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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from . . . . . . . . . . to . . . . . . . . . .
Commission file number 333-76473
EQUISTAR CHEMICALS, LP
(Exact name of registrant as specified in its charter)
Delaware 76-0550481
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1221 McKinney Street, 77010
Suite 700, Houston, Texas (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 652-7200
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No [ ]
PART I. FINANCIAL INFORMATION
EQUISTAR CHEMICALS, LP
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended For the six months ended
June 30, June 30,
----------------------------- ------------------------------
Millions of dollars 2002 2001 2002 2001
- --------------------- ------------- ------------- -------------- -------------
Sales and other operating revenues:
Unrelated parties $ 1,111 $ 1,239 $ 2,006 $ 2,552
Related parties 351 361 592 821
------- ------- -------- -------
1,462 1,600 2,598 3,373
Operating costs and expenses:
Cost of sales 1,390 1,522 2,552 3,245
Selling, general and administrative expenses 41 45 81 91
Research and development expense 9 10 18 20
Amortization of goodwill - - 9 - - 17
Unusual charges - - - - - - 22
------- ------- -------- -------
1,440 1,586 2,651 3,395
------- ------- -------- -------
Operating income (loss) 22 14 (53) (22)
Interest expense (51) (45) (103) (91)
Interest income 1 - - 1 - -
Other income, net - - 1 1 6
------- ------- -------- -------
Net loss before cumulative effect
of accounting change (28) (30) (154) (107)
Cumulative effect of accounting change - - - - (1,053) - -
------- ------- -------- -------
Net loss $ (28) $ (30) $ (1,207) $ (107)
======== ======== ======== =======
See Notes to Consolidated Financial Statements.
1
EQUISTAR CHEMICALS, LP
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
Millions of dollars 2002 2001
- ------------------- ---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 25 $ 202
Accounts receivable:
Trade, net 557 440
Related parties 133 100
Inventories 445 448
Prepaid expenses and other current assets 28 36
------- -------
Total current assets 1,188 1,226
Property, plant and equipment, net 3,615 3,705
Investment in PD Glycol 46 47
Goodwill, net - - 1,053
Other assets, net 301 277
------- -------
Total assets $ 5,150 $ 6,308
======= =======
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities:
Accounts payable:
Trade $ 404 $ 331
Related parties 24 29
Current maturities of long-term debt 4 104
Other accrued liabilities 170 197
------- -------
Total current liabilities 602 661
Long-term debt 2,331 2,233
Other liabilities 187 177
Commitments and contingencies
Partners' capital:
Partners' accounts 2,050 3,257
Accumulated other comprehensive loss (20) (20)
------- -------
Total partners' capital 2,030 3,237
------- -------
Total liabilities and partners' capital $ 5,150 $ 6,308
======= =======
See Notes to Consolidated Financial Statements.
2
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended
June 30,
------------------------------
Millions of dollars 2002 2001
- ------------------- ------------- -------------
Cash flows from operating activities:
Net loss $ (1,207) $ (107)
Adjustments to reconcile net loss to net
cash (used in) provided by operating activities:
Cumulative effect of accounting change 1,053 - -
Depreciation and amortization 150 159
Net gain on disposition of assets - - (3)
Changes in assets and liabilities that provided (used) cash:
Accounts receivable (150) 145
Inventories 3 (34)
Accounts payable 68 (73)
Other assets and liabilities (56) 8
-------- --------
Net cash (used in) provided by operating activities (139) 95
-------- --------
Cash flows from investing activities:
Expenditures for property, plant and equipment (29) (53)
Contributions to affiliates (6) - -
Purchase of business from AT Plastics, Inc. - - (7)
Proceeds from sales of assets - - 4
-------- --------
Net cash used in investing activities (35) (56)
-------- --------
Cash flows from financing activities:
Net borrowing under lines of credit 100 - -
Repayment of long-term debt (101) - -
Other (2) - -
-------- --------
Net cash used in financing activities (3) - -
-------- --------
(Decrease) increase in cash and cash equivalents (177) 39
Cash and cash equivalents at beginning of period 202 18
-------- --------
Cash and cash equivalents at end of period $ 25 $ 57
======== ========
See Notes to Consolidated Financial Statements.
3
EQUISTAR CHEMICALS, LP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Preparation
The accompanying consolidated financial statements are unaudited and have been
prepared from the books and records of Equistar Chemicals, LP ("Equistar" or
"the Partnership") in accordance with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X for interim financial information. Accordingly,
they do not include all of the information and notes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments, consisting only of normal, recurring
adjustments, considered necessary for a fair presentation have been included.
For further information, refer to the consolidated financial statements and
notes thereto for the year ended December 31, 2001 included in the Equistar 2001
Annual Report on Form 10-K.
2. Company Ownership
Equistar is a Delaware limited partnership, which commenced operations on
December 1, 1997. Equistar is owned 41% by Lyondell Chemical Company
("Lyondell"), 29.5% by Millennium Chemicals Inc. ("Millennium"), and 29.5% by
Occidental Petroleum Corporation ("Occidental").
During 2002, Lyondell entered into an agreement to purchase Occidental's
interest in Equistar. Upon completion of the related transactions, Lyondell's
ownership interest in Equistar would increase to 70.5%. Closing of the
transactions, which is expected to occur by September 1, 2002, is subject to
certain conditions, including approval by Lyondell's shareholders. There can be
no assurance that the proposed transactions will be completed.
3. Unusual Charges
Equistar shut down its Port Arthur, Texas polyethylene facility in February
2001. The asset values of the Port Arthur production units were previously
adjusted as part of a $96 million restructuring charge recognized in 1999.
