10-Q 1 d10q.txt FORM 10-Q FOR PERIOD ENDING MARCH 31, 2002 -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------- ---------- Commission file number 1-10145 ------------ LYONDELL CHEMICAL COMPANY (Exact name of registrant as specified in its charter) ------------ Delaware 95-4160558 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1221 McKinney Street, 77010 Suite 700, Houston, Texas (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (713) 652-7200 ------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No __ Number of shares of Common Stock, $1.00 par value, outstanding as of March 31, 2002: 117,564,920 -------------------------------------------------------------------------------- PART I. FINANCIAL INFORMATION LYONDELL CHEMICAL COMPANY ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) CONSOLIDATED STATEMENTS OF INCOME
For the three months ended March 31, -------------------------------------- Millions of dollars, except per share data 2002 2001 ------------------------------------------ ------------------ ----------------- Sales and other operating revenues $ 674 $ 849 Operating costs and expenses: Cost of sales 589 761 Selling, general and administrative expenses 40 41 Research and development expense 7 8 Amortization of goodwill - - 8 -------- -------- 636 818 -------- -------- Operating income 38 31 Interest expense (93) (99) Interest income 2 7 Other income, net 1 3 -------- -------- Loss before equity investments and income taxes (52) (58) -------- -------- Income (loss) from equity investments: Equistar Chemicals, LP (45) (22) LYONDELL-CITGO Refining LP 27 27 Other (3) (3) -------- -------- (21) 2 -------- -------- Loss before income taxes (73) (56) Benefit from income taxes (18) (22) -------- -------- Net loss $ (55) $ (34) ======== ======== Basic and diluted earnings per share: Net loss $ (.47) $ (.29) ======== ========
See Notes to Consolidated Financial Statements. 1 LYONDELL CHEMICAL COMPANY CONSOLIDATED BALANCE SHEETS
March 31, December 31, Millions, except shares and par value data 2002 2001 ------------------------------------------ --------- ------------ ASSETS Current assets: Cash and cash equivalents $ 228 $ 146 Accounts receivable, net 320 352 Inventories 303 316 Prepaid expenses and other current assets 45 116 Deferred tax assets 61 277 ------- ------ Total current assets 957 1,207 Property, plant and equipment, net 2,265 2,293 Investments and long-term receivables: Investment in PO joint ventures 722 717 Investment in Equistar Chemicals, LP 477 522 Receivable from LYONDELL-CITGO Refining LP 229 229 Investment in LYONDELL-CITGO Refining LP 54 29 Other investments and long-term receivables 118 122 Goodwill, net 1,100 1,102 Other assets, net 453 482 ------ ------ Total assets $6,375 $6,703 ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 275 $ 319 Current maturities of long-term debt 7 7 Accrued liabilities 282 233 ------ ------ Total current liabilities 564 559 Long-term debt 3,833 3,846 Other liabilities 589 583 Deferred income taxes 580 790 Commitments and contingencies - - - - Minority interest 155 176 Stockholders' equity: Common stock, $1.00 par value, 250,000,000 shares authorized, 120,250,000 issued 120 120 Additional paid-in capital 854 854 Retained earnings 166 247 Accumulated other comprehensive loss (411) (397) Treasury stock, at cost, 2,685,080 and 2,687,080 shares, respectively (75) (75) ------ ------ Total stockholders' equity 654 749 ------ ------ Total liabilities and stockholders' equity $6,375 $6,703 ====== ======
See Notes to Consolidated Financial Statements. 2 LYONDELL CHEMICAL COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 31, ---------------------------------------- Millions of dollars 2002 2001 ------------------- ------------------ ------------------ Cash flows from operating activities: Net loss $ (55) $ (34) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 60 65 Losses from equity investments 48 26 Deferred income taxes 7 (29) Changes in assets and liabilities that provided (used) cash: Accounts receivable 28 68 Inventories 13 (92) Accounts payable (42) (17) Prepaid expenses and other current assets 71 (7) Other assets and liabilities 40 (21) ----- ----- Cash provided by (used in) operating activities 170 (41) ----- ----- Cash flows from investing activities: Expenditures for property, plant and equipment (11) (11) Contributions and advances to affiliates (38) (20) Distributions from affiliates in excess of earnings -- 7 ----- ----- Cash used in investing activities (49) (24) ----- ----- Cash flows from financing activities: Dividends paid (26) (27) Repayments of long-term debt (13) (2) Other -- (3) ----- ----- Cash used in financing activities (39) (32) ----- ----- Effect of exchange rate changes on cash -- (1) ----- ----- Increase (decrease) in cash and cash equivalents 82 (98) Cash and cash equivalents at beginning of period 146 260 ----- ----- Cash and cash equivalents at end of period $ 228 $ 162 ===== =====
