and Hercules businesses are fully reserved to our best estimates under applicable accounting standards. As such, while we would project no EBITDA impact, there will be ongoing cash outflows.
We've conservatively shown that $80 million here for illustration purposes. As we've mentioned previously, we have dramatically capital expenditure forecasts versus the prior year spend and are forecasting $200 million for this year.
This is a reduction of $120 million from what the two businesses spent on a pro forma basis in fiscal 2008. Dividends at the $0.075 level represent about a $22 million use of cash.
We are also expecting about $60 million of cash integration costs that will not run through the income statement. There are additional integration costs that do run through the income statement as required by GAP.
We have also assumed roughly $20 million use of cash for miscellaneous cash items in this scenario. You will note that a reasonable estimate to this scenario, that we might generate about $260 million to $270 million in cash to retire debt.
The next two items show the implied year end debt to EBITDA ratio of 3.2 times and a fixed charge coverage ratio of 1.8 times presuming no debt reduction from divestitures or from additional sales of the student loan auction rate securities. Even at just $600 million EBITDA, the debt to EBITDA ratio would be approximately 3.7 times, still below the covenant threshold.
Additionally, each $100 million further reduction in debt provides about a 1.5 times benefit to the debt to EBITDA ratio. Ashland currently has $225 million in book value of student loan auction rate securities with a par value of $255 million.
Please turn to Slide 32 for a discussion about EBITDA. Our first quarter results generated $155 million of consolidated EBITDA for covenant calculation purposes in a quarter where volume was down significantly.
Simply multiplying the $155 million by four to run up to a full EBITDA figure, is $620 million. However, when looking at the first quarter results, you may wish to bear in mind that the effects of both seasonality and our cost cutting initiatives as you think about modeling our business.
Our second quarter historically has been about 10% stronger than the first quarter and our third quarter almost 25% stronger than the first quarter if you look at the combined Ashland and Hercules over the last five years. We also expect more than $265 million of run rate savings to be achieved by the end of the fourth fiscal quarter as you'll hear from Jim O'Brien shortly.
With that, I'll now turn the presentation over to Jim to talk about our number one priority, cash generation.
James O'Brien
Slide 33 talks to our current primary focus as an organization, and that is, cash generation. We are focused on cash generation and savings from six sources; increased profitability from sales, reductions in operating expenses, working capital, capital expenditures and dividends and sales of non strategic assets primarily business divestitures of auction rate securities.
Maintaining our share of business for our customers and driving gross margin improvement from the depressed levels we have experienced as of late are paramount to our performance. You've already heard about our business segments' progress in these areas from Lamar.
Cost reductions represent a significant component of our plan to generate cash and I will spend some time on our progress shortly. Cash generation through working capital has been a focus for the company for well over a year.
Last year we generated $134 million of cash from operating assets and liabilities almost all of which was from reductions in working capital. In addition to our continued active approach to managing working capital, the market forces driving reductions in volume and price should provide a natural counterbalance for cash generation in the depressed current operating environment.
Capital expenditure reductions are a priority for us as well in the current economic situation. We are now planning only $200 million of capital expenditures for fiscal 2009 which represents a reduction of roughly $120 million on a pro forma basis.
This will be achieved by delaying projects that will not generate positive cash flow in the very near term. We spent $57 million on capital expenditures in the first quarter putting us right on track for our forecast of $200 million.
We already announced and implemented a reduction in our quarterly dividend to $0.075 per share which will reduce cash outflows by approximately $60 million annually as compared with our prior dividend rate. As Eric already mentioned, we completed the divestiture of the fiber business unit.
This transaction generated significant capital loss for tax purposes which we would expect to apply to capital gains from any potential future divestitures to better maximize net cash proceeds. We are evaluating offers for the potential sale of several small to medium sized non core business units.
We do not necessarily expect to close on all of these transactions but if completed, the proceeds will be used to reduce debt and/or enhance our liquidity. Finally, we have the student loan auction rate securities available and should market conditions provide for reasonable proceeds from some or all of these instruments, we would plan to liquidate as appropriate.
