UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2004
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 incorporation or organization) | (I.R.S. Employer Identification No.) | |
1221 McKinney Street, Suite 700, Houston, Texas | 77010 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (713) 652-7200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
There is no established public trading market for the registrant’s equity securities.
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended | For the nine months ended | |||||||||||||||
Millions of dollars | 2004 | 2003 | 2004 | 2003 | ||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Trade | $ | 1,816 | $ | 1,225 | $ | 4,888 | $ | 3,669 | ||||||||
Related parties | 623 | 417 | 1,612 | 1,211 | ||||||||||||
2,439 | 1,642 | 6,500 | 4,880 | |||||||||||||
Cost of sales | 2,255 | 1,561 | 6,063 | 4,754 | ||||||||||||
Selling, general and administrative expenses | 47 | 47 | 129 | 131 | ||||||||||||
Research and development expenses | 8 | 10 | 23 | 29 | ||||||||||||
(Gain) loss on asset dispositions | — | 12 | (4 | ) | 26 | |||||||||||
2,310 | 1,630 | 6,211 | 4,940 | |||||||||||||
Operating income (loss) | 129 | 12 | 289 | (60 | ) | |||||||||||
Interest expense | (57 | ) | (53 | ) | (171 | ) | (159 | ) | ||||||||
Interest income | 2 | 2 | 6 | 6 | ||||||||||||
Other expense, net | (2 | ) | (1 | ) | (4 | ) | (22 | ) | ||||||||
Net income (loss) | $ | 72 | $ | (40 | ) | $ | 120 | $ | (235 | ) | ||||||
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
CONSOLIDATED BALANCE SHEETS
Millions of dollars | September 30, 2004 | December 31, 2003 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 147 | $ | 199 | ||||
Accounts receivable: | ||||||||
Trade, net | 651 | 471 | ||||||
Related parties | 162 | 137 | ||||||
Inventories | 497 | 408 | ||||||
Prepaid expenses and other current assets | 34 | 46 | ||||||
Total current assets | 1,491 | 1,261 | ||||||
Property, plant and equipment, net | 3,198 | 3,334 | ||||||
Investments | 60 | 60 | ||||||
Other assets, net | 376 | 373 | ||||||
Total assets | $ | 5,125 | $ | 5,028 | ||||
LIABILITIES AND PARTNERS’ CAPITAL | ||||||||
Current liabilities: | ||||||||
Accounts payable: | ||||||||
Trade | $ | 522 | $ | 462 | ||||
Related parties | 59 | 51 | ||||||
Current maturities of long-term debt | 1 | — | ||||||
Accrued liabilities | 233 | 241 | ||||||
Total current liabilities | 815 | 754 | ||||||
Long-term debt | 2,312 | 2,314 | ||||||
Other liabilities and deferred revenues | 380 | 359 | ||||||
Commitments and contingencies | ||||||||
Partners’ capital: | ||||||||
Partners’ accounts | 1,639 | 1,619 | ||||||
Accumulated other comprehensive loss | (21 | ) | (18 | ) | ||||
Total partners’ capital | 1,618 | 1,601 | ||||||
Total liabilities and partners’ capital | $ | 5,125 | $ | 5,028 | ||||
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, | ||||||||
Millions of dollars | 2004 | 2003 | ||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | 120 | $ | (235 | ) | |||
Adjustments to reconcile net income (loss) to cash provided by operating activities: | ||||||||
Depreciation and amortization | 234 | 230 | ||||||
Deferred revenues | — | 159 | ||||||
Deferred maintenance turnaround expenditures | (55 | ) | (65 | ) | ||||
(Gain) loss on asset dispositions | (4 | ) | 26 | |||||
Debt prepayment premiums and charges | — | 19 | ||||||
Changes in assets and liabilities that (used) provided cash: | ||||||||
Accounts receivable | (205 | ) | 56 | |||||
Inventories | (89 | ) | (36 | ) | ||||
Accounts payable | 80 | (8 | ) | |||||
Accrued interest | (16 | ) | (29 | ) | ||||
Other assets and liabilities, net | 11 | (19 | ) | |||||
Cash provided by operating activities | 76 | 98 | ||||||
Cash flows from investing activities: | ||||||||
Expenditures for property, plant and equipment | (69 | ) | (62 | ) | ||||
Proceeds from sales of assets | 41 | 69 | ||||||
Cash (used in) provided by investing activities | (28 | ) | 7 | |||||
Cash flows from financing activities: | ||||||||
Distributions to owners | (100 | ) | — | |||||
Issuance of long-term debt | — | 439 | ||||||
Repayment of long-term debt | — | (469 | ) | |||||
Net borrowing under lines of credit | — | 29 | ||||||
Other | — | (3 | ) | |||||
Cash used in financing activities | (100 | ) | (4 | ) | ||||
(Decrease) increase in cash and cash equivalents | (52 | ) | 101 | |||||
Cash and cash equivalents at beginning of period | 199 | 27 | ||||||
Cash and cash equivalents at end of period | $ | 147 | $ | 128 | ||||
See Notes to the Consolidated Financial Statements.