During the first quarter 2001, Equistar recorded an additional $22 million
charge, which included environmental remediation liabilities of $7 million,
severance benefits of $5 million, pension benefits of $2 million, and other exit
costs of $3 million. The remaining $5 million of the charge related primarily to
the write down of certain assets. The severance and pension benefits covered
approximately 125 people employed at the Port Arthur facility. Payments of $5
million for severance, $3 million for exit costs and $3 million for
environmental remediation were made through June 30, 2002. The pension benefits
of $2 million will be paid from the assets of the pension plans. As of June 30,
2002, the remaining liability included $4 million for environmental remediation
costs (see Note 9).
4. Accounting Changes
Effective January 1, 2002, Equistar implemented Statement of Financial
Accounting Standards ("SFAS") No. 141, Business Combinations, SFAS No. 142,
Goodwill and Other Intangible Assets, and SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Implementation of SFAS No. 141 and
SFAS No. 144 did not have a material effect on the consolidated financial
statements of Equistar.
Upon implementation of SFAS No. 142, Equistar reviewed goodwill for impairment
and concluded that the entire balance of goodwill was impaired, resulting in a
$1.1 billion charge that was reported as the cumulative effect of an accounting
change as of January 1, 2002. The conclusion was based on a comparison to
Equistar's indicated fair value, using multiples of EBITDA (earnings before
interest, taxes, depreciation and amortization) for comparable companies as an
indicator of fair value.
4
As a result of implementing SFAS No. 142, earnings in 2002 and subsequent years
will be favorably affected by $33 million annually because of the elimination of
goodwill amortization. The following table presents Equistar's loss before
cumulative effect of accounting change and net loss for all periods presented as
adjusted to eliminate goodwill amortization expense.
For the three months For the six months
ended June 30, ended June 30,
-------------------- ------------------
Millions of dollars 2002 2001 2002 2001
- ------------------- ------- ------- ------ ------
Reported loss before cumulative effect
of accounting change $ (28) $ (30) $ (154) $ (107)
Add back: goodwill amortization -- 9 -- 17
------- ------- ------- -------
Adjusted loss before cumulative effect
of accounting change $ (28) $ (21) $ (154) $ (90)
======= ======= ======= =======
Reported net loss $ (28) $ (30) $(1,207) $ (107)
Add back: Goodwill amortization -- 9 -- 17
------- ------- ------- -------
Adjusted net loss $ (28) $ (21) $(1,207) $ (90)
======= ======= ======= =======
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No.13, and Technical Corrections. The primary impact of the statement
on Equistar will be the classification of losses that result from the early
extinguishment of debt as a charge to income before extraordinary items.
Reclassification of prior period losses that were originally reported as
extraordinary items also will be required. Application of the statement will be
required in 2003.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal
Activities. SFAS No. 146 addresses the recognition, measurement, and reporting
of costs associated with exit and disposal activities, including restructuring
activities, essentially codifying prior accounting guidance on these matters.
SFAS No. 146 will be effective for activities initiated after December 31, 2002.
Early application is permitted. Equistar does not expect adoption of SFAS No.
146 to have any impact on its consolidated financial statements.
5. Inventories
Inventories consisted of the following at:
June 30, December 31,
Millions of dollars 2002 2001
- ------------------- -------- ------------
Finished goods $ 247 $ 243
Work-in-process 14 12
Raw materials 100 104
Materials and supplies 84 89
----- ------
Total inventories $ 445 $ 448
===== ======
5
6. Property, Plant and Equipment, Net
The components of property, plant and equipment, at cost, and the related
accumulated depreciation were as follows at:
June 30, December 31,
Millions of dollars 2002 2001
- ------------------- ------ ------------
Land $ 79 $ 79
Manufacturing facilities and equipment 5,973 5,929
Construction in progress 75 92
------ ------
Total property, plant and equipment 6,127 6,100
Less accumulated depreciation 2,512 2,395
------ ------
Property, plant and equipment, net $3,615 $3,705
====== ======
Depreciation and amortization are summarized as follows:
For the three months ended For the six months ended
June 30, June 30,
-------------------------------- ------------------------------
2002 2001 2002 2001
--------------- --------------- --------------- -------------
Millions of dollars
- -------------------
Property, plant and equipment $ 59 $ 58 $ 119 $ 117
Goodwill - - 9 - - 17
Turnaround expense 5 5 12 11
Software costs 4 2 8 5
Catalysts 3 4 4 5
Debt issuance costs 1 - - 3 - -
Other 3 3 4 4
------ ------ ----- -----
$ 75 $ 81 $ 150 $ 159
====== ====== ===== =====
7. Long-Term Debt
In late March 2002, Equistar amended its credit facility making certain
financial ratio requirements less restrictive, making the covenant limiting
acquisitions more restrictive and adding a covenant limiting certain
non-regulatory capital expenditures (see also Note 8). As a result of the
amendment, the interest rate on the credit facility was increased by 0.5% per
annum.
Long-term debt consisted of the following at:
June 30, December 31,
Millions of dollars 2002 2001
- ------------------- -------- ------------
Bank credit facility:
Revolving credit facility due 2006 $ 100 $ - -
Term loan due 2007 298 299
Other debt obligations:
Medium-term notes due 2002-2005 31 31
9.125% Notes due 2002 - - 100
8.50% Notes due 2004 300 300
6.50% Notes due 2006 150 150
10.125% Senior Notes due 2008 700 700
8.75% Notes due 2009 599 598
7.55% Debentures due 2026 150 150
Other 7 9
------- -------
Total long-term debt 2,335 2,337
Less current maturities 4 104
------- -------
Total long-term debt, net $ 2,331 $ 2,233
======= =======
6
Lyondell remains a guarantor of $300 million of Equistar debt and a co-obligor
with Equistar for $31 million of debt. The consolidated financial statements
(unaudited) of Lyondell are filed as an exhibit to Equistar's Quarterly Report
on Form 10-Q for the quarterly period ended June 30, 2002.
8. Lease Commitments
Equistar leases railcars, under operating leases, from unaffiliated entities
established for the purpose of serving as lessors with respect to these leases.
