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, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to ___________________ Commission file number 333-76473 EQUISTAR CHEMICALS, LP (Exact name of registrant as specified in its charter) DELAWARE 76-0550481 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 1221 MCKINNEY STREET, 77010 SUITE 700, HOUSTON, TEXAS (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 652-7200 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] PART I. FINANCIAL INFORMATION EQUISTAR CHEMICALS, LP ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------------- --------------------------- MILLIONS OF DOLLARS 2000 1999 2000 1999 - ------------------- ------ ------ ------ ------ SALES AND OTHER OPERATING REVENUES: Unrelated parties $1,452 $1,161 $4,223 $3,086 Related parties 462 310 1,357 697 -------- ------- -------- ------- 1,914 1,471 5,580 3,783 OPERATING COSTS AND EXPENSES: Cost of sales: Unrelated parties 1,340 1,046 3,837 2,790 Related parties 398 276 1,142 604 Selling, general and administrative expenses 49 54 142 170 Research and development expense 9 11 28 31 Amortization of goodwill and other intangibles 9 8 25 25 -------- ------- -------- ------- 1,805 1,395 5,174 3,620 -------- ------- -------- ------- Operating income 109 76 406 163 Interest expense (46) (43) (137) (132) Interest income 1 1 3 5 Other (expense) income, net (1) 1 (1) 47 -------- ------- -------- ------- NET INCOME AND COMPREHENSIVE INCOME $ 63 $ 35 $ 271 $ 83 ======== ======= ======== ======= See Notes to Consolidated Financial Statements. 1 EQUISTAR CHEMICALS, LP CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, DECEMBER 31, MILLIONS OF DOLLARS 2000 1999 - ------------------- ------------- ------------ ASSETS Current assets: Cash and cash equivalents $ 42 $ 108 Accounts receivable: Trade, net 608 491 Related parties 178 209 Inventories 556 520 Prepaid expenses and other current assets 25 32 ------ ------ Total current assets 1,409 1,360 Property, plant and equipment, net 3,829 3,926 Investment in PD Glycol 53 52 Goodwill, net 1,094 1,119 Other assets 282 279 ------ ------ Total assets $6,667 $6,736 ====== ====== LIABILITIES AND PARTNERS' CAPITAL Current liabilities: Accounts payable: Trade $ 459 $ 424 Related parties 32 35 Current maturities of long-term debt 90 92 Other accrued liabilities 140 233 ------ ------ Total current liabilities 721 784 Long-term debt, less current maturities 2,157 2,169 Other liabilities 132 121 Commitments and contingencies Partners' capital 3,657 3,662 ------ ------ Total liabilities and partners' capital $6,667 $6,736 ====== ====== See Notes to Consolidated Financial Statements. 2 EQUISTAR CHEMICALS, LP CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, -------------------------- MILLIONS OF DOLLARS 2000 1999 - ------------------- ------ ------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 271 $ 83 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 230 222 Net loss (gain) on disposition of assets 3 (40) Increase in accounts receivable (86) (170) Increase in receivables from partners -- (3) (Increase) decrease in inventories (36) 19 Increase in accounts payable 32 113 Decrease in payables to partners -- (6) Decrease in other accrued liabilities (91) (21) Net change in other working capital accounts 7 3 Other (17) (27) ----- ----- Net cash provided by operating activities 313 173 ----- ----- CASH FLOWS FROM INVESTING ACTIVITIES: Expenditures for property, plant and equipment (81) (112) Proceeds from sales of assets 4 73 ----- ----- Net cash used in investing activities (77) (39) ----- ----- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowing under lines of credit 20 (552) Borrowing of long-term debt -- 898 Payment of debt issuance costs -- (6) Repayment of long-term debt (42) (150) Repayment of obligations under capital leases -- (205) Distributions to partners (280) (175) ----- ----- Net cash used in financing activities (302) (190) ----- ----- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (66) (56) Cash and cash equivalents at beginning of period 108 66 ----- ----- Cash and cash equivalents at end of period $ 42 $ 10 ===== ===== See Notes to Consolidated Financial Statements. 3 EQUISTAR CHEMICALS, LP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PREPARATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States 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, 1999 included in the Equistar Chemicals, LP ("Equistar" or "Partnership") 1999 Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Certain amounts from prior periods have been reclassified to conform to the current period presentation. 