Everyone in the Ashland organization has a responsibility to generate cash from one or several of these six primary levers. On Slide 34, I'd like to highlight one of these levers that has been the focus of the business for nearly a year; cost reductions.
Beginning with the $65 million original cost structure initiative we announced in April last year, primarily targeted at our Performance Materials and Water Technology businesses, we have now announced a total of $265 million of ongoing cost reductions to be achieved. These reductions are necessary both as a result of a combination of the Ashland and Hercules businesses and the need to adapt our business models to the current market realities.
These cost reductions are wide sweeping and while necessary to retain Ashland's competitiveness, these actions that affect our employees are never easy or taken lightly. To realize these cost savings, we're reducing our work force by 1,300 people, reducing a number of other employee's expenses which I'll get to in a minute, and significantly curtailing travel and entertainment costs.
The staff reductions represented approximately a 9% decrease in our global work force excluding Valvoline retail employees. Through the end of December, more than 500 jobs have been eliminated.
We have reduced our production capacity in most of our economically substantive businesses by about 30% through facility closures and shift reductions. We have nearly completed the cost reductions targeted by our original $65 million program and have an additional $15 million now targeted from our Performance Materials businesses.
We have consolidated the management structure of our composites and adhesive businesses within Performance Materials and reduced about 100 positions in our Heritage Water Technology business. As of the end of December quarter, we at a $100 million run rate.
The Hercules integration continues to proceed well. We closed the transaction with no significant issues.
We have developed the organizational structure and filled most roles at the manager level. We are implementing our detailed action plans to achieve many of our key synergy opportunities.
We are actively working to advance the time line for achieving these synergies as quickly as possible. We now expect to generate a total of $130 million from integration activities by the end of 2010, a $10 million increase over our previously stated objective.
We expect to have $90 million achieved on a run rate basis by the end of this fiscal year with $33 million already achieved in the first six weeks we've owned the business. During those six weeks, we eliminated approximately 150 roles, primarily in the corporate resource groups.
To achieve these synergies we expect a total of $130 million of cash costs. We are announcing today a number of additional significant actions to reduce the cost structure of the company in addition to the savings we have previously disclosed.
Please turn to Slide 35. These difficult economic conditions warrant swift and significant action.
We are implementing a wage and salary freeze for 2009 for all Ashland employees except for those in a limited number of areas where legally mandated otherwise. Simultaneously, we are announcing a two week unpaid furlough program which will be conducted from February through June for most U.S.
and Canadian based non hourly employees. Meanwhile, the senior executive team including myself, will be taking pay reductions and reduced executive benefits.
In addition, certain other executives and I are forfeiting our long term incentive payment due in February 2009. We have also shut down Ashland's corporate aviation department and all employees and directors will be flying commercial.
Additionally, we have implemented across the board programs to reduce travel and entertainment expenses by a minimum of 30%. The combination of these reductions will save approximately $80 million.
Please turn to Slide 36 for some closing thoughts. As you've just heard, we are taking strong actions to adjust our operations to the realities of the current world wide economic conditions.
To make our debt payments and to meet the requirements of our debt covenants, all spending is being scrutinized and we are pursuing opportunities to take advantage of all sources of cash. We have made progress in our cost reduction initiatives and to date eliminated approximately $100 million of costs on an annualized run rate basis with more reductions on the way.
We are targeting $265 million of run rate costs reductions by the end of fiscal 2009. In addition, we will have an additional $25 million of one time savings.
Our businesses are focused on serving their customers, generating cash and managing expenses. With that, I'll open the line for questions.
Operator
(Operator Instructions) Your first call comes from [James Sheehan – Deutsche Bank]
[James Sheehan – Deutsche Bank]
On the functional ingredients, can you talk a little bit about the traction you're getting there and do you expect that to continue despite volume weakness?
James O'Brien
The activities that the group is trying to do is focus primarily on placing the volume and they still have strength areas where they continue to get price. But the focus is primarily on filling the plants out and getting the operations to run at the most efficient rate.
[James Sheehan – Deutsche Bank]
On Water Technologies, you spoke last quarter about municipal contracts being renewed. Can you comment a little bit about the progress you've made there?
Is that in line with what you had expected and how does that impact your pricing and margins in 2009?
