Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ü] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
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 __No ü
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer __ Accelerated filer __
Non-accelerated filer ü Smaller reporting company __
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes __ No ü
There is no established public trading market for the registrant’s equity securities.
The Registrant meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and, therefore, is filing this form with a reduced disclosure format.
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF INCOME
Successor | Predecessor | Successor | Predecessor | |||||||||||||
For the three months ended June 30, | For the six months ended June 30, | |||||||||||||||
Millions of dollars | 2008 | 2007 | 2008 | 2007 | ||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Trade | $ | 3,159 | $ | 2,560 | $ | 6,091 | $ | 4,680 | ||||||||
Related parties | 977 | 974 | 1,866 | 1,723 | ||||||||||||
4,136 | 3,534 | 7,957 | 6,403 | |||||||||||||
Operating cost and expenses: | ||||||||||||||||
Cost of sales | 4,362 | 3,362 | 8,269 | 6,100 | ||||||||||||
Selling, general and administrative expenses | 59 | 72 | 129 | 131 | ||||||||||||
Research and development expenses | 8 | 9 | 16 | 18 | ||||||||||||
4,429 | 3,443 | 8,414 | 6,249 | |||||||||||||
Operating income (loss) | (293 | ) | 91 | (457 | ) | 154 | ||||||||||
Interest expense: | ||||||||||||||||
Push-down debt | (374 | ) | - - | (760 | ) | - - | ||||||||||
Related party | (2 | ) | - - | (6 | ) | - - | ||||||||||
Debt of Equistar | (5 | ) | (54 | ) | (8 | ) | (108 | ) | ||||||||
Interest income: | ||||||||||||||||
Related parties | 8 | - - | 20 | - - | ||||||||||||
Other | 1 | 4 | 1 | 5 | ||||||||||||
Other expense, net | - - | (33 | ) | (2 | ) | (32 | ) | |||||||||
Net income (loss) | $ | (665 | ) | $ | 8 | $ | (1,212 | ) | $ | 19 |
See Notes to the Consolidated Financial Statements.
EQUISTAR CHEMICALS, LP
CONSOLIDATED BALANCE SHEETS
Millions of dollars | June 30, 2008 | December 31, 2007 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 23 | $ | 60 | ||||
Accounts receivable: | ||||||||
Trade, net | 78 | 95 | ||||||
Related parties | 71 | 43 | ||||||
Inventories | 1,674 | 1,754 | ||||||
Prepaid expenses and other current assets | 125 | 60 | ||||||
Total current assets | 1,971 | 2,012 | ||||||
Notes receivable from related party | 685 | 785 | ||||||
Property, plant and equipment, net | 5,170 | 5,116 | ||||||
Investments | 67 | 65 | ||||||
Intangible assets, net: | ||||||||
Debt issuance costs on push-down debt | 251 | 334 | ||||||
Intangible assets of Equistar | 822 | 998 | ||||||
Goodwill | 639 | 750 | ||||||
Other assets, net | 11 | 12 | ||||||
Total assets | $ | 9,616 | $ | 10,072 | ||||
LIABILITIES AND PARTNERS’ CAPITAL | ||||||||
Current liabilities: | ||||||||
Current maturities of long-term debt: | ||||||||
Push-down debt | $ | 144 | $ | 146 | ||||
Debt of Equistar | - - | 27 | ||||||
Related party borrowings: | ||||||||
Notes payable | 200 | 80 | ||||||
Push-down debt | 740 | 717 | ||||||
Accounts payable: | ||||||||
Trade | 1,122 | 975 | ||||||
Related parties | 143 | 191 | ||||||
Accrued liabilities | 182 | 295 | ||||||
Total current liabilities | 2,531 | 2,431 | ||||||
Long-term debt: | ||||||||
Push-down debt | 16,764 | 16,829 | ||||||
Debt of Equistar | 130 | 129 | ||||||
Other liabilities and deferred revenues | 297 | 295 | ||||||
Commitments and contingencies | ||||||||
Partners’ capital: | ||||||||
Partners’ accounts | 7,293 | 7,746 | ||||||
Push-down debt | (17,397 | ) | (17,358 | ) | ||||
Accumulated other comprehensive loss | (2 | ) | - - | |||||
Total partners’ capital | (10,106 | ) | (9,612 | ) | ||||
Total liabilities and partners’ capital | $ | 9,616 | $ | 10,072 |
See Notes to the Consolidated Financial Statements.
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF CASH FLOWS
Successor | Predecessor | |||||||
For the six months ended June 30, | ||||||||
Millions of dollars | 2008 | 2007 | ||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | (1,212 | ) | $ | 19 | |||
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: | ||||||||
Push-down debt interest | 760 | - - | ||||||
Depreciation and amortization | 283 | 162 | ||||||
Debt prepayment premiums and charges | 1 | 34 | ||||||
Deferred maintenance turnaround expenditures | - - | - - | ||||||
Changes in assets and liabilities that provided (used) cash: | ||||||||
Accounts receivable | (11 | ) | (160 | ) | ||||
Inventories | 80 | 105 | ||||||
Accounts payable | 99 | 130 | ||||||
Other, net | (140 | ) | (99 | ) | ||||
Net cash provided by (used in) operating activities | (140 | ) | 191 | |||||
Cash flows from investing activities: | ||||||||
Expenditures for property, plant and equipment | (79 | ) | (90 | ) | ||||
Proceeds from related party notes receivable | 100 | - - | ||||||
Other | - - | 8 | ||||||
Net cash provided by (used in) investing activities | 21 | (82 | ) | |||||
Cash flows from financing activities: | ||||||||
Repayment of long-term debt | (28 | ) | (632 | ) | ||||
Distributions to owners | - - | (100 | ) | |||||
Net proceeds from related party notes payable | 120 | 500 | ||||||
Other | (10 | ) | - - | |||||
Net cash provided by (used in) financing activities | 82 | (232 | ) | |||||
Decrease in cash and cash equivalents | (37 | ) | (123 | ) | ||||
Cash and cash equivalents at beginning of period | 60 | 133 | ||||||
Cash and cash equivalents at end of period | $ | 23 | $ | 10 |
See Notes to the Consolidated Financial Statements.
TABLE OF CONTENTS
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14. | 13 |
4
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
1. Basis of Preparation
The accompanying consolidated financial statements are unaudited and have been prepared from the books and records of Equistar Chemicals, LP and its subsidiaries (“Equistar”) 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 audited consolidated financial statements and notes thereto included in the Equistar Annual Report on Form 10-K for the year ended December 31, 2007. Certain previously reported amounts have been reclassified to conform to current period presentation.
As a result of the acquisition of Lyondell by LyondellBasell Industries on December 20, 2007, Equistar’s assets and liabilities were revalued to reflect the values assigned in LyondellBasell Industries’ accounting for the purchase of Lyondell, resulting in a new basis of accounting. In addition, Equistar has recognized in its financial statements $17,648 million of debt at June 30, 2008 for which it is not the primary obligor, but which it has guaranteed, and which was used by LyondellBasell Industries in the acquisition of Lyondell (“push-down debt”), and $251 million of related unamortized debt issuance costs at June 30, 2008.
In Staff Accounting Bulletin (“SAB”), Topic 5J, Push Down Basis of Accounting Required in Certain Limited Circumstances, the Securities and Exchange Commission requires, among other things, that, in situations where debt is used to acquire substantially all of an acquiree’s common stock and the acquiree guarantees the debt or pledges its assets as collateral for the debt, the debt and related interest expense and debt issuance costs be reflected in, or “pushed down” to, the acquiree’s financial statements.
Although this presentation may not reflect the likely future demands on Equistar resources for servicing the debt of LyondellBasell Industries, it provides an indication of that financial position after considering the maximum possible demand on Equistar resources relating to the debt incurred by LyondellBasell Industries in its acquisition of Lyondell. To facilitate an understanding of the impact on these consolidated financial statements, the effects of push-down debt are segregated.
Equistar's carrying value of push-down debt could be adjusted based on repayment or refinancing of the push-down debt by affiliates or if Equistar is required to repay push-down debt on an affiliate's behalf. Any adjustment to the carrying value of push-down debt would result in a corresponding adjustment to partner's capital.
The consolidated statements of income for the three and six months ended June 30, 2008 reflect post-acquisition depreciation and amortization expense based on the new value of the related assets and interest expense that resulted from the debt used to finance the acquisition; therefore, the financial information for the periods prior to and subsequent to the acquisition on December 20, 2007 is not generally comparable. To indicate the application of a different basis of accounting for the period subsequent to the acquisition, periods prior to the acquisition are designated “predecessor” periods and those subsequent to the acquisition are designated “successor” periods.
2. Company Ownership
Equistar became an indirect wholly owned subsidiary of Lyondell Chemical Company (together with its consolidated subsidiaries, “Lyondell”) as a result of Lyondell’s acquisition of Millennium Chemicals Inc. (together with its consolidated subsidiaries, “Millennium”) in 2004. Prior to December 20, 2007, Equistar was owned 70.5% by Lyondell and 29.5% by Millennium.
5
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
2. Company Ownership – (Continued)
On December 20, 2007, LyondellBasell Industries AF S.C.A. (formerly known as Basell AF S.C.A.) indirectly acquired all of the shares of Lyondell common stock. As a result, Lyondell and Equistar both became indirect wholly owned subsidiaries of LyondellBasell Industries AF S.C.A. (together with its consolidated subsidiaries, “LyondellBasell Industries” and without Lyondell, the “Basell Group”). As part of the acquisition, Lyondell made a contribution to Equistar of $1,703 million, which was used to repay certain Equistar debt, resulting in an increase of Lyondell’s direct ownership interest to 79% and a corresponding decrease in Millennium’s ownership interest to 21%.