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EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Preparation
The accompanying consolidated financial statements are unaudited and have been prepared from the books and records of Equistar Chemicals, LP (“Equistar”) in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X for interim financial information. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal, recurring adjustments, considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and notes thereto for the year ended December 31, 2003 included in the Equistar 2003 Annual Report on Form 10-K.
2. Company Ownership
Equistar, a Delaware limited partnership which commenced operations on December 1, 1997, is owned 70.5% by Lyondell Chemical Company (“Lyondell”) and 29.5% by Millennium Chemicals Inc. (“Millennium”).
In late March 2004, Lyondell and Millennium executed a definitive agreement for Lyondell to acquire Millennium in a stock-for-stock business combination. Upon completion of the transaction, Lyondell would, through subsidiaries of Lyondell and Millennium, own 100% of Equistar. The proposed transaction is subject to approval by Lyondell and Millennium shareholders and other customary conditions. The proposed transaction is expected to close after the close of business on November 30, 2004; however, there can be no assurance that the proposed transaction will be completed.
3. Accounts Receivable
The outstanding amount of Equistar’s accounts receivable sold under its $450 million, four-year accounts receivable sales facility was $120 million at September 30, 2004 and $102 million at December 31, 2003. The Equistar accounts receivable sales facility was amended in June 2004 to clarify certain provisions.
4. Inventories
Inventories consisted of the following:
Millions of dollars | September 30, 2004 | December 31, 2003 | ||||
Finished goods | $ | 264 | $ | 223 | ||
Work-in-process | 12 | 12 | ||||
Raw materials | 131 | 83 | ||||
Materials and supplies | 90 | 90 | ||||
Total inventories | $ | 497 | $ | 408 | ||
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EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
5. Property, Plant and Equipment, Net
The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows:
Millions of dollars | September 30, 2004 | December 31, 2003 | ||||||
Land | $ | 77 | $ | 76 | ||||
Manufacturing facilities and equipment | 6,037 | 6,015 | ||||||
Construction in progress | 75 | 63 | ||||||
Total property, plant and equipment | 6,189 | 6,154 | ||||||
Less accumulated depreciation | (2,991 | ) | (2,820 | ) | ||||
Property, plant and equipment, net | $ | 3,198 | $ | 3,334 | ||||
Depreciation and amortization is summarized as follows:
For the three months ended | For the nine months ended | |||||||||||
Millions of dollars | 2004 | 2003 | 2004 | 2003 | ||||||||
Property, plant and equipment | $ | 64 | $ | 61 | $ | 185 | $ | 185 | ||||
Turnaround costs | 10 | 8 | 29 | 22 | ||||||||
Software costs | 4 | 4 | 12 | 12 | ||||||||
Other | 3 | 3 | 8 | 11 | ||||||||
Total depreciation and amortization | $ | 81 | $ | 76 | $ | 234 | $ | 230 | ||||
In addition, amortization of debt issuance costs of $1 million and $2 million for the three-month periods ended September 30, 2004 and 2003, respectively, and $4 million and $6 million for the nine-month periods ended September 30, 2004 and 2003, respectively, is included in interest expense in the Consolidated Statements of Income.
6. Deferred Revenues
Deferred revenues at September 30, 2004 of $161 million represent advances from customers for partial prepayments for products to be delivered under long-term product supply contracts. Trade sales and other operating revenues include $4 million in each of the three-month periods ended September 30, 2004 and 2003, and $12 million and $8 million in the nine-month periods ended September 30, 2004 and 2003, respectively, of such previously deferred revenues.
5
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
7. Long-Term Debt
Long-term debt consisted of the following:
Millions of dollars | September 30, 2004 | December 31, 2003 | ||||
Inventory-based revolving credit facility | $ | — | $ | — | ||
Other debt obligations: | ||||||
Notes due 2006, 6.5% | 150 | 150 | ||||
Senior Notes due 2008, 10.125% | 700 | 700 | ||||
Notes due 2009, 8.75% | 600 | 600 | ||||
Senior Notes due 2011, 10.625% | 700 | 700 | ||||
Debentures due 2026, 7.55% | 150 | 150 | ||||
Other | 4 | 4 | ||||
Unamortized premium, net | 9 | 10 | ||||
Total long-term debt | 2,313 | 2,314 | ||||
Less current maturities | 1 | — | ||||
Total long-term debt, net | $ | 2,312 | $ | 2,314 | ||
The Equistar credit facility was amended in June 2004 to clarify certain provisions. Lyondell remains a guarantor of $300 million of Equistar debt, consisting of the 6.5% notes due 2006 and the 7.55% debentures due 2026. The unaudited consolidated financial statements of Lyondell are filed as an exhibit to Equistar’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2004.
