Item 3. Legal Proceedings
Litigation Matters
Equistar is, from time to time, a defendant in lawsuits, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of legal liability and the resulting financial impact with respect to any such litigation cannot be ascertained with any degree of certainty, Equistar
does not believe that any ultimate uninsured liability resulting from the legal proceedings in which it currently is involved (directly or indirectly) will individually, or in the aggregate, have a material adverse effect on its business or financial condition. However, the adverse resolution in any reporting period of one or more of these suits could have a material impact on Equistar’s results of operations for that period, which may be mitigated by contribution or indemnification obligations of co-defendants or others, or by any insurance coverage that may be available.
Although Equistar is involved in numerous and varied legal proceedings, a significant portion of its outstanding litigation arose in five contexts: (1) claims for personal injury or death allegedly arising out of exposure to the products produced by Equistar or located on Equistar’s premises; (2) claims for personal injury or death, and/or property damage allegedly arising out of the generation and disposal of chemical wastes at Superfund and other waste disposal sites; (3) claims for personal injury, property damage and/or air, noise and water pollution allegedly arising out of operations; (4) employment and benefits related claims; and (5) commercial disputes.
Environmental Proceedings
From time to time Equistar receives notices from federal, state or local governmental entities of alleged violations of environmental laws and regulations pertaining to, among other things, the disposal, emission and storage of chemical and petroleum substances, including hazardous wastes. Such alleged violations may become the subject of enforcement actions or other legal proceedings and may (individually or in the aggregate) involve monetary sanctions of $100,000 or more (exclusive of interest and costs). For additional information regarding environmental matters, see “Items 1. and 2. Business and Properties-Risks and Other Factors that May Affect Equistar-Environmental and Other Regulatory Matters” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Environmental Matters.”
In April 1997, the Illinois Attorney General’s Office filed a complaint in Grundy County, Illinois Circuit Court seeking monetary sanctions for releases into the environment at Millennium’s Morris, Illinois plant in alleged violation of state regulations. The Morris, Illinois plant was contributed to Equistar on December 1, 1997 in connection with the formation of Equistar. Equistar has reached a settlement with the State of Illinois, which includes a civil penalty in the amount of $175,000.
In May 2003, the TCEQ notified Equistar that it is seeking a civil penalty of $167,000 in connection with alleged exceedances of permitted emissions at certain cooling towers at Equistar’s Channelview plant. Equistar does not believe that the ultimate resolution of this matter will have a material adverse effect on the business or financial condition of Equistar.
Indemnification
In connection with the formation of Equistar, Lyondell, Millennium and Occidental each agreed to provide certain indemnifications or guarantees thereof to Equistar with respect to the businesses they each contributed to Equistar. In addition, Equistar agreed to assume third party claims that are related to certain contingent liabilities arising prior to the contribution transactions that were filed prior to December 1, 2004 as to Lyondell and Millennium, and are filed prior to 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 December 31, 2004, Equistar had incurred substantially all of the $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 Lyondell’s November 2004 acquisition of Millennium.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Omitted pursuant to General Instruction I of Form 10-K.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Equistar does not have a class of equity securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. There is no established public trading market for the partnership interests of Equistar. As a result of Lyondell’s acquisition of Millennium, Equistar is an indirect, wholly owned subsidiary of Lyondell.
Under its partnership agreement, Equistar is required to distribute to its owners (Lyondell and Millennium), as soon as practicable following the end of each month, all of its surplus cash in excess of its estimated cash needs for its next 12 months. Under the partnership agreement, distributions other than of surplus cash may only be made upon approval of Equistar’s Partnership Governance Committee. As a result of adverse conditions in the industry and its debt service obligations, Equistar made no distributions to owners in 2003 and the first two quarters of 2004. In August 2004, Equistar resumed making distributions to its owners, making the following distributions in 2004:
Equistar’s credit facility and indentures do not contain any restrictions on Equistar’s ability to make distributions to its owners in accordance with its partnership agreement, except that the credit facility prohibits distributions during any default under the facility. However, the indentures under which the 10 1/8% senior notes due 2008 and the 10 5/8% notes due 2011 were issued require that Equistar pay additional interest, in the form of additional notes, if Equistar makes distributions when Equistar’s fixed charge coverage ratio is less than 1.75 to 1. All distributions by Equistar to date have been made when that ratio requirement was satisfied and, accordingly, no additional interest was due.
Item 6.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with the Consolidated Financial Statements, including the related notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(a) The 2002 net loss includes a $1,053 million charge related to goodwill impairment.
Item 7.
Item 7. 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 annual operating results, Equistar has included, as additional disclosure, certain “trailing quarter” comparisons of fourth quarter 2004 operating results to third 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
Equistar manufactures and markets ethylene and its co-products, primarily propylene, butadiene and aromatics, which include benzene and toluene. Equistar also manufactures and markets derivatives, primarily polyethylene (including high density polyethylene (“HDPE”), low density polyethylene (“LDPE”) and linear-low density polyethylene (“LLDPE”)), ethylene glycol, ethylene oxide and its derivatives, and ethanol. Equistar also produces methyl tertiary butyl ether (“MTBE”) and alkylate. As a result of the acquisition of Millennium Chemicals Inc. (“Millennium”) by Lyondell Chemical Company (“Lyondell”) on November 30, 2004, Equistar became a wholly owned subsidiary of Lyondell.
During 2004, the chemical industry experienced broad-based improvements as a stronger global economy led to increased demand and tighter chemical industry supply/demand balances compared to 2003. U.S. ethylene demand grew an estimated 9% in 2004 compared to 2003. In this improved business environment, the industry experienced higher sales volumes and generally higher product margins in 2004 compared to 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. Ethylene and its co-products are produced from two major raw material groups:
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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
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natural gas liquids (“NGLs”), 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 ethylene and co-products to take advantage of the relative costs of liquids and NGLs.
The following table shows the average benchmark prices for crude oil and natural gas for the applicable three-year period, 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 ratio of crude-oil based liquid raw materials and NGLs used in U.S. ethylene production and is subject to revision.
Equistar was able to implement sales price increases in many products that more than offset the effect of significantly higher raw material and energy costs during 2004 and 2003. In addition to higher sales prices for ethylene and derivatives, Equistar was able to implement significant sales price increases for co-products such as propylene, benzene and fuels. The higher raw material and energy costs in 2004 and 2003 reflected the effect of a significant escalation in crude oil prices and ongoing high natural gas costs compared to 2002.
The magnitude of price increases had a negative effect on product demand in 2003, and contributed to Equistar experiencing lower sales volumes in 2003 compared to 2002. For the year 2003, U.S. industry ethylene demand decreased slightly compared to 2002. In addition, Equistar completed scheduled maintenance turnarounds at its two largest ethylene plants in 2003.
RESULTS OF OPERATIONS
Equistar, a Delaware limited partnership which commenced operations on December 1, 1997, was formed by Lyondell and Millennium. On May 15, 1998, Equistar was expanded with the contribution of certain assets from Occidental Petroleum Corporation and subsidiaries (“Occidental”). Until August 22, 2002, Equistar was owned 41% by Lyondell, 29.5% by Millennium and 29.5% by Occidental. On August 22, 2002, Lyondell purchased Occidental’s interest in Equistar and, as a result, Lyondell’s ownership interest in Equistar increased to 70.5%. As a result of Lyondell’s acquisition of Millennium, Equistar became a wholly owned subsidiary of Lyondell from December 1, 2004.
Management evaluates the performance of the Equistar businesses and allocates resources based on the integrated economics of ethylene, co-products and derivatives. Accordingly, management has determined that Equistar has one reportable segment, ethylene, co-products and derivatives (“EC&D”). As additional information, Equistar’s operating results are reviewed below in two product groups: ethylene and co-products; and derivatives. Ethylene co-products primarily include propylene, butadiene, fuels, which include MTBE and alkylates, and aromatics, which include benzene and toluene. Derivatives primarily include polyethylene, ethylene glycol, ethylene oxide and its derivatives, and ethanol and polypropylene.
The operating results of Equistar, as a whole, are analyzed below, followed by a review of the product group results.
Revenues-Revenues of $9,316 million in 2004 increased 42% compared to revenues of $6,545 million in 2003, reflecting higher average sales prices and volumes. Benchmark ethylene sales prices were 18% higher in 2004 compared to 2003. Benchmark benzene sales prices averaged 87% higher and benchmark propylene sales prices averaged 49% higher in 2004 compared to 2003. Benchmark prices of HDPE averaged 20% higher in 2004 than in 2003. Ethylene and derivative sales volumes were 10% higher in 2004 compared to 2003.
Revenues of $6,545 million in 2003 increased 18% compared to revenues of $5,537 million in 2002 due to higher sales prices, partly offset by a decrease in sales volumes. Benchmark ethylene prices averaged 28% higher in 2003 compared to 2002 in response to significant increases in the cost of ethylene production, while benchmark propylene sales prices averaged 19% higher. Sales volumes were lower in 2003 compared to 2002 due to the negative effect of price increases on product demand and maintenance turnarounds noted above, as well as the sale of the polypropylene production facility in Pasadena, Texas in 2003.
Cost of Sales-Cost of sales of $8,587 million in 2004 increased 34% compared to $6,387 million in 2003 due to higher costs of raw materials and energy in 2004 compared to 2003. The benchmark price of crude oil averaged 33% higher in 2004 than in 2003, while benchmark natural gas prices averaged 10% higher.
Cost of sales of $6,387 million in 2003 increased 19% compared to $5,388 million in 2002. Benchmark natural gas prices averaged 63% higher, and the benchmark price of crude oil averaged 19% higher in 2003 than in 2002.