3. Accounting and Reporting Changes
On April 25, 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 142-3, Determination of the Useful Life of Intangible Assets. This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets in order to improve the consistency between the useful life of a recognized intangible asset under Statement No. 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007), Business Combinations, and other U.S. generally accepted accounting principles. This FSP is effective for Equistar beginning in 2009. Early adoption is prohibited. Equistar does not expect the application of FSP 142-3 to have a material effect on its consolidated financial statements.
In March 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 161, Disclosures about Derivative Instruments and Hedging Activities, which amends and expands the disclosure requirements of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, by requiring qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of, and gains and losses on, derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 will be effective for Equistar beginning in 2009. Equistar is currently evaluating the effect of SFAS No. 161 on its disclosures.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment to ARB No. 51, which establishes new accounting and disclosure requirements for noncontrolling, or minority, interests, including their classification as a separate component of equity and the adjustment of net income to include amounts attributable to minority interests. SFAS No. 160 also establishes new accounting standards requiring recognition of a gain or loss upon deconsolidation of a subsidiary. SFAS No. 160 will be effective for Equistar beginning in 2009, with earlier application prohibited.
Also in December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, which requires an acquiring entity to recognize all assets acquired and liabilities assumed in a transaction at the acquisition date at fair value with limited exceptions. SFAS No. 141 (revised 2007) will change the accounting treatment for certain specific items, including: expensing of most acquisition and restructuring costs; recording acquired contingent liabilities, in-process research and development and noncontrolling, or minority, interests at fair value; and recognizing changes in income tax valuations and uncertainties after the acquisition date as income tax expense. SFAS No. 141 (revised 2007) also includes new disclosure requirements. For Equistar, SFAS No. 141 (revised 2007) will apply to business combinations with acquisition dates beginning in 2009. Earlier adoption is prohibited.
6
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
3. Accounting and Reporting Changes – (Continued)
Although certain past transactions, including the acquisition of Lyondell by LyondellBasell Industries, would have been accounted for differently under SFAS No. 160 and SFAS No. 141 (revised 2007), application of these statements in 2009 will not affect historical amounts.
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115, which permits election of fair value to measure many financial instruments and certain other items, was applicable to Equistar effective January 1, 2008. Equistar has elected not to apply the fair value option to any assets or liabilities.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. The new standard defines fair value, establishes a framework for its measurement and expands disclosures about such measurements. In February 2008, the FASB issued FASB Staff Position FAS 157-2, delaying the effective date of SFAS No. 157 for certain nonfinancial assets and liabilities until January 1, 2009. Equistar is currently evaluating the effect to its consolidated financial statements of prospectively applying the provisions of SFAS No. 157 to those assets and liabilities.
Implementation of the provisions of SFAS No. 157 to financial assets and liabilities beginning January 1, 2008 did not have a material effect on Equistar consolidated financial statements.
4. Acquisition of Lyondell by LyondellBasell Industries
On December 20, 2007, LyondellBasell Industries indirectly acquired the outstanding common shares of Lyondell and, as a result, Lyondell and Equistar became indirect wholly owned subsidiaries of LyondellBasell Industries.
From December 20, 2007, Equistar’s consolidated financial statements reflect a revaluation of Equistar’s assets and liabilities, to reflect the allocation of $7,811 million of the purchase price to Equistar assigned in LyondellBasell Industries’ accounting for the purchase of Lyondell. In addition, at June 30, 2008, Equistar recognized in its financial statements $17,648 million of push-down debt for which it is not the primary obligor and $251 million of related unamortized debt issuance costs.
The purchase price allocations used in the preparation of the June 30, 2008 and December 31, 2007 financial statements are preliminary due to the continuing analyses relating to the determination of the fair values of the assets acquired and liabilities assumed. Based upon additional information received to date, the fair value of the assets and liabilities acquired were adjusted in the six month period ended June 30, 2008. The adjustments and their effect on goodwill for the six month period ended June 30, 2008 are summarized in Note 8. Any further changes to the estimates of fair value of net assets acquired would result in additional adjustments to assets and liabilities and corresponding adjustments to goodwill. Management does not expect the finalization of these matters to have a material effect on the allocation.
Equistar has completed a preliminary assignment of the goodwill to reportable segments. Goodwill of $500 million was assigned to the chemicals segment and $250 million was assigned to the polymers segment. Management does not expect the finalization of the purchase price allocation to have a material effect on the assignment of goodwill to reportable segments.
7
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
5. Related Party Transactions
Effective December 2007, Equistar and a subsidiary of Lyondell entered into two loan agreements. Under one of the loan agreements, Equistar may borrow from, and under the other loan agreement Equistar may make advances to the Lyondell subsidiary amounts up to and not exceeding $2,000 million. The loans, which bear interest at London Interbank Offered Rate (“LIBOR”) plus 4%, mature in 2012. Accrued interest may, at the option of the parties, be added to the outstanding principal amount of the note. At June 30, 2008, Equistar had a note payable of $200 million and at December 31, 2007 Equistar had a note receivable of $44 million, under the respective loan agreements. It is anticipated that Equistar and Lyondell will replace the loan agreements with a current account agreement for an indefinite period, under which Equistar may deposit excess cash balances with the Lyondell subsidiary and have access to uncommitted revolving lines of credit in excess of deposits.
In 2007, Equistar and Millennium entered into loan agreements permitting Equistar to borrow up to $600 million from Millennium. In connection with the acquisition of Lyondell by LyondellBasell Industries (see Note 2), the maturity of the notes was extended to February 16, 2008 from December 21, 2007, or earlier upon demand. The notes bore interest, which was payable quarterly, at LIBOR plus 1.75%. The balance of the notes outstanding at December 31, 2007 was $80 million and was repaid in January 2008.
6. Accounts Receivable
On December 20, 2007, as part of the acquisition of Lyondell by LyondellBasell Industries, Lyondell entered into a $1,150 million Accounts Receivable Securitization Facility. Concurrently, Equistar entered into a receivable sales agreement with Lyondell and terminated its $600 million accounts receivable sales facility.
Pursuant to the receivables sales agreement, Equistar sells, on an ongoing basis and without recourse, substantially all of its domestic accounts receivable to a wholly owned bankruptcy-remote subsidiary of Lyondell. The payment received for these sales may, at the option of Lyondell, be a combination of cash and notes payable. A portion of the Equistar accounts receivables sold under the facility with Lyondell may then be sold under Lyondell’s $1,150 million Accounts Receivable Securitization Facility.
At June 30, 2008, the outstanding amount of receivables sold by Equistar to Lyondell was $1,402 million, for which Equistar received cash of $717 million and a note receivable of $685 million. At December 31, 2007, the outstanding amount of receivables sold by Equistar to Lyondell was $1,407 million for which Equistar received cash proceeds of $666 million and a note receivable from Lyondell for $741 million.
7. Inventories
Inventories consisted of the following:
Millions of dollars | June 30, 2008 | December 31, 2007 | ||||||
Finished goods | $ | 921 | $ | 902 | ||||
Work-in-process | 49 | 40 | ||||||
Raw materials | 545 | 650 | ||||||
Materials and supplies | 159 | 162 | ||||||
Total inventories | $ | 1,674 | $ | 1,754 |
8
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
8. Property, Plant and Equipment and Goodwill
The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows:
Millions of dollars | June 30, 2008 | December 31, 2007 | ||||||
Land | $ | 45 | $ | 46 | ||||
Manufacturing facilities and equipment | 5,223 | 4,890 | ||||||
Construction in progress | 166 | 193 | ||||||
Total property, plant and equipment | 5,434 | 5,129 | ||||||
Less accumulated depreciation | (264 | ) | (13 | ) | ||||
Property, plant and equipment, net | $ | 5,170 | $ | 5,116 |
Depreciation and amortization is summarized as follows:
Successor | Predecessor | Successor | Predecessor | |||||||||||||
For the three months ended June 30, | For the six months ended June 30, | |||||||||||||||
Millions of dollars | 2008 | 2007 | 2008 | 2007 | ||||||||||||
Property, plant and equipment | $ | 130 | $ | 74 | $ | 257 | $ | 148 | ||||||||
Software costs | 2 | 5 | 3 | 9 | ||||||||||||
Other | 12 | 2 | 23 | 5 | ||||||||||||
Total depreciation and amortization | $ | 144 | $ | 81 | $ | 283 | $ | 162 |
Equistar believes that there are asset retirement obligations associated with some of its facilities, but that the present value of those obligations normally is not material in the context of an indefinite expected life of the facilities. Equistar continually reviews the optimal future alternatives for its facilities. Any decision to retire one or more facilities would result in an increase in the present value of such obligations. The liabilities that had been recognized for all asset retirement obligations were $15 million and $16 million at June 30, 2008 and December 31, 2007, respectively.
Based on additional information received to date, adjustments to the preliminary purchase price allocated to the fair value of assets and liabilities acquired as a result of Lyondell’s acquisition by LyondellBasell Industries resulted in a decrease of Equistar’s goodwill from $750 million at December 31, 2007 to $639 million at June 30, 2008.
The following table summarizes the changes to Equistar’s goodwill during the six months ended June 30, 2008, by reportable segment. Equistar’s reportable segments include chemicals and polymers.
Millions of dollars | Chemicals | Polymers | Total | |||||||||
Goodwill at January 1, 2008 | $ | 500 | $ | 250 | $ | 750 | ||||||
Acquisition of Lyondell | ||||||||||||
Adjustment to the estimated fair value of contracts | (92 | ) | - - | (92 | ) | |||||||
Adjustments to property, plant and equipment and other assets and liabilities | (14 | ) | (5 | ) | (19 | ) | ||||||
(106 | ) | (5 | ) | (111 | ) | |||||||
Goodwill at June 30, 2008 | $ | 394 | $ | 245 | $ | 639 |
9
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
9. Accounts Payable
Accounts payable included liabilities in the amounts of $5 million and $7 million as of June 30, 2008 and December 31, 2007, respectively, for checks issued in excess of associated bank balances but not yet presented for collection.