8. Pension and Other Postretirement Benefits
Net periodic pension and other postretirement benefit costs included the following components for the periods presented:
Pension Benefits | Other Postretirement Benefits | |||||||||||||||||||||||||||
For the three months ended September 30, | For the nine months ended September 30, | For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||||||||||||
Millions of dollars | 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | 2004 | 2003 | ||||||||||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||||||||||||||
Service cost | $ | 5 | $ | 4 | $ | 14 | $ | 13 | $ | 1 | $ | 1 | $ | 2 | $ | 2 | ||||||||||||
Interest cost | 3 | 3 | 9 | 8 | 2 | 2 | 6 | 6 | ||||||||||||||||||||
Recognized gain on plan assets | (3 | ) | (2 | ) | (8 | ) | (6 | ) | — | — | — | — | ||||||||||||||||
Actuarial and investment loss amortization | 1 | 2 | 3 | 5 | — | — | 1 | 1 | ||||||||||||||||||||
Net periodic benefit cost | $ | 6 | $ | 7 | $ | 18 | $ | 20 | $ | 3 | $ | 3 | $ | 9 | $ | 9 | ||||||||||||
TheMedicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was enacted in December 2003. In January 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 106-1,Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. As permitted by FSP FAS 106-1, Equistar elected to defer recognition of the effects of the Act in accounting for its plans until the FASB developed and issued authoritative guidance on accounting for subsidies provided by the Act. In May 2004, the FASB issued FSP FAS 106-2 of the
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EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
same title, which gave final guidance on accounting for subsidies under the Act and requires Equistar to implement its provisions no later than the third quarter 2004, if the effects are significant. Equistar does not expect the Act to have a significant effect on its financial statements. Through September 30, 2004, the accumulated postretirement benefit obligation and the net periodic postretirement benefit costs do not reflect any potential benefit associated with the subsidy.
9. Commitments and Contingencies
Leased Facility—Equistar’s Lake Charles facility has been idled since the first quarter of 2001, pending sustained improvement in market conditions. The facility and land, which are included in property, plant and equipment at a net book value of $146 million, are leased from a subsidiary of Occidental Petroleum Corporation (together with its subsidiaries and affiliates, “Occidental”). In May 2003, Equistar and Occidental entered into a new one-year lease, which has renewal provisions for two additional one-year periods at either party’s option. Equistar exercised its first one-year renewal option in April 2004.
Indemnification Arrangements—Lyondell, Millennium and Occidental have each agreed to provide certain indemnifications or guarantees thereof to Equistar with respect to the petrochemicals and polymers businesses they each contributed. In addition, Equistar has agreed to assume third party claims that are related to certain contingent liabilities arising prior to the contribution transactions that are filed prior to December 1, 2004 as to Lyondell and Millennium, and May 15, 2005 as to Occidental, to the extent the aggregate thereof does not exceed $7 million for each entity, subject to certain terms of the respective asset contribution agreements. As of September 30, 2004, Equistar had incurred the full $21 million assumed for these claims and liabilities. Lyondell, Millennium, Occidental and Equistar remain liable under these indemnification or guarantee arrangements to the same extent as they were before Lyondell’s August 2002 acquisition of Occidental’s interest in Equistar and will continue to remain liable to the same extent after the closing of the proposed transaction between Lyondell and Millennium – see Note 2.
Environmental Remediation—Equistar’s accrued liability for environmental matters as of September 30, 2004 was $1 million and primarily related to the Port Arthur facility, which was permanently shut down in February 2001. In the opinion of management, there is currently no material estimable range of possible loss in excess of the liability recorded for environmental remediation.
Clean Air Act—The eight-county Houston/Galveston region has been designated a severe non-attainment area for ozone by the U.S. Environmental Protection Agency (“EPA”) under a “one-hour” ozone standard. Emission reduction controls for nitrogen oxides (“NOx”), which contribute to ozone formation, must be installed at each of Equistar’s six plants located in the Houston/Galveston region prior to a November 2007 compliance deadline for the one-hour ozone standard. Revised rules adopted by the regulatory agencies changed the required NOx emission reduction levels from 90% to 80%. Under the revised 80% standard, Equistar estimates that the incremental capital expenditures would range between $165 million and $200 million. Equistar’s cumulative capital expenditures through September 30, 2004 totaled $96 million. This estimate could be affected by increased costs for stricter proposed controls over highly reactive, volatile organic compounds (“HRVOCs”). The regulatory agency for the state of Texas, the Texas Commission on Environmental Quality (“TCEQ”), plans to finalize the HRVOC rules by December 2004. Equistar is still assessing the impact of the proposed HRVOC revisions. In addition, in April 2004, the EPA designated the eight-county Houston/Galveston region a moderate non-attainment area under an “eight-hour” ozone standard. As a result, the TCEQ must submit a plan to the EPA in 2007 to demonstrate compliance with the eight-hour ozone standard in 2010. The TCEQ is continuing with its current plan to revise the HRVOC rules in 2004. The timing and amount of the estimated expenditures are subject to these regulatory and other uncertainties, as well as to obtaining the necessary permits and approvals. There can be no assurance as to the ultimate cost of implementing any plan developed to comply with the final ozone standards.
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EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
General—Equistar is involved in various lawsuits and proceedings. Subject to the uncertainty inherent in all litigation, management believes the resolution of these proceedings will not have a material adverse effect on the financial position, liquidity or results of operations of Equistar.