2. COMPANY OPERATIONS Equistar is a Delaware limited partnership, which commenced operations on December 1, 1997. Equistar is owned 41% by Lyondell Chemical Company ("Lyondell"), 29.5% by Millennium Chemicals Inc. ("Millennium"), and 29.5% by Occidental Petroleum Corporation ("Occidental"). Equistar owns and operates the petrochemicals and polymers businesses contributed by Lyondell, Millennium and Occidental ("Contributed Businesses") which consist of 17 manufacturing facilities on the U.S. Gulf Coast and in the U.S. Midwest. The petrochemicals segment manufactures and markets olefins, oxygenated chemicals, aromatics and specialty products. Olefins include ethylene, propylene and butadiene, and oxygenated chemicals include ethylene oxide, ethylene glycol, ethanol and methyl tertiary butyl ether ("MTBE"). Aromatics include benzene and toluene. The polymers segment manufactures and markets polyolefins, including high-density polyethylene ("HDPE"), low-density polyethylene ("LDPE"), linear low-density polyethylene ("LLDPE"), polypropylene, and performance polymers products, all of which are used in the production of a wide variety of consumer and industrial products. The performance polymers include enhanced grades of polyethylene, including wire and cable resins, and polymeric powders. The concentrates and compounds business, which was part of performance polymers, was sold effective April 30, 1999 (see Note 3). 3. SALE OF CONCENTRATES AND COMPOUNDS BUSINESS Effective April 30, 1999, Equistar completed the sale of its concentrates and compounds business. The transaction included two manufacturing facilities, located in Heath, Ohio and Crockett, Texas, and related inventories. Equistar recorded a net gain on the sale of approximately $42 million during the second quarter 1999. 4. INVENTORIES The components of inventories consisted of the following: SEPTEMBER 30, DECEMBER 31, MILLIONS OF DOLLARS 2000 1999 - ------------------- ------------- ------------ Finished goods $ 296 $ 278 Work-in-process 16 10 Raw materials 150 137 Materials and supplies 94 95 ----- ----- Total inventories $ 556 $ 520 ===== ===== 4 5. PROPERTY, PLANT AND EQUIPMENT, NET The components of property, plant and equipment, at cost, and the related accumulated depreciation consisted of the following: SEPTEMBER 30, DECEMBER 31, MILLIONS OF DOLLARS 2000 1999 - ------------------- ------------- ------------ Land $ 78 $ 78 Manufacturing facilities and equipment 5,749 5,656 Construction in progress 109 134 ------ ------ Total property, plant and equipment 5,936 5,868 Less accumulated depreciation 2,107 1,942 ------ ------ Property, plant and equipment, net $3,829 $3,926 ====== ====== 6. OTHER ACCRUED LIABILITIES Other accrued liabilities consisted of the following: SEPTEMBER 30, DECEMBER 31, MILLIONS OF DOLLARS 2000 1999 - ------------------- ------------- ------------ Accrued property taxes $ 62 $ 68 Accrued payroll costs 45 68 Accrued interest 23 50 Accrued severance and other employee-related costs -- 24 Other 10 23 ----- ----- Other accrued liabilities $ 140 $ 233 ===== ===== During the fourth quarter 1999, Equistar recorded a total charge of $96 million associated with decisions to shut down certain polymer reactors and to consolidate certain administrative functions between Lyondell and Equistar. This included severance and other employee-related costs of $24 million related to the elimination of approximately 500 employee positions. Through September 30, 2000, approximately $19 million of severance and other employee-related costs had been paid and charged against the accrued liability. As of September 30, 2000, substantially all of the employee terminations had been completed and the remaining liability was eliminated. 7. COMMITMENTS AND CONTINGENCIES Equistar has various purchase commitments for materials, supplies and services incident to the ordinary conduct of business. In the aggregate, such commitments are not at prices in excess of current market. Equistar is also subject to 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 upon the financial statements or liquidity of Equistar. Equistar has agreed to indemnify and defend Lyondell and Millennium, individually, against certain uninsured claims and liabilities which Equistar may incur relating to the operation of the Contributed Businesses prior to December 1, 1997 up to $7 million each within the first seven years of the Partnership, subject to certain terms of the agreements under which the assets were contributed. Equistar has also agreed to indemnify Occidental up to $7 million on a similar basis relating to the operation of the Occidental Contributed Business prior to May 15, 1998. During the nine months ended September 30, 2000 and 1999, Equistar incurred and paid $3 million and $4 million, respectively, in expenses for these uninsured claims and liabilities. Equistar has cumulatively paid $15 million for these uninsured claims and liabilities since its formation in December 1997. Equistar's policy is to be in compliance with all applicable environmental laws. Equistar is subject to extensive environmental laws and regulations concerning emissions to the air, discharges to surface and subsurface waters and the generation, handling, storage, transportation, treatment and disposal of waste materials. Some of these laws and 5 regulations are subject to varying and conflicting interpretations. In addition, Equistar cannot accurately predict future developments, such as increasingly strict requirements of environmental laws, inspection