10. Deferred Revenues
Deferred revenues at June 30, 2008 and December 31, 2007 of $130 million and $142 million, respectively, represent advances from customers as partial prepayments for products to be delivered under long-term product supply contracts. Trade sales and other operating revenues included $21 million and $9 million in the three-month periods ended June 30, 2008 and 2007, respectively, and $26 million and $18 million in the six-month periods ended June 30, 2008 and 2007, respectively, of such previously deferred revenues.
11. Long-Term Debt
As a result of the December 20, 2007 acquisition of Lyondell by LyondellBasell Industries, Equistar recorded the following long-term push-down debt for which it is not a primary obligor:
Millions of dollars | June 30, 2008 | December 31, 2007 | ||||||
Term loan A due 2013 | $ | 1,465 | $ | 1,500 | ||||
Term loan B due 2014 ($69 million of discount) | 7,443 | 7,475 | ||||||
Senior Secured Interim Loan | 8,000 | 8,000 | ||||||
Total long-term debt | 16,908 | 16,975 | ||||||
Less current maturities | (144 | ) | (146 | ) | ||||
Total long-term debt, net | $ | 16,764 | $ | 16,829 |
Long-term debt under which Equistar is the primary obligor consisted of the following:
Millions of dollars | June 30, 2008 | December 31, 2007 | ||||||
Senior Notes due 2008, 10.125% | $ | - - | $ | 8 | ||||
Senior Notes due 2011, 10.625% | - - | 4 | ||||||
Debentures due 2026, 7.55% ($21 million of discount) | 129 | 129 | ||||||
Notes due 2009, 8.75% | - - | 15 | ||||||
Other | 1 | - - | ||||||
Total long-term debt | 130 | 156 | ||||||
Less current maturities | - - | (27 | ) | |||||
Total long-term debt, net | $ | 130 | $ | 129 |
10
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
11. Long-Term Debt – (Continued)
Debt Agreement Amendments—Under the terms of the financing for the Lyondell acquisition, the joint lead arrangers (“JLAs”) retained the right to flex certain provisions of the financing, including pricing and the reallocation and retranching of the Term Loans. Effective April 30, 2008, the JLAs exercised the price flex provisions and, in conjunction with the exercise, the Senior Secured Credit Facility was amended to (i) convert each of the U.S. Tranche B Dollar Term Loan and the German Tranche B Euro Term Loan into three separate tranches, some of which tranches are subject to a prepayment penalty, (ii) increase interest rates and fee rates by 0.5%, (iii) establish a LIBOR floor of 3.25% on the U.S. Tranche B Dollar Term Loan, (iv) modify certain debt covenants, including increasing a general debt basket from $750 million to $1,000 million, eliminating an interest rate hedging requirement, increasing the asset backed facility basket by $500 million, and adding a covenant prohibiting reduction of aggregate commitments under the Revolving Credit Facility with Access Industries before its initial maturity, (v) amend the calculation of Consolidated EBITDA, as defined, for the purpose of determining compliance with the debt requirements, to reflect adjustments for 2007 cost of sales in accordance with FIFO inventory accounting, and (vi) make other changes, including technical and typographical corrections.
In conjunction with the exercise by the JLAs of their flex rights, additional amendments were made to each of the Senior Secured Interim Loan, Senior Secured Inventory-Based Credit Facility, Revolving Credit Facility with Access Industries and Accounts Receivable Securitization Facility. The amendments to the Senior Secured Interim Loan and Senior Secured Inventory-Based Credit Facility and the Revolving Credit Facility with Access Industries were effective on April 30, 2008. The amendments to the Accounts Receivable Securitization Facility were effective on May 6, 2008.
Each of the Senior Secured Interim Loan, the Senior Secured Inventory-Based Credit Facility, the Accounts Receivable Securitization Facility and Revolving Credit Facility with Access Industries were amended to (i) conform to certain of the amendments to the Senior Secured Credit Facility and (ii) make other changes, including technical and typographical corrections. In addition, the Senior Secured Inventory-Based Credit Facility was amended to allow Lyondell the future option to increase the aggregate amount of commitments under the facility by a further $500 million.
Under the terms of the Senior Secured Inventory-Based Credit Facility, as amended, Lyondell could elect to increase commitments under the facility by up to an aggregate $1,100 million. Effective April 30, 2008, Lyondell exercised the option to increase the facility by $600 million and, as a result, aggregate commitments under the facility increased from $1,000 million to $1,600 million. Concurrent with the exercise of the increase in commitments, Lyondell Chemical Company became a lien grantor and added the following as collateral: (i) a first priority pledge of all equity interests owned by Lyondell Chemical Company in, and all indebtedness owed to it by, LyondellBasell Receivables I, LLC (the seller under the Accounts Receivable Securitization Facility) and (ii) a first priority security interest in all accounts receivable, inventory and related assets owned by Lyondell Chemical Company, subject to customary exceptions.
11
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
11. Long-Term Debt – (Continued)
Other—Lyondell is a guarantor of Equistar’s 7.55% Debentures due 2026.
In addition to push-down debt, Equistar is a guarantor of certain LyondellBasell Industries debt, comprising the Basell Group’s 8.375% High Yield Notes due 2015, comprising borrowings of $615 million and €500 million ($789 million), and amounts borrowed by the Basell Group under the Senior Secured Credit Facility, consisting of $488 million borrowed under term loan A, €1,294 million ($2,043 million) under term loan B and outstanding borrowings under the revolving credit facility of which there was none at June 30, 2008. Equistar is also a guarantor for amounts borrowed under the Senior Secured Inventory-Based Credit Facility by Lyondell Chemical Company and another Lyondell subsidiary as well as a U.S.-based subsidiary of the Basell Group. At June 30, 2008, borrowings of $1,183 million were outstanding under the Senior Secured Inventory-Based Credit Facility; $1,053 million on the part of Lyondell and $130 million on the part of the Basell Group.
Amortization of debt discounts and debt issuance costs resulted in expenses of $51 million and $1 million for the three-month periods ended June 30, 2008 and 2007, respectively, and $101 million and $2 million for the six-month periods ended June 30, 2008 and 2007, respectively, which are included in interest expense. Amounts related to pushdown debt are included in “Interest Expense: Push-Down Debt” in the Consolidated Statements of Income for the three and six months ended June 30, 2008.
12. Pension and Other Postretirement Benefits
Net periodic pension and other postretirement benefits included the following cost components:
Successor | Predecessor | Successor | Predecessor | |||||||||||||
For the three months ended June 30, | For the six months ended June 30, | |||||||||||||||
Millions of dollars | 2008 | 2007 | 2008 | 2007 | ||||||||||||
Pension benefits: | ||||||||||||||||
Service cost | $ | 6 | $ | 5 | $ | 11 | $ | 11 | ||||||||
Interest cost | 5 | 4 | 9 | 8 | ||||||||||||
Recognized return on plan assets | (6 | ) | (4 | ) | (11 | ) | (8 | ) | ||||||||
Amortization | - - | 1 | - - | 1 | ||||||||||||
Net periodic pension benefit cost | $ | 5 | $ | 6 | $ | 9 | $ | 12 | ||||||||
Other postretirement benefits: | ||||||||||||||||
Service cost | $ | - - | $ | - - | $ | 1 | $ | 1 | ||||||||
Interest cost | 2 | 2 | 3 | 3 | ||||||||||||
Net periodic other postretirement benefit cost | $ | 2 | $ | 2 | $ | 4 | $ | 4 |
12
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
13. Commitments and Contingencies
Environmental Remediation—Equistar’s accrued liability for future environmental remediation costs totaled $3 million and $4 million as of June 30, 2008 and December 31, 2007, respectively. In the opinion of management, there is no material estimable range of reasonably possible loss in excess of the liability recorded for environmental remediation. However, it is possible that new information about the sites for which the accrual has been established, new technology or future developments such as involvement in investigations by regulatory agencies, could require Equistar to reassess its potential exposure related to environmental matters.
Other—Equistar is, from time to time, a defendant in lawsuits and other commercial disputes, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of any liability and resulting financial impact with respect to any such matters cannot be ascertained with any degree of certainty, management does not believe that any ultimate uninsured liability resulting from these matters in which it currently is involved will, individually or in the aggregate, have a material adverse effect on the financial position, liquidity or results of operations of Equistar.
General—In the opinion of management, the matters discussed in this note are not expected to have a material adverse effect on the financial position or liquidity of Equistar. However, the adverse resolution in any reporting period of one or more of these matters could have a material impact on Equistar’s results of operations for that period, which may be mitigated by contribution or indemnification obligations of others, or by any insurance coverage that may be available.
14. Segment and Related Information
At the time of the acquisition of Lyondell by LyondellBasell Industries, LyondellBasell Industries established new business segments. Equistar’s operations, which are managed as part of LyondellBasell Industries, are primarily in two of these segments:
· | Chemicals, primarily manufacturing and marketing of ethylene; its co-products, including propylene, butadiene and aromatics, which include benzene and toluene; ethylene derivatives, including ethylene glycol, ethylene oxide (“EO”) and other EO derivatives, as well as ethanol; and |
· | Polymers, including manufacturing and marketing of polyethylene, including high density polyethylene, low density polyethylene and linear low density polyethylene, and polypropylene. |
13
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
14. Segment and Related Information – (Continued)
Segment operating results reported to management reflect cost of sales determined under the first-in, first-out (“FIFO”) method of accounting for inventory. These FIFO-basis operating results are reconciled to LIFO-basis operating results in the following table.