SG&A Expenses-Selling, general and administrative (“SG&A”) expenses were $197 million in 2004, $182 million in 2003 and $155 million in 2002. The $15 million increase in 2004 compared to 2003 was primarily due to incentive compensation cost increases in 2004, reflecting the effect of Equistar’s improved performance. The $27 million increase in 2003 compared to 2002 was primarily due to higher employee benefit costs, including $6 million in employee severance costs in 2003.
Gain (Loss) on Asset Dispositions-Equistar had a gain of $4 million in 2004 and a loss of $27 million in 2003 from disposal of assets. The 2003 loss included a $12 million loss from the sale of Equistar’s polypropylene production facility in Pasadena, Texas and an $11 million charge for the write-off of a research and development (“R&D”) facility for derivatives.
Interest Expense-Interest expense was $227 million in 2004, $215 million in 2003 and $205 million in 2002. During this three-year period, Equistar refinanced variable rate debt with fixed rate debt that had longer terms to maturity and higher interest rates, which resulted in the higher interest expense.
Other Income (Expense), Net-Equistar had other expense, net of $6 million in 2004 and $43 million in 2003 and other income, net of $2 million in 2002. The 2003 net expense of $43 million included $37 million of refinancing costs.
Net Income-Equistar’s net income was $276 million in 2004, compared to a net loss of $339 million in 2003. The $615 million improvement in 2004 was primarily due to higher product margins and higher sales volumes in 2004 due to improved supply/demand fundamentals compared to 2003. The higher sales prices more than offset the effect of significantly higher raw material and energy costs compared to 2003. 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 2003. The higher raw material and energy costs during 2004 reflected the effect of 33% higher average benchmark crude oil prices in 2004, as well as ongoing high natural gas prices compared to 2003. Also, ethylene and derivative sales volumes in 2004 were 11% higher compared to 2003. The net loss in 2003 included the $37 million of refinancing costs, the $12 million loss from the sale of the polypropylene production facility, the $11 million charge for the write-off of the R&D facility, as well as $6 million of employee severance costs.
Equistar had a 2003 net loss of $339 million compared to a 2002 loss of $246 million before the cumulative effect of an accounting change in 2002. The $93 million higher loss in 2003 included the $37 million of refinancing costs, the $12 million loss on the sale of the polypropylene plant, the $11 million charge for the write-off of the R&D facility and the $6 million of employee severance costs. The 2002 net loss included a $33 million negative impact of certain fixed price natural gas and NGL purchase contracts entered into in early 2001. The remaining $60 million decrease in operating results was primarily due to lower sales volumes, which were only partly offset by higher average product margins in 2003. In addition, SG&A expenses in 2003 were $27 million higher than in 2002, primarily due to higher employee benefit costs.
Cumulative Effect of Accounting Change-Effective January 1, 2002, Equistar adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. Upon implementation of SFAS No. 142, Equistar reviewed goodwill for impairment and concluded that the entire balance of goodwill was impaired, resulting in a $1.1 billion charge that was reported as the cumulative effect of an accounting change as of January 1, 2002.
Fourth Quarter 2004 versus Third Quarter 2004
Equistar’s fourth quarter 2004 net income was $156 million compared to net income of $72 million in the third quarter 2004. The $84 million improvement primarily resulted from higher sales prices for ethylene and derivatives, which more than offset the higher raw material costs compared to the third quarter 2004. All ethylene-based product prices increased during the fourth quarter 2004. In addition, ethylene and derivative sales
volumes were 2% higher compared to the third quarter 2004. Benchmark crude prices averaged 10% higher in the fourth quarter 2004 compared to the third quarter 2004, but this increase in raw material costs was offset by an increase in co-product prices.
Product Group Analysis
The following analysis discusses Equistar’s operating results focusing on two product groups: ethylene and co-products; and derivatives. Ethylene co-products primarily include propylene, butadiene, fuels, which include MTBE and alkylates, and aromatics, which include benzene and toluene. Derivatives primarily include polyethylene, ethylene glycol, ethylene oxide and its derivatives, and ethanol and polypropylene.
The following tables reflect selected sales data, including sales of ethylene and co-products used as derivative raw materials, and summarized financial information for the two product groups.
Ethylene and co-products
Revenues-Ethylene and co-products revenues of $8,136 million in 2004 increased 47% compared to $5,537 million in 2003. The increase reflected higher average sales prices and volumes during 2004 compared to 2003. Benchmark ethylene sales prices were 18% higher in 2004 compared to 2003. Increases in sales prices of co-products were much more significant. Benchmark benzene sales prices averaged 87% higher and benchmark propylene sales prices averaged 49% higher in 2004 compared to 2003. Sales volumes, including sales of ethylene and co-products included in derivatives, were 12% higher in 2004 compared to 2003.
Revenues of $5,537 million in 2003 increased 22% compared to revenues of $4,544 million in 2002 due to higher sales prices, partly offset by lower sales volumes. Benchmark ethylene prices averaged 28% higher in 2003 compared to 2002 in response to significant increases in raw material and energy costs, and benchmark propylene sales prices averaged 19% higher. Sales volumes decreased 4% in 2003 compared to 2002 due to lower sales of ethylene and co-products included in derivatives and lower co-product production in 2003. Lower co-product production reflected the scheduled maintenance turnarounds at two major ethylene plants in 2003.
Operating Income-Operating income in 2004 for the ethylene and co-products product group was $482 million compared to $62 million in 2003. The increase was primarily due to higher product margins and higher
sales volumes in 2004 due to improved supply/demand fundamentals compared to 2003. The effect of sales price increases in response to higher raw material and energy costs were generally more favorable in 2004 than in 2003, resulting in higher average product margins in 2004. Additionally, sales volumes were lower in 2003 as a result of the scheduled turnarounds at the two major ethylene plants.
Operating income of $62 million in 2003 decreased $33 million compared to operating income of $95 million in 2002. Operating income for 2002 included the $33 million negative effect of the fixed price natural gas and NGL purchase contracts entered into in early 2001. The decrease in 2003 operating income was due to the negative effect of the two scheduled maintenance turnarounds and 4% lower sales volumes compared to 2002.
Derivatives
Revenues-Derivatives revenues of $3,257 million in 2004 increased 29% compared to $2,522 million in 2003. The increase was due to higher average sales prices and volumes in 2004 compared to 2003. The average sales price increases in 2004 reflected higher demand and higher raw material costs. Sales volumes were 11% higher in 2004 compared to 2003, reflecting the stronger demand.
Revenues of $2,522 million in 2003 increased 11% compared to $2,281 million in 2002. The increase was due to an 18% increase in average sales prices, partly offset by a 6% decrease in sales volumes. Average sales prices increased in response to higher raw material costs, primarily ethylene, compared to 2002. The average benchmark price of ethylene increased 28% in 2003 compared to 2002. The lower sales volumes reflected the negative effect of the higher sales prices on product demand.
Operating Income-Operating income for derivatives was $20 million in 2004 compared to an operating loss of $151 million in 2003. The improvement in 2004 was primarily the result of higher product margins, especially in the third and fourth quarters of 2004, and higher sales volumes compared to 2003. In addition, the operating loss in 2003 included the $11 million charge for the write-off of the R&D facility and the $12 million loss on the sale of the polypropylene production facility.
The operating loss of $151 million in 2003 compared to an operating loss of $139 million in 2002. The combined effects of the $11 million write-off of the R&D facility and the $12 million loss on sale of the polypropylene production facility, as well as the negative effect of the 6% decrease in sales volumes, were offset by higher product margins in 2003 compared to 2002. Margins increased in 2003 compared to 2002 as higher average sales prices more than offset higher raw material costs.
FINANCIAL CONDITION
Operating Activities-Operating activities provided cash of $215 million in 2004, $164 million in 2003, and $55 million in 2002. The 2004 increase compared to 2003 reflected the earnings improvement in 2004, and lower 2004 maintenance turnaround expenditures, largely offset by a significant increase in 2004 in the main components of working capital-receivables, inventory and payables. In addition, the 2003 period included a receipt of $159 million 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.
Net income of $276 million in 2004 improved $615 million from a net loss of $339 million in 2003. This increase in operating cash flow was substantially offset by a net increase in the main components of working capital that used cash of $360 million in 2004 compared to a net decrease that provided cash of $70 million in 2003. The increase in working capital in 2004 was primarily due to higher accounts receivable balances, which reflected higher product sales prices and volumes compared to 2003, and a $174 million increase in inventory compared to low December 31, 2003 inventory levels. The increase in receivables was partly offset by a $98 million increase in the outstanding amount of accounts receivable sold under Equistar’s accounts receivables
sales facility in 2004 compared to a $21 million increase in 2003. The outstanding amount of Equistar’s accounts receivable sold under this facility was $200 million at December 31, 2004 and $102 million at December 31, 2003.
In consideration of discounts offered to certain customers for early payment for product, some receivable amounts were collected in December 2004 and December 2003 that otherwise would have been expected to be collected in January of the following years. This included $66 million in December 2004 and $41 million in December 2003 from Occidental Chemical Corporation, a subsidiary of Occidental.
Operations in 2004 included cash expenditures of $55 million for scheduled maintenance turnarounds compared to cash expenditures of $97 million in 2003.
The $109 million increase in operating cash flow in 2003 compared to 2002 reflected the $159 million received by Equistar as a partial prepayment for the long-term propylene supply arrangement entered into in March 2003. The cash flow benefit of this prepayment was partially offset by a higher net loss in 2003, excluding the $1.1 billion cumulative effect of an accounting change in 2002.