See Notes to Consolidated Financial Statements. 3 LYONDELL CHEMICAL COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Basis of Preparation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation, have been included. For further information, refer to the consolidated financial statements and notes thereto for the year ended December 31, 2001 included in the Lyondell Chemical Company ("Lyondell") 2001 Annual Report on Form 10-K. Certain amounts from prior periods have been reclassified to conform to the current period presentation. 2. Accounting Changes Effective January 1, 2002, Lyondell implemented Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, SFAS No. 142, Goodwill and Other Intangible Assets, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Implementation of SFAS No. 141 and SFAS No. 144 did not have a material effect on the consolidated financial statements of Lyondell. Upon implementation of SFAS No. 142, Lyondell reviewed its goodwill for impairment and concluded that goodwill is not impaired. However, Equistar (see Note 4) reviewed its goodwill for impairment and concluded that the entire balance was impaired, resulting in a $1.1 billion charge. 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 the indicator of fair value. Lyondell's 41% share of the Equistar charge was offset by a corresponding reduction in Lyondell's negative goodwill, representing a portion of the excess of Lyondell's 41% share of Equistar's partners' capital over the carrying value of Lyondell's investment in Equistar. Consequently, there was no net effect on Lyondell's earnings or equity investment in Equistar. In addition, as a result of implementing SFAS No. 142, pretax earnings in 2002 and subsequent years will be favorably affected by $30 million annually because of the elimination of goodwill amortization. The following table presents Lyondell's reported net loss for all periods presented as adjusted for goodwill amortization expense.
For the three months ended March 31, -------------------------- Millions of dollars 2002 2001 ------------------- -------- ---------- Reported net loss $(55) $(34) Add back: goodwill amortization, net of tax -- 5 ---- ---- Adjusted net loss $(55) $(29) ==== ====
3. Unusual Charges During 2001, Lyondell recorded a pretax charge of $63 million associated with its decision to exit the aliphatic diisocyanates ("ADI") business. The $63 million charge included $45 million to adjust the carrying values of the ADI assets to their net realizable value, and accrued liabilities of $15 million for exit costs and $3 million for severance and other employee-related costs for nearly 100 employee positions that were eliminated. Payments of $5 million for exit costs and $2 million for severance and other employee-related costs were made through March 31, 2002, resulting in a remaining accrued liability of $11 million. 4 4. Equity Interest in Equistar Chemicals, LP Lyondell has a 41% interest in Equistar Chemicals, LP ("Equistar"), while Millennium Chemicals Inc. ("Millennium") and Occidental Petroleum Corporation ("Occidental") each have a 29.5% interest (see Note 14). Because the partners jointly control certain management decisions, Lyondell accounts for its investment in Equistar using the equity method of accounting. As a partnership, Equistar is not subject to federal income taxes. Summarized financial information for Equistar follows:
March 31, December 31, Millions of dollars 2002 2001 ------------------- ---------------- ---------------- BALANCE SHEETS Total current assets $1,047 $1,226 Property, plant and equipment, net 3,660 3,705 Goodwill, net -- 1,053 Other assets 341 324 ------ ------ Total assets $5,048 $6,308 ====== ====== Current maturities of long-term debt $ 4 $ 104 Other current liabilities 523 557 Long-term debt 2,282 2,233 Other liabilities 181 177 Partners' capital 2,058 3,237 ------ ------ Total liabilities and partners' capital $5,048 $6,308 ====== ====== For the three months ended March 31, ----------------------------------------- 2002 2001 ---------------- ---------------- STATEMENTS OF INCOME Sales and other operating revenues $ 1,136 $ 1,773 Cost of sales 1,162 1,723 Selling, general and administrative expenses 49 56 Amortization of goodwill -- 8 Unusual charges -- 22 ------- ------- Operating loss (75) (36) Interest expense, net (52) (46) Other income, net 1 5 ------- ------- Loss before cumulative effect of accounting change (126) (77) Cumulative effect of accounting change (1,053) -- ------- ------- Net loss $(1,179) $ (77) ======= ======= SELECTED CASH FLOW INFORMATION Depreciation and amortization $ 75 $ 78 Expenditures for property, plant and equipment 15 24