and enforcement policies and compliance costs therefrom which might affect the handling, manufacture, use, emission or disposal of products, other materials or hazardous and non- hazardous waste. Equistar had no reserves for environmental matters as of September 30, 2000 and December 31, 1999. In the opinion of management, any liability arising from the matters discussed in this note is not expected to have a material adverse effect on the consolidated financial statements or liquidity of Equistar. However, the adverse resolution in any reporting period of one or more of these matters discussed in this note could have a material impact on Equistar's results of operations for that period without giving effect to contribution or indemnification obligations of co-defendants or others, or to the effect of any insurance coverage that may be available to offset the effects of any such award. 6 8. SEGMENT AND RELATED INFORMATION Equistar has two reportable segments in which it operates: (i) petrochemicals; and (ii) polymers. Summarized financial information concerning Equistar's reportable segments is shown in the following table: MILLIONS OF DOLLARS PETROCHEMICALS POLYMERS UNALLOCATED ELIMINATIONS TOTAL - ------------------ -------------- -------- ----------- ------------ ----- For the three months ended September 30, 2000: Sales and other operating revenues: Customers $1,341 $ 573 $ -- $ -- $1,914 Intersegment 495 (495) -- ---------------------------------------------------------------------- Total sales and operating revenues 1,836 573 (495) 1,914 Operating income (loss) 204 (46) (49) 109 Interest expense (46) (46) Interest income 1 1 Other expense, net (1) (1) Net income (loss) 204 (46) (95) 63 FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999: Sales and other operating revenues: Customers 938 533 $1,471 Intersegment 362 (362) -- ---------------------------------------------------------------------- Total sales and operating revenues 1,300 533 (362) 1,471 Operating income (loss) 99 26 (49) 76 Interest expense (43) (43) Interest income 1 1 Other income, net 1 1 Net income (loss) 99 26 (90) 35 FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000: Sales and other operating revenues: Customers 3,867 1,713 $5,580 Intersegment 1,435 -- (1,435) -- ---------------------------------------------------------------------- Total sales and operating revenues 5,302 1,713 (1,435) 5,580 Operating income (loss) 643 (100) (137) 406 Interest expense (137) (137) Interest income 3 3 Other expense, net (1) (1) Net income (loss) 643 (100) (272) 271 FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999: Sales and other operating revenues: Customers 2,318 1,465 $3,783 Intersegment 932 -- (932) -- ---------------------------------------------------------------------- Total sales and operating revenues 3,250 1,465 (932) 3,783 Operating income (loss) 274 46 (157) 163 Interest expense (132) (132) Interest income 5 5 Other income, net 47 47 Net income (loss) 274 46 (237) 83 The "Operating income (loss)" amounts presented above in the "Unallocated" column consist of expenses not allocated to the petrochemicals and polymers segments, principally general and administrative expenses. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS OVERVIEW GENERAL--Crude oil prices, which affect Equistar's raw material costs, increased steadily throughout 1999 and the first quarter 2000. After a temporary decrease in April 2000, crude oil prices became more volatile, but still trended upward, peaking in September 2000 at a three-year high. Third quarter 2000 average benchmark crude oil prices were 12% higher than second quarter 2000 and 74% higher than the third quarter 1999. Prices for the first nine months of 2000 averaged 85% higher than the comparable 1999 period. These crude oil price increases put upward pressure on Equistar's raw material costs. In response, Equistar implemented a series of sales price increases over this time frame, however, in some cases, these were limited by market resistance and other competitive factors. More recently, competitive pressures and new industry capacity have put downward pressure on prices. In addition, third quarter 2000 GDP (gross domestic product) growth in the U.S. slowed significantly from growth rates experienced in the prior four quarters. Unless otherwise indicated, the following analysis of operating results compares the third quarter 2000 and the first nine months 2000 to the comparable 1999 periods. An analysis comparing third quarter 2000 to second quarter 2000 is also included. NET INCOME--Equistar's net income of $63 million in the third quarter 2000 increased from $35 million in the third quarter 1999. Net income of $271 million for the first nine months of 2000 increased from $83 million in the first nine months of 1999. The increases in the 2000 periods primarily reflected the benefit of higher margins in Equistar's petrochemicals segment. This benefit was only partly offset by lower margins in the polymers segment and the effect, on the nine-month comparison, of net gains on asset sales of $41 