The leases include options for Equistar to purchase the railcars covered by the
leases during a lease term. If Equistar does not exercise a purchase option, the
affected railcars will be sold upon termination of the lease. In the event the
sales proceeds are less than the lessor's unrecovered investment, Equistar will
pay the difference to the lessor, but no more than the guaranteed residual
value.
Early in 2002, Equistar's credit rating was lowered by two major rating
agencies, which permitted the early termination of one of Equistar's railcar
leases by the lessor. As a result, Equistar renegotiated the lease during the
first quarter 2002, resulting in a payment of additional fees and a $17 million
prepayment, which is being amortized over the remaining lease term. The
prepayment reduced the guaranteed residual value and reduced future lease
payments. The guaranteed residual value at June 30, 2002 was $85 million.
Two of the three Equistar railcar operating leases contain financial and other
covenants that are substantially the same as those contained in Equistar's
credit facility. A breach of these covenants could permit the early termination
of these railcar leases by the lessors. Under one of the leases, the covenants
were automatically updated with the March 2002 amendment to the credit facility.
Under the other lease, Equistar amended the covenants to incorporate the March
2002 amendment to the credit facility. The amendment, which was completed in the
second quarter 2002, required the payment of additional fees and a $16 million
prepayment, which is being amortized over the remaining lease term. The $16
million prepayment reduced the guaranteed residual value and the future lease
payments. The guaranteed residual value at June 30, 2002 was $72 million.
Equistar plans either to exercise the purchase option under this lease or to
enter into a new lease arrangement with another lessor covering the subject
railcars, prior to December 31, 2002.
The third railcar lease, with a guaranteed residual value of $34 million at June
30, 2002, terminates in December 2002. Equistar plans either to exercise its
option to purchase the railcars covered by this lease or to enter into another
lease arrangement with a new lessor covering the subject railcars.
The total guaranteed residual value under these leases at June 30, 2002, after
considering the prepayments noted above, was approximately $191 million. Based
on indications of lower current market values Equistar has estimated a potential
loss on two of these leases and is accruing this amount ratably over the
remaining terms of the respective leases.
9. Commitments and Contingencies
Indemnification Arrangements--Lyondell, Millennium Petrochemicals and certain
subsidiaries of Occidental have each agreed to provide certain indemnifications
to Equistar with respect to the petrochemicals and polymers businesses
contributed by the partners. In addition, Equistar agreed to assume third party
claims that are related to certain pre-closing contingent liabilities that are
asserted prior to December 1, 2004 as to Lyondell and Millennium Petrochemicals,
and May 15, 2005 as to certain Occidental subsidiaries, to the extent the
aggregate thereof does not exceed $7 million with respect to each partner,
subject to certain terms of the respective asset contribution agreements. From
formation through June 30, 2002, Equistar had incurred a total of $20 million
for these uninsured claims and liabilities. Equistar also agreed to assume third
party claims that are related to certain pre-closing contingent liabilities that
are asserted for the first time after December 1, 2004 as to Lyondell and
Millennium Petrochemicals, and for the first time after May 15, 2005 as to
certain Occidental subsidiaries.
Environmental Remediation--Equistar's accrued liability for environmental
matters as of June 30, 2002 was $4 million and primarily related to the Port
Arthur facility, which was permanently shut down in February 2001. In
7
the opinion of management, there is currently no material estimable range of
loss in excess of the amounts recorded for environmental remediation.
Clean Air Act--The eight-county Houston/Galveston region has been designated a
severe non-attainment area for ozone by the U.S. Environmental Protection Agency
("EPA"). Emission reduction controls for nitrogen oxides ("NOx") must be
installed at each of Equistar's six plants located in the Houston/Galveston
region during the next several years. Compliance with the plan will result in
increased capital investment, which could be between $200 million and $260
million, before the 2007 deadline, as well as higher annual operating costs for
Equistar. The timing and amount of these expenditures are subject to regulatory
and other uncertainties, as well as obtaining the necessary permits and
approvals. In January 2001, Equistar and an organization composed of industry
participants filed a lawsuit to encourage adoption of an alternative plan to
achieve the same air quality improvement with less negative economic impact on
the region. Adoption of the alternative plan, as sought by the lawsuit, would be
expected to reduce Equistar's estimated capital investments for NOx reductions
required to comply with the standards. Recently proposed revisions by the
regulatory agencies would change the required NOx reduction levels from 90% to
80%. However, any potential resulting savings from this proposed revision could
be offset by the costs of stricter proposed controls over volatile organic
compounds, or VOCs. Equistar is still assessing the impact of these proposed
regulations and there can be no guarantee as to the ultimate capital cost of
implementing any final plan developed to ensure ozone attainment by the 2007
deadline.
In the United States, the Clean Air Act Amendments of 1990 set minimum levels
for oxygenates, such as methyl tertiary butyl ether ("MTBE"), in gasoline sold
in areas not meeting specified air quality standards. The presence of MTBE in
some water supplies in California and other states due to gasoline leaking from
underground storage tanks and in surface water from recreational water craft has
led to public concern about the use of MTBE. Certain federal and state
governmental initiatives in the U.S. have sought either to rescind the oxygen
requirement for reformulated gasoline or to restrict or ban the use of MTBE. On
April 25, 2002, the U.S. Senate passed its version of an omnibus energy bill,
which, among other things, would ban the use of MTBE as a fuel oxygenate. The
Senate bill is not law and needs to be reconciled with the U.S. House of
Representatives' omnibus energy bill, which was passed in July 2001 and which
would not ban the use of MTBE. Equistar's MTBE sales represented approximately
4% of its total 2001 revenues. Equistar does not expect these initiatives to
have a significant impact on MTBE margins or volumes in 2002. Should it become
necessary or desirable to reduce MTBE production, Equistar would need to make
capital expenditures to add the flexibility to produce alternative gasoline
blending components at its plants. The profit margins on such alternative
gasoline blending components could be lower than those historically realized on
MTBE.