Millions of dollars | Chemicals | Polymers | Other | Total | ||||||||||||
Successor | ||||||||||||||||
For the three months ended June 30, 2008 | ||||||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Customers | $ | 3,070 | $ | 1,066 | $ | - - | $ | 4,136 | ||||||||
Intersegment | 800 | - - | (800 | ) | - - | |||||||||||
3,870 | 1,066 | (800 | ) | 4,136 | ||||||||||||
Segment operating income (loss) | 45 | (16 | ) | 39 | 68 | |||||||||||
Adjustment to LIFO basis | (361 | ) | ||||||||||||||
Operating loss | (293 | ) | ||||||||||||||
Predecessor | ||||||||||||||||
For the three months ended June 30, 2007 | ||||||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Customers | $ | 2,652 | $ | 882 | $ | - - | $ | 3,534 | ||||||||
Intersegment | 586 | - - | (586 | ) | - - | |||||||||||
3,238 | 882 | (586 | ) | 3,534 | ||||||||||||
Segment operating income | 185 | 20 | - - | 205 | ||||||||||||
Adjustment to LIFO basis | (114 | ) | ||||||||||||||
Operating income | 91 | |||||||||||||||
Successor | ||||||||||||||||
For the six months ended June 30, 2008 | ||||||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Customers | $ | 5,952 | $ | 2,005 | $ | - - | $ | 7,957 | ||||||||
Intersegment | 1,510 | - - | (1,510 | ) | - - | |||||||||||
7,462 | 2,005 | (1,510 | ) | 7,957 | ||||||||||||
Segment operating loss | (52 | ) | (35 | ) | (27 | ) | (114 | ) | ||||||||
Adjustment to LIFO basis | (343 | ) | ||||||||||||||
Operating loss | (457 | ) | ||||||||||||||
Predecessor | ||||||||||||||||
For the six months ended June 30, 2007 | ||||||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Customers | $ | 4,711 | $ | 1,692 | $ | - - | $ | 6,403 | ||||||||
Intersegment | 1,080 | - - | (1,080 | ) | - - | |||||||||||
5,791 | 1,692 | (1,080 | ) | 6,403 | ||||||||||||
Segment operating income | 294 | 36 | - - | 330 | ||||||||||||
Adjustment to LIFO basis | (176 | ) | ||||||||||||||
Operating income | 154 |
14
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
14. Segment and Related Information – (Continued)
The 2007 segment information presented above has been reclassified to conform with the new business segments created during the acquisition of Lyondell by LyondellBasell Industries.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This discussion should be read in conjunction with information contained in the Consolidated Financial Statements of Equistar Chemicals, LP, together with its consolidated subsidiaries (collectively, “Equistar”) and the notes thereto.
In addition to comparisons of current operating results with the same period in the prior year, Equistar has included, as additional disclosure, certain “trailing quarter” comparisons of second quarter 2008 operating results to first quarter 2008 operating results. Equistar’s businesses are highly cyclical, in addition to experiencing some less significant seasonal effects. Trailing quarter comparisons may offer important insight into current business directions.
The consolidated statements of income for the three and six months ended June 30, 2008 reflect post-acquisition depreciation and amortization expense based on the new value of the related assets and interest expense that resulted from the debt used to finance the acquisition; therefore, the financial information for the periods prior to and subsequent to the acquisition on December 20, 2007 is not generally comparable. To indicate the application of a different basis of accounting for the period subsequent to the acquisition, the 2007 financial information presents separately the period prior to the acquisition (“Predecessor”) and the period after the acquisition (“Successor”).
References to industry benchmark prices or costs, including the weighted average cost of ethylene production, are generally to industry prices and costs reported by Chemical Marketing Associates, Incorporated (“CMAI”), except that crude oil and natural gas benchmark price references are to industry prices reported by Platts, a reporting service of The McGraw-Hill Companies.
ACQUISITION
On December 20, 2007, Basell AF S.C.A. (“Basell”) indirectly acquired the outstanding common shares of Lyondell. As a result, Lyondell and Equistar became indirect wholly owned subsidiaries of Basell, and Basell was renamed LyondellBasell Industries AF S.C.A. (together with its consolidated subsidiaries, “LyondellBasell Industries” and without Lyondell, the “Basell Group”).
OVERVIEW
General―Equistar manufactures and markets ethylene and its co-products, ethylene derivatives, primarily polyethylene, and gasoline blending components, as well as polypropylene.
As a result of the acquisition of Lyondell by LyondellBasell Industries, Equistar reassessed segment reporting based on the current management structure, including the impact of the integration of Equistar’s businesses into the LyondellBasell Industries portfolio of businesses. Based on this analysis, Equistar concluded that management is focused on the chemicals segment and the polymers segment. See “Segment Analysis” below for a description of the segments.
In the first six months of 2008 compared to the same period in 2007, record high prices for crude oil and higher prices for natural gas liquids contributed to higher raw material costs for chemical producers, putting pressure on chemical product margins, particularly ethylene. Chemicals and polymers markets generally experienced balanced supply and demand conditions with some weakening of demand.
During the second quarter and first six months of 2008 compared to the same periods in 2007, Equistar experienced lower profitability as sales price increases failed to keep pace with significantly higher average raw material costs. Equistar’s operating results in the second quarter and first six months of 2008, compared to the same periods in 2007, reflected the effects of lower product margins in both the chemicals and polymers segments. The segment operating results are reviewed in the “Segment Analysis” below.
Ethylene Raw Materials—Benchmark crude oil and natural gas prices generally have been indicators of the level and direction of movement of raw material and energy costs for ethylene and its co-products in the chemicals segment. Ethylene and its co-products are produced from two major raw material groups:
· | crude oil-based liquids (“liquids” or “heavy liquids”), including naphthas, condensates, and gas oils, the prices of which are generally related to crude oil prices; and |
· | natural gas liquids (“NGLs”), principally ethane and propane, the prices of which are generally affected by natural gas prices. |
Although the prices of these raw materials are generally related to crude oil and natural gas prices, during specific periods the relationships among these materials and benchmarks may vary significantly.
Equistar has the ability to shift its ratio of raw materials used in the production of ethylene and its co-products to take advantage of the relative costs of heavy liquids and NGLs. However, this ability is limited and, in the first six months of 2008, was not sufficient to offset the unprecedented differential increase in the price of liquids versus NGLs and the failure of co-product price increases to offset this differential increase.
The following table shows the average U.S. benchmark prices for crude oil and natural gas for the applicable three- and six-month periods, as well as benchmark U.S. sales prices for ethylene, propylene, benzene and HDPE, which Equistar produces and sells. The benchmark weighted average cost of ethylene production, which is reduced by co-product revenues, is based on CMAI’s estimated ratio of heavy liquid raw materials and NGLs used in U.S. ethylene production and is subject to revision.
Average Benchmark Price | ||||||||||||||||
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Crude oil – dollars per barrel | 123.90 | 64.87 | 110.95 | 61.43 | ||||||||||||
Natural gas – dollars per million BTUs | 11.07 | 7.25 | 9.55 | 6.91 | ||||||||||||
NWE Naphtha-dollars per barrel | 110.00 | 74.46 | 101.73 | 68.04 | ||||||||||||
Weighted average cost of ethylene production – cents per pound | 55.46 | 33.79 | 52.62 | 31.34 | ||||||||||||
Ethylene – cents per pound | 65.67 | 44.67 | 63.08 | 42.33 | ||||||||||||
Propylene – cents per pound | 68.17 | 49.92 | 63.92 | 46.52 | ||||||||||||
Benzene – cents per gallon | 397.67 | 394.67 | 381.50 | 373.83 | ||||||||||||
HDPE – cents per pound | 91.67 | 69.67 | 88.33 | 66.83 |
While the increases in natural gas prices were not as dramatic as those of crude oil, NGL prices were significantly higher during the second quarter and first six months of 2008 compared to the same periods in 2007. These increases were indicative of the pressure on Equistar’s raw material costs, primarily crude oil-based, but also NGL-based.
RESULTS OF OPERATIONS
Revenues—Equistar’s revenues of $4,136 million in the second quarter 2008 were 17% higher compared to revenues of $3,534 million in the second quarter 2007, while the first six months of 2008 revenues of $7,957 million were 24% higher compared to revenues of $6,403 million in the first six months of 2007. The higher revenues in the second quarter and first six months of 2008 reflected the effects of higher average sales prices, partially offset by the effect of lower sales volumes, compared to the same periods in 2007. As noted in the table above, benchmark sales prices in the second quarter 2008 averaged higher compared to the second quarter 2007. Ethylene and derivative sales volumes in the second quarter 2008 were 8% lower, while ethylene co-product sales volumes were 18% lower and polymer sales volumes were 5% lower compared to the second quarter 2007.
Cost of Sales—Equistar’s cost of sales of $4,362 million in the second quarter 2008 was 30% higher compared to $3,362 million in the second quarter 2007, while cost of sales in the fist six months of 2008 of $8,269 million was 36% higher compared to $6,100 million in the first six months of 2007. The increases were primarily due to higher raw material costs resulting from the effects of higher crude oil and NGL-based raw material prices.
SG&A Expenses—Selling, general and administrative (“SG&A”) expenses were $59 million in the second quarter of 2008 compared to $72 million in the second quarter of 2007 and $129 million for the first six months of 2008 compared to $131 million for the first six months of 2007. The decreases were primarily attributable to lower compensation expense partially offset by $18 million and $48 million of higher fees incurred in the second quarter and first six months of 2008,respectively, under Equistar’s receivables sales agreement with Lyondell reflecting higher utilization of that facility compared to the 2007 periods.
Operating Income—Equistar had an operating loss of $293 million in the second quarter 2008 compared to operating income of $91 million in the second quarter 2007 and an operating loss of $457 million in the first six months of 2008 compared to operating income of $154 million in the first six months of 2007. The operating losses in the second quarter and first six months of 2008 were primarily due to lower product margins as sales prices did not increase as rapidly as raw material costs compared to the same periods in 2007. In addition, depreciation and amortization expense increased by $63 million and $121 million in the second quarter and first six months of 2008, respectively, as a result of the higher values assigned to Equistar’s assets in the acquisition.