Investing Activities-Investing activities used cash of $60 million, $37 million and $124 million in 2004, 2003 and 2002, respectively. The year-to-year changes were primarily due to proceeds from asset sales. Proceeds from asset sales were $41 million in 2004, $69 million in 2003 and less than $1 million in 2002. In 2004, Equistar sold certain railcars for $37 million and leased the railcars from the buyer under an operating lease agreement. The proceeds from the asset sales in 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 $101 million in 2004, $106 million in 2003, and $118 million in 2002. The 2003 and 2002 expenditures included $18 million and $47 million, respectively, for purchases of previously leased railcars. Equistar’s level of capital expenditures during 2003 and 2002, excluding the railcar purchases, reflected reduced discretionary spending in view of the poor business environment in those years. Equistar’s increased 2004 capital spending was primarily related to environmental compliance projects. Equistar’s 2005 capital budget is $167 million. The increase over 2004 spending is primarily to ensure continued compliance with environmental regulations. See “Environmental Matters” below.
Financing Activities-Financing activities used cash of $315 million in 2004, provided cash of $45 million in 2003 and used cash of $106 million in 2002. In 2004, Equistar resumed making distributions to its owners, distributing a total of $315 million to Lyondell and Millennium. Equistar made no distributions to its owners in 2003 or 2002. The $45 million provided in 2003 reflected net proceeds of debt refinancing activity, and the $106 million used in 2002 included the scheduled retirement of $100 million of 9.125% Notes.
The Equistar credit facility was amended in June 2004 to clarify certain provisions. In March 2003 and March 2002, Equistar obtained amendments to its previous $354 million revolving credit facility that provided additional financial flexibility by generally making certain financial ratio requirements less restrictive.
In December 2003, concurrent with entering into a $450 million accounts receivable sales facility, Equistar entered into a $250 million, four-year, inventory-based revolving credit facility, which replaced Equistar’s previous $354 million revolving credit facility. At December 31, 2004, the interest rate under the $250 million revolving credit facility was LIBOR plus 2.25%. The $250 million revolving credit facility is secured by a lien on all inventory and certain personal property, including a pledge of accounts receivable.
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 issued $450 million of 10.625% senior unsecured 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 term loans under Equistar’s previous $354 million
revolving 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. In November 2003, Equistar issued $250 million of 10.625% senior unsecured notes due in 2011. The gross proceeds of $262 million, net of related fees, were used to prepay in full $173 million of the outstanding term loan under Equistar’s previous $354 million revolving credit facility and to repay borrowing under that revolving credit facility.
Liquidity and Capital Resources-At December 31, 2004, Equistar’s long-term debt, including current maturities, totaled $2.3 billion, or approximately 60% of its total capitalization. Equistar had cash on hand of $39 million. In addition, the total amount available at December 31, 2004 under both the $250 million inventory-based revolving credit facility and the $450 million accounts receivable sales facility was approximately $394 million, which gives effect to the borrowing base less a $75 million unused availability requirement and is net of the $200 million sold under the accounts receivable facility and $31 million of outstanding letters of credit under the revolving credit facility as of December 31, 2004. The borrowing base is determined using a formula applied to accounts receivable and inventory balances. The 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 outstanding borrowing under the revolving credit facility at December 31, 2004.
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 other payments, and mergers. The credit facility does not require Equistar to maintain specified financial ratios. The breach of the covenants could permit the lenders or noteholders to declare any outstanding debt payable and could permit the lenders under Equistar’s credit facility to terminate future lending commitments. In addition, some of Equistar’s indentures require additional interest payments to the noteholders if Equistar makes distributions when Equistar does not meet a specified fixed charge coverage ratio. Equistar met this ratio and was in compliance with all covenants under these agreements as of December 31, 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 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 and ongoing operations.
Off-Balance Sheet Arrangements-The Securities and Exchange Commission (“SEC”) has described various characteristics to identify contractual arrangements that would fall within the SEC’s definition of off-balance sheet arrangements. Equistar is a party to the following accounts receivable sales facility that has some of those characteristics.
In December 2003, Equistar entered into a $450 million, four-year, accounts receivable sales facility to replace its previous accounts receivable sales facility. Pursuant to the facility, Equistar sells, through a wholly owned bankruptcy remote subsidiary, on an ongoing basis and without recourse, an interest in a pool of accounts receivable to financial institutions participating in the facility. Equistar is responsible for servicing the receivables. The $450 million accounts receivable sales facility is subject to substantially the same minimum unused availability requirements and covenant requirements as the $250 million inventory-based revolving credit facility. See discussion of “Liquidity and Capital Resources” above and discussion of “Long-Term Debt” below. The breach of these covenants would permit the counterparty to the accounts receivable sales facility to terminate further purchases of Equistar’s accounts receivable. At December 31, 2004 and 2003, the balance of Equistar’s accounts receivable sold under the facility was $200 million and $102 million, respectively. 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. See Note 4 to the Consolidated Financial Statements for additional accounts receivable information.
Contractual and Other Obligations-The following table summarizes, as of December 31, 2004, Equistar’s minimum payments for long-term debt, and contractual and other obligations for the next five years and thereafter.
Long-Term Debt-Equistar’s long-term debt includes credit facility and debt obligations. See “Liquidity and Capital Resources” above for a discussion of the covenant requirements under the Equistar credit facility and indentures and Note 9 to the Consolidated Financial Statements for descriptions of Equistar’s long-term debt and credit facility.
Interest Payable-The long-term debt agreements contain provisions for the payment of either monthly or semi-annual interest at a stated rate of interest over the term of the debt. These payment obligations are reflected in the table above.
Pension Benefits-Equistar maintains several defined benefit pension plans as described in Note 12 to the Consolidated Financial Statements. At December 31, 2004, the projected benefit obligation for Equistar’s pension plans exceeded the fair value of plan assets by $71 million. Subject to future actuarial gains and losses, as well as actual asset earnings, Equistar will be required to fund the $71 million, with interest, in future years. Pension contributions were $16 million, $15 million, and $18 million for the years 2004, 2003, and 2002, respectively, and are estimated to be approximately $16 million for 2005, $23 million in 2006, $19 million in 2007, $18 million in 2008 and $17 million in 2009. Current projections indicate that contributions will be required to be made quarterly, rather than annually, beginning in 2006, resulting in an acceleration of payments in 2006.
Other Postretirement Benefits-Equistar sponsors postretirement benefit plans other than pensions, which provide medical and life insurance benefits as described in Note 12 to the Consolidated Financial Statements. Other postretirement benefits are unfunded and are paid by Equistar as incurred. Estimates of other postretirement benefit payments through 2009 are included in the table above.
Advances from Customers-Equistar received advances from customers in 2003 and in 2002 in connection with long-term sales agreements under which Equistar is obligated to deliver product primarily at cost-based prices. These advances are treated as deferred revenue and will be amortized to earnings over the remaining
terms of the respective contracts, which range from 8 to 14 years. The unamortized long-term portion of such advances totaled $139 million as of December 31, 2004. See Note 8 to the Consolidated Financial Statements.
Other Noncurrent Obligations-Other noncurrent obligations primarily include deferred compensation arrangements other than pension and postretirement benefits.
Purchase Obligations-Equistar is a party to various unconditional obligations to purchase products and services, as summarized in the above table. These primarily include commitments for steam and power from a co-generation facility. These commitments are designed to assure sources of supply and are not expected to be in excess of normal requirements. See “Commitments” section of Note 13 to the Consolidated Financial Statements.
Operating Leases-Equistar leases various facilities and equipment, including railcars, under noncancelable operating lease arrangements for various periods. See Note 10 to the Consolidated Financial Statements for information on Equistar’s operating leases.
CURRENT BUSINESS OUTLOOK
Business conditions continue to be positive for the majority of Equistar’s products, and Equistar continues to benefit from strong economics for its liquids-based ethylene facilities. Supply/demand conditions for the majority of Equistar’s products have strengthened, and Equistar generally expects this strengthening to continue throughout 2005.
Volatile and elevated energy prices and resultant raw material prices continue to be a concern. While the industry appears to continue to adapt to this energy price environment, the primary concern is the impact that it may have on the broader global economy. Overall, Equistar believes that 2005 will be characterized by additional tightening of supply/demand for its products.
RELATED PARTY TRANSACTIONS
Equistar makes significant sales of product to Lyondell, LYONDELL-CITGO Refining LP (“LCR”), affiliates of Millennium and affiliates of Occidental, including Occidental Chemical Corporation. Equistar also makes significant purchases of raw materials and products from LCR and receives significant administrative services from Lyondell.
Prior to August 22, 2002, Equistar was owned 41% by Lyondell, 29.5% by Millennium, and 29.5% by Occidental. On August 22, 2002, Lyondell completed the purchase of Occidental’s interest in Equistar, increasing its ownership interest in Equistar to 70.5%. As a result of that transaction, Occidental has two representatives on Lyondell’s board of directors and, as of December 31, 2004, Occidental Chemical Holding Corporation owned approximately 17% of Lyondell. In view of Occidental’s relationship with Lyondell, which indirectly owns 100% of Equistar as a result of the acquisition of Millennium by Lyondell on November 30, 2004, Occidental’s transactions with Equistar continue to be reported as related party transactions in Equistar’s Consolidated Statements of Income and Consolidated Balance Sheets.
Equistar believes that all such aforementioned related party transactions are effected on terms substantially no more or less favorable than those that would have been agreed upon by unrelated parties on an arm’s length basis. See Note 3 to the Consolidated Financial Statements for a description of related party transactions.
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. Equistar’s more critical accounting policies include those related to long-lived assets, including the costs of major maintenance
turnarounds and repairs, and accruals for long-term employee benefit costs such as pension and other postretirement costs. 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. These critical accounting policies have been discussed with the Equistar Partnership Governance Committee. Equistar’s significant accounting policies are summarized in Note 2 to the Consolidated Financial Statements.