As of January 1, 2002, as part of the implementation of SFAS No. 142, the entire unamortized balance of Equistar's goodwill was determined to be impaired. Accordingly, Equistar's earnings in the first quarter 2002 were reduced by $1.1 billion. Lyondell's 41% share of the charge for impairment of Equistar's goodwill was offset by a corresponding reduction in the difference between Lyondell's investment in Equistar and its underlying equity in Equistar's net assets (see Note 2). Lyondell's "Income (loss) from equity investments" in Equistar as presented in the Consolidated Statements of Income consists of Lyondell's share of Equistar's loss before cumulative effect of accounting change and the accretion of the remaining difference between Lyondell's investment and its underlying equity in Equistar's net assets. 5 5. Equity Interest in LYONDELL-CITGO Refining LP Lyondell has a 58.75% interest in LYONDELL-CITGO Refining LP ("LCR"), while CITGO Petroleum Corporation ("CITGO") has a 41.25% interest. As a partnership, LCR is not subject to federal income taxes. Summarized financial information for LCR follows:
March 31, December 31, Millions of dollars 2002 2001 ------------------- --------- ------------ BALANCE SHEETS Total current assets $ 258 $ 230 Property, plant and equipment, net 1,338 1,343 Other assets 97 97 ------ ------ Total assets $1,693 $1,670 ====== ====== Notes payable $ 16 $ 50 Current maturities of long-term debt 450 -- Other current liabilities 374 335 Long-term debt -- 450 Loans payable to partners 264 264 Other liabilities 80 79 Partners' capital 509 492 ------ ------ Total liabilities and partners' capital $1,693 $1,670 ====== ====== For the three months ended March 31, -------------------- 2002 2001 ----- ------ STATEMENTS OF INCOME Sales and other operating revenues $ 707 $ 910 Cost of sales 646 838 Selling, general and administrative expenses 12 14 ----- ------ Operating income 49 58 Interest expense, net (8) (16) ----- ------ Net income $ 41 $ 42 ===== ======= SELECTED CASH FLOW INFORMATION Depreciation and amortization $ 29 $ 28 Expenditures for property, plant and equipment 22 11
Lyondell's "Income (loss) from equity investments" in LCR as presented in the Consolidated Statements of Income consists of Lyondell's share of LCR's net income and the accretion of the difference between Lyondell's investment and its underlying equity in LCR's net assets. 6 6. Inventories Inventories consisted of the following components at:
March 31, December 31, Millions of dollars 2002 2001 ------------------- --------- ------------ Finished goods $250 $262 Work-in-process 5 5 Raw materials 16 19 Materials and supplies 32 30 ---- ---- Total inventories $303 $316 ==== ====
7. Property, Plant and Equipment, Net The components of property, plant and equipment, at cost, and the related accumulated depreciation were as follows at:
March 31 December 31, Millions of dollars 2002 2001 ------------------- -------- ------------ Land $ 12 $ 10 Manufacturing facilities and equipment 2,524 2,529 Construction in progress 117 113 ------ ------ Total property, plant and equipment 2,653 2,652 Less accumulated depreciation 388 359 ------ ------ Property, plant and equipment, net $2,265 $2,293 ====== ======
Depreciation and amortization is summarized as follows:
March 31, March 31, Millions of dollars 2002 2001 ------------------- --------- --------- Property, plant and equipment $31 $30 Investment in PO joint venture 8 8 Goodwill -- 8 Debt issuance costs 4 3 Turnaround expense 3 4 Software costs 2 -- Other intangibles 12 12 --- --- $60 $65 === ===
8. Long-Term Debt Long-term debt consisted of the following at:
March 31, December 31, Millions of dollars 2002 2001 ------------------- ---------- ----------- Term Loan E due 2006 $ 621 $ 634 Senior Secured Notes, Series A due 2007, 9.625% 900 900 Senior Secured Notes, Series B due 2007, 9.875% 1,000 1,000 Senior Secured Notes due 2008, 9.5% 393 393 Senior Subordinated Notes due 2009, 10.875% 500 500 Debentures due 2005, 9.375% 100 100 Debentures due 2010, 10.25% 100 100 Debentures due 2020, 9.8% 224 224 Other 2 2 ------ ------ Total long-term debt 3,840 3,853 Less current maturities 7 7 ------ ------ Long-term debt, net $3,833 $3,846 ====== ======
7 9. Derivative Financial Instruments The following table summarizes activity included in accumulated other comprehensive loss ("AOCL") related to the after-tax impact of the effective portion of the fair value of derivative instruments used as cash flow hedges for the three-month periods ended:
March 31, March 31, Millions of dollars 2002 2001 ------------------- --------- --------- Gain (loss): Balance at beginning of period $(2) $-- Net losses on derivative instruments charged to AOCL (1) (4) --- --- Net change in AOCL for the period (1) (4) --- --- Net loss on derivative instruments included in AOCL at March 31 $(3) $(4) === ===