Interest Expense—Equistar’s interest expense, excluding push-down and related party debt, was $5 million in the second quarter 2008 compared to $54 million in the second quarter 2007 and $8 million in the first six months of 2008 compared to $108 million in the first six months of 2007. The decrease was primarily due to a decrease in debt, for which Equistar is the primarily obligor, of approximately $1.4 billion from second quarter 2007 to second quarter 2008. Equistar also recognized $2 million in related party interest expense and $374 million of interest expense on push-down debt in the second quarter 2008 and $6 million in related party interest expense and $760 million of interest expense on push-down debt in the first six months of 2008.
Net Income (Loss)—Equistar’s net loss was $665 million in the second quarter 2008 compared to net income of $8 million in the second quarter 2007 and a net loss of $1,212 million in the first six months of 2008 compared to net income of $19 million in the first six months of 2007. The net loss during the second quarter of 2008 was primarily due to $374 million of interest expense on push-down debt and the operating loss in the second quarter 2008 compared to operating income in second quarter of 2007. The net loss during the first six months of 2008 was primarily due to $760 million of interest expense on push-down debt and the operating loss in the first six months of 2008 compared to operating income during the first six months of 2007. Segment operating results are discussed under the “Segment Analysis.”
Second Quarter 2008 versus First Quarter 2008
Equistar’s second quarter 2008 net loss was $665 million compared to a net loss of $547 million in the first quarter 2008. The increase of $118 million in the net loss is primarily due to higher liquid and NGL-based raw material costs, which were partly offset by increases in sales prices.
Segment Analysis
The following analysis discusses Equistar’s operating results, focusing on the two business segments: chemicals and polymers.
For purposes of evaluating segment results, management reviews operating results, as presented below, determined using the FIFO method of accounting for inventory. The following discussion is supplemental to the above “Overview” and “Results of Operations” sections, which discuss Equistar’s consolidated operating results determined using the LIFO method of accounting for inventory.
The following table sets forth Equistar’s sales and other operating revenues, operating income and selected product sales volumes.
Successor | Predecessor | Successor | Predecessor | |||||||||||||
For the three months ended | For the six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Millions of dollars | 2008 | 2007 | 2008 | 2007 | ||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Chemicals segment | $ | 3,870 | $ | 3,238 | $ | 7,462 | $ | 5,791 | ||||||||
Polymers segment | 1,066 | 882 | 2,005 | 1,692 | ||||||||||||
Intersegment eliminations | (800 | ) | (586 | ) | (1,510 | ) | (1,080 | ) | ||||||||
Total | $ | 4,136 | $ | 3,534 | $ | 7,957 | $ | 6,403 | ||||||||
Operating income (loss): | ||||||||||||||||
Chemicals segment | $ | 45 | $ | 185 | $ | (52 | ) | $ | 294 | |||||||
Polymers segment | (16 | ) | 20 | (35 | ) | 36 | ||||||||||
Other, including intersegment eliminations | 39 | - - | (27 | ) | - - | |||||||||||
LIFO adjustment | (361 | ) | (114 | ) | (343 | ) | (176 | ) | ||||||||
Total | $ | (293 | ) | $ | 91 | $ | (457 | ) | $ | 154 | ||||||
Sales volumes, in millions | ||||||||||||||||
Ethylene and derivatives (pounds): | 2,826 | 3,070 | 5,703 | 5,982 | ||||||||||||
Intersegment sales to polymers included above (pounds) | 1,269 | 1,391 | 2,537 | 2,729 | ||||||||||||
Other ethylene derivatives included above (pounds) | 603 | 604 | 1,105 | 1,152 | ||||||||||||
Ethylene co-products: | ||||||||||||||||
Non-aromatics (pounds) | 1,645 | 2,009 | 3,488 | 4,034 | ||||||||||||
Aromatics (gallons) | 70 | 87 | 149 | 182 | ||||||||||||
Polyethylene (pounds) | 1,347 | 1,404 | 2,643 | 2,788 | ||||||||||||
Polypropylene (pounds) | 49 | 62 | 91 | 132 |
Chemicals Segment
Overview—In its chemicals segment, Equistar manufactures and markets ethylene and its co-products, primarily propylene, butadiene and aromatics, which include benzene and toluene. Equistar also manufactures and markets ethylene derivatives, including ethylene glycol, ethylene oxide (“EO”) and other EO derivatives, and ethanol.
During the second quarter and first six months of 2008 compared to the same periods in 2007, U.S. ethylene markets experienced lower profitability as increases in benchmark ethylene and co-products sales prices did not keep pace with rapidly rising raw material costs. As discussed above, prices of both crude oil-based liquid raw materials and natural gas liquids-based raw materials averaged higher in the 2008 periods, with crude oil prices reaching record levels. U.S. ethylene operating rates were in the 90% to 95% range. U.S. demand for ethylene decreased an estimated 5% and 3% in the second quarter and first six months of 2008, respectively, compared to the same periods in 2007.
The chemicals segment’s operating results in the second quarter and first six months of 2008 compared to the same 2007 periods reflected the negative effects of higher raw material costs on ethylene product margins. The operating results for the first six months of 2008 also reflected the negative effect of selling inventories recorded at fair value in the acquisition of Lyondell.
Revenues—Revenues of $3,870 million in the second quarter 2008 were 20% higher compared to revenues of $3,238 million in the second quarter 2007 and revenues of $7,462 million in the first six months of 2008 were 29% higher compared to revenues of $5,791 million in the first six months of 2007. The higher revenues in the second quarter and first six months of 2008 reflected higher average sales prices, partially offset by the effect of lower sales volumes.
Operating Income—The operating income in the second quarter 2008 was $45 million compared to operating income of $185 million in the second quarter 2007, while an operating loss of $52 million in the first six months of 2008 compared to operating income of $294 million in the first six months of 2007. The decreases were primarily due to lower ethylene product margins, reflecting higher raw material costs for ethylene, and, in the first six months of 2008, a $14 million negative effect of selling inventories recorded at fair value in the acquisition.
Polymers Segment
Overview—In its polymers segment, Equistar manufactures and markets polyethylene, including high density polyethylene (“HDPE”) low density polyethylene (“LDPE”) and linear low density polyethylene (“LLDPE”), and polypropylene.
During the first six months of 2008 compared to the same 2007 period, U.S. polyethylene operating rates continued in the 90% range. While the U.S. market experienced weaker domestic demand growth in the 2008 periods, this was partly offset by continued strong export demand as a result of the weak U.S. dollar. Total U.S. demand for polyethylene increased an estimated 2% in the second quarter 2008 and decreased an estimated 1% in the first six months of 2008 compared to the same periods in 2007. Higher raw material costs in the first six months of 2008 compared to the same 2007 period put pressure on polymers product margins.
Equistar’s polymers segment operating results in the second quarter and first six months of 2008 compared to the same 2007 periods primarily reflected the effects of lower product margins due to higher raw material costs. In addition, the first six months of 2008 included an unfavorable effect from selling inventories that were recorded at fair value as a result of the Lyondell acquisition.
Revenues—Revenues of $1,066 million in the second quarter 2008 were 21% higher compared to revenues of $882 million in the second quarter 2007 and revenues of $2,005 million in the first six months of 2008 were 18% higher compared to revenues of $1,692 million in the first six months of 2007. The increase in the second quarter 2008 and first six months of 2008 revenues reflected higher average sales prices, which were partially offset by the effects of 4% and 5% lower sales volumes in the second quarter and first six months of 2008, respectively, compared to the same periods in 2007.
Operating Income—The polymers segment had an operating loss of $16 million in the second quarter 2008 compared to operating income of $20 million in the second quarter 2007 and an operating loss of $35 million in the first six months of 2008 compared to operating income of $36 million in the first six months of 2007. The decreases were primarily the result of lower product margins as well as lower sales volumes in the second quarter and first six months of 2008 compared to the same periods in 2007. In addition, the first six months of 2008 included a $24 million negative effect of selling inventories that were recorded at fair value in the acquisition.
FINANCIAL CONDITION
Operating Activities—Operating activities used cash of $140 million in the first six months of 2008 and provided cash of $191 million in the first six months of 2007. The $331 million change primarily reflected the negative effect of the net loss in the first six months of 2008 and, as indicated by changes in other, net, an increase in cash used in the 2008 period for annual payments of employee bonus awards and property taxes. This was partly offset by the effects of changes in the main components of working capital – accounts receivable and inventory, net of accounts payable – which provided cash of $168 million in the first six months of 2008 compared to $75 million in the first six months of 2007. The improvement in the 2008 period was primarily due to accelerated collections of certain customer accounts receivable as a result of Equistar’s use of discounts for early payment.
Investing Activities—Investing activities provided cash of $21 million in the first six months of 2008 and used cash of $82 million in the first six months of 2007. The $103 million improvement primarily reflected $100 million of proceeds of notes receivable from related parties and an $11 million decrease in capital expenditures in the first six months of 2008 compared to the same period in 2007. The notes receivable from related parties relate to accounts receivable sold by Equistar to Lyondell under the receivables sales agreement (see Note 6 to the Consolidated Financial Statements).
Financing Activities—Financing activities provided cash of $82 million in the first six months of 2008 and used cash of $232 million in the first six months of 2007.
In the first six months of 2008, Equistar had net borrowings of $120 million under related party loan agreements. Also during the first six months of 2008, Equistar called and repaid the remaining $28 million principal amount due under notes that were not tendered in December 2007, and paid premiums totaling $2 million.
During the first six months of 2007, Equistar borrowed $500 million under loan agreements with Millennium and used the proceeds of the Millennium loans, along with cash on hand, to repay $300 million principal amount of its 10.125% Senior Notes due 2008, $300 million principal amount of its 10.625% Senior Notes due 2011 and related premiums totaling $32 million (see Notes 5 and 11 to the Consolidated Financial Statements).
During the first six months of 2008, Equistar did not make any distributions to its owners compared to $100 million distributed in the first six months of 2007.