Long-Lived Assets-With respect to long-lived assets, key assumptions include the estimates of useful asset lives and the recoverability of the carrying values of fixed assets and intangible assets as well as the existence of any obligations associated with the retirement of fixed assets. Such estimates could be significantly modified and/or the carrying values of the assets could be impaired by such factors as new technological developments, new chemical industry entrants with significant raw material or other cost advantages, uncertainties associated with the U.S. and world economies, the cyclical nature of the chemical industry, and uncertainties associated with governmental regulatory actions.
To reflect economic and market conditions, from time to time Equistar may temporarily idle manufacturing facilities. Assets that are temporarily idled are reviewed for impairment at the time they are idled, and at least annually thereafter. Fixed assets with a net book value of $145 million were temporarily idled as of December 31, 2004. Those assets continue to be depreciated over their remaining useful lives. No impairments were recorded in 2004, 2003 or 2002 for temporarily idled facilities. Charges of $11 million were recorded in 2003 for abandoned research and development facilities.
Equistar defers the costs of major periodic maintenance and repair activities (“turnarounds”) in excess of $5 million, amortizing such costs over the period until the next expected major turnaround of the affected unit. During 2004, 2003 and 2002, expenditures of $55 million, $97 million and $49 million, respectively, were deferred and are being amortized, generally over a period of 5 to 7 years. Amortization in 2004, 2003 and 2002, of previously deferred turnaround costs was $38 million, $30 million and $24 million, respectively.
The estimated useful lives of long-lived assets range from 3 to 30 years. Depreciation and amortization of these assets, including amortization of deferred turnaround costs, under the straight-line method over their estimated useful lives totaled $313 million in 2004. If the useful lives of the assets were found to be shorter than originally estimated, depreciation charges would be accelerated.
Additional information on long-lived assets, deferred turnaround costs and related depreciation and amortization appears in Note 6 to the Consolidated Financial Statements.
Long-Term Employee Benefit Costs-The costs to Equistar of long-term employee benefits, particularly pension and postretirement medical and life insurance benefits, are incurred over long periods of time, and involve many uncertainties over those periods. The net periodic benefit cost attributable to current periods is based on several assumptions about such future uncertainties, and is sensitive to changes in those assumptions. It is management’s responsibility, often with the assistance of independent experts, to select assumptions that in its judgment represent its best estimates of the future effects of those uncertainties. It also is management’s responsibility to review those assumptions periodically to reflect changes in economic or other factors that affect those assumptions.
The current benefit service costs, as well as the existing liabilities, for pensions and other postretirement benefits are measured on a discounted present value basis. The discount rate is a current rate, related to the rate at which the liabilities could be settled. Equistar’s assumed discount rate is based on average rates published by Moody’s and Merrill Lynch for high-quality (Aa rating) ten-year fixed income securities. For the purpose of measuring the benefit obligations at December 31, 2004, Equistar lowered its assumed discount rate from 6.25% to 5.75%, reflecting the general decline in market interest rates during 2004. The 5.75% rate also will be used to measure net periodic benefit cost during 2005. A further one percentage point reduction in the assumed discount
rate for Equistar would increase Equistar’s benefit obligation for pensions and other postretirement benefits by approximately $38 million, and would reduce Equistar’s net income by approximately $5 million annually.
The benefit obligation and the periodic cost of postretirement medical benefits also are measured based on assumed rates of future increase in the per capita cost of covered health care benefits. As of December 31, 2004, the assumed rate of increase was 10% for 2004, 7% for 2005 through 2007 and 5% thereafter. A one percentage point change in the health care cost trend rate assumption would have no significant effect on either the benefit liability or the net periodic cost, due to limits on Equistar’s maximum contribution level under the medical plan.
The net periodic cost of pension benefits included in expense also is affected by the expected long-term rate of return on plan assets assumption. Investment returns that are recognized currently in net income represent the expected rate of return on plan assets applied to a market-related value of plan assets which, for Equistar, is defined as the market value of assets. The expected rate of return on plan assets is a longer term rate, and is expected to change less frequently than the current assumed discount rate, reflecting long-term market expectations, rather than current fluctuations in market conditions.
Prior to 2003, Equistar’s expected long-term rate of return on plan assets of 9.5% had been based on the average level of earnings that its independent pension investment advisor had advised could be expected to be earned over time. The expectation was based on an asset allocation of 50% U.S. equity securities (11% expected return), 20% non-U.S. equity securities (11.7% expected return), and 30% fixed income securities (6.5% expected return) that had been recommended by the advisor, and had been adopted for the plans. Over the three-year period ended December 31, 2003, Equistar’s actual return on plan assets averaged 0.9% per year. In 2003, Equistar reviewed its asset allocation and expected long-term rate of return assumptions, and obtained an updated asset allocation study from the independent pension investment advisor, including updated expectations for long-term market earnings rates for various classes of investments. Based on this review, Equistar reduced its expected long-term rate of return on plan assets to 8%, and did not significantly change its plan asset allocations.
The actual rate of return on plan assets may differ from the expected rate due to the volatility normally experienced in capital markets. Management’s goal is to manage the investments over the long term to achieve optimal returns with an acceptable level of risk and volatility. Based on the market value of plan assets at December 31, 2004, a one percentage point decrease in this assumption for Equistar would decrease Equistar’s net income by approximately $2 million annually.
Net periodic pension cost recognized each year includes the expected asset earnings, rather than the actual earnings or loss. As a result of asset earnings significantly below the expected return on plan assets rate over the last several years, the level of unrecognized investment losses, together with the net actuarial gains and losses, is $61 million at December 31, 2004. This unrecognized amount, to the extent it exceeds ten percent of the projected benefit obligation for the respective plan, will be recognized as additional net periodic benefit cost over the average remaining service period of the participants in each plan. This annual amortization charge will be approximately $12 million per year based on the December 31, 2004 unrecognized amount.
Additional information on the key assumptions underlying these benefit costs appears in Note 12 to the Consolidated Financial Statements.
ACCOUNTING AND REPORTING CHANGES
Effective January 1, 2002, Equistar implemented SFAS No. 142, Goodwill and Other Intangible Assets. Upon implementation of SFAS No. 142, Equistar reviewed goodwill for impairment and concluded that the entire balance of goodwill was impaired, resulting in a $1.1 billion charge to earnings that was reported as the cumulative effect of an accounting change as of January 1, 2002. The conclusion was based on a comparison to Equistar’s indicated fair value, using multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) for comparable companies as an indicator of fair value. As a result of implementing SFAS No. 142,
income in 2002 and subsequent years is favorably affected by $33 million annually because of the elimination of goodwill amortization. See Note 2 to Consolidated Financial Statements.
ANTICIPATED ACCOUNTING CHANGES
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets, which is replaced with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange is defined to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Equistar will be required to adopt SFAS No. 153 no later than the third quarter 2005 with prospective application. Equistar is currently evaluating the impact, if any, that application of SFAS No. 153 will have on its financial statements.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs. The primary impact of the statement on Equistar will be recognition as period costs of any abnormal amounts of idle facility expense, freight, handling costs, and spoilage. The provisions of SFAS No. 151 will be applied prospectively upon implementation, which is required no later than the first quarter 2006. Equistar does not expect application of SFAS No. 151 to have a material impact on its financial statements.
ENVIRONMENTAL MATTERS
Various environmental laws and regulations impose substantial requirements upon the operations of Equistar. Equistar’s policy is to be in compliance with such laws and regulations, which include, among others, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”) as amended, the Resource Conservation and Recovery Act (“RCRA”) and the Clean Air Act Amendments. Equistar does not specifically track all recurring costs associated with managing hazardous substances and pollution in ongoing operations. Such costs are included in cost of sales. Equistar also makes capital expenditures to comply with environmental regulations. Such capital expenditures totaled approximately $44 million, $38 million and $14 million for 2004, 2003 and 2002, respectively. Capital expenditures increased in 2004 and 2003 as a result of new emission reduction rules, discussed below, and Equistar currently estimates 2005 and 2006 expenditures at approximately $80 million and $70 million, respectively. These amounts include estimated expenditures related to air emission control standards, as discussed below, and a wastewater management project.
Under the 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”) must be installed at each of Equistar’s six plants in the Houston/Galveston region prior to a November 2007 compliance deadline for the one-hour ozone standard. In addition, in December 2004, the regulatory agency for the state of Texas, the Texas Commission on Environmental Quality (“TCEQ”), finalized controls over highly reactive, volatile organic compounds (“HRVOCs”). Equistar is still assessing the impact of the HRVOC rules. 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. Although the one-hour ozone standard expires in 2005, the controls under that standard will not be relaxed under the EPA’s new eight-hour transition rules. As a result, Equistar will still be required to meet the new emission standards for NOx and HRVOCs. The timing and amount of these expenditures are subject to regulatory and other uncertainties, as well as to obtaining the necessary permits and approvals. The ultimate cost of implementing any plan developed to comply with the final ozone standards cannot be estimated at this time.
Equistar’s accrued liability for environmental remediation as of December 31, 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 loss in excess of the liability recorded for environmental matters.
Item 7A.
Item 7A. Disclosure of Market and Regulatory Risk
COMMODITY PRICE RISK
A substantial portion of Equistar’s products and raw materials are commodities whose prices fluctuate as market supply and demand fundamentals change. Accordingly, product margins and the level of Equistar’s profitability tend to fluctuate with changes in the business cycle. Equistar tries to protect against such instability through various business strategies. These include utilization of the ethylene plants’ raw material flexibility and entering into multi-year processing and sales agreements.