General--Equistar is involved in various lawsuits and proceedings. Subject to
the uncertainty inherent in all litigation, management believes the resolution
of these proceedings, or any liability arising from the matters discussed in
this note, will not have a material adverse effect on the financial position,
liquidity or results of operations of Equistar.
10. Comprehensive Loss
The components of the comprehensive loss were as follows:
For the three months For the six months
ended June 30, ended June 30,
-------------------- ------------------
2002 2001 2002 2001
------ ------ ------ ------
Net loss $ (28) $ (30) $ (1,207) $(107)
------ ----- -------- -----
Other comprehensive income (loss):
Derivative instruments - - - - - - (2)
Available-for-sale securities - - 1 - - - -
------ ----- -------- -----
Total other comprehensive income (loss) - - 1 - - (2)
------ ----- -------- -----
Comprehensive loss $ (28) $ (29) $ (1,207) $ (109)
====== ===== ======== =======
8
11. Segment and Related Information
Equistar operates in two reportable segments, petrochemicals and polymers.
Summarized financial information concerning Equistar's reportable segments is
shown in the following table. Intersegment sales between the petrochemicals and
polymers segments were based on current market prices.
Millions of dollars Petrochemicals Polymers Unallocated Eliminations Total
- ------------------- -------------- ----------- ------------ ------------ -----------
For the three months ended June 30, 2002:
Sales and other operating revenues:
Customers $ 983 $ 479 $ - - $ - - $ 1,462
Intersegment 335 - - - - (335) - -
--------- -------- -------- --------- ---------
Total sales and operating revenues 1,318 479 - - (335) 1,462
Operating income (loss) 79 (26) (31) - - 22
Interest expense, net - - - - (50) - - (50)
Net income (loss) 79 (26) (81) - - (28)
For the three months ended June 30, 2001:
Sales and other operating revenues:
Customers $ 1,084 $ 516 $ - - $ - - $ 1,600
Intersegment 391 - - - - (391) - -
--------- -------- -------- --------- ---------
Total sales and operating revenues 1,475 516 - - (391) 1,600
Operating income (loss) 81 (23) (44) - - 14
Interest expense, net - - - - (45) - - (45)
Other income, net - - - - 1 - - 1
Net income (loss) 81 (23) (88) - - (30)
For the six months ended June 30, 2002:
Sales and other operating revenues:
Customers $ 1,709 $ 889 $ - - $ - - $ 2,598
Intersegment 602 - - - - (602) - -
--------- -------- -------- --------- ---------
Total sales and operating revenues 2,311 889 - - (602) 2,598
Operating income (loss) 55 (47) (61) - - (53)
Interest expense, net - - - - (102) - - (102)
Other income, net - - - - 1 - - 1
Net income (loss) 55 (47) (162) - - (154)
For the six months ended June 30, 2001:
Sales and other operating revenues:
Customers $ 2,315 $ 1,058 $ - - $ - - $ 3,373
Intersegment 849 - - - - (849) - -
--------- -------- -------- --------- ---------
Total sales and operating revenues 3,164 1,058 - - (849) 3,373
Operating income (loss) 196 (112) (106) - - (22)
Interest expense, net - - - - (91) - - (91)
Other income, net - - - - 6 - - 6
Net income (loss) 196 (112) (191) - - (107)
9
The following table presents the details of "Operating income (loss)" as
presented above in the "Unallocated" column:
For the three months ended For the six months ended
June 30, June 30,
---------------------------- -----------------------------
Millions of dollars 2002 2001 2002 2001
- ------------------- ------------ ------------ ------------- ------------
Expenses not allocated to petrochemicals and polymers:
Principally general and
administrative expenses $ (31) $ (44) $ (61) $ (84)
Unusual charges - - - - - - (22)
------ ------ ------ ------
Total--Unallocated $ (31) $ (44) $ (61) $ (106)
====== ====== ====== =======
During the first quarter of 2002, Equistar wrote off the entire balance of its
goodwill, resulting in a $1.1 billion charge that was reported as the cumulative
effect of an accounting change (see Note 4).
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
U.S. demand for ethylene in the second quarter 2002 was approximately 7% higher
than in the second quarter 2001 and 1.5% higher than in the first quarter 2002.
For the first six months 2002, U.S. ethylene demand was an estimated 4.4% higher
compared to the first six months of 2001. Nonetheless, the demand growth failed
to absorb the effects of increases in worldwide ethylene industry capacity
during 2001 or to offset the effects of a 10% contraction in U.S. ethylene
demand from 2000 to 2001.
Partly in response to political uncertainties in the Middle East and Venezuela,
raw material and energy costs, which had trended downward since the beginning of
2001, rose rapidly toward the end of the first quarter 2002. During the second
quarter 2002, these costs stabilized at the higher levels. Second quarter 2002
benchmark crude oil prices averaged 22% higher than in the first quarter 2002,
while second quarter 2002 natural gas prices averaged 45% higher than in the
first quarter 2002.
Nonetheless, raw material and energy costs were still lower in the second
quarter and the first six months of 2002 than in the comparable 2001 periods.
The benchmark price of crude oil averaged 5% lower in the second quarter 2002
and 15% lower in the first six months of 2002 than in the comparable 2001
periods. Natural gas prices, which spiked to historically high levels in January
2001, averaged 28% lower in the second quarter 2002 and 51% lower in the first
six months of 2002 than in the comparable 2001 periods, resulting in lower
energy costs.
The increased demand for ethylene in the first six months of 2002 as well as the
higher raw material costs and industry outages in the second quarter 2002
provided support for sales price increases in the second quarter 2002. Average
benchmark sales prices for ethylene were 17% higher in the second quarter 2002
compared to the first quarter 2002, while average benchmark prices for
co-product propylene were 28% higher in the second quarter 2002 compared to the
first quarter 2002. As a result, Equistar's second quarter 2002 operating
margins approached the levels experienced in the second quarter 2001. However,
on a six-month basis, 2002 margins were considerably below the comparable 2001
period.