The transition adjustment resulting from the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as of January 1, 2001 was insignificant. 10. Commitments and Contingencies Bayer Claim--On April 30, 2002, Lyondell and Bayer AG settled the claims of Bayer AG in relation to its March 2000 purchase of Lyondell's polyols business. Lyondell had received notice of these claims in June 2001, which alleged various breaches of representations and warranties related to the condition of the business and assets and which sought damages in excess of $100 million. The settlement included new or amended commercial agreements between the parties, generally relating to the existing PO partnership. As a whole, the new or amended agreements provide new business opportunities and value for both parties over the next five to ten years. Concurrent with the settlement, Lyondell made a $5 million indemnification payment to Bayer. The settlement had no effect on Lyondell's financial position or results of operations. Capital Commitments--Lyondell has various commitments related to capital expenditures, all made in the normal course of business. At March 31, 2002, major capital commitments primarily consisted of Lyondell's 50% share of those related to the construction of a world-scale PO facility, known as PO-11, in The Netherlands. The outstanding commitments, which are funded through contributions and advances to affiliates, totaled $101 million as of March 31, 2002. Construction Lease--During the third quarter 2000, construction began on a new butanediol ("BDO") production facility in Europe known as BDO-2. Construction is being financed by an unaffiliated entity that was established for the purpose of serving as lessor with respect to this facility. Construction spending through March 31, 2002, including interest incurred by the lessor during construction, totaled 162 million euros, or approximately $141 million using March 31, 2002 exchange rates. Upon completion in mid-2002, Lyondell will lease the facility under an operating lease for an initial term of five years. Minimum payments under the operating lease will approximate an amount equivalent to interest on the final construction costs at the interest rate implicit in the lease. Lyondell may, at its option, purchase the facility at any time during the lease term for the unrecovered construction costs of the lessor or, subject to certain conditions, renew the lease for four successive five-year terms. If Lyondell does not exercise the purchase option before the end of the last renewal period, the facility will be sold. In the event the sales proceeds are less than the guaranteed residual value, Lyondell will pay the difference to the lessor. The guaranteed residual value at the end of the lease term is estimated at approximately 206 million euros, or $180 million using March 31, 2002 exchange rates. Under the transaction documents, Lyondell is subject to certain financial and other covenants that are substantially the same as those contained in the credit facility. Crude Supply Agreement--Under the Crude Supply Agreement, PDVSA Oil is required to sell, and LCR is required to purchase, 230,000 barrels per day of extra heavy crude oil. This constitutes approximately 86% of the refinery's capacity of 268,000 barrels per day of crude oil. By letter dated April 16, 1998, PDVSA Oil informed LCR that the 8 Venezuelan government, through the Ministry of Energy and Mines, had instructed that production of certain grades of crude oil be reduced. The letter stated that PDVSA Oil declared itself in a force majeure situation and would reduce deliveries of crude oil. Such reductions in deliveries were purportedly based on announced OPEC production cuts. LCR began receiving reduced deliveries of crude oil from PDVSA Oil in August 1998, of 195,000 barrels per day in that month. LCR was advised by PDVSA Oil in May 1999 of a further reduction in the deliveries of crude oil supplied under the Crude Supply Agreement to 184,000 barrels per day, effective May 1999. On several occasions since then, PDVSA Oil further reduced crude oil deliveries, although it made payments under a different provision of the Crude Supply Agreement in partial compensation for such reductions. Subsequently, PDVSA Oil unilaterally increased deliveries of crude oil to LCR to 195,000 barrels per day effective April 2000, to 200,000 barrels per day effective July 2000 and to 230,000 barrels per day effective October 2000. During 2001, PDVSA Oil declared itself in a force majeure situation, but did not reduce crude oil deliveries to LCR during 2001. In January 2002, PDVSA Oil again declared itself in a force majeure situation and stated that crude oil deliveries could be reduced by up to 20.3% beginning March 1, 2002. In February 2002, LCR was advised by PDVSA Oil that deliveries of crude oil to LCR in March 2002 