In addition, Equistar selectively enters into commodity derivative hedging transactions, primarily price swaps and call options, to help manage its exposure to commodity price risk with respect to purchases of natural gas and crude oil-related raw materials as well as product sales. Market risks created by these derivative instruments and the mark-to-market valuations of open positions are monitored by management. During 2004, 2003 and 2002, the derivative transactions were not significant compared to Equistar’s overall inventory purchases and product sales. At December 31, 2004 and 2003, the market value of outstanding derivatives was not material.
INTEREST RATE RISK
During 2003, Equistar repaid its remaining variable rate debt that was outstanding at December 31, 2002, using proceeds of new fixed-rate debt offerings. Equistar had no borrowing outstanding under its inventory-based revolving credit facility as of December 31, 2004 and 2003. Accordingly, Equistar’s exposure to variable interest rate risk was minimal at December 31, 2004 and 2003.
REGULATORY RISK
New air pollution standards promulgated by federal and state regulatory agencies in the U.S., including those specifically targeting the eight-county Houston/Galveston region, will affect a substantial portion of the operating facilities of Equistar. Compliance with these standards will result in increased capital investment during the next several years and higher annual operating costs for Equistar. Equistar is still assessing the impact of these proposed regulations and the ultimate cost of implementing any plan developed to comply with the final ozone standards cannot be estimated at this time. See “Clean Air Act” section of Note 13 to the Consolidated Financial Statements and “Environmental Matters” above.
Item 8.
Item 8. Financial Statements and Supplementary Data
Index to the Consolidated Financial Statements
Page
EQUISTAR CHEMICALS, LP
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Statements of Income
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Consolidated Statements of Partners’ Capital
Notes to the Consolidated Financial Statements
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Equistar is responsible for establishing and maintaining adequate internal control over financial reporting. Equistar’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting in accordance with generally accepted accounting principles.
Equistar management assessed the effectiveness of Equistar’s internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on its assessment, Equistar’s management has concluded that Equistar’s internal control over financial reporting was effective as of December 31, 2004 based on those criteria.
PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K, has audited management’s assessment of the effectiveness of Equistar’s internal control over financial reporting as of December 31, 2004, as stated in their report that appears on the following page.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Partnership Governance Committee
of Equistar Chemicals, LP
We have completed an integrated audit of Equistar Chemicals, LP’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Equistar Chemicals, LP (the “Partnership”) and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Accounting for Goodwill and Other Intangible Assets.”
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 8, that the Partnership maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the COSO. The Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Partnership’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 16, 2005
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF INCOME
See Notes to the Consolidated Financial Statements.
EQUISTAR CHEMICALS, LP
CONSOLIDATED BALANCE SHEETS
See Notes to the Consolidated Financial Statements.
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF CASH FLOWS
See Notes to the Consolidated Financial Statements.
EQUISTAR CHEMICALS, LP
CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
See Notes to the Consolidated Financial Statements.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Formation of the Partnership and Operations
Equistar Chemicals, LP (“Equistar” or “the Partnership”), a Delaware limited partnership which commenced operations on December 1, 1997, was formed by Lyondell Chemical Company and subsidiaries (“Lyondell”) and Millennium Chemicals Inc. and subsidiaries (“Millennium”). On May 15, 1998, Equistar was expanded with the contribution of certain assets from Occidental Petroleum Corporation and subsidiaries (“Occidental”). Prior to August 22, 2002, Equistar was owned 41% by Lyondell, 29.5% by Millennium and 29.5% by Occidental. On August 22, 2002, Lyondell purchased Occidental’s interest in Equistar and, as a result, Lyondell’s ownership interest in Equistar increased to 70.5%. Equistar became a wholly owned subsidiary of Lyondell as a result of Lyondell’s acquisition of Millennium on November 30, 2004. The consolidated financial statements of Equistar reflect its historical cost basis, and, accordingly, do not reflect any purchase accounting adjustments related to the acquisition by Lyondell of Millennium and Millennium’s interest in Equistar.
Equistar manufactures and markets ethylene and its co-products, primarily propylene, butadiene, fuels and aromatics. Equistar also manufactures and markets derivatives, primarily ethylene oxide, ethylene glycol and polyethylene.
2. Summary of Significant Accounting Policies
Basis of Presentation-The consolidated financial statements include the accounts of Equistar and its subsidiaries.
Revenue recognition-Revenue from product sales is recognized at the time of transfer of title and risk of loss to the customer, which usually occurs at the time of shipment. Revenue is recognized at the time of delivery if Equistar retains the risk of loss during shipment. For products that are shipped on a consignment basis, revenue is recognized when the customer uses the product. Costs incurred in shipping products sold are included in cost of sales. Billings to customers for shipping costs are included in sales revenue.
Cash and Cash Equivalents-Cash equivalents consist of highly liquid debt instruments such as certificates of deposit, commercial paper and money market accounts. Cash equivalents include instruments with maturities of three months or less when acquired. Cash equivalents are stated at cost, which approximates fair value. Equistar’s policy is to invest cash in conservative, highly rated instruments and to limit the amount of credit exposure to any one institution.
Equistar has no requirements for compensating balances in a specific amount at a specific point in time. The Partnership does maintain compensating balances for some of its banking services and products. Such balances are maintained on an average basis and are solely at Equistar’s discretion. As a result, none of Equistar’s cash is restricted.
Allowance for Doubtful Accounts-Equistar establishes provisions for doubtful accounts receivable based on management’s estimates of amounts that it believes are unlikely to be collected. Collectibility of receivables is reviewed and the allowance for doubtful accounts is adjusted at least quarterly, based on aging of specific accounts and other available information about the associated customers.
Inventories-Inventories are stated at the lower of cost or market. Cost is determined using the last-in, first-out (“LIFO”) method for substantially all inventories, except for materials and supplies, which are valued using the average cost method.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Inventory exchange transactions, which involve fungible commodities and do not involve the payment or receipt of cash, are not accounted for as purchases and sales. Any resulting volumetric exchange balances are accounted for as inventory in accordance with the normal LIFO valuation policy.
Property, Plant and Equipment-Property, plant and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful asset lives, generally 25 years for major manufacturing equipment, 30 years for buildings, 5 to 15 years for light equipment and instrumentation, 15 years for office furniture and 3 to 5 years for information systems equipment. Upon retirement or sale, Equistar removes the cost of the assets and the related accumulated depreciation from the accounts and reflects any resulting gains or losses in the Consolidated Statements of Income. Equistar’s policy is to capitalize interest cost incurred on debt during the construction of major projects exceeding one year.
Long-Lived Asset Impairment-Equistar evaluates long-lived assets, including identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When it is probable that undiscounted future cash flows will not be sufficient to recover an asset’s carrying amount, the asset is written down to its estimated fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or estimated fair value less costs to sell the assets.
Investments-Equistar’s investments primarily consist of a 50% interest in a joint venture that owns an ethylene glycol facility in Beaumont, Texas (“PD Glycol”). The investment in PD Glycol is accounted for using the equity method of accounting.
Turnaround Maintenance and Repair Costs-Costs of maintenance and repairs exceeding $5 million incurred in connection with turnarounds of major units at Equistar’s manufacturing facilities are deferred and amortized using the straight-line method over the period until the next planned turnaround, generally 5 to 7 years. These costs are necessary to maintain, extend and improve the operating capacity and efficiency rates of the production units.
Identifiable Intangible Assets-Costs to purchase and to develop software for internal use are deferred and amortized on a straight-line basis over periods of 3 to 10 years.
Other intangible assets are carried at amortized cost and primarily consist of deferred debt issuance costs, patents and license costs, capacity reservation fees and other long-term processing rights and costs. These assets are amortized using the straight-line method over their estimated useful lives or the term of the related agreement, if shorter.
Environmental Remediation Costs-Anticipated expenditures related to investigation and remediation of contaminated sites, which include operating facilities and waste disposal sites, are accrued when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Only ongoing operations and monitoring costs, the timing of which can be determined with reasonable certainty, are discounted to present value. Future legal costs associated with such matters, which generally are not estimable, are not included in these liabilities.
Income Taxes-The Partnership is not subject to federal income taxes as income is reportable directly by the individual partners; therefore, there is no provision for income taxes in the accompanying financial statements.
Use of Estimates-The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Accounting and Reporting Changes-Effective January 1, 2002, Equistar implemented SFAS No. 142, Goodwill and Other Intangible Assets. Upon implementation of SFAS No. 142, Equistar reviewed goodwill for impairment and concluded that the entire balance of goodwill was impaired, resulting in a $1.1 billion charge to earnings that was reported as the cumulative effect of an accounting change as of January 1, 2002. The conclusion was based on a comparison to Equistar’s indicated fair value, using multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) for comparable companies as an indicator of fair value. As a result of implementing SFAS No. 142, income in 2002 and subsequent years is favorably affected by $33 million annually because of the elimination of goodwill amortization.
Anticipated Accounting Changes-In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 153, Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets, which is replaced with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange is defined to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. Equistar will be required to adopt SFAS No. 153 no later than the third quarter 2005 with prospective application. Equistar is currently evaluating the impact, if any, that application of SFAS No. 153 will have on its financial statements.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs. The primary impact of the statement on Equistar will be recognition as period costs of any abnormal amounts of idle facility expense, freight, handling costs and spoilage. The provisions of SFAS No. 151 will be applied prospectively upon implementation, which is required no later than the first quarter 2006. Equistar does not expect application of SFAS No. 151 to have a material impact on its financial statements.