James O'Brien
The time line of getting new contracts, there is a significant number that are coming due through the December quarter in January and February. Obviously with the current economic conditions, the negotiations are different than we would have otherwise expected, so the intention is to continue to get as much price to cover cost but the activities being negotiated with these customers is what is, what is the raw material base that we're basing our discussions off of, and that's still somewhat unclear.
So these negotiations are not as easy as one would expect in the previous environment, but we fully intend to get a sufficient recovery of margin to cover our service and the raw material costs. But those negotiations are ongoing.
[James Sheehan – Deutsche Bank]
With respect to sales of non strategic assets, could you elaborate a little bit about what types of businesses you're referring to and is that expected to be wrapped up in 2009 or is that more of a longer term ambition?
James O'Brien
As we look at this concept of this idea, it's around reducing our debt, so if we can find a time frame where we can get a significant value for the assets we have for sale, we would do a transaction, but we have no intention of just giving these businesses away to gain cash. So our anticipation is, this may continue on through '09 and will be dependent upon the environment that we continue to discuss these issues with potential buyers and I don't anticipate anything near term.
Operator
Your next question comes from Laurence Alexander – Jefferies & Co.
Laurence Alexander – Jefferies & Co.
This is Lucy sitting in for Lawrence. Just had a couple of quick questions.
Going back to the divestitures, can you give any more color on particulars in each area that you are focusing on for divestitures?
James O'Brien
I think at this time all we've said is that there would be areas that we would view as non core and this does not necessarily mean it would be one particular business or another whether it's viewed as core or non core in the description. It's really in the sub segment how we would view its importance to the corporation going forward.
So these are normally between $100 to $500 million in size and scale at this stage and they go across basically the whole range of businesses that we have. So as we look at the importance of monetizing it or running it for EBITDA, the real analysis is what is the EBITDA contribution versus what would be the cash generated from the sale for reduction of debt, and that's the analysis that would be completed before we would decide to make any decision on sale or keeping the asset.
Laurence Alexander – Jefferies & Co
Can you give any additional color on distribution margin expansion?
James O'Brien
The effect you're seeing right now is with the falling values that we have. Distribution is on a LIPO basis so much of the cost that we have incurred through the run up has already been taken through the P&L so now they're going to gain a benefit on the run down of price because on the LIPO basis, we'll get a benefit from that.
Laurence Alexander – Jefferies & Co
Going back to the Aqualon segment, pricing was less than raw material increases in calendar 2008? What would you expect for 2009?
James O'Brien
They are a very aggressive group and they're out negotiating new contracts, new business, continuing discussion with their customers, continue to negotiate the raw material costs for the cellulose that they purchase, and they had about a 95% recovery as we reported in our prepared remarks. The continually go out and look for price, look for business, and as I stated before, our primary intent is to fill the plants out.
So having the plant through put to us is just if not more important than an incremental margin at this point in time.
Operator
Your next question comes from Mike Harrison – First Analysis.
Mike Harrison – First Analysis
Looking at the Aqualon business, a couple of questions. I was wondering first of all if you could speak broadly about the strategy in China and maybe provide an update on the Changzhou joint venture and whether that's ramped up on the higher margin MC products following the fire that they had about a year ago, and also wondering how the construction of the Nanjing ATC facility is proceeding.
James O'Brien
What we've done in China is adjust the volumes there to the current demand curve in China which is down from where it was, so in Changzhou we've actually taken the opportunity to use this time for training and upgrading the facilities so we can run it at the higher grade materials. So a lot of production has been taken out of that plant.
We have taken shifts out of several other lines in China as well to adjust for the demand curve. And as far as our Nanjing plant, we continue to have construction but we have pushed that out at least one quarter for completion, so the need for assets in China are not as great as they once were going back six months.
So we're adjusting our plans and our through puts there appropriately to adjust for that demand curve.
Mike Harrison – First Analysis
So the timing for Nanjing then is that getting into the first calendar quarter of 2010?
James O'Brien
Yes. It would be pushed out to '010 and it's at least one quarter.