For the first six months of 2002, the ongoing industry overcapacity and the
decreases in raw material costs during 2001 and most of the first quarter 2002
resulted in lower product sales prices compared to the first six months of 2001.
Average benchmark sales prices for ethylene were 31% lower in the first six
months of 2002 compared to the first six months of 2001, while average benchmark
prices for co-product propylene were 12% lower. Compared to the first six months
of 2001, sales prices decreased more than the costs of raw materials. As a
result, Equistar's product margins in the first six months of 2002 were
generally lower compared to the first six months of 2001.
RESULTS OF OPERATIONS
Net Loss--Equistar's net loss of $28 million in the second quarter 2002 was
comparable to a net loss of $30 million in the second quarter 2001, which
included goodwill amortization of $9 million. Excluding the effect of the second
quarter 2001 goodwill amortization, the net loss would have increased by $7
million in the second quarter 2002. Petrochemicals and polymers segment
operating results in the second quarter 2002 were roughly comparable to the
second quarter 2001, while interest expense increased by $6 million in the
second quarter 2002 compared to the second quarter 2001. The increase in
interest expense was due to the August 2001 refinancing of Equistar's debt,
which included the issuance of fixed rate debt with higher rates of interest.
Equistar's net loss before cumulative effect of accounting change was $154
million in the first six months of 2002 compared to a net loss of $107 million
in the first six months of 2001. The first six months of 2001 included $17
million of goodwill amortization and $22 million of shutdown costs for
Equistar's Port Arthur polyethylene facility. Excluding the effects of the
goodwill amortization and shutdown costs, the net loss for the first six months
of 2001 would have been $68 million. Compared to the adjusted net loss of $68
million for the first six months of 2001, the net loss for the first six months
of 2002 increased by $86 million. The increased net loss reflected lower margins
in the petrochemicals segment as sales prices decreased more than raw
11
material costs. In addition, certain fixed-price natural gas and natural gas
liquid ("NGL") supply contracts negatively impacted the first quarter 2002 by
approximately $33 million. These fixed-price contracts largely expired by the
end of the first quarter 2002. The petrochemicals segment margin decreases were
only partly offset by the benefit of higher polymers segment margins and higher
sales volumes in both segments.
Second Quarter 2002 versus First Quarter 2002
Equistar had a net loss of $28 million in the second quarter 2002 or an
improvement of $98 million compared to a net loss before cumulative effect of
accounting change of $126 million in the first quarter 2002. The petrochemicals
segment reported operating income of $79 million in the second quarter 2002
compared to an operating loss of $24 million in the first quarter 2002, a $103
million improvement. The polymers segment had an operating loss of $26 million
in the second quarter 2002 compared to an operating loss of $21 million in the
first quarter 2002.
Improvement in the petrochemicals segment was driven by sales price increases
across the entire product line, while Equistar's net cost of ethylene production
remained relatively stable. Benchmark ethylene prices increased 3.25 cents per
pound, or 17%, in the second quarter 2002 compared to the first quarter 2002.
The average cost of ethylene production for the industry increased by
approximately 1.2 cents per pound. However, Equistar's cost of ethylene
production, which was aided by Equistar's higher proportionate utilization of
heavy liquid raw materials, did not experience the same increase. The heavy
liquid raw material utilization provided benefits from higher co-product prices
as propylene, benzene and butadiene sales price increases offset heavy liquid
raw material cost increases. Also contributing to the sequential improvement was
the expiration of certain fixed-price natural gas and NGL supply contracts,
which negatively impacted the first quarter 2002 by approximately $33 million.
Petrochemicals segment sales volumes increased 5% in the second quarter 2002
compared to the first quarter 2002.
Sales price increases in Equistar's polymers segment kept pace with price
increases in ethylene and propylene, the key raw materials for polymers. Sales
volumes for the polymers segment increased by 6% in the second quarter 2002
compared to the first quarter 2002. Overall, performance in this segment
remained relatively unchanged. The sales volume increases for both segments of
5% to 6% were in line with industry trends.
12
Segment Data
The following tables reflect selected actual sales volume data, including
intersegment sales volumes, and summarized financial information for Equistar's
business segments.
For the three months For the six months
ended June 30, ended June 30,
-------------------- ------------------
In millions 2002 2001 2002 2001
----------- ------ ------ ------ ------
Selected petrochemicals products:
Olefins (pounds) 4,393 4,072 8,530 8,313
Aromatics (gallons) 103 98 189 188
Polymers products (pounds) 1,593 1,396 3,101 2,837
Millions of dollars
-------------------
Sales and other operating revenues:
Petrochemicals segment $ 1,318 $ 1,475 $ 2,311 $ 3,164
Polymers segment 479 516 889 1,058
Intersegment eliminations (335) (391) (602) (849)
------- ------- ------- -------
Total $ 1,462 $ 1,600 $ 2,598 $ 3,373
======= ======= ======= =======
Cost of sales:
Petrochemicals segment $ 1,236 $ 1,393 $ 2,251 $ 2,961
Polymers segment 489 520 903 1,133
Intersegment eliminations (335) (391) (602) (849)
------- ------- ------- -------
Total $ 1,390 $ 1,522 $ 2,552 $ 3,245
======= ======= ======= =======
Other operating expenses:
Petrochemicals segment $ 3 $ 1 $ 5 $ 7
Polymers segment 16 19 33 37
Unallocated 31 44 61 84
Unusual charges -- -- -- 22
------- ------- ------- -------
Total $ 50 $ 64 $ 99 $ 150
======= ======= ======= =======
Operating income (loss):
Petrochemicals segment $ 79 $ 81 $ 55 $ 196
Polymers segment (26) (23) (47) (112)
Unallocated (31) (44) (61) (84)
Unusual charges -- -- -- (22)
------- ------- ------- -------
Total $ 22 $ 14 $ (53) $ (22)
======= ======= ======= =======
Petrochemicals Segment
Revenues--Revenues of $1.3 billion in the second quarter 2002 decreased 11%
compared to second quarter 2001 revenues of $1.5 billion as a result of lower
average sales prices, which were partly offset by 5% higher sales volumes. The
lower sales prices in the second quarter 2002 reflect the effects of lower raw
material costs and excess industry capacity. Benchmark quoted ethylene prices
averaged 22.6 cents per pound in the second quarter 2002, a 21% decrease
compared to the second quarter 2001. However, average benchmark prices of
co-product propylene increased 10% compared to the second quarter 2001, partly
offsetting the ethylene decrease. Sales volumes increased due to demand growth
in the second quarter 2002.