3. Related Party Transactions
Equistar is a wholly owned subsidiary of Lyondell. As of December 31, 2004, Occidental owns approximately 17% of Lyondell, and has two representatives on the Lyondell Board of Directors. Lyondell owns 58.75% of Lyondell-CITGO Refining, LP (LCR) and 100% of Millennium. All of the above companies are considered related parties of Equistar.
Product Transactions with Lyondell-Lyondell purchases ethylene, propylene and benzene at market-related prices from Equistar under various agreements expiring in 2013 and 2014. With the exception of one pre-existing third-party product supply agreement expiring in 2015, Lyondell is required, under the agreements, to purchase 100% of its ethylene, propylene and benzene requirements for its Channelview and Bayport, Texas facilities from Equistar. Lyondell licenses methyl tertiary butyl ether (“MTBE”) technology to Equistar, and purchases a significant portion of the MTBE produced by Equistar at market-related prices.
Through December 31, 2004, Equistar acted as sales agent for the methanol products of Lyondell. Equistar also provided operating and other services for Lyondell including the lease to Lyondell by Equistar of the real property on which the methanol plant was located. Pursuant to the terms of those agreements, Lyondell paid Equistar a management fee and reimbursed certain expenses of Equistar at cost.
Product Transactions with Millennium-Equistar sells ethylene to Millennium at market-related prices pursuant to an agreement entered into in connection with the formation of Equistar. Under this agreement, Millennium is required to purchase 100% of its ethylene requirements for its LaPorte, Texas facility from Equistar. The initial term of the contract expired December 31, 2000 and it continues thereafter for one-year periods unless either party serves notice twelve months in advance.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Also Equistar is required to purchase 100% of its vinyl acetate monomer raw material requirements at market-related prices from Millennium for the production of ethylene vinyl acetate products at its LaPorte, Texas; Clinton, Iowa and Morris, Illinois plants, and 100% of its glacial acetic acid requirements at market-related prices from Millennium for the production of glycol ether acetate as its Bayport, Texas plant. These agreements expire December 31, 2005 and continue year to year thereafter unless terminated by either party.
Product Transactions with Occidental-Equistar and Occidental entered into an ethylene sales agreement on May 15, 1998, which was amended effective April 1, 2004, pursuant to which Occidental agreed to purchase a substantial amount of its ethylene raw material requirements from Equistar. Either party has the option to “phase down” volumes over time. However, a “phase down” cannot begin until January 1, 2014 and the annual minimum requirements cannot decline to zero prior to December 31, 2018, unless certain specified force majeure events occur. In addition to the sales of ethylene, from time to time Equistar has made sales of ethers and glycols to Occidental, and Equistar has purchased various other products from Occidental, all at market-related prices.
Product Transactions with LYONDELL-CITGO Refining LP-Equistar has product sales and raw material purchase agreements with LCR, a joint venture investment of Lyondell. Certain ethylene co-products and MTBE are sold by Equistar to LCR for processing into gasoline and certain refined products are sold by LCR to Equistar as raw materials. Equistar also has processing and storage arrangements with LCR and provides certain marketing services for LCR. All of the agreements between LCR and Equistar are on terms generally representative of prevailing market prices.
Shared Services Agreement with Lyondell-Under a shared services agreement, Lyondell provides office space and various services to Equistar including information technology, human resources, sales and marketing, raw material supply, supply chain, health, safety and environmental, engineering, research and development, facility services, legal, accounting, treasury, internal audit and tax. Lyondell charges Equistar for Equistar’s share of the cost of such services. Direct costs, incurred exclusively for Equistar, also are charged to Equistar. Costs related to a limited number of shared services, primarily engineering, continue to be incurred by Equistar. In such cases, Equistar charges Lyondell for its share of such costs.
Shared Services and Shared-Site Agreements with Millennium-Equistar and Millennium provide operating services, utilities and raw materials to each other at common locations. Millennium and Equistar have entered into various operating, manufacturing and technical service agreements under which, Millennium billed Equistar for certain operational services, including utilities, plant related transportation and other services, and Equistar billed Millennium for utilities and fuel streams.
Lease Agreements with Occidental-Equistar subleases certain railcars from Occidental. In addition, Equistar leases its Lake Charles facility and the land related thereto from Occidental - see “Leased Facility” section of Note 13.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Related party transactions are summarized as follows:
4. Accounts Receivable
Equistar sells its products primarily to other chemical manufacturers in the petrochemical industry. Equistar performs ongoing credit evaluations of its customers’ financial condition and, in certain circumstances, requires letters of credit from them. The Partnership’s allowance for doubtful accounts, which is reflected in the accompanying Consolidated Balance Sheets as a reduction of accounts receivable, totaled $8 million and $12 million at December 31, 2004 and 2003, respectively. The Consolidated Statements of Income for 2004, 2003 and 2002 included provisions for doubtful accounts of less than $1 million, $9 million and $5 million, respectively.
In December 2003, Equistar entered into a $450 million, four-year, accounts receivable sales facility to replace Equistar’s previous $100 million accounts receivable sales facility. Pursuant to the facility, Equistar sells, through a wholly owned bankruptcy remote subsidiary, on an ongoing basis and without recourse, an interest in a pool of accounts receivable to financial institutions participating in the facility. Equistar is responsible for servicing the receivables.
At December 31, 2004 and 2003, the balance of Equistar’s accounts receivable sold under the facility was $200 million and $102 million, respectively. Accounts receivable in the Consolidated Balance Sheets are reduced by the sales of interests in the pool. Upon termination of the facility, cash collections related to accounts receivable then in the pool would first be applied to the outstanding interest sold. Increases and decreases in the amount sold are reflected in operating activities in the Consolidated Statements of Cash Flows. Fees related to the sales are included in “Other income (expense), net” in the Consolidated Statements of Income. The $450 million accounts receivable sales facility is subject to substantially the same minimum unused availability requirements and covenant requirements as the $250 million inventory-based revolving credit facility, which also is secured by a pledge of accounts receivable. See Note 9.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
5. Inventories
Inventories consisted of the following components at December 31:
At December 31, 2004, all of Equistar’s inventories, excluding materials and supplies, were valued using the LIFO method.
The excess of the current cost of inventories valued using the LIFO method over book value was approximately $305 million at December 31, 2004. In December 2003, Equistar entered into a $250 million, four-year, inventory-based revolving credit facility, which was undrawn at December 31, 2004. See Note 9.
6. Property, Plant and Equipment and Other Assets
The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows at December 31:
In 2004, Equistar sold certain railcars for $37 million and leased the railcars from the buyer under an operating lease agreement. The sale resulted in a book gain of $7 million that is being recognized over the 10 year term of the lease as a reduction in monthly lease rent expense. In addition, in January 2004, Equistar sold its alcohol-blending plant located in Anaheim, California for a gain of $4 million. The effects of these transactions were included in gains (loss) on asset dispositions in the Consolidated Statements of Income.
Equistar did not capitalize any interest during 2004, 2003 and 2002 with respect to construction projects.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The components of other assets, at cost, and the related accumulated amortization were as follows at December 31:
Scheduled amortization of these intangible assets for the next five years is estimated to be $65 million in 2005, $61 million in 2006, $53 million in 2007, $41 million in 2008 and $28 million in 2009.
Depreciation and amortization expense is summarized as follows:
In addition, amortization of debt issuance costs of $6 million, $7 million and $7 million in 2004, 2003 and 2002, respectively, is included in interest expense in the Consolidated Statements of Income.
7. Accrued Liabilities
Accrued liabilities consisted of the following components at December 31:
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
8. Deferred Revenues
Deferred revenues at December 31, 2004 of $139 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 $17 million, $12 million and $2 million in 2004, 2003 and 2002 respectively, of such previously deferred revenues.
In March 2003, Equistar received an advance of $159 million, representing a partial prepayment for product to be delivered under a long-term product supply arrangement, primarily at cost-based prices. Equistar is recognizing this deferred revenue over 15 years, as the associated product is delivered.
9. Long-Term Debt
Long-term debt consisted of the following at December 31:
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 consolidated financial statements of Lyondell are filed as an exhibit to Equistar’s Annual Report on Form 10-K for the year ended December 31, 2004.
Aggregate maturities of long-term debt during the next five years are $1 million, $150 million, $700 million and $600 million in 2005, 2006, 2008 and 2009, respectively, and $862 million thereafter.
In December 2003, Equistar entered into a $250 million, four-year, inventory-based revolving credit facility, which replaced Equistar’s previous $354 million revolving credit facility. The total amount available at December 31, 2004 under both the $250 million inventory-based revolving credit facility and the $450 million accounts receivable sales facility (see Note 4) was approximately $394 million, which gives effect to the borrowing base less a $75 million unused availability requirement and is net of the $200 million sold under the accounts receivable facility and $31 million of outstanding letters of credit under the revolving credit facility as of December 31, 2004. The borrowing base is determined using a formula applied to accounts receivable and inventory balances. The 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. At December 31, 2004, the interest rate under the inventory-based revolving credit facility was LIBOR plus 2.25%.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The revolving credit facility is secured by a lien on all inventory and certain personal property, including a pledge of accounts receivable. There was no outstanding borrowing under the revolving credit facility at December 31, 2004.
In November 2003, Equistar issued $250 million of 10.625% senior unsecured notes due in 2011. The proceeds, net of related fees, were used to prepay in full $173 million of the outstanding term loan under Equistar’s previous credit facility and to repay borrowing under that $354 million revolving credit facility. In September 2003, $29 million of Equistar’s medium term notes matured and were repaid using funds borrowed under Equistar’s revolving credit facility. In April 2003, Equistar issued $450 million of 10.625% senior unsecured 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 term loans under Equistar’s previous $354 million revolving credit facility and prepayment premiums of approximately $17 million.