10. Comprehensive Income
The components of comprehensive income (loss) were as follows:
For the three months ended September 30, | For the nine months ended September 30, | ||||||||||||||
Millions of dollars | 2004 | 2003 | 2004 | 2003 | |||||||||||
Net income (loss) | $ | 72 | $ | (40 | ) | $ | 120 | $ | (235 | ) | |||||
Other comprehensive loss | — | — | (3 | ) | — | ||||||||||
Comprehensive income (loss) | $ | 72 | $ | (40 | ) | $ | 117 | $ | (235 | ) | |||||
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EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)
11. Segment and Related Information
Equistar operates in two reportable segments:
• | Petrochemicals, including ethylene, ethylene glycol, ethylene oxide and derivatives, propylene, butadiene, and aromatics; and |
• | Polymers, primarily polyethylene. |
Summarized financial information concerning Equistar’s reportable segments is shown in the following table. Intersegment sales between the petrochemicals and polymers segments were based on then-current market prices.
Millions of dollars | Petrochemicals | Polymers | Unallocated | Eliminations | Total | ||||||||||||||
For the three months ended September 30, 2004: | |||||||||||||||||||
Sales and other operating revenues: | |||||||||||||||||||
Customers | $ | 1,772 | $ | 667 | $ | — | $ | — | $ | 2,439 | |||||||||
Intersegment | 505 | — | — | (505 | ) | — | |||||||||||||
Total sales and other operating revenues | 2,277 | 667 | — | (505 | ) | 2,439 | |||||||||||||
Operating income | 132 | 32 | (35 | ) | — | 129 | |||||||||||||
For the three months ended September 30, 2003: | |||||||||||||||||||
Sales and other operating revenues: | |||||||||||||||||||
Customers | $ | 1,125 | $ | 517 | $ | — | $ | — | $ | 1,642 | |||||||||
Intersegment | 366 | — | — | (366 | ) | — | |||||||||||||
Total sales and other operating revenues | 1,491 | 517 | — | (366 | ) | 1,642 | |||||||||||||
Operating income (loss) | 66 | (19 | ) | (35 | ) | — | 12 | ||||||||||||
For the nine months ended September 30, 2004: | |||||||||||||||||||
Sales and other operating revenues: | |||||||||||||||||||
Customers | $ | 4,673 | $ | 1,827 | $ | — | $ | — | $ | 6,500 | |||||||||
Intersegment | 1,437 | — | — | (1,437 | ) | — | |||||||||||||
Total sales and other operating revenues | 6,110 | 1,827 | — | (1,437 | ) | 6,500 | |||||||||||||
Operating income | 372 | 12 | (95 | ) | — | 289 | |||||||||||||
For the nine months ended September 30, 2003: | |||||||||||||||||||
Sales and other operating revenues: | |||||||||||||||||||
Customers | $ | 3,404 | $ | 1,476 | $ | — | $ | — | $ | 4,880 | |||||||||
Intersegment | 1,104 | — | — | (1,104 | ) | — | |||||||||||||
Total sales and other operating revenues | 4,508 | 1,476 | — | (1,104 | ) | 4,880 | |||||||||||||
Operating income (loss) | 119 | (81 | ) | (98 | ) | — | (60 | ) |
The unallocated amounts included in operating income (loss) consisted principally of general and administrative expenses.
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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 (“Equistar”) and the notes thereto.
In addition to comparisons of current operating results with the same period in the prior year, Equistar has included certain “trailing quarter” comparisons of third quarter 2004 operating results to second quarter 2004 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 the current business direction of Equistar.
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.
OVERVIEW
General— Equistar produces and markets olefins, including ethylene, propylene, and butadiene; aromatics, including benzene and toluene; and oxygenated products, including ethylene oxide and derivatives, ethylene glycol, ethanol and methyl tertiary butyl ether (“MTBE”) in its petrochemicals segment. Additionally, Equistar produces and markets polyolefins, including high density polyethylene (“HDPE”), low density polyethylene (“LDPE”), linear-low density polyethylene (“LLDPE”) and polypropylene; and performance polymers products, including wire and cable insulating resins, and polymeric powders in its polymers segment.
A stronger global economy led to increased demand and tighter chemical industry supply/demand balances in the third quarter and first nine months of 2004 compared to the third quarter and first nine months of 2003. U.S. ethylene demand grew an estimated 9% in the third quarter and first nine months of 2004 compared to the same periods in 2003. In this improved business environment, the industry experienced higher sales volumes and generally higher product margins in the third quarter and first nine months of 2004 compared to the same periods in 2003.
Equistar was generally able to implement sales price increases that more than offset the effect of significantly higher raw material and energy costs. In addition to higher sales prices for ethylene and derivatives, Equistar benefited from significantly higher prices for co-products such as propylene, benzene and fuels. The higher raw material and energy costs in the third quarter and first nine months of 2004 reflected the effect of a significant escalation in crude oil prices and ongoing high natural gas costs compared to the same periods in 2003.
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 Equistar. Olefins are produced from two major raw material groups:
• | crude oil-based liquids (“liquids”), including naphthas, condensates, and gas oils, the prices of which are generally related to crude oil prices; and |
• | natural gas liquids (“NGL’s”), principally ethane and propane, the prices of which are generally affected by natural gas prices. |
Equistar has the ability to shift its ratio of raw materials used in the production of olefins to take advantage of the relative costs of liquids and NGL’s.