million included in the second quarter 1999. In the petrochemicals segment, sales prices increased more than the costs of raw materials, leading to higher margins. In the polymers segment, sales price increases generally lagged behind raw material cost increases. THIRD QUARTER 2000 VERSUS SECOND QUARTER 2000 Equistar's net income of $63 million in the third quarter 2000 decreased compared to net income of $152 million in the second quarter 2000. The $89 million decrease primarily reflected higher raw material costs and lower product sales prices. Sales prices declined due to increased competitive activity as a result of new industry capacity and weaker demand, particularly in the early part of the third quarter. Operating income for the petrochemicals segment decreased to $204 million in the third quarter from $267 million in the second quarter. The decrease was driven by higher raw material costs and somewhat lower olefins selling prices, leading to a reduction in margins. Average benchmark contract ethylene prices were down one cent per pound from the second quarter. Industry cash margins decreased from 16 cents per pound in the second quarter to 12 cents per pound in the third quarter. The operating loss for the polymers segment increased from $23 million in the second quarter to $46 million in the third quarter primarily due to lower margins. Margins decreased as sales price erosion for polymers was greater than the decline in raw materials costs. Average benchmark prices for high molecular weight film went from 48 cents per pound in the second quarter to 45 cents per pound in the third quarter. Although polymers segment sales volumes increased 10% compared to the second quarter, the increase was due to increased export sales, as domestic demand was weak, particularly in the early part of the third quarter. 8 SEGMENT DATA The following tables reflect selected sales volume data and summarized financial information for Equistar's business segments. FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- -------------------------- IN MILLIONS 2000 1999 2000 1999 - ----------- ------ ------ ------ ------ Selected petrochemicals products: Olefins (pounds) 4,512 4,760 14,020 13,795 Aromatics (gallons) 101 94 312 270 POLYMERS PRODUCTS (pounds) 1,622 1,541 4,763 4,804 MILLIONS OF DOLLARS - ------------------- SALES AND OTHER OPERATING REVENUES: Petrochemicals segment $1,836 $1,300 $ 5,302 $ 3,250 Polymers segment 573 533 1,713 1,465 Intersegment eliminations (495) (362) (1,435) (932) ------ ------ ------- ------- Total $1,914 $1,471 $ 5,580 $ 3,783 ====== ====== ======= ======= COST OF SALES: Petrochemicals segment $1,630 $1,198 $ 4,653 $ 2,967 Polymers segment 603 486 1,761 1,359 Intersegment eliminations (495) (362) (1,435) (932) ------ ------ ------- ------- Total $1,738 $1,322 $ 4,979 $ 3,394 ====== ====== ======= ======= OTHER OPERATING EXPENSES: Petrochemicals segment $ 2 $ 3 $ 6 $ 9 Polymers segment 16 21 52 60 Unallocated 49 49 137 157 ------ ------ ------- ------- Total $ 67 $ 73 $ 195 $ 226 ====== ====== ======= ======= OPERATING INCOME (LOSS): Petrochemicals segment $ 204 $ 99 $ 643 $ 274 Polymers segment (46) 26 (100) 46 Unallocated (49) (49) (137) (157) ------ ------ ------- ------- Total $ 109 $ 76 $ 406 $ 163 ====== ====== ======= ======= PETROCHEMICALS SEGMENT REVENUES--Revenues of $1.8 billion in the third quarter 2000 increased 41% compared to third quarter 1999 revenues of $1.3 billion as a result of higher sales prices, which were partly offset by lower volumes. The higher sales prices reflect significantly higher raw material costs, while the decrease in volumes reflects a slowdown in demand in the third quarter 2000. Revenues of $5.3 billion for the first nine months of 2000 increased 63% compared to $3.25 billion for the first nine months of 1999, primarily due to higher sales prices as well as higher volumes. The increase in sales prices is in response to the significant increases in raw material costs, which have risen steadily since the first quarter 1999. Benchmark quoted ethylene prices averaged 31 cents per pound for the first nine months of 2000, a 49% increase over the first nine months of 1999. Sales volumes increased about 3% due to higher demand in the first six months of 2000 compared to the 1999 period. COST OF SALES--Cost of sales of $1.6 billion in the third quarter 2000 increased 36% compared to $1.2 billion for the third quarter 1999. Cost of sales of $4.7 billion in the first nine months of 2000 increased 57% compared to $3.0 billion for the first nine months of 1999. The increases primarily reflected the significant increase in raw material costs. 