The Equistar credit facility was amended in June 2004 to clarify certain provisions. In March 2003, Equistar obtained amendments to its previous $354 million revolving credit facility that provided additional financial flexibility by generally making certain financial ratio requirements less restrictive.
The $250 million 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 other payments, and mergers. The credit facility does not require Equistar to maintain specified financial ratios. The breach of the covenants could permit the lenders or noteholders to declare any outstanding debt payable, and could permit the lenders under Equistar’s credit facility to terminate future lending commitments. In addition, some of Equistar’s indentures require additional interest payments to the noteholders if Equistar makes distributions when Equistar does not meet a specified fixed charge coverage ratio. Equistar met this ratio and was in compliance with all covenants under these agreements as of December 31, 2004.
10. Lease Commitments
Equistar leases various facilities and equipment under noncancelable operating lease arrangements for various periods. Operating leases include leases of railcars used in the distribution of products in Equistar’s business.
At December 31, 2004, future minimum lease payments relating to noncancelable operating leases with lease terms in excess of one year were as follows:
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Net rental expense was $94 million, $106 million and $125 million for the years ending December 31, 2004, 2003 and 2002, respectively. Net rental expense in 2002 included $21 million of amortization of lease prepayments related to certain railcar leases that were terminated as of December 31, 2003.
11. Financial Instruments and Derivatives
The fair value of all nonderivative financial instruments included in current assets and current liabilities, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximated their carrying value due to their short maturity. Based on the borrowing rates currently available to Equistar for debt with terms and average maturities similar to Equistar’s debt portfolio, the fair value of Equistar’s long-term debt, including amounts due within one year, was approximately $2,597 million and $2,459 million at December 31, 2004 and 2003, respectively.
Equistar is exposed to credit risk with respect to accounts receivable. Equistar performs ongoing credit evaluations of its customers and, in certain circumstances, requires letters of credit from the customers. See Note 4.
12. Pension and Other Postretirement Benefits
All full-time regular employees are covered by defined benefit pension plans sponsored by Equistar. In connection with the formation of Equistar, no pension assets or obligations were contributed to Equistar, with the exception of union represented plans contributed by Occidental and Millennium.
Retirement benefits are based upon years of service and the employee’s highest three consecutive years of compensation during the last ten years of service. Equistar funds the plans through periodic contributions to pension trust funds. Equistar also has unfunded supplemental nonqualified retirement plans, which provide pension benefits for certain employees in excess of the U.S. tax-qualified plans’ limits. In addition, Equistar sponsors unfunded postretirement benefit plans other than pensions, which provide medical and life insurance benefits. The postretirement medical plans are contributory while the life insurance plans are, generally, noncontributory. The life insurance benefits are provided to employees who retired before July 1, 2002. The measurement date for Equistar’s pension and other postretirement benefit plans is December 31, 2004.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table provides a reconciliation of benefit obligations, plan assets and the funded status of these plans:
The accrued benefit liability for pension and other postretirement benefits is included in “Other Liabilities” in the Consolidated Balance Sheets.
Pension plans with projected benefit obligations and accumulated benefit obligations in excess of the fair value of assets are summarized as follows at December 31:
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Net periodic pension and other postretirement benefit costs included the following components:
The assumptions used in determining the net benefit liability were as follows at December 31:
The assumptions used in determining net benefit cost were as follows for the year ended December 31:
Management’s goal is to manage pension investments over the long term to achieve optimal returns with an acceptable level of risk and volatility. Targeted asset allocations of 55% U.S. equity securities, 15% non-U.S. equity securities, and 30% fixed income securities were adopted in 2003 for the plans based on recommendations by its independent pension investment advisor. Investment policies prohibit investments in securities issued by Equistar or an affiliate, such as Lyondell or Millennium, or investment in speculative derivative instruments. The investments are marketable securities that provide sufficient liquidity to meet expected benefit obligation payments.
The expected rate of return on plan assets is a longer term rate, and is expected to change less frequently than the current assumed discount rate, reflecting long-term market expectations, rather than current fluctuations in market conditions. Prior to 2003, Equistar’s expected long-term rate of return on plan assets of 9.5% had been based on the average level of earnings that its independent pension investment advisor had advised could be expected to be earned over time, using the expected returns for the above-noted asset allocations that had been
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
recommended by the advisor, and had been adopted for the plans. Over the three-year period ended December 31, 2003, Equistar’s actual return on plan assets was a gain averaging 0.9% per year. In 2003, Equistar reviewed its asset allocation and expected long-term rate of return assumptions, and obtained an updated asset allocation study from the independent pension investment advisor, including updated expectations for long-term market earnings rates for various classes of investments. Based on this review, in 2003 Equistar reduced its expected long-term rate of return on plan assets to 8%, and did not significantly change its plan asset allocations in 2004.
Equistar’s pension plan weighted-average asset allocations by asset category were as follows at December 31:
Equistar expects to contribute approximately $25 million to its pension plan in 2005.
The Medicare 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 same title, which gave final guidance on accounting for subsidies under the Act and required Equistar to implement its provisions no later than the third quarter 2004, if the effects were significant. The effect of the Act was not significant to Equistar’s financial statements and was recognized in the accumulated postretirement benefit obligation as of December 31, 2004.
As of December 31, 2004, future expected benefit payments, which reflect expected future service, as appropriate, were as follows:
The assumed annual rate of increase in the per capita cost of covered health care benefits as of December 31, 2004 was 10% for 2005, 7% for 2006 through 2008 and 5% thereafter. The health care cost trend rate assumption does not have a significant effect on the amounts reported due to limits on Equistar’s maximum contribution level under the medical plan. To illustrate, increasing or decreasing the assumed health care cost trend rates by one percentage point in each year would change the accumulated postretirement benefit liability as of December 31, 2004 by less than $1 million and would not have a material effect on the aggregate service and interest cost components of the net periodic postretirement benefit cost for the year then ended.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Equistar also maintains voluntary defined contribution savings plans for eligible employees. Contributions to the plans by Equistar were $12 million, $12 million and $13 million for the years ended December 31, 2004, 2003 and 2002, respectively.
13. Commitments and Contingencies
Commitments-Equistar is a party to various unconditional obligations to purchase products and services, principally for steam and power from a co-generation facility. See also Note 3, describing related party transactions. At December 31, 2004, future minimum payments under those contracts with noncancelable contract terms in excess of one year and fixed minimum payments were as follows:
Equistar’s total purchases under these agreements were $378 million, $317 million and $230 million for the years ended December 31, 2004, 2003 and 2002, respectively.
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 $145 million, are leased from 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.
Environmental Remediation-Equistar’s accrued liability for environmental matters as of December 31, 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 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. In addition, in December 2004, the regulatory agency for the state of Texas, the Texas Commission on Environmental Quality, or “TCEQ,” finalized controls over highly reactive, volatile organic compounds (“HRVOCs”). Equistar is still assessing the impact of the HRVOC rules. 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. Although the one-hour ozone standard expires in 2005, the controls under that standard will not be relaxed under the EPA’s new eight-hour transition rules. As a result, Equistar still will be required to meet the new emission standards for NOx and HRVOCs. The timing and amount of these expenditures are subject to regulatory and other uncertainties, as well as obtaining the necessary permits and approvals. The ultimate cost of implementing any plan developed to comply with the final ozone standards cannot be estimated at this time.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Indemnification-In connection with the formation of Equistar, Lyondell, Millennium and Occidental each agreed to provide certain indemnifications or guarantees thereof to Equistar with respect to the businesses they each contributed to Equistar. In addition, Equistar agreed to assume third party claims related to certain contingent liabilities arising prior to the contribution transactions that were filed prior to December 1, 2004 as to Lyondell and Millennium, and are filed prior to May 15, 2005 as to Occidental, to the extent the aggregate thereof did not exceed $7 million for each entity, subject to certain terms of the respective asset contribution agreements. As of December 31, 2004, Equistar had incurred substantially all of the $21 million assumed for these claims and liabilities. Lyondell, Millennium, Occidental and Equistar remain liable under these indemnifications or guarantee arrangements to the same extent as they were before Lyondell’s August 2002 acquisition of Occidental’s interest in Equistar and Lyondell’s November 2004 acquisition of Millennium.
General-Equistar is, from time to time, a defendant in lawsuits, some of which are not covered by insurance. Many of these suits make no specific claim for relief. Although final determination of legal liability and the resulting financial impact with respect to any such litigation cannot be ascertained with any degree of certainty, Equistar does not believe that any ultimate uninsured liability resulting from the legal proceedings in which it currently is involved (directly or indirectly) will individually, or in the aggregate, have a material adverse effect on its financial position, liquidity or results of operations.
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 financial position 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 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. Supplemental Cash Flow Information
Supplemental cash flow information is summarized as follows for the periods presented:
15. Segment and Related Information
Equistar operates in one reportable segment, ethylene, co-products and derivatives, which includes: the ethylene and co-products product group, including primarily ethylene, propylene, butadiene, fuels and aromatics; and the derivatives product group, including primarily ethylene oxide, ethylene glycol and polyethylene (see Note 1). The accounting policies of the segment are the same as those described in “Summary of Significant Accounting Policies” (see Note 2). No trade customer accounted for 10% or more of sales during any year in the three-year period ended December 31, 2004; however, sales to Lyondell were approximately 10% in 2004.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Although Equistar operates in one integrated reportable segment, Equistar has chosen to provide certain additional data, as shown below, for two product groups: the ethylene and co-product group, reflecting the products of the core ethylene manufacturing processes, and the derivative products group.