Revenues of $2.3 billion for the first six months of 2002 decreased 27% compared
to the first six months of 2001 as lower 2002 average sales prices were only
partly offset by a 2% increase in sales volumes. Sales prices in the first six
months of 2002 averaged 29% lower than in the first six months of 2001 as a
result of the effects of lower raw material costs and excess industry capacity.
13
Cost of Sales--Cost of sales of $1.2 billion in the second quarter 2002
decreased 11% compared to $1.4 billion in the second quarter 2001. The decrease
was primarily due to lower raw material and natural gas costs in the second
quarter 2002. The decreases were partly offset by the 5% increase in sales
volumes in the second quarter 2002.
Cost of sales of $2.3 billion in the first six months of 2002 decreased 24%
compared to the first six months of 2001, somewhat less than the percentage
decrease in revenues noted above. While the costs of natural gas and NGL raw
materials decreased from the historically high levels experienced in the first
six months of 2001, other raw material costs, such as heavy liquids, did not
decrease proportionately to the decrease in sales prices. Costs were also higher
in the first quarter 2002 due to certain fixed price natural gas and NGL supply
contracts entered into in early 2001. In the first quarter 2002, Equistar's
costs under these fixed-price contracts were approximately $33 million higher
than market-based contracts would have been, whereas these contracts benefited
the first six months of 2001 by approximately $10 million. These fixed-price
contracts largely expired by the end of the first quarter 2002.
Operating Income--The petrochemicals segment had operating income of $79 million
in the second quarter 2002 compared to $81 million in the second quarter 2001.
Operating margins in the second quarter 2002 were slightly lower than in the
second quarter 2001. This was offset by the benefit from a 5% increase in sales
volumes in the second quarter 2002 compared to the second quarter 2001.
Operating income of $55 million for the first six months of 2002 decreased from
$196 million in the first six months of 2001. The decrease was primarily due to
lower margins as sales prices decreased more than raw material costs in the
first six months of 2002 compared to the first six months of 2001. This was only
partly offset by a 2% increase in sales volumes in the first six months of 2002.
Polymers Segment
Revenues--Revenues of $479 million in the second quarter 2002 decreased 7%
compared to $516 million in the second quarter 2001, reflecting a 19% decrease
in average sales prices offset by a 14% increase in sales volumes. Second
quarter 2002 average sales prices decreased in response to lower raw material
costs, primarily ethylene. The higher sales volumes reflected improvement in
demand.
Revenues of $889 million for the first six months of 2002 decreased 16% compared
to $1,058 million in the first six months of 2001 due to a 23% decrease in
average sales prices offset by a 9% increase in sales volumes.
Cost of Sales--Cost of sales of $489 million in the second quarter 2002
decreased 6% compared to $520 million in the second quarter 2001. The decrease
in the second quarter 2002 reflected lower raw material costs, primarily
ethylene, partly offset by the 14% increase in sales volumes.
Cost of sales of $903 million in the first six months of 2002 decreased 20%
compared to $1,133 million for the first six months of 2001, more than the
percentage decrease in revenues noted above. The decrease in the first six
months of 2002 reflected lower raw material costs, both ethylene and propylene,
partly offset by the 9% increase in sales volumes. Benchmark ethylene and
propylene costs were 31% and 12% lower, respectively, in the first six months of
2002 compared to the first six months of 2001.
Operating Income--The polymers segment had an operating loss of $26 million in
the second quarter 2002 compared to a $23 million operating loss in the second
quarter 2001. Operating margins in the second quarter 2002 were comparable to
the second quarter 2001.
For the first six months of 2002, the operating loss was $47 million compared to
an operating loss of $112 million in the comparable 2001 period. The reduced
operating loss was due to improvement in polymer margins and, to a lesser
extent, higher sales volumes. Margins improved in the first six months of 2002
compared to the first six months of 2001 as decreases in sales prices were less
than the decreases in polymer raw material costs.
14
Unallocated Items
The following discusses expenses that were not allocated to the petrochemicals
or polymers segments.
Other Operating Expenses--Other operating expenses not allocated to the
petrochemicals and polymers segments were $31 million in the second quarter 2002
compared to $44 million in the second quarter 2001 and $61 million in the first
six months of 2002 compared to $84 million in the first six months of 2001. The
decreases were primarily due to goodwill amortization of $9 million and $17
million included in the second quarter 2001 and the first six months of 2001,
respectively, as well as cost reduction efforts. Goodwill amortization ceased
effective January 1, 2002. See Note 2 of Notes to Consolidated Financial
Statements.
Unusual Charges--Equistar discontinued production at its higher-cost Port
Arthur, Texas polyethylene facility on February 28, 2001 and shut down the
facility. During the first quarter 2001, Equistar recorded a $22 million charge,
which included environmental remediation liabilities of $7 million, other exit
costs of $3 million and severance and pension benefits of $7 million for
approximately 125 people employed at the Port Arthur facility. The remaining $5
million balance primarily related to the write down of certain assets.
FINANCIAL CONDITION
Operating Activities--Operating activities used cash of $139 million in the
first six months of 2002 compared to providing $95 million in the first six
months of 2001. The decrease in operating cash flow in the 2002 period was due
to a $47 million higher loss before the cumulative effect of an accounting
change, increases in working capital levels, and payments related to railcar
leases in the first six months of 2002.