Liquidity and Capital Resources—At June 30, 2008, Equistar’s long-term debt, under which Equistar is the primary obligor, was $130 million, and there were no current maturities. In addition, Equistar recognized in its financial statements a total of $17,648 million of acquisition-related or push-down debt for which it is a guarantor, as described below, but is not the primary obligor (see Note 11 to the Consolidated Financial Statements). As a result of recognizing the push-down debt in its financial statements, Equistar has a $10,106 million deficit in partners’ capital; however, Equistar does not expect that it will be required to fund a substantial portion of the push-down debt.
LyondellBasell Industries manages the cash and liquidity of Equistar and its other subsidiaries as a single group and a global cash pool. Substantially all of the group’s cash is managed centrally, with operating subsidiaries participating through an intercompany uncommitted revolving credit facility. The majority of the operating subsidiaries of LyondellBasell Industries, including Equistar, have provided guarantees or collateral for the new debt of various LyondellBasell Industries subsidiaries totaling approximately $22 billion that was used primarily to acquire Lyondell. Accordingly, the major bond rating agencies have assigned a corporate rating to LyondellBasell Industries as a group relevant to such borrowings. Management believes this corporate rating is reflective of the inherent credit for Equistar, as well as for the group as a whole.
In May 2008, Moody’s Investors Service affirmed LyondellBasell Industries’ corporate rating at B1 and lowered its outlook for LyondellBasell Industries from stable to negative citing LyondellBasell Industries’ lower than expected operating results and the effect the current weakness in the U.S. olefins market may have on LyondellBasell Industries’ plan to substantially reduce debt. In April 2008, Standard & Poor’s Rating Services (“S&P”) affirmed LyondellBasell Industries’ corporate rating at B+ and lowered its outlook for LyondellBasell Industries from stable to negative. The outlook revision cited increased risks to LyondellBasell Industries in 2008 including weaker economic growth in the U.S. and Europe and a significant increase in oil prices.
In March 2008, LyondellBasell Industries entered into a senior unsecured $750 million, eighteen-month revolving credit facility, under which Lyondell and a subsidiary of the Basell Group are borrowers. The $750 million revolving credit facility is in addition to the existing credit facilities available to LyondellBasell Industries and is provided to LyondellBasell Industries by Access Industries Holdings, LLC, an affiliate of Access Industries, which indirectly owns LyondellBasell Industries. The revolving credit facility has substantially the same terms as the Senior Secured Credit Facility except that it is unsecured and is not guaranteed by the subsidiaries of LyondellBasell Industries.
As of June 30, 2008, there were no borrowings outstanding under the facility. At each borrower’s option, loans under the revolving credit facility bear interest until the first full fiscal quarter commencing on or after June 30, 2008, at rates equal to LIBOR plus 6% or the higher of the (i) federal funds rate plus 0.5% and (ii) prime rate, plus, in each case, 5%. Thereafter, interest rates will be adjusted, from time to time, based upon the First Lien Senior Secured Leverage Ratio as calculated at such time. Neither Millennium nor Equistar can borrow under this facility.
At June 30, 2008, Equistar had cash on hand of $23 million. The total amount available to borrowers under both the $1,600 million Senior Secured Inventory-Based Credit Facility and the $1,150 million Accounts Receivable Securitization Facility totaled approximately $241 million, giving effect to a total minimum unused availability requirement of $100 million under the Accounts Receivable Securitization Facility and the Senior Secured Inventory-Based Credit Facility and the total amount of outstanding letters of guarantee and letters of credit under the Senior Secured Inventory-Based Credit Facility. In addition, Equistar has up to $1,800 million available under the loan agreement with a Lyondell subsidiary subject to availability through LyondellBasell Industries’ global cash management program.
Equistar believes that its cash balances, cash generated from operating activities, funds from lines of credit and cash generated from funding under various liquidity facilities available to Equistar through LyondellBasell Industries will be adequate to meet anticipated future cash requirements, including scheduled debt repayments, necessary capital expenditures, and ongoing operations.
Debt Agreement Amendments—Under the terms of the financing for the Lyondell acquisition, the joint lead arrangers (“JLAs”) retained the right to flex certain provisions of the financing, including pricing and the reallocation and retranching of the Term Loans. Effective April 30, 2008, the JLAs exercised the price flex provisions and, in conjunction with the exercise, the Senior Secured Credit Facility was amended to (i) convert each of the U.S. Tranche B Dollar Term Loan and the German Tranche B Euro Term Loan into three separate tranches, some of which tranches are subject to a prepayment penalty, (ii) increase interest rates and fee rates by 0.5%, (iii) establish a LIBOR floor of 3.25% on the U.S. Tranche B Dollar Term Loan, (iv) modify certain debt covenants, including increasing a general debt basket from $750 million to $1,000 million, eliminating an interest rate hedging requirement, increasing the asset backed facility basket by $500 million, and adding a covenant prohibiting reduction of aggregate commitments under the Revolving Credit Facility with Access Industries before its initial maturity, (v) amend the calculation of Consolidated EBITDA, as defined, for the purpose of determining compliance with the debt requirements, to reflect adjustments to present 2007 cost of sales in accordance with FIFO inventory accounting, and (vi) make other changes, including technical and typographical corrections.
In conjunction with the exercise by the JLAs of their flex rights, additional amendments were made to each of the Senior Secured Interim Loan, Senior Secured Inventory-Based Credit Facility, Revolving Credit Facility with Access Industries and Accounts Receivable Securitization Facility. The amendments to the Senior Secured Interim Loan and Senior Secured Inventory-Based Credit Facility and the Revolving Credit Facility with Access Industries were effective on April 30, 2008. The amendments to the Accounts Receivable Securitization Facility were effective on May 6, 2008.
Each of the Senior Secured Interim Loan, the Senior Secured Inventory-Based Credit Facility, the Accounts Receivable Securitization Facility and Revolving Credit Facility with Access Industries were amended to (i) conform to certain of the amendments to the Senior Secured Credit Facility and (ii) make other changes, including technical and typographical corrections. In addition, the Senior Secured Inventory-Based Credit Facility was amended to allow Lyondell the future option to increase the aggregate amount of commitments under the facility by a further $500 million.
Under the terms of the Senior Secured Inventory-Based Credit Facility, as amended, Lyondell could elect to increase commitments under the facility by up to an aggregate $1,100 million. Effective April 30, 2008, Lyondell exercised the option to increase the facility by $600 million and, as a result, aggregate commitments under the facility increased from $1,000 million to $1,600 million. Concurrent with the exercise of the increase in commitments, Lyondell Chemical Company became a lien grantor and added the following as collateral: (i) a first priority pledge of all equity interests owned by Lyondell Chemical Company in, and all indebtedness owed to it by, LyondellBasell Receivables I, LLC (the seller under the Accounts Receivable Securitization Facility) and (ii) a first priority security interest in all accounts receivable, inventory and related assets owned by Lyondell Chemical Company, subject to customary exceptions.
Equistar is a guarantor of certain debt of the Basell Group and Lyondell. The Basell Group debt includes an $8,000 million Senior Secured Interim Loan and 8.375% High Yield Notes due 2015, comprising borrowings of $615 million and €500 million ($789 million). The Senior Secured Interim Loan, together with proceeds of other borrowings, was used to finance the acquisition of Lyondell. If not repaid or exchanged prior to the 12 months tenure, the Senior Secured Interim Loan converts to a senior secured loan in December 2008 and is due June 2015. The Senior Secured Interim Loan bears interest at LIBOR plus an initial margin of 4.625%, which margin increased in June 2008 to 5.125%, and increases by 0.5% for each three-month period thereafter, subject to a maximum interest rate of 12% per annum (or 12.5% in the event of certain ratings declines). Through a series of actions, the validity of which LyondellBasell Industries disputes, the JLAs have attempted to increase the applicable rate under the Senior Secured Interim Loan to 12% per annum. Since June 20, 2008, LyondellBasell Industries has been paying 12% interest, which is approximately 4% higher than the currently applicable rate under the Senior Secured Interim Loan as at June 30, 2008, in order to avoid any allegation of default by the lenders. LyondellBasell Industries has protested the higher rate of interest and has reserved its right to recover any such amounts based upon a determination that the JLAs’ attempt to impose a rate increase is not supported by the terms of the applicable loan documentation.
Equistar is also committed to lend amounts to Lyondell through the accounts receivable sales facility with Lyondell. Under the accounts receivable sales facility with Lyondell, Equistar sells substantially all of its domestic accounts receivable to a subsidiary of Lyondell in exchange for, at the option of Lyondell, a combination of cash and promissory notes from the subsidiary.
In addition, Equistar is a guarantor under the Senior Secured Credit Facility entered into on December 20, 2007, in connection with the acquisition of Lyondell by LyondellBasell Industries. Lyondell and other subsidiaries of the Basell Group are borrowers under the Senior Secured Credit Facility, which includes a six-year $2,000 million term loan A facility due 2013; a seven-year $7,550 million and €1,300 million term loan B facility due 2014; and a six-year $1,000 million multicurrency revolving credit facility due 2013. Equistar is also a guarantor for amounts borrowed under the senior secured inventory-based credit facility by Lyondell and other subsidiaries of Lyondell and a U.S.-based subsidiary of the Basell Group.
At June 30, 2008, amounts borrowed by the Basell Group under the Senior Secured Credit Facility consisted of $488 million borrowed under term loan A and €1,294 million ($2,043 million) under term loan B, and Lyondell borrowings included $1,465 million borrowed under term loan A and $7,512 million under term loan B. At June 30, 2008, borrowings of $1,183 million were outstanding under the Senior Secured Inventory-Based Credit Facility, $1,053 million on the part of Lyondell and $130 million on the part of the Basell Group.
In view of the interrelated nature of the credit and liquidity position of LyondellBasell Industries and its subsidiaries, and pursuant to Staff Accounting Bulletin Topic 5(j) of the Securities and Exchange Commission, Equistar has recognized debt of $17,648 million for which it is not the primary obligor, but which it has guaranteed (the push-down debt), that was used in the acquisition of Lyondell by LyondellBasell Industries.