EQUISTAR CHEMICALS, LP
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table presents the details of “Total assets” as presented above in the “Other” column as of December 31, for the years indicated:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. 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 the Senior Vice President 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 December 31, 2004. Based upon that evaluation, the Chief Executive Officer and the Senior Vice President and 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 (the fourth quarter 2004) that have materially affected, or are reasonably likely to materially affect, Equistar’s internal control over financial reporting.
Equistar’s management’s report on internal control over financial reporting appears on page 34 of this Annual Report on
Form 10-K. In addition, PricewaterhouseCoopers LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K, has audited management’s assessment of the effectiveness of Equistar’s internal control over financial reporting, as of December 31, 2004, as stated in their report that appears on page 35 of this Annual Report on Form 10-K.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Omitted pursuant to General Instruction I of Form 10-K. See “Additional Information Available” for information regarding Equistar’s code of ethics.
Item 11.
Item 11. Executive Compensation
Omitted pursuant to General Instruction I of Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Omitted pursuant to General Instruction I of Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions
Omitted pursuant to General Instruction I of Form 10-K.
Item 14.
Item 14. Principal Accountant Fees and Services
Audit and Non-Audit Fees
The following table presents fees for audit services rendered by PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) for the audit of Equistar’s annual financial statements for the years ended December 31, 2004 and December 31, 2003, and fees billed or expected to be billed for audit-related, tax and all other services rendered by PricewaterhouseCoopers during those periods.
(a) Audit fees consist of the aggregate fees billed or expected to be billed for professional services rendered by PricewaterhouseCoopers for the audit of Equistar’s annual financial statements, the review of financial statements included in Equistar’s Form 10-Qs or for services that are normally provided by the independent auditors in connection with statutory and regulatory filings or engagements for those fiscal years. Amounts previously reported for 2003 have been adjusted to include only fees that pertain to that year. Accordingly, fees of $185,000 paid in 2003 but related to 2002 and prior periods have been excluded. Of the 2003 audit fees shown in the table, $615,000 represents fees paid in 2004 but related to 2003 audit services. The 2004 audit fees include $773,000 for services related to Section 404 of the Sarbanes-Oxley Act of 2002. Of the 2004 audit fees shown in the table, $733,000 represents fees expected to be billed in 2005 related to 2004 audit services.
(b) Audit-related fees consist of the aggregate fees billed for assurance and related services by PricewaterhouseCoopers that are reasonably related to the performance of the audit or review of Equistar’s financial statements. This category includes fees related to: the performance of audits of Equistar’s benefit plans; agreed-upon or expanded audit procedures relating to accounting and/or billing records required to respond to or comply with financial, accounting or regulatory reporting matters; and consultations as to the accounting or disclosure treatment of transactions or events and/or the actual or potential impact of final or proposed rules, standards or interpretations by regulatory or standard setting bodies. Amounts previously reported for 2003 have been adjusted to include only fees that pertain to that year. Accordingly, fees of $32,000 paid in 2003 but related to 2002 and prior periods have been excluded. Of the 2003 audit-related fees shown in the table, $123,000 represents fees paid in 2004 but related to 2003 audit-related services. Of the 2004 audit-related fees shown in the table, $120,000 represents fees expected to be billed in 2005 related to 2004 audit-related services.
(c) Tax fees consist of the aggregate fees billed for professional services rendered by PricewaterhouseCoopers for state sales and use tax compliance. Amounts previously reported for 2003 have been adjusted to include only fees that pertain to that year. Accordingly, fees of $248,000 paid in 2003 but related to 2002 and prior periods have been excluded. Of the 2003 tax fees shown in the table, $1,000 represents fees paid in 2004 but related to 2003 tax services.
(d) All other fees consist of the aggregate fees billed for products and services provided by PricewaterhouseCoopers, other than the services described in notes (a) through (c) above.
Pre-Approval Policy
Generally, the Partnership Governance Committee of Equistar serves as Equistar’s Audit Committee, and is directly responsible for overseeing the work of the independent registered public accounting firm. In 2003, the Partnership Governance Committee established a policy requiring the Partnership Governance Committee to pre- approve all audit and non-audit services to be performed for Equistar by Equistar’s independent registered public
accounting firm (including affiliates or related member firms) to ensure that the provision of such services does not impair the independent registered public accounting firm’s independence. However, as a result of Lyondell’s November 30, 2004 acquisition of Millennium, Equistar and Millennium became consolidated subsidiaries of Lyondell. Therefore, to protect the independence of Equistar’s independent registered public accounting firm and to ensure that services provided by the independent registered public accounting firm are pre-approved by an independent governing body, on December 1, 2004, Equistar’s Partnership Governance Committee approved revisions to its pre-approval policy. Under the revised pre-approval policy, Equistar’s Partnership Governance Committee has delegated to Lyondell’s Audit Committee, which is comprised entirely of independent directors, the responsibility for reviewing and pre-approving services to be provided for Equistar by Equistar’s independent registered public accounting firm (including affiliates or related member firms).
Under the revised policy, a centralized service request procedure is used for all requests for the independent registered public accounting firm to provide services to Equistar. Under this procedure, all requests for the independent registered public accounting firm to provide services to Equistar initially are submitted to Lyondell’s Vice President and Controller. Each such request must include a detailed description of the services to be rendered. If the proposed services have not already been pre-approved by Lyondell’s Audit Committee, Lyondell’s Vice President and Controller will submit the request and a detailed description of the proposed services to Lyondell’s Audit Committee. Requests to provide services that require pre-approval by Lyondell’s Audit Committee also must include a statement as to whether, in the view of Lyondell’s Vice President and Controller, the request is consistent with the SEC’s rules on independent registered public accounting firm independence.
Pursuant to the revised policy, the Partnership Governance Committee has designated Lyondell’s Senior Vice President and Chief Financial Officer to review compliance with the pre-approval policy. Lyondell’s Senior Vice President and Chief Financial Officer will report to Lyondell’s Audit Committee periodically on the results of the monitoring.
Other than the delegation to Lyondell’s Audit Committee and the roles provided for Lyondell’s Senior Vice President and Chief Financial Officer and Lyondell’s Vice President and Controller, the revised pre-approval policy is substantially the same as the one originally adopted by the Partnership Governance Committee in 2003.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following exhibits are filed as a part of this report:
The Registrant is a party to several long-term debt instruments under which the total amount of long-term debt securities authorized does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. Pursuant to paragraph 4(iii)(A) of Item 601(b) of Registration S-K, the Registrant agrees to furnish a copy of such instruments to the Commission upon request.
The Registrant is party to several compensatory plans, contracts or arrangements that the Registrant has not included herein based on paragraph 10(iii)(C)(6) of Item 601(b) of Regulation S-K since the Registrant is a wholly owned subsidiary of Lyondell Chemical Company, a company that has a class of securities registered pursuant to section 12 or files reports pursuant to section 15(d) of the Exchange Act and is filing a report on Form 10-K.
(1) Filed as an exhibit to the Registrant’s Registration Statement on Form S-4 (No. 333-76473) and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant’s Registration Statement on Form S-4 (No. 333-70048) and incorporated herein by reference.
(3) Filed as an exhibit to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000 and incorporated herein by reference.
(4) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference.
(5) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference.
(6) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 and incorporated herein by reference.
(7) Filed as an exhibit to the Registrant’s Registration Statement on Form S-4 (No. 333-111134) and incorporated herein by reference.
(8) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated December 17, 2003 and incorporated herein by reference.
(9) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference.
(10) Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 and incorporated herein by reference.
(11) Filed as an exhibit to the Registrant’s Current Report on Form 8-K dated as of November 30, 2004 and incorporated herein by reference.
Copies of exhibits will be furnished upon prepayment of 25 cents per page. Requests should be addressed to the Secretary.
(b) Consolidated Financial Statements and Financial Statement Schedules
(1) Consolidated Financial Statements
Consolidated Financial Statements filed as part of this Annual Report on Form 10-K are listed in the Index to Financial Statements on page 33.
(2) Financial Statement Schedules
Financial statement schedules are omitted because they are not applicable or the required information is contained in the Financial Statements or notes thereto.
SIGNATURES
Pursuant to the requirements of Section 13 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 this 16th day of March, 2005.
EQUISTAR CHEMICALS, LP,
by its General Partner
MILLENNIUM PETROCHEMICALS GP LLC
By: Millennium Petrochemicals Inc.
By:
/S/ MORRIS GELB
Morris Gelb
President
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on March 16, 2005.
Name
Title (Millennium Petrochemicals Inc.)
/S/ MORRIS GELB
Morris Gelb
(Principal Executive Officer)
President and Director
/S/ KAREN A. TWITCHELL
Karen A. Twitchell
(Principal Financial and Accounting Officer)
Vice President and Treasurer
/S/ T. KEVIN DENICOLA
T. Kevin DeNicola
Director
/S/ EDWARD J. DINEEN
Edward J. Dineen
Director
SIGNATURES
Pursuant to the requirements of Section 13 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 this 16th day of March, 2005.
Name
Title
/S/ DAN F. SMITH
Dan F. Smith
(Principal Executive Officer)
Chief Executive Officer, Equistar Chemicals, LP, Member, Partnership Governance Committee
/S/ T. KEVIN DENICOLA
T. Kevin DeNicola
(Principal Financial Officer)
Senior Vice President and Chief Financial Officer Member, Partnership Governance Committee
/S/ CHARLES L. HALL
Charles L. Hall
(Principal Accounting Officer)
Vice President and Controller, Equistar Chemicals, LP
/S/ BART DE JONG
Bart de Jong
Member, Partnership Governance Committee
/S/ MORRIS GELB
Morris Gelb
Member, Partnership Governance Committee
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED
PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT
Neither an annual report covering the Registrant’s last fiscal year nor proxy materials with respect to any annual or other meeting of security holders have been sent to security holders.