Equistar's working capital increased during the first six months of 2002
compared to a decrease during the first six months of 2001. The major components
of working capital - receivables, inventory and payables - increased by a net
$79 million in the first six months of 2002, primarily due to increases in
receivables. The increase in receivables reflected higher sales prices and
volumes, primarily during the second quarter 2002. By contrast, in the first six
months of 2001, these three major components of working capital decreased by a
net $38 million.
During the first six months of 2002, Equistar made certain payments totaling $33
million, discussed further below, related to its railcar leases. The payments
are reflected in other assets, net at June 30, 2002.
Investing Activities--Equistar's capital expenditures were $29 million in the
first six months of 2002 and $53 million in the first six months of 2001. The
reduced level of expenditures in 2002 reflects the continuing poor business
environment. Equistar's capital budget for 2002 is $94 million, primarily for
regulatory and environmental compliance and cost reduction projects. Equistar
currently estimates that 2002 capital expenditures will be 5% to 10% below the
annual budget amounts.
During the second quarter 2002, Equistar contributed $6 million to a mutual
insurance company formed by Equistar and other companies in the industry to
provide catastrophic business interruption and excess property damage insurance
coverage for its members.
Financing Activities--Cash used by financing activities was a net $3 million in
the first six months of 2002. Financing activities in the first six months of
2002 included net borrowing of $100 million under the revolving credit facility,
partly to fund the increase in working capital, primarily receivables. See
"Liquidity and Capital Resources" discussion below. Financing activities also
included the scheduled retirement of $100 million principal amount of the 9.125%
notes. There were no distributions to partners in the first six months of 2002.
Liquidity and Capital Resources--At June 30, 2002, Equistar had cash on hand of
$25 million. In addition, $400 million of the $500 million revolving credit
facility, which matures in August 2006, was undrawn at June 30, 2002. Amounts
available under the revolving credit facility are also reduced to the extent of
certain outstanding letters of credit provided under the credit facility, which
totaled $16 million as of June 30, 2002.
15
Early in 2002, Equistar's credit rating was lowered by two major rating
agencies, which could affect Equistar's borrowing costs in the future.
Management believes that conditions will be such that cash balances, cash flow
from operations and funding under the credit facility will be adequate to meet
anticipated future cash requirements, including scheduled debt repayments, other
contractual obligations, necessary capital expenditures and ongoing operations.
Long-Term Debt--The credit facility and the indenture governing Equistar's
senior notes contain covenants that, subject to certain exceptions, restrict
sale and leaseback transactions, lien incurrence, debt incurrence, sales of
assets, investments, non-regulatory capital expenditures, certain payments, and
mergers and consolidations. In addition, the credit facility requires Equistar
to maintain specified financial ratios. The breach of these covenants could
permit the lenders under Equistar's credit facility and the indenture governing
the senior notes to declare the loans immediately payable and could permit the
lenders under Equistar's credit facility to terminate future lending
commitments.
Equistar amended its credit facility in late March 2002, making certain
financial ratio requirements less restrictive, making the covenant limiting
acquisitions more restrictive and adding a covenant limiting certain
non-regulatory capital expenditures. The amendment increased the interest rate
on the credit facility by 0.5% per annum. Equistar was in compliance with all
covenants under its debt instruments as of June 30, 2002.
Railcar Leases--Equistar leases railcars, under operating leases, from
unaffiliated entities established for the purpose of serving as lessors with
respect to these leases. The leases include options for Equistar to purchase the
railcars covered by the leases during a lease term. If Equistar does not
exercise a purchase option, the affected railcars will be sold upon termination
of the lease. In the event the sales proceeds are less than the lessor's
unrecovered investment, Equistar will pay the difference to the lessor, but no
more than the guaranteed residual value.
Early in 2002, Equistar's credit rating was lowered by two major rating
agencies, which permitted the early termination of one of Equistar's railcar
leases by the lessor. As a result, Equistar renegotiated the lease during the
first quarter 2002, resulting in a payment of additional fees and a $17 million
prepayment, which is being amortized over the remaining lease term. The
prepayment reduced the guaranteed residual value and reduced future cash lease
payments. The guaranteed residual value at June 30, 2002 was $85 million.
Two of the three Equistar railcar operating leases contain financial and other
covenants that are substantially the same as those contained in Equistar's
credit facility. A breach of these covenants could permit the early termination
of these railcar leases by the lessors. Under one of the leases, the covenants
were automatically updated with the March 2002 amendment to the credit facility.
Under the other lease, Equistar amended the covenants to incorporate the March
2002 amendment to the credit facility. The amendment, which was completed in the
second quarter 2002, required the payment of additional fees and a $16 million
prepayment, which is being amortized over the remaining lease term. The $16
million prepayment reduced the guaranteed residual value and the future lease
payments. The guaranteed residual value at June 30, 2002 was $72 million.
Equistar plans either to exercise the purchase option under this lease or to
enter into a new lease arrangement with another lessor covering the subject
railcars, prior to December 31, 2002.
The third railcar lease, with a guaranteed residual value of $34 million at June
30, 2002, terminates in December 2002. Equistar plans either to exercise its
option to purchase the railcars covered by this lease or to enter into another
lease arrangement with a new lessor covering the subject railcars.
The total guaranteed residual value under these leases at June 30, 2002, after
considering the prepayments noted above, was approximately $191 million. Based
on indications of lower current market values Equistar has estimated a
potential loss on two of these leases and is accruing this amount ratably over
the remaining terms of the respective leases.
16
PROPOSED TRANSACTION BETWEEN LYONDELL AND OCCIDENTAL
During 2002, Lyondell entered into an agreement to purchase Occidental's 29.5%
interest in Equistar. Upon completion of the related transactions, Lyondell's
ownership interest in Equistar would increase to 70.5%. Millennium holds the
remaining 29.5% interest in Equistar. Closing of the transactions, which is
expected to occur by September 1, 2002, is subject to certain conditions,
including approval by Lyondell's shareholders. There can be no assurance that
the proposed transactions will be completed.