would be reduced to approximately 198,000 barrels per day. Lyondell currently expects second quarter 2002 deliveries under the Crude Supply Agreement to average 190,000 barrels per day. The recent political uncertainty in Venezuela has not affected crude oil deliveries, the Crude Supply Agreement or related matters to date, and the long-term effects of these events, if any, are not yet clear. LCR has consistently contested the validity of PDVSA Oil's and PDVSA's reductions in deliveries under the Crude Supply Agreement. The parties have different interpretations of the provisions of the contracts concerning the delivery of crude oil. The contracts do not contain dispute resolution procedures, and the parties have been unable to resolve their commercial dispute. As a result, on February 1, 2002, LCR filed a lawsuit against PDVSA and PDVSA Oil in connection with the January 2002 force majeure declaration, as well as the claimed force majeure from April 1998 to September 2000. In 1999, PDVSA announced its intention to renegotiate its crude supply agreements with all third parties, including LCR. In light of PDVSA's announced intent, there can be no assurance that PDVSA Oil will continue to perform its obligations under the Crude Supply Agreement. However, it has confirmed that it expects to honor its commitments if a mutually acceptable restructuring of the Crude Supply Agreement is not achieved. From time to time, the Company and PDVSA have had discussions covering both a restructuring of the Crude Supply Agreement and a broader restructuring of the LCR partnership. Lyondell is unable to predict whether changes in either arrangement will occur. The breach or termination of the Crude Supply Agreement, or reduction in supply thereunder, would require LCR to purchase all or a portion of its crude oil feedstocks in the merchant market, could subject LCR to significant volatility and price fluctuations and could adversely affect LCR and, therefore, Lyondell. Cross Indemnity Agreement--In connection with the transfer of assets and liabilities from Atlantic Richfield Company ("ARCO"), now wholly owned by BP p.l.c., Lyondell agreed to assume certain liabilities arising out of the operation of Lyondell's integrated petrochemicals and refining business prior to July 1, 1988. In connection with the transfer of such liabilities, Lyondell and ARCO entered into an agreement, updated in 1997 ("Revised Cross-Indemnity Agreement"), whereby Lyondell agreed to defend and indemnify ARCO against certain uninsured claims and liabilities which ARCO may incur relating to the operation of Lyondell prior to July 1, 1988, including certain liabilities which may arise out of pending and future lawsuits. For current and future cases related to Lyondell's products and operations, ARCO and Lyondell bear a proportionate share of judgment and settlement costs according to a formula that allocates responsibility based upon years of ownership during the relevant time period. Under the Revised Cross-Indemnity Agreement, Lyondell will assume responsibility for its proportionate share of future costs for waste site matters not covered by ARCO insurance. In connection with the acquisition of ARCO Chemical Company ("ARCO Chemical"), Lyondell succeeded, indirectly, to a cross indemnity agreement with ARCO whereby ARCO Chemical indemnified ARCO against certain claims or liabilities that ARCO may incur relating to ARCO's former ownership and operation of the businesses of ARCO Chemical, including liabilities under laws relating to the protection of the environment and the workplace, and liabilities arising out of certain litigation. As part of the agreement, ARCO indemnified ARCO 9 Chemical with respect to claims or liabilities and other matters of litigation not related to the ARCO Chemical business. Indemnification Arrangements Relating to Equistar--Lyondell, Millennium Petrochemicals and certain subsidiaries of Occidental have each agreed to provide certain indemnifications to Equistar with respect to the petrochemicals and polymers businesses contributed by the partners. In addition, Equistar agreed to assume third party claims that are related to certain pre-closing contingent liabilities that are asserted prior to December 1, 2004 as to Lyondell and Millennium Petrochemicals, and May 15, 2005 as to certain Occidental subsidiaries, to the extent the aggregate thereof does not exceed $7 million to each partner, subject to certain terms of the respective asset contribution agreements. As of March 31, 2002, Equistar had expensed nearly all of the $7 million indemnification basket with respect to the business contributed by Lyondell. Equistar also agreed to assume third party claims that are related to certain pre-closing contingent liabilities that are asserted for the first time after December 1, 2004 as to Lyondell and