9 OPERATING INCOME--Operating income of $204 million in the third quarter 2000 more than doubled from $99 million in the third quarter 1999 as higher product margins were only partly offset by the effect of lower volumes. Product margins improved as sales prices increased more than raw material costs. Operating income of $643 million for the first nine months of 2000 increased 135% from $274 million in the first nine months of 1999 due primarily to higher product margins and, to a lesser extent, higher sales volumes. POLYMERS SEGMENT REVENUES--Revenues of $573 million in the third quarter 2000 increased 7.5% compared to $533 million in the third quarter 1999 primarily due to a 5% increase in sales volumes. Volumes were lower in the third quarter 1999 due to the shut down, during that quarter, of less efficient HDPE and other polymer product capacity and plant maintenance. Equistar started up new HDPE capacity in the fourth quarter 1999. Revenues of $1.7 billion for the first nine months of 2000 increased 17% compared to $1.5 billion in the first nine months of 1999 as a result of higher sales prices, which were partly offset by a 1% decrease in volumes. The sales price increases reflect pressure from higher raw material costs. The decrease in volumes reflects the effect of the turnaround at the Morris, Illinois facility during the second quarter 2000. COST OF SALES--Cost of sales of $603 million in the third quarter 2000 increased 24% compared to $486 million for the third quarter 1999, while cost of sales of $1.8 billion in the first nine months of 2000 increased 30% compared to $1.4 billion for the first nine months of 1999. The increases primarily reflected the significant increases in raw material costs, primarily ethylene and propylene. OPERATING INCOME--For the third quarter 2000, the polymers segment had an operating loss of $46 million compared to operating income of $26 million in the third quarter 1999. For the first nine months of 2000, the operating loss was $100 million compared to an operating profit of $46 million in the comparable 1999 period. The decreases were primarily due to lower polymers margins as sales price increases lagged behind increases in polymers raw material costs. UNALLOCATED ITEMS The following discusses expenses that were not allocated to the petrochemicals or polymers segments. OTHER OPERATING EXPENSES, UNALLOCATED--These include general and administrative expenses and amortization of goodwill and other intangibles. For the first nine months of 2000, unallocated expenses were $137 million compared to $157 million in the comparable 1999 period. The decrease was primarily due to nonrecurring transition service costs related to the business contributed by Occidental in May 1998 and system implementation costs included in the first quarter 1999. OTHER INCOME (EXPENSE), NET--Other income of $47 million in the first nine months 1999 primarily consisted of net gains on asset sales, including the sale of Equistar's concentrates and compounds business. FINANCIAL CONDITION OPERATING ACTIVITIES--Operating activities provided cash of $313 million in the first nine months of 2000 compared to $173 million in the comparable 1999 period. The increase in 2000 primarily reflected higher income from operations, partly offset by a significant reduction in accrued liabilities and a net increase in other components of working capital. The decrease in accrued liabilities reflected the timing of severance and other compensation-related payments as well as a change in the timing of interest payments due to the February 1999 refinancing. An increase in payables in the 2000 period only partly offset increases in receivables and inventories. Despite improved receivables collection efficiency and higher inventory turnover, receivables and inventory increased because of higher product prices and raw material costs. The increase in receivables also reflected the timing of certain payments, which fell into the fourth quarter 2000. 10 INVESTING ACTIVITIES--Equistar's capital expenditures were $81 million in the first nine months of 2000 and $112 million in the first nine months of 1999. Capital expenditures in 2000 decreased due to the timing of projects and primarily include low-cost, incremental capacity expansions and cost-reduction projects. The most significant capital expenditures in 1999 related to the 480- million-pound HDPE resin expansion project at the Matagorda, Texas facility, which started operating in the fourth quarter 1999. FINANCING ACTIVITIES--Net cash used in financing activities was $302 million in the first nine months of 2000, including $280 million of distributions to partners and $42 million of scheduled debt repayment. Equistar also had net borrowing of $20 million under its credit facility during the first nine months of 2000. LIQUIDITY AND CAPITAL RESOURCES--Equistar has a $1.25 billion revolving credit facility that extends until November 2002. At September 30, 2000, Equistar had drawn $820 million, leaving $430 million available. Current maturities of long term debt were $90 million. The credit facility contains covenants relating to liens, sale and leaseback transactions, debt incurrence, leverage and interest coverage ratios, sales of assets and mergers and consolidations. Management believes that business conditions will be such that cash balances, cash flow from operations and funds available under the revolving credit facility will be adequate to meet Equistar's cash requirements for scheduled debt repayments and to fund ongoing