The Senior Secured Credit Facility, Accounts Receivable Securitization Facility, senior secured inventory-based credit facility and the Senior Secured Interim Loan contain restrictive covenants, including covenants that establish maximum levels of annual capital expenditures and require the maintenance of specified financial ratios by LyondellBasell Industries on a consolidated basis. These covenants, as well as debt guarantees, are described in Note 13 to Equistar’s Consolidated Financial Statements in Item 8 of its Annual Report on Form 10-K for the year ended December 31, 2007. See “Effects of a Breach” below for discussion of the potential impact of a breach of these covenants.
The indenture governing Equistar’s 7.55% Notes due 2026 contains restrictive covenants. These covenants are described in Note 13 to Equistar’s Consolidated Financial Statements in Item 8 of its Annual Report on Form 10-K for the year ended December 31, 2007.
Effects of a Breach—A breach by Equistar or any other obligor of the covenants or the failure to pay principal and interest when due under any of the Senior Secured Credit Facility, Senior Secured Interim Loan, senior secured inventory-based credit facility, Accounts Receivable Securitization Facility or other indebtedness of Equistar or its affiliates could result in a default or cross-default under all or some of those instruments, although Equistar’s 7.55% Notes due 2026 do not have cross-acceleration or cross-default provisions. If any such default or cross default occurs, the applicable lenders may elect to declare all outstanding borrowings, together with accrued interest and other amounts payable thereunder, to be immediately due and payable. In such circumstances, the lenders under the Senior Secured Credit Facility and the Senior Secured Inventory-Based Credit Facility also have the right to terminate any commitments they have to provide further borrowings, and the counterparties under the Accounts Receivable Securitization Facility may terminate further purchases of interests in accounts receivable and receive all collections from previously sold interests until they have collected on their interests in those receivables, thus reducing the entity’s liquidity. In addition, following such an event of default, the lenders under the Senior Secured Facility and the Senior Secured Interim Loan and the counterparties under the senior secured inventory–based credit facility have the right to proceed against the collateral granted to them to secure the obligations, which in some cases includes Equistar’s available cash. If the obligations under the Senior Secured Credit Facility, the Senior Secured Interim Loan, the Senior Secured Inventory-Based Credit Facility, Accounts Receivable Securitization Facility or any other material financing arrangement were to be accelerated, it is not likely that the obligors would have, or be able to obtain, sufficient funds to make these accelerated payments, and as a result, Equistar could be forced into bankruptcy or liquidation.
Off-Balance Sheet Arrangements—Equistar’s off-balance sheet arrangements are described in Item 7 of its Annual Report on Form 10-K for the year ended December 31, 2007. Equistar’s off-balance sheet arrangements did not change materially in the quarter ended June 30, 2008.
CURRENT BUSINESS OUTLOOK
Through mid-August 2008, crude oil prices have declined from the peak levels of late June and early July 2008 and averaged close to second quarter 2008 levels, resulting in some moderation of raw material cost pressures for chemical products, but also creating downward pressure on product sales prices
The U.S. ethylene business has continued to experience volatile raw material costs and pressure on product margins. NGL raw materials have been favored over naphtha, a heavy liquid raw material, but select naphthas are economically competitive with NGLs. Chemical product sales prices have displayed positive price momentum early in the third quarter of 2008, driven by raw material costs and market tightness in certain product areas. More recently, the decline in the price of crude oil and natural gas has pressured sales prices downward in most chemical markets. Supply and demand is generally balanced with demand lagging in some areas.
In the polymers segment, U.S. product sales prices also moved up early in the quarter, but are now facing downward pressure. U.S. polyolefin products continue to be pressured by high ethylene and propylene costs, while demand is consistent with a slowing U.S. economy.
In both segments, cost and price volatility creates an uncertain outlook.
CRITICAL ACCOUNTING POLICIES
Equistar applies those accounting policies that management believes best reflect the underlying business and economic events, consistent with accounting principles generally accepted in the U.S. Inherent in such policies are certain key assumptions and estimates made by management. Management periodically updates its estimates used in the preparation of the financial statements based on its latest assessment of the current and projected business and general economic environment. Information regarding Equistar’s Critical Accounting Policies is included in Item 7 of Equistar’s Annual Report on Form 10-K for the year ended December 31, 2007.
ACCOUNTING AND REPORTING CHANGES
For a discussion of the potential impact of new accounting pronouncements on Equistar’s consolidated financial statements, see Note 3 to the Consolidated Financial Statements.
Item 3. Disclosure of Market Risk
Equistar’s exposure to market risk is described in Item 7A of its Annual Report on Form 10-K for the year ended December 31, 2007. Equistar’s exposure to market risk has not changed materially in the quarter ended June 30, 2008.
Item 4. Controls and Procedures
Equistar performed an evaluation, under the supervision and with the participation of its management, including the President and Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), of the effectiveness of Equistar’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of June 30, 2008. Based upon that evaluation, the President and Chief Executive Officer and the Chief Financial Officer concluded that Equistar’s disclosure controls and procedures are effective.
There were no changes in Equistar’s internal control over financial reporting that occurred during Equistar’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, Equistar’s internal control over financial reporting.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this report are “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements can be identified by words such as “estimate,” “believe,” “expect,” “anticipate,” “plan,” “budget” or other words that convey the uncertainty of future events or outcomes. Many of these forward-looking statements have been based on expectations and assumptions about future events that may prove to be inaccurate. While management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond Equistar’s control. Equistar’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to the following:
· | the availability, cost and price volatility of raw materials and utilities, |
· | the supply/demand balances for Equistar’s products, and the related effects of industry production capacities and operating rates, |
· | uncertainties associated with the U.S. and worldwide economies |
· | legal and environmental proceedings, |
· | the cyclical nature of the chemical industry, |
· | Equistar’s ability to service its indebtedness, |
· | available cash and access to capital markets, |
· | technological developments, |
· | operating interruptions (including leaks, explosions, fires, weather-related incidents, mechanical failures, unscheduled downtimes, supplier disruptions, labor shortages or other labor difficulties, transportation interruptions, spills and releases and other environmental risks), |
· | current and potential governmental regulatory actions in the U.S. and in other countries, |
· | international political unrest and terrorist acts, |
· | competitive products and pricing pressures, and |
· | Equistar’s ability to implement its business strategies, including integration within LyondellBasell Industries. |
Any of these 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, elsewhere in this report and in Equistar’s Annual Report on Form 10-K for the year ended December 31, 2007. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These factors are not necessarily all of the important factors that could affect Equistar. Use caution and common sense when considering these forward-looking statements. Equistar does not intend to update these statements unless securities laws require it to do so.
In addition, this Form 10-Q contains summaries of contracts and other documents. These summaries may not contain all of the information that is important to an investor, and reference is made to the actual contract or document for a more complete understanding of the contract or document involved.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments with respect to Equistar’s legal proceedings previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2007 and the Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, except as disclosed below.
Environmental Matters
In December 2006, the State of Texas filed a lawsuit in the District Court, Travis County, Texas, against Equistar and its owners, Lyondell and Millennium, alleging past violations of various environmental regulatory requirements at Equistar’s Channelview, Chocolate Bayou and La Porte, Texas facilities and Millennium’s La Porte, Texas facility, and seeking an unspecified amount of damages. The previously disclosed Texas Commission on Environmental Quality (“TCEQ”) notifications alleging noncompliance of emissions monitoring requirements at Equistar’s Channelview facility and Millennium’s La Porte facility and seeking civil penalties of $167,000 and $179,520, respectively, have been included as part of this lawsuit. In July 2008, Equistar signed an Agreed Final Judgment resolving this lawsuit. Under the terms of the settlement, Equistar Chemicals and Millennium Petrochemicals Inc. each agreed to pay $3,250,000 in penalties (with $500,000 being offset by funding of various local supplemental environmental projects by each company). The companies also agreed to each pay $250,000 in attorney fees to the state. This agreement resolved outstanding alleged violations at several company-owned and/or operated Texas facilities. No other additional expenditures are required. The settlement is still subject to public comment and final review by the Texas Attorney General and the district court.
Item 1A. Risk Factors
There have been no material developments with respect to Equistar’s risk factors previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2007 and the Quarterly Report on Form 10-Q for the quarter ended March 31, 2008 except as disclosed below.
Risks Relating to the Businesses
Costs of raw materials and energy, as well as reliability of supply, may result in increased operating expenses and reduced results of operations.
Equistar purchases large amounts of raw materials and energy for its businesses. The cost of these raw materials and energy, in the aggregate, represents a substantial portion of its operating expenses. The costs of raw materials and energy used for Equistar’s products generally follow price trends of, and vary with the market conditions for, crude oil and natural gas, which may be highly volatile and cyclical. Raw material and energy cost are at or near historically record high levels, and a weak U.S. dollar adds to the volatility in Equistar’s raw material costs. There have been, and will likely continue to be, periods of time when Equistar is unable to pass raw material and energy cost increases on to customers quickly enough to avoid adverse impacts on its results of operations. Customer consolidation also has made it more difficult to pass along cost increases to customers. Equistar’s results of operations have been, and could be in the future, significantly affected by increases and volatility in these costs. Cost increases also may increase working capital needs, which could reduce Equistar’s liquidity and cash flow. In addition, when raw material and energy costs increase rapidly and are passed along to customers as product price increases, the credit risks associated with certain customers can be compounded. To the extent Equistar increases its product sales prices to reflect rising raw material and energy costs, demand for products may decrease as customers reduce their consumption or use substitute products, which may have an adverse impact on Equistar’s results of operations.
In addition, higher North American natural gas prices relative to natural gas cost-advantaged regions, such as the Middle East, have diminished the ability of many domestic chemical producers to compete internationally since natural gas prices affect a significant portion of the industry’s raw materials and energy sources. This environment has in the past caused and may in the future cause a reduction in Equistar’s exports, and has in the past reduced and may in the future reduce the competitiveness of U.S. producers. It also has in the past increased the competition for product sales in North America, as U.S. production that would otherwise have been sold overseas was instead offered for sale domestically, resulting in excess supply and lower margins in North America, and may do so in the future.