Mike Harrison – First Analysis
In the Water Technologies business, you mentioned you expect raw material costs to decline. Pricing is still something you're working through.
Do you have a metric for where you are in the pricing versus raw material gap that needs to be covered and maybe when you expect that gap to close and start to turn positive for you?
James O'Brien
We will have that metric I would expect by the end of this month because of all the changes that are being made to this business. As we've stated in the discussion, we've closed the agreement with GE which was important to how we were going to wind out some of our plants and how we were going to source materials.
So that is being decided now. As far as the pricing, we're getting our analysis of what our true costs are so we can go in and negotiate appropriately with our customers, and at the same time we are going through significant cost reduction because of integration in that business.
So they're really focused on that, which in the near term, that probably has a larger impact on the performance of the business as far as getting the right sizing of the business integration done quickly versus a slow incremental increase of margin. So all these things are going to be worked simultaneously and they've made significant progress in each area.
So I would hope that by the end of this month we would have some real clear ideas about where we stand in that business and what the opportunities and the challenges are. And by the end of this quarter, they will have run for one quarter as a combined business, so as we report out next quarter, we'll probably have a clear metrics for you of what's really occurring in that business.
Operator
Your next question comes from Robert Felice – Gabelli & Company.
Robert Felice – Gabelli & Company
I wanted to focus on the statements that you made about divestiture of assets. Jim, you've been very clear that priority number one is maximizing cash to reduce debt and you mentioned $100 million to $500 million as a ball park range for divestitures.
If the world continues to deteriorate at the pace we've seen during this quarter, is it fair to assume that you'd consider divestiture of some of your larger non specialty chemical businesses?
James O'Brien
If you take a look the contingency scenarios that perhaps we would be looking at, obviously one of the primary objectives is to meet our covenants and to protect the company. So we would do whatever is necessary to achieve those two outcomes.
Robert Felice – Gabelli & Company
One of the big questions that's swirling around right now is the extent to which the large volume declines we're seeing both for Ashland and its peers alike is due to end market demand versus a massive inventory de-stocking or recalibration of the supply chain, if I can call it that. Do you have any sense as to the magnitude of the de-stocking versus the decline in end market demand to give us a better sense as to a run rate level of underlying volumes?
James O'Brien
As you look at the business, the best transparency into that is our Distribution business, and it varies market to market. These markets are off anywhere from 10% to 25% and as we look at January, there's been some recovery, but nothing significant.
So what we're looking at for our forecasting and what we're planning on, and why you're seeing us take significant issues on cost cutting is, we're not counting on anything more than what we've already seen which is about a 20% reduction in demand. So we're making all our plans and all our forecasts and working all the requirements to meet our covenants and our cash requirements based upon that outlook.
So we are not forecasting or anticipating any improvement this year.
Robert Felice – Gabelli & Company
While you're not planning for that which seems to be the prudent thing to do, your sense, would you say it's fair to assume that a portion of that is due to de-stocking?
James O'Brien
I would say there was some de-stocking but everybody is still pretty much working off "make to order". No one's "making to inventory".
So the fact that everybody is making to order, the supply chain is still very, very tight and if there would ever be a significant uptick in demand, there would be a lot of catch up being made because there's really slim if any inventories out there in the supply chain.
Robert Felice – Gabelli & Company
You made mention of price cuts in your Valvoline business. Can you give us a sense as to the magnitude of those and then also given the magnitude of the decline of base oil costs you're seeing as we look to the second quarter and beyond, would you expect year over year improvement in EBITDA just to kind of balance the cost versus volume?
James O'Brien
What we see in this type of environment is obviously as the price of lub stock is announced to decrease, we follow that at some point in time with some decrease in the price of lubricant. In our prepared remarks, we anticipate that our margin should expand through this period, so this is a favorable environment for us for increasing EBITDA during the period.
Robert Felice – Gabelli & Company
On Valvoline, are you seeing any decline in lubricant additives costs right now?
James O'Brien
We require all our suppliers, as the price of the raw materials go down, within our negotiated contracts with them, there is a transparency of the flow through of those costs.
Robert Felice – Gabelli & Company
So you would expect to see those decline as the year progresses?
James O'Brien
I'd better.