operations for the foreseeable future. CURRENT BUSINESS OUTLOOK Equistar is anticipating lower profitability as a result of the continuing high level and volatility of raw material costs and downward pressure on product prices from new industry capacity. Industry forecasts project a continuing difficult business environment due to industry capacity additions in late 2000 and 2001. This new capacity will put pressure on product margins until demand growth absorbs the new capacity. Management's priority in the current business environment is to enhance Equistar's financial performance by actively managing its current portfolio of assets and maximizing earnings and cash flow. This includes ongoing efforts to effectively manage working capital, achieve further cost reductions and employ a disciplined capital spending program. ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities. Subsequently, the FASB delayed the effective date by one year. In June 2000 the FASB issued SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, amending certain provisions of SFAS No. 133. The statements are effective for Equistar's calendar year 2001 with early adoption permitted. SFAS No. 133, as amended by SFAS No. 138, requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending upon whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the hedged item. The ineffective portion of all hedges will be recognized in current-period earnings. Equistar is currently evaluating the effect SFAS No. 133 implementation will have on its financial statements. In December 1999, the staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB") No. 101, Revenue Recognition in Financial Statements. SAB No. 101 summarizes certain of the staff's views in applying generally accepted accounting principles to revenue recognition in the financial statements. The statement is effective for Equistar's fourth quarter of 2000 with early adoption encouraged. Equistar is currently evaluating the effect SAB No. 101 implementation will have on its financial statements. ITEM 3. DISCLOSURE OF MARKET RISK Equistar's exposure to market risks is described in Item 7a of its Annual Report on Form 10-K for the year ended December 31, 1999. During the current year, Equistar continued to enter into over-the-counter "derivative" 11 contracts for crude oil to help manage its exposure to commodity price risk with respect to crude-oil related raw material purchases. These hedging arrangements have the effect of locking in, at predetermined prices and for a specified period of time, the prices that Equistar will pay for the volumes to which the hedge relates. As of September 30, 2000, the outstanding over-the-counter "derivative" contracts totaled 4.6 million barrels. They mature from October 2000 through March 2001, and cover from 25% to 10% of Equistar's raw material requirements that are exposed to crude oil price fluctuations during this period. Based on quoted market prices as of September 30, 2000, Equistar recorded an asset of $5 million at September 30, 2000 for those contracts. Assuming a hypothetical 30% decrease in crude oil prices from those in effect at September 30, 2000 the loss in earnings for the derivatives contracts would be approximately $42 million. Sensitivity analysis was used for this purpose. Crude oil prices varied by as much as 30% during the nine months ended September 30, 2000. The quantitative information about market risk is necessarily limited because it does not take into account the effects of the underlying operating transactions. FORWARD-LOOKING STATEMENTS Certain of the statements contained in this report are "forward-looking statements" within the meaning of the federal securities laws. Although Equistar believes the expectations reflected in such forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties, and Equistar can give no assurance that such expectations will prove to have been correct. Equistar's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the cyclical nature of the chemical industry, uncertainties associated with the economy, current and potential governmental regulatory actions, substantial chemical industry capacity additions resulting in oversupply and declining prices and margins, raw material costs or supply arrangements, Equistar's ability to implement cost reductions, and operating interruptions (including leaks, explosions, fires, mechanical failure, unscheduled downtime, labor difficulties, transportation interruptions, spills and releases and other environmental risks). Many of such factors are beyond Equistar's ability to control or predict. 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. 12 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 1999 Annual Report on Form 10-K. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 Financial Data Schedule. (b) Reports on Form 8-K None 13 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 14, 2000 /s/ KELVIN R. COLLARD ------------------------------ Kelvin R. Collard Vice President and Controller (Duly Authorized Officer and Principal Accounting Officer) 14