10
The following table shows the average benchmark prices for crude oil and natural gas for the applicable periods, as well as benchmark sales prices for ethylene and co-product propylene, which Equistar produces and sells. The benchmark weighted average cost of ethylene production is based on CMAI’s estimated average ratio of liquid and NGL raw materials used in U.S. ethylene production and is subject to revision.
Average Benchmark Price | ||||||||
For the three months ended | For the nine months ended September 30, | |||||||
2004 | 2003 | 2004 | 2003 | |||||
Crude oil – dollars per barrel | 43.87 | 30.20 | 39.12 | 31.10 | ||||
Natural gas – dollars per million BTUs | 5.68 | 4.95 | 5.62 | 5.51 | ||||
Weighted average cost of ethylene production – cents per pound | 23.92 | 18.84 | 21.79 | 19.50 | ||||
Ethylene – cents per pound | 32.83 | 27.25 | 31.94 | 28.67 | ||||
Propylene – cents per pound | 30.83 | 19.33 | 29.67 | 21.83 |
In the third quarter and first nine months of 2004, as indicated in the above table, benchmark crude oil prices continued to escalate compared to the same periods in 2003, putting upward pressure on the cost of crude oil-based liquid raw materials.
RESULTS OF OPERATIONS
Net Income—Equistar’s net income was $72 million and $120 million in the third quarter and first nine months of 2004, respectively, compared to net losses of $40 million and $235 million in the third quarter and first nine months of 2003, respectively. The improvements were due to higher sales prices and margins, and to higher sales volumes. The higher sales prices more than offset the effect of significantly higher raw material and energy costs compared to the 2003 periods. In addition to higher sales prices for ethylene and derivatives, Equistar benefited from significantly higher prices for co-products such as propylene, benzene and fuels compared to the 2003 periods. The higher raw material and energy costs during the 2004 periods reflected the effect of 45% and 26% higher average benchmark crude oil prices in the third quarter and first nine months of 2004, respectively, as well as ongoing high natural gas prices compared to the 2003 periods. As a result of higher demand, ethylene and derivative sales volumes for the third quarter and first nine months of 2004 were 6% and 11% higher, respectively, compared to the 2003 periods. The third quarter 2003 was negatively affected by an $11 million charge for the write-off of a polymer research and development (“R&D”) facility. In addition to the $11 million charge for the write-off of the polymer R&D facility, the first nine months of 2003 included $19 million of refinancing costs and a $12 million loss from the sale of a polypropylene production facility.
Third Quarter 2004 versus Second Quarter 2004
Equistar’s third quarter 2004 net income of $72 million compares to net income of $43 million in the second quarter 2004. The $29 million improvement primarily resulted from higher sales prices of ethylene derivatives, which more than offset the higher raw material costs compared to the second quarter 2004. In addition, ethylene and derivative sales volumes were 3% higher compared to the second quarter 2004. Ethylene margins were relatively unchanged as the increase in raw material costs of approximately $160 million compared to the second quarter 2004 was substantially offset by higher sales prices for ethylene and co-products, particularly benzene. The average benchmark price of benzene was $3.62 per gallon, which was 50% higher than in the second quarter 2004.
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Segment Data
The following tables reflect selected sales volume data, including intersegment sales volumes, and summarized financial information for Equistar’s business segments.
For the three months ended September 30, | For the nine months ended | |||||||||||||||
In millions | 2004 | 2003 | 2004 | 2003 | ||||||||||||
Selected petrochemicals products: | ||||||||||||||||
Olefins (pounds) | 4,568 | 3,976 | 13,228 | 11,620 | ||||||||||||
Aromatics (gallons) | 99 | 96 | 272 | 288 | ||||||||||||
Polymers products (pounds) | 1,536 | 1,405 | 4,451 | 3,945 | ||||||||||||
Millions of dollars | ||||||||||||||||
Sales and other operating revenues: | ||||||||||||||||
Petrochemicals segment | $ | 2,277 | $ | 1,491 | $ | 6,110 | $ | 4,508 | ||||||||
Polymers segment | 667 | 517 | 1,827 | 1,476 | ||||||||||||
Intersegment eliminations | (505 | ) | (366 | ) | (1,437 | ) | (1,104 | ) | ||||||||
Total | $ | 2,439 | $ | 1,642 | $ | 6,500 | $ | 4,880 | ||||||||
Cost of sales: | ||||||||||||||||
Petrochemicals segment | $ | 2,141 | $ | 1,421 | $ | 5,728 | $ | 4,377 | ||||||||
Polymers segment | 619 | 506 | 1,772 | 1,481 | ||||||||||||
Intersegment eliminations | (505 | ) | (366 | ) | (1,437 | ) | (1,104 | ) | ||||||||
Total | $ | 2,255 | $ | 1,561 | $ | 6,063 | $ | 4,754 | ||||||||
Other operating expenses: | ||||||||||||||||
Petrochemicals segment | $ | 5 | $ | 4 | $ | 10 | $ | 12 | ||||||||
Polymers segment | 15 | 30 | 43 | 76 | ||||||||||||
Unallocated | 35 | 35 | 95 | 98 | ||||||||||||
Total | $ | 55 | $ | 69 | $ | 148 | $ | 186 | ||||||||
Operating income (loss): | ||||||||||||||||
Petrochemicals segment | $ | 132 | $ | 66 | $ | 372 | $ | 119 | ||||||||
Polymers segment | 32 | (19 | ) | 12 | (81 | ) | ||||||||||
Unallocated | (35 | ) | (35 | ) | (95 | ) | (98 | ) | ||||||||
Total | $ | 129 | $ | 12 | $ | 289 | $ | (60 | ) | |||||||
Petrochemicals Segment