Millennium Petrochemicals, and for the first time after May 15, 2005 as to certain subsidiaries of Occidental. Environmental Remediation--As of March 31, 2002, Lyondell's environmental liability for future remediation costs at its plant sites and a limited number of Superfund sites totaled $23 million. The liabilities per site range from less than $1 million to $11 million and are expected to be incurred over the next two to seven years. In the opinion of management, there is currently no material estimable range of loss in excess of the amount recorded for these sites. However, it is possible that new information about the sites for which the accrual has been established, new technology or future developments such as involvement in investigations by regulatory agencies, could require Lyondell to reassess its potential exposure related to environmental matters. Clean Air Act--The eight-county Houston/Galveston region has been designated a severe non-attainment area for ozone by the U.S. Environmental Protection Agency ("EPA"). Emission reduction controls for nitrogen oxides ("NOx") must be installed at LCR's refinery and each of Lyondell's two facilities and Equistar's six facilities in the Houston/Galveston region. Lyondell estimates that aggregate related capital expenditures could total between $400 million and $500 million for Lyondell, Equistar and LCR before the 2007 deadline. Lyondell's direct share of such expenditures could total between $65 million and $80 million. Lyondell's proportionate share of Equistar's expenditures could total between $85 million and $105 million, and Lyondell's proportionate share of LCR's expenditures could total between $75 million and $95 million. The timing and amount of these expenditures are subject to regulatory and other uncertainties, as well as obtaining the necessary permits and approvals. In January 2001, Lyondell and an organization composed of industry participants filed a lawsuit to encourage adoption of their alternative plan to achieve the same air quality improvement with less negative economic impact on the region. Adoption of the alternative plan, as sought by the lawsuit, is expected to reduce the estimated capital investments for NOx reductions required by Lyondell, Equistar and LCR to comply with the standards. However, there can be no guarantee as to the ultimate capital cost of implementing any final plan developed to ensure ozone attainment by the 2007 deadline. In the United States, the Clean Air Act Amendments of 1990 set minimum levels for oxygenates, such as MTBE, in gasoline sold in areas not meeting specified air quality standards. The presence of MTBE in some water supplies in California and other states due to gasoline leaking from underground storage tanks and in surface water from recreational water craft has led to public concern about the use of MTBE. Certain federal and state governmental initiatives in the U.S. have sought either to rescind the oxygenate requirement for reformulated gasoline or to restrict or ban the use of MTBE. On April 25, 2002, the U.S. Senate passed its version of an omnibus energy bill, which, among other things, would ban the use of MTBE as a fuel oxygenate. The Senate bill is not law and needs to be reconciled with the U.S. House of Representatives' omnibus energy bill, which was passed in July 2001. Lyondell's MTBE sales represented approximately 35% of its total 2001 revenues. Lyondell does not expect these initiatives to have a significant impact on MTBE margins and volumes in 2002. Should it become necessary to reduce MTBE production, Lyondell would need to make capital expenditures to convert its MTBE plants to production of alternate gasoline blending components. The profit margins on such alternate gasoline blending components could differ from those historically realized on MTBE. The Clean Air Act specified certain emissions standards for vehicles beginning in the 1994 model year and required the EPA to study whether further emissions reductions from vehicles were necessary. In 1998, the EPA concluded that additional controls on gasoline and diesel fuel were necessary to meet these emission standards. New standards for gasoline were finalized in 1999 and will require refiners to produce a low sulfur gasoline by 2004, with final 10 compliance by 2006. A new "on-road" diesel standard was adopted in January 2001 and will require refiners to produce ultra low sulfur diesel by June 2006, with some allowance for a conditional phase-in period that could extend final compliance until 2009. Lyondell estimates that these standards will result in increased capital investment for LCR, totaling between $175 million to $225 million for the new gasoline standards and $250 million to $300 million for the new diesel standard, between now and the implementation dates. Lyondell's share of LCR's capital expenditures would be between $250 million and $300 million. In addition, these standards could result in higher operating costs for LCR. Equistar's business may also be impacted if these standards increase the cost for processing fuel components. General--Lyondell is involved in various lawsuits and proceedings. Subject to the uncertainty inherent in all litigation, management believes the resolution of these proceedings will not have a material adverse effect on the financial position, liquidity or results of operations of Lyondell. 