Furthermore, across Equistar, there are a limited number of suppliers for some of its raw materials and utilities and, in some cases, the number of sources for and availability of raw materials and utilities is specific to the particular geographic region in which a facility is located. It is also common in the chemical industry for a facility to have a sole, dedicated source for its utilities, such as steam, electricity and gas. For some of Equistar’s products, the facilities and/or distribution channels of raw material suppliers and utilities suppliers and Equistar form an integrated system. This is especially true in the U.S. Gulf Coast where the infrastructure of the chemical and refining industries is tightly integrated such that a major disruption of supply of a given commodity or utility can negatively affect numerous participants, including suppliers of other raw materials. If one or more of Equistar’s significant raw material or utility suppliers were unable to meet its obligations under present supply arrangements, raw materials become unavailable within the geographic area from which they are now sourced, or supplies are otherwise disrupted, Equistar’s businesses could suffer reduced supplies or be forced to incur increased costs for their raw materials or utilities, which would have a direct negative impact on plant operations. For example, Hurricanes Katrina and Rita negatively affected crude oil and natural gas supplies, as well as supplies of some of Equistar’s other raw materials, contributing to increases in raw material prices during the second half of 2005 and, in some cases, disrupting production. In addition, hurricane-related disruption of rail and pipeline traffic in the U.S. Gulf Coast area negatively affected shipments of raw materials and product.
In addition, in light of near record raw material costs and Equistar’s current debt levels, the cost to Equistar of trade credit from its suppliers could increase or credit lines from those suppliers could be reduced, resulting in shorter payment cycles.
Risks Relating to Debt and Other Financial Obligations
Equistar’s available cash, access to additional capital and business and future prospects could be limited by its significant amount of debt and other financial obligations and the current weak condition of the capital markets.
At June 30, 2008, Equistar had $330 million of consolidated debt, including $200 million owed to related parties and the current portion of long-term debt. On December 20, 2007, Equistar recognized in its financial statements $17,692 million of acquisition-related debt or “push-down debt” under which Equistar is not the primary obligor but which it had guaranteed. In addition to the push-down debt, Equistar had also guaranteed $1.1 billion and €1.8 billion of debt of related parties. Substantially all of the indebtedness owed or guaranteed by Equistar is secured by assets of Equistar pledged as collateral. Equistar is also committed to lend substantial amounts to Lyondell, including through a $2.0 billion intercompany revolving loan agreement, which had no amount outstanding at June 30, 2008, and through its accounts receivable sales facility with Lyondell under which it is required to sell substantially all of its domestic accounts receivable to a subsidiary of Lyondell in exchange for, at the option of Lyondell, a combination of cash and promissory notes from the subsidiary. A portion of the Equistar accounts receivable sold under the facility with Lyondell may then be sold under Lyondell’s Accounts Receivable Securitization Facility.
In addition, Equistar has contractual commitments and ongoing pension and post-retirement benefit obligations that will require cash contributions in the future. See “—Contractual and Other Obligations” under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation” in Equistar’s Annual Report on Form 10-K for the year ended December 31, 2007.
Equistar’s level of debt and other obligations could have significant adverse consequences on its business and its future prospects, including that it could:
· | make Equistar more vulnerable to a downturn in its businesses, its industry or the economy in general as a significant percentage of its cash flow from operations is required to make payments on its indebtedness, making it more difficult to react to changes in its business and in market or industry conditions; |
· | require Equistar to dedicate a substantial portion of its future cash flow from operations to the payment of principal and interest on indebtedness and to satisfy other financial obligations, thereby reducing the availability of its cash flow to grow its business and to fund working capital, capital expenditures, research and development efforts and other general corporate purposes; |
· | constrain its ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, debt service requirements or other purposes, on satisfactory terms or at all, especially given the current weak environment in the capital markets; |
· | make it more difficult for it to satisfy its financial obligations; |
· | place it at a competitive disadvantage as compared to competitors that have less debt and other financial obligations and lower debt service requirements; and |
· | make it more vulnerable to increases in interest rates since part of its indebtedness is, and any future debt may be, subject to variable interest rates. |
Subsequent to the acquisition of Lyondell, LyondellBasell Industries manages the cash and liquidity of Equistar and its other subsidiaries as a single group and a global cash pool. Substantially all of the group’s cash is managed centrally, with operating subsidiaries participating through an intercompany uncommitted revolving credit facility. The majority of the operating subsidiaries of LyondellBasell Industries, including Equistar, have provided guarantees or collateral for the new debt of various LyondellBasell Industries subsidiaries totaling approximately $22 billion that was used primarily to acquire Lyondell. Accordingly, the major credit rating agencies have assigned a corporate rating to LyondellBasell Industries as a group relevant to such borrowings. Management believes this corporate rating is reflective of the inherent credit for Equistar, as well as for the group as a whole.
In the event that LyondellBasell Industries’ ratings are lowered by any of the major credit rating agencies, LyondellBasell Industries (including Equistar) may have increased borrowing costs for trade credit and other indebtedness, and any new financing or credit facilities, if available at all, may not be on terms as attractive as those LyondellBasell Industries and Equistar have currently or other terms acceptable to LyondellBasell Industries and Equistar. LyondellBasell Industries’ operating subsidiaries (including Equistar) also could be required to provide cash collateral to obtain surety bonds or other forms of credit, which would reduce available cash or require additional financing.
For a discussion regarding Equistar’s ability to pay or refinance its debt and satisfy its other financial obligations, see the “—Liquidity and Capital Resources” section under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Equistar’s Annual Report on Form 10-K for the year ended December 31, 2007.
The substantial level of indebtedness and other financial obligations of Equistar, as well of LyondellBasell Industries generally, also increases the possibility that Equistar, or another borrower whose obligations are guaranteed by Equistar, may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of its indebtedness and other financial obligations. If Equistar, or another borrower for which Equistar is a guarantor, were unable to pay principal and interest on debt, a default would exist under the terms of that debt instrument, which could have significant adverse consequences for Equistar.
Equistar’s variable rate obligations subject it to interest rate risk and, in addition, interest rates under the Senior Secured Interim Loan are subject to increase for other reasons, which could cause its debt service obligations to increase significantly.
As of June 30, 2008, Equistar was an obligor with respect to variable rate borrowings under the Senior Secured Credit Facilities and the Senior Secured Interim Loan of approximately $20,622 million. Although Equistar and its co-obligors may have interest rate hedge arrangements in effect from time to time, its interest expense could increase if interest rates increase, because its variable rate obligations may not be fully hedged and they bear interest at floating rates, generally equal to adjusted EURIBOR and LIBOR plus an applicable margin. Additionally, the Senior Secured Credit Facility, the Senior Secured Asset-Based Facilities, consisting of an Accounts Receivable Securitization Facility and a Senior Secured Inventory-Based Credit Facility, may bear interest at an alternate base rate plus an applicable margin. In addition, the Senior Secured Interim Loan bears interest at LIBOR plus an initial margin of 4.625%, which margin increased in June 2008 to 5.125%, and increases by 0.5% for each three-month period thereafter, subject to a maximum interest rate of 12% per annum (or 12.5% in the event of certain ratings declines). Through a series of actions, the validity of which LyondellBasell Industries disputes, the joint lead arrangers of the Senior Secured Interim Loan have attempted to increase the applicable rate under the Senior Secured Interim Loan to 12% per annum. Since June 20, 2008, LyondellBasell Industries has been paying 12% interest, which is approximately 4% higher than the currently applicable rate under the Senior Secured Interim Loan as at June 20, 2008, in order to avoid any allegation of default by the lenders. LyondellBasell Industries has protested the higher rate of interest and has reserved its right to recover any such amounts based upon a determination that the joint lead arrangers’ attempt to impose a rate increase is not supported by the terms of the applicable loan documentation. A 0.5% increase in the interest rate on variable rate obligations as at June 30, 2008 would cost Equistar approximately $89 million per year in incremental interest expense.
Item 6. Exhibits
3.2(a) | First Supplement to Amended and Restated Limited Partnership Agreement (filed as an exhibit to the Registrant’s Current Report on Form 8-K filed on April 14, 2008 and incorporated herein by reference) | |
4.2 | Amended and Restated Senior Secured Credit Agreement Dated as of April 30, 2008 (filed as an exhibit to Lyondell Chemical Company’s Current Report on Form 8-K filed on May 6, 2008 and incorporated herein by reference) | |
4.3 | Amended and Restated Bridge (Interim) Loan Credit Agreement Dated as of April 30, 2008 (filed as an exhibit to Lyondell Chemical Company’s Current Report on Form 8-K filed on May 6, 2008 and incorporated herein by reference) | |
4.5(a) | Amendment No. 1 to Senior Secured Inventory-Based Credit Agreement Dated as of April 30, 2008 (filed as an exhibit to Lyondell Chemical Company’s Current Report on Form 8-K filed on May 6, 2008 and incorporated herein by reference) | |
4.8(a) | Amendment No. 1 to Receivables Purchase Agreement and Undertaking Agreement Dated as of April 30, 2008 (filed as an exhibit to Lyondell Chemical Company’s Current Report on Form 8-K filed on May 7, 2008 and incorporated herein by reference) | |
31.1 | Rule 13a – 14(a)/15d – 14(a) Certification of Principal Executive Officer | |
31.2 | Rule 13a – 14(a)/15d – 14(a) Certification of Principal Financial Officer | |
32.1 | Section 1350 Certification of Principal Executive Officer | |
32.2 | Section 1350 Certification of Principal Financial Officer |
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 14, 2008 | /s/ Eberhard Faller | |
Eberhard Faller | ||
Vice President, Controller and Chief Accounting Officer | ||
(Duly Authorized and Principal Accounting Officer) |