Revenues—Revenues of $2,277 million in the third quarter 2004 increased 53% compared to revenues of $1,491 million in the third quarter 2003, while revenues of $6,110 million in the first nine months of 2004 increased 36% compared to revenues of $4,508 million in the first nine months of 2003. The increases reflect higher average sales prices and higher sales volumes during the 2004 periods compared to the 2003 periods. Benchmark ethylene sales prices were 20% and 11% higher in the third quarter and first nine months of 2004, respectively, compared to the third quarter and first nine months of 2003. Increases in sales prices of co-products were much more significant. Benchmark benzene sales prices averaged 158% and 70% higher and benchmark propylene sales prices averaged 59% and 36% higher in the third quarter and first nine months of 2004, respectively, compared to the third quarter and first nine months of 2003. Sales volumes were 13% higher in the third quarter 2004 compared to the third quarter 2003 and 11% higher in the first nine months of 2004 compared to the first nine months of 2003.
Cost of Sales—Cost of sales of $2,141 million in the third quarter 2004 increased 51% compared to $1,421 million in the third quarter 2003, while cost of sales of $5,728 million in the first nine months of 2004 increased 31% compared to $4,377 million in the first nine months of 2003. The increases reflect the higher cost of raw materials and the higher sales volumes. The cost of liquid raw materials was affected by 45% higher average benchmark crude oil costs in the third quarter 2004 compared to the third quarter 2003 and 26% higher average benchmark crude oil costs in the first nine months of 2004 compared to the first nine months of 2003.
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Operating Income—Operating income in the third quarter 2004 was $132 million compared to operating income of $66 million in the third quarter 2003, while operating income was $372 million in the first nine months of 2004 compared to operating income of $119 million in the first nine months of 2003. The increases were primarily due to higher product margins and higher sales volumes in the 2004 periods due to improved supply/demand fundamentals compared to the 2003 periods. The effect of sales price increases in response to higher raw material and energy costs were generally more favorable in the 2004 periods than in the 2003 periods, resulting in higher average product margins in the 2004 periods.
Polymers Segment
Revenues—Revenues of $667 million in the third quarter 2004 increased 29% compared to revenues of $517 million in the third quarter 2003, while revenues of $1,827 million in the first nine months of 2004 increased 24% compared to revenues of $1,476 million in the first nine months of 2003. The increases were due to higher average sales prices and higher sales volumes in the 2004 periods compared to the 2003 periods. The average sales price increases in the 2004 periods reflected higher demand and higher raw material costs. Sales volumes were 9% higher in the third quarter 2004 compared to the third quarter 2003 and 13% higher in the first nine months of 2004 compared to the first nine months of 2003, reflecting the stronger demand.
Cost of Sales—Cost of sales of $619 million in the third quarter 2004 increased 22% compared to $506 million in the third quarter 2003, while cost of sales of $1,772 million in the first nine months of 2004 increased 20% compared to $1,481 million in the first nine months of 2003. The increases reflect higher raw material costs, primarily ethylene, along with the increases in sales volumes. Benchmark ethylene costs were 20% higher in the third quarter 2004 compared to the third quarter 2003 and 11% higher in the first nine months of 2004 compared to the first nine months of 2003.
Other Operating Expenses—Other operating expenses were $15 million in the third quarter 2004 compared to $30 million in the third quarter 2003, while other operating expenses were $43 million in the first nine months of 2004 compared to $76 million in the first nine months of 2003. The third quarter and first nine months of 2003 included the $11 million charge for the write-off of the polymer R&D facility. In addition, the first nine months of 2003 included the $12 million loss on the sale of Equistar’s polypropylene production facility in Pasadena, Texas.
Operating Income—Operating income was $32 million and $12 million in the third quarter and first nine months of 2004, respectively, compared to operating losses of $19 million and $81 million in the third quarter and first nine months of 2003, respectively. The improvements in the 2004 periods were the result of higher product margins, especially in the third quarter 2004, and higher sales volumes compared to the 2003 periods. In addition, operating income in the third quarter and first nine months of 2003 reflected the charges noted above under “Other Operating Expenses.”
FINANCIAL CONDITION
Operating Activities—Operating activities provided cash of $76 million in the first nine months of 2004 and $98 million in the first nine months of 2003. The earnings improvement, resulting in net income of $120 million in the first nine months of 2004 compared to a net loss of $235 million in the first nine months of 2003, was substantially offset by a net increase of $214 million in the main components of working capital – receivables, inventory and payables – in the first nine months of 2004 compared to a net decrease of $12 million in the 2003 period. In addition, a payment of $159 million was received in the first nine months of 2003 as a partial prepayment for propylene to be delivered over a period of 15 years in connection with a long-term propylene supply arrangement entered into in March 2003.