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 Lyondell. However, the adverse resolution in any reporting period of one or more of the matters discussed in this note could have a material impact on Lyondell's results of operations for that period without giving effect to contribution or indemnification obligations of co-defendants or others, or to the effect of any insurance coverage that may be available to offset the effects of any such award. 11. Earnings Per Share Basic earnings per share for the periods presented are computed based upon the weighted average number of shares outstanding for the periods. Diluted earnings per share include the effect of outstanding stock options issued under the Executive Long-Term Incentive Plan and the Incentive Stock Option Plan. These stock options were antidilutive in the three-month periods ended March 31, 2002 and 2001. Net loss per share ("EPS") data is as follows:
For the three months ended March 31, ---------------------------------------------------- 2002 2001 ------------------------- ----------------------- Thousands of shares Shares EPS Shares EPS ------------------- ----------- --------- ---------- --------- Basic 117,565 $ (.47) 117,562 $ (.29) Dilutive effect of options -- -- -- -- -------- -------- ------- ------- Diluted 117,565 $ (.47) 117,562 $ (.29) ======== ======== ======= =======
12. Comprehensive Loss The components of the comprehensive loss were as follows:
For the three months ended March 31, -------------------------------- 2002 2001 ------------- ------------- Net loss $(55) $(34) ---- ---- Other comprehensive loss: Foreign currency translation loss (17) (50) Net losses on derivative instruments (1) (4) Minimum pension liability adjustment 4 -- ---- ---- Total other comprehensive loss (14) (54) ---- ---- Comprehensive loss $(69) $(88) ==== ====
11 13. Segment and Related Information Lyondell operates in four reportable segments: (i) intermediate chemicals and derivatives; (ii) petrochemicals; (iii) polymers; and (iv) refining. The methanol operations are not a reportable segment. Lyondell's entire $1.1 billion balance of goodwill is allocated to the intermediate chemicals and derivatives segment. Summarized financial information concerning reportable segments is shown in the following table:
Intermediate Chemicals and Millions of dollars Derivatives Petrochemicals Polymers Refining Other Total ------------------- ----------- -------------- -------- -------- ----- ----- For the three months ended March 31, 2002: Sales and other operating revenues $ 674 $ -- $ -- $ -- $ -- $ 674 Operating income 38 38 Interest expense (93) (93) Interest income 2 2 Other income, net 1 1 Income (loss) from equity investments -- (10) (9) 27 (29) (21) Loss before income taxes (73) For the three months ended March 31, 2001: Sales and other operating revenues $ 849 $ -- $ -- $ -- $ -- $ 849 Operating income 31 31 Interest expense (99) (99) Interest income 7 7 Other income, net 3 3 Income (loss) from equity investments 1 47 (36) 27 (37) 2 Loss before income taxes (56)
The following table presents the details of "Income (loss) from equity investments" as presented above in the "Other" column for the periods indicated:
For the three months ended March 31, ----------------------------------- Millions of dollars 2002 2001 ------------------- --------------- --------------- Equistar items not allocated to segments: Principally general and administrative expenses and interest expense, net $(26) $(24) Unusual charges -- (9) Loss from equity investment in LMC (3) (4) ---- ---- Total--Other $(29) $(37) ==== ====