Operator
Your next question comes from Dmitry Silversteyn – Longbow Research.
Dmitry Silversteyn – Longbow Research
This is Jonathan Grassy in for Dmitry. Could you provide us a regional outbreak on how you see the paper technologies business performing over the next year and are you expecting volumes to be down across all regions and then the pricing dynamics as well.
James O'Brien
What we've seen so far is that U.S. has probably been the strongest of the lot at this point.
Europe is down significantly and China is basically way down. So for the most part the paper industry in China has been shut for several weeks and we don't anticipate it any time soon coming back up with any rates that would be meaningful to us.
So as you look at the paper business, it's going to be under some stress going forward, but I think the good news with the Hercules business, historically it's been that the type of customer that it has, it's in the higher end of the tissue and towel and not really tied to the more cyclical, although they do have some business there with packaging and paperboard and loose print and those areas, so the areas that get impacted the greatest we have the least exposure as far as our chemicals where they're applied. So to some extent we have some mitigation into that, but overall the direction of paper consumption obviously with the downtrend in the economy is going to follow that, so it's no different than anything else.
But we do have some mitigating factors in that tissue and towel is a big part of our business, and it's impacted the least.
Dmitry Silversteyn – Longbow Research
And did you see any significant incremental deterioration in the European market?
James O'Brien
We saw some in the first quarter and we anticipate some deterioration in the second quarter, pretty much on line with the economic forecast.
Dmitry Silversteyn – Longbow Research
Can you provide some detail on how you broke out Hercules's ventures business amongst the five operating segments? There were multiple businesses with the ventures.
James O'Brien
We pretty much kept it all into the old TV group. It's still all contained there.
One thing that Lamar mentioned was we took part of a small additives business that we had, we put that into the Aqualon business.
Operator
Your next call comes from [Douglas Shoody – Keybanc Capital Markets].
[Douglas Shoody – Keybanc Capital Markets]
A couple of questions on Valvoline. You mentioned the Goodyear win.
Can you maybe quantify that in terms of what that means in new business? Is there any way to put some kind of figure on that?
James O'Brien
It's about two million gallons.
[Douglas Shoody – Keybanc Capital Markets]
As far as holding onto pricing when base oil falls, you've discussed, do you have confidence that you can hold on to it permanently or is it just temporary for the lag and you're going to have to give all that back considering that demand has been pretty weak?
James O'Brien
The demand in the lubricants has decreased some but the price of gasoline and people's driving habits, and plus their intention of keeping their cars longer, they're paying more attention to the maintenance schedules. And actually, we have seen improvement in our Valvoline and oil changes as far as car counts and the ticket, and also part of the reason why companies like Goodyear and other want to work with us, is that we have a very strong program that help the retailer service the car more appropriately and get a much broader preventative maintenance schedule set up with the customer.
So as a consequence, we see the business actually performing fairly well this year. And plus, with the volatility accrued, although you do pass through to a certain extent the price decreases as they come, you don't get ahead of it because there's obviously an unknown about when crude will bounce back up.
So the volatility of that market place really prevents you from having to chase it down as aggressive as you would think otherwise, because the retailer and other don't want to decrease their prices either and so we have that dynamic. So it's more about negotiating the margin than it is the price on the shelf.
[Douglas Shoody – Keybanc Capital Markets]
As far as monthly trends, has January for Valvoline improved over December or was December the weakest or did December improve as oil price?
James O'Brien
December was the weakest for all of our businesses and everything has improved somewhat from December.
Operator
Your next question comes from Steve Velgot– SIG.
Steve Velgot – SIG
The results that you talked about amounting to $7 million of net income from Hercules before you owned it, do you have the EBITDA contribution that that translated to?
Lamar Chambers
As a part of our earnings release, let me recap that business overall. The EBITDA that we added through that stub approximately a six week period prior to that acquisition for Hercules was right at $91 million.
James O'Brien
From an EBITDA perspective, it was $34 million.
Operator
There are no other questions at this time. I'd like to turn the things back to our speakers for any closing remarks.
James O'Brien
I'd like to thank everybody for joining us today and we appreciate your following action. Thank you.