CURRENT BUSINESS OUTLOOK
Third quarter 2002 operating results will largely depend on the strength of the
economy. The near-term volatility of product markets as well as the energy
market are difficult to forecast. Polymer and co-product prices are expected to
provide some momentum for the third quarter 2002, as market support has
continued going into the period. Industry operating rates have improved, but
oversupply exists and the industry remains vulnerable to any sudden increases in
raw material costs or to a fall-off in economic activity. While Equistar is
optimistic that the global economic recovery will continue, it also believes
that it is prudent to remain cautious. Equistar is well positioned financially
should there be disruptions or delays in the economic recovery.
RECENT ACCOUNTING STANDARDS
Effective January 1, 2002, Equistar implemented SFAS No. 141, Business
Combinations, SFAS No. 142, Goodwill and Other Intangible Assets, and SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets.
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. The primary impact of the statement
on Equistar will be the classification of losses that result from the early
extinguishment of debt as a charge to income before extraordinary items.
Reclassification of prior period losses that were originally reported as
extraordinary items also will be required. Application of the statement will be
required in 2003.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal
Activities. SFAS No. 146 addresses the recognition, measurement, and reporting
of costs associated with exit and disposal activities, including restructuring
activities, essentially codifying prior accounting guidance on these matters.
SFAS No. 146 will be effective for activities initiated after December 31, 2002.
Early application is permitted. Equistar does not expect adoption of SFAS No.
146 to have any impact on its consolidated financial statements.
See "Results of Operations" and Note 4 of Notes to Consolidated Financial
Statements.
Item 3. Disclosure of Market and Regulatory Risk.
Equistar's exposure to market and regulatory risks is described in Item 7a of
its Annual Report on Form 10-K for the year ended December 31, 2001. Equistar's
exposure to market and regulatory risks has not changed materially in the
quarter ended June 30, 2002, except as noted below.
Certain federal and state governmental initiatives in the U.S. have sought
either to rescind the oxygen requirement for reformulated gasoline or to
restrict or ban the use of MTBE. On April 25, 2002, the U.S. Senate passed its
version of an omnibus energy bill, which, among other things, would ban the use
of MTBE as a fuel oxygenate. The Senate bill is not law and needs to be
reconciled with the U.S. House of Representatives' omnibus energy bill, which
was passed in July 2001 and which would not ban the use of MTBE. Equistar's MTBE
sales represented approximately 4% of its total 2001 revenues. Equistar does not
expect these initiatives to have a significant impact on MTBE margins and
volumes in 2002. Should it become necessary or desirable to reduce MTBE
production, Equistar would need to make capital expenditures to add the
flexibility to produce alternative gasoline blending components at its
17
plants. The profit margins on such alternative gasoline blending components
could be lower than those historically realized on MTBE.
New air pollution standards promulgated by federal and state regulatory agencies
in the U.S., including those specifically targeting the eight-county
Houston/Galveston region, will affect a substantial portion of the operating
facilities of Equistar. Compliance with these standards will result in increased
capital investment during the next several years and higher annual operating
costs for Equistar. Recently proposed revisions by the regulatory agencies would
change the required nitrogen oxides, or NOx, reduction levels from 90% to 80%.
However, any potential resulting savings from this proposed revision could be
offset by the costs of stricter proposed controls over volatile organic
compounds, or VOCs. Equistar is still assessing the impact of these proposed
regulations and there can be no guarantee as to the ultimate capital cost of
implementing any final plan developed to ensure ozone attainment by the 2007
deadline. See Note 9 of Notes to Consolidated Financial Statements.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this report are "forward-looking
statements" within the meaning of the federal securities laws. Although Equistar
believes the expectations reflected in such forward-looking statements are
reasonable, they do involve certain assumptions, risks and uncertainties, and
Equistar can give no assurance that such expectations will prove to have been
correct. Equistar's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including:
o the cyclical nature of the chemical industry,
o uncertainties associated with the economy,
o substantial chemical industry capacity additions resulting in oversupply
and declining prices and margins,
o the availability and cost of raw materials and utilities,
o access to capital markets,
o technological developments,
o current and potential governmental regulatory actions,
o potential terrorist acts,
o operating interruptions (including leaks, explosions, fires, mechanical
failure, unscheduled downtime, labor difficulties, transportation
interruptions, spills and releases and other environmental risks), and
o Equistar's ability to implement its business strategies, including cost
reductions.
Many of such factors are beyond Equistar's ability to control or predict. Any of
the factors, or a combination of these factors, could materially affect
Equistar's future results of operations and the ultimate accuracy of the
forward-looking statements. These forward-looking statements are not guarantees
of Equistar's future performance, and Equistar's actual results and future
developments may differ materially from those projected in the forward-looking
statements. Management cautions against putting undue reliance on
forward-looking statements or projecting any future results based on such
statements or present or prior earnings levels.
All forward-looking statements in this Form 10-Q are qualified in their entirety
by the cautionary statements contained in this section and in Equistar's Annual
Report on Form 10-K for the year ended December 31, 2001.
18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments with respect to Equistar's
legal proceedings previously reported in the Annual Report on Form
10-K for the year ended December 31, 2001.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certificate of Chief Executive Officer pursuant to
Section 906 of Sarbanes-Oxley Act of 2002
99.2 Certificate of Controller (principal financial officer)
pursuant to Section 906 of Sarbanes-Oxley Act of 2002
99.3 Consolidated Financial Statements (Unaudited)
of Lyondell Chemical Company
(b) Reports on Form 8-K
None.
19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Equistar Chemicals, LP
Dated: August 13, 2002 /s/ CHARLES L. HALL
-------------------------------------
Charles L. Hall
Vice President and Controller
(Duly Authorized Officer and
Principal Accounting Officer)
20