The increase in working capital in the first nine months of 2004 was primarily due to higher accounts receivable balances, which reflected higher product sales prices and sales volumes compared to the first nine months of 2003. The increase in receivables was partly offset by an $18 million increase in the outstanding amount of accounts receivable sold under Equistar’s accounts receivable sales facility in the 2004 period compared to a $4 million decrease in the first nine months of 2003. The outstanding amount of Equistar’s accounts receivable sold under this facility was $120 million at September 30, 2004 and $77 million at September 30, 2003.
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In consideration of discounts offered to certain customers for early payment for product, some receivable amounts were collected in September 2004 and September 2003 that otherwise would have been expected to be collected in October of the respective years. This included $51 million in September 2004 and $33 million in September 2003 from Occidental Chemical Corporation, a subsidiary of Occidental Petroleum Corporation (together with its subsidiaries and affiliates, collectively “Occidental”).
Investing Activities—Investing activities used cash of $28 million in the first nine months of 2004, but provided cash of $7 million in the first nine months of 2003. Proceeds from asset sales were $41 million in the first nine months of 2004 and $69 million in the first nine months of 2003. In the second quarter of 2004, Equistar sold certain railcars for $37 million and leased the railcars from the buyer under an operating lease agreement. The proceeds from asset sales in the first nine months of 2003 included $35 million from the sale of the polypropylene production facility and $34 million from railcar sale-leaseback transactions.
Equistar’s capital expenditures were $69 million in the first nine months of 2004 and $62 million in the first nine months of 2003. Equistar’s capital budget for 2004 is $148 million, reflecting increased anticipated spending for regulatory and environmental compliance projects. Equistar expects that full year 2004 capital spending will be between $30 million and $40 million below the budgeted level. Certain expenditures that had been expected to occur in 2004, primarily related to environmental compliance projects, are expected to occur in 2005.
Financing Activities—Financing activities used cash of $100 million during the first nine months of 2004 and $4 million in the first nine months of 2003.
In August 2004, Equistar resumed making distributions to its owners, distributing a total of $100 million to Lyondell Chemical Company (“Lyondell”) and Millennium Chemicals Inc. (“Millennium”).
The Equistar credit facility was amended in June 2004 to clarify certain provisions.
In March 2003, Equistar repaid $104 million borrowed during the quarter under its previous revolving credit facility with a portion of the proceeds received from the 15-year propylene supply arrangement and sale of the polypropylene production facility in March 2003.
In April 2003, Equistar completed a private placement of $450 million of 10.625% senior notes due in 2011. The proceeds, net of related fees, were used to prepay $300 million of 8.5% notes due in the first quarter 2004, approximately $122 million of outstanding term loans under Equistar’s credit facility and prepayment premiums of approximately $17 million. In September 2003, $29 million of Equistar’s medium term notes matured and were repaid using funds borrowed under Equistar’s revolving credit facility.
Liquidity and Capital Resources—At September 30, 2004, Equistar’s long-term debt, including current maturities, totaled $2.3 billion, or approximately 59% of its total capitalization. Equistar had cash on hand of $147 million. In addition, the total amount available at September 30, 2004 under both the $250 million inventory-based revolving credit facility and the $450 million accounts receivable sales facility was approximately $475 million, which gave effect to the borrowing base and was net of a $75 million unused availability requirement, the $120 million sold under the accounts receivable sales facility and $30 million of outstanding letters of credit under the revolving credit facility. The borrowing base is determined using a formula applied to accounts receivable and inventory balances. The new revolving credit facility requires that the unused available amounts under that facility and the $450 million accounts receivable sales facility equal or exceed $75 million through March 30, 2005 and $50 million thereafter or $100 million thereafter if the interest coverage ratio, as defined, is less than 2:1. There was no borrowing under the revolving credit facility at September 30, 2004.
Equistar’s ability to pay or refinance its debt will depend on future operating performance, which could be affected by general economic, financial, competitive, legislative, regulatory, business and other factors, many of which are
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beyond its control. Management believes that conditions will be such that cash balances, cash flow from operations, cash generated from higher utilization of the accounts receivable sales facility and funding under the credit facility will be adequate to meet anticipated future cash requirements, including scheduled debt repayments, other contractual obligations, necessary capital expenditures, ongoing operations and distributions to owners. However, if future operating cash flows are less than currently anticipated, due to raw material prices or other factors, Equistar may be forced to reduce or delay capital expenditures or distributions to its owners, sell assets, or reduce operating expenditures.
Long-Term Debt—The $250 million inventory-based revolving credit facility and the indentures governing Equistar’s senior notes contain covenants that, subject to certain exceptions, restrict lien incurrence, debt incurrence, sales of assets, investments, capital expenditures, certain payments, and mergers. The breach of these covenants would permit the lenders or noteholders to declare any outstanding debt immediately payable and would permit the lenders under Equistar’s new credit facility to terminate future lending commitments. Equistar was in compliance with all covenants under these agreements as of September 30, 2004.
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, 2003.
At September 30, 2004, the outstanding amount of Equistar’s accounts receivable sold under an accounts receivable sales facility entered into in December 2003 was $120 million compared to $102 million at December 31, 2003. The facility accelerates availability to the business of cash from product sales that otherwise would have been collected over the normal billing and collection cycle. The availability of the accounts receivable sales facility provides one element of Equistar’s ongoing sources of liquidity and capital resources. Upon termination of the facility, cash collections related to accounts receivable then in the pool would first be applied to the outstanding interest sold, but Equistar would in no event be required to repurchase such interest. The Equistar accounts receivable sales facility was amended in June 2004 to clarify certain provisions.
RECENT LEGISLATIVE DEVELOPMENT
In October 2004, the American Jobs Creation Act of 2004, which, among other things, overhauls the federal income tax treatment of a wide variety of nonqualified compensation arrangements, was signed into law. Equistar is assessing the impact of this legislation on its deferred compensation arrangements.
PROPOSED TRANSACTION BETWEEN LYONDELL AND MILLENNIUM
In late March 2004, Lyondell and Millennium executed a definitive agreement for Lyondell to acquire Millennium in a stock-for-stock business combination. Upon completion of the transaction, Lyondell would, through subsidiaries of Lyondell and Millennium, own 100% of Equistar. The proposed transaction is subject to approval by Lyondell and Millennium shareholders and other customary conditions. Lyondell and Millennium have obtained amendments to Lyondell’s and Millennium’s respective bank credit agreements and Lyondell’s accounts receivable sales facility that were required to permit the proposed transaction. The proposed transaction is expected to close after the close of business on November 30, 2004; however, there can be no assurance that the proposed transaction will be completed. Lyondell and Millennium have sent the definitive joint proxy statement/prospectus to their respective shareholders in connection with the proposed transaction. Investors and security holders are urged to read that document for more information about the proposed transaction.
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CURRENT BUSINESS OUTLOOK
Industry conditions have continued to strengthen through October 2004. Product price increase initiatives are underway for almost all products in response to both the strong supply/demand fundamentals and the high level of and volatility in crude oil and natural gas prices. Solid global sales volume growth has tightened industry supply/demand conditions, which, in turn, has led to modest margin improvement despite significant increases in raw material costs. Subject to the uncertainties of any significant economic slowdown or global disruption, these industry conditions and resulting improving cyclical trends are expected to continue. While there is significant uncertainty related to the potential near-term earnings impacts of raw material price volatility and seasonality, positive longer-term trends appear to be established.
Item 3. Disclosure of Market and Regulatory Risk
Equistar’s exposure to market and regulatory risks is described in Item 7a of its Annual Report on Form 10-K for the year ended December 31, 2003. Equistar’s exposure to market and regulatory risks has not changed materially in the nine months ended September 30, 2004, except as discussed in the “Clean Air Act” section of Note 9 to the Consolidated Financial Statements.
Item 4. Controls and Procedures
Equistar performed an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer (principal executive officer) and Vice President and Controller (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 September 30, 2004. Based upon that evaluation, the Chief Executive Officer and the Vice President and Controller 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.
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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 availability, cost and price volatility of raw materials and utilities, |
• | uncertainties associated with the United States and worldwide economies, including those due to political tensions in the Middle East and elsewhere, |
• | current and potential governmental regulatory actions in the United States and in other countries, |
• | terrorist acts and international political unrest, |
• | operating interruptions (including leaks, explosions, fires, weather-related incidents, mechanical failures, unscheduled downtimes, labor difficulties, transportation interruptions, spills and releases and other environmental risks), |
• | the cyclical nature of the chemical industry, |
• | competitive products and pricing pressures, |
• | industry production capacities and operating rates, |
• | the supply/demand balances for Equistar’s products, |
• | access to capital markets, |
• | technological developments, and |
• | Equistar’s ability to implement its business strategies. |
Any of the factors, or a combination of these factors, could materially affect Equistar’s future results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of Equistar’s future performance, and Equistar’s actual results and future developments may differ materially from those projected in the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels.
All forward-looking statements in this Form 10-Q are qualified in their entirety by the cautionary statements contained in this section and in Equistar’s Annual Report on Form 10-K for the year ended December 31, 2003. 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.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments with respect to Equistar’s legal proceedings previously reported in the Annual Report on Form 10-K for the year ended December 31, 2003 and the Quarterly Report on Form 10-Q for the quarter ended June 30, 2004.
Item 6. Exhibits
10.15 | Amended and Restated Ethylene Sales Agreement between Equistar Chemicals, LP and Occidental Chemical Corporation dated as of August 20, 2004 | |
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 | |
99.1 | Consolidated Financial Statements (Unaudited) of Lyondell Chemical Company |
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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: November 8, 2004 | /s/ Charles L. Hall | |
Charles L. Hall | ||
Vice President and Controller | ||
(Duly Authorized Officer, Principal Financial Officer and Principal Accounting Officer) |