12 14. Proposed Transactions with Occidental Early in 2002, Lyondell and Occidental agreed in principle to Lyondell's acquisition of Occidental's 29.5% interest in Equistar and to Occidental's acquisition of an equity interest in Lyondell. Upon consummation of these transactions, Occidental would receive the following from Lyondell: .. 30 to 34 million shares of newly issued Lyondell Series B Common Stock, with the final number to be determined at closing of this transaction. These shares would have the same rights as Lyondell's regular common stock with the exception of the dividend. The Series B Common Stock would pay a dividend at the same rate as the regular common stock but, at Lyondell's option, the dividend may be paid in additional shares of Series B Common Stock or in cash. These new Series B shares also would include provisions for conversion to regular common stock three years after issuance or earlier in certain circumstances; .. five-year warrants to acquire five million shares of Lyondell regular common stock at $25 per share, subject to adjustment upon the occurrence of certain events; and .. a contingent payment equivalent in value to 7.38% of Equistar's cash distributions for 2002 and 2003, up to a total of $35 million, payable in cash, Series B Common Stock or regular common stock, as determined by Lyondell. On April 19, 2002, the formal right of first offer process began in connection with certain of the transactions. Under this process, Millennium, the third partner in Equistar, has 45 days to decide whether to participate on a pro rata basis in the acquisition of Occidental's Equistar interest. At the end of the process, Occidental, Lyondell and, if it elects to participate, Millennium are expected to sign definitive documentation. Lyondell's board of directors approved the transactions on May 2, 2002. Closing of the transactions is subject to certain conditions, including approval by Lyondell's shareholders. Lyondell anticipates that these transactions will close during the third quarter of 2002. However, there can be no assurance that the proposed transactions will be completed. 15. Deferred Tax Assets The deferred tax assets classified as current assets decreased by $216 million during the first quarter of 2002. The reduction primarily represented a change in the timing of anticipated realization of the tax benefits of domestic net operating loss carryforwards. These benefits, which are expected to be realized within the next few years, have been reclassified from current assets to long-term net liabilities on the consolidated balance sheet. There was no change in management's expectation that these deferred tax assets will be fully realized. 16. Supplemental Guarantor Information ARCO Chemical Technology Inc. ("ACTI"), ARCO Chemical Technology L.P. ("ACTLP") and Lyondell Chemical Nederland, Ltd. ("LCNL") are guarantors, jointly and severally, (collectively "Guarantors") of the $393 million senior secured notes issued in December 2001 and the $500 million senior subordinated notes and $1.9 billion senior secured notes issued in May 1999. LCNL, a Delaware corporation, is a wholly owned subsidiary of Lyondell that owns a Dutch subsidiary that operates a chemical production facility near Rotterdam, The Netherlands. ACTI is a Delaware corporation, which holds the investment in ACTLP. ACTLP is a Delaware limited partnership, which holds and licenses technology to other Lyondell affiliates and to third parties. Separate financial statements of the Guarantors are not considered to be material to the holders of the senior subordinated notes and senior secured notes. The following condensed consolidating financial information present supplemental information for the Guarantors as of March 31, 2002 and December 31, 2001 and for the three-month periods ended March 31, 2002 and 2001. 13 CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED BALANCE SHEET As of March 31, 2002
Non- Consolidated Millions of dollars Lyondell Guarantors Guarantors Eliminations Lyondell ------------------- -------- ---------- ---------- ------------ ------------ Total current assets $ 595 $ 136 $ 226 $ -- $ 957 Property, plant and equipment, net 910 505 850 -- 2,265 Investments and long-term receivables 7,000 475 1,508 (7,383) 1,600 Goodwill, net 453 386 261 -- 1,100 Other assets 361 86 4 2 453 ------- ------- ------- ------- ------- Total assets $ 9,319 $ 1,588 $ 2,849 $(7,381) $ 6,375 ======= ======= ======= ======= ======= Current maturities of long-term debt $ 7 $ -- $ -- $ -- $ 7 Other current liabilities 401 68 88 -- 557 Long-term debt 3,831 -- 2 -- 3,833 Other liabilities 518 55 16 -- 589 Deferred income taxes 399 130 51 -- 580 Intercompany liabilities (assets) 3,509 (1,115) (2,394) -- -- Minority interest -- -- 155 -- 155 Stockholders' equity 654 2,450 4,931 (7,381) 654 ------- ------- ------- ------- ------- Total liabilities and stockholders' equity $ 9,319 $ 1,588 $ 2,849 $(7,381) $ 6,375 ======= ======= ======= ======= =======
BALANCE SHEET As of December 31, 2001
Non- Consolidated Millions of dollars Lyondell Guarantors Guarantors Eliminations Lyondell ------------------- -------- ---------- ---------- ------------ ------------ Total current assets $ 781 $ 132 $ 294 $ -- $ 1,207 Property, plant and equipment, net 915 516 862 -- 2,293 Other investments and long-term receivables 7,007 461 1,537 (7,386) 1,619 Goodwill, net 453 389 260 -- 1,102 Other assets 344 88 50 -- 482 ------- ------- ------- ------- ------- Total assets $ 9,500 $ 1,586 $ 3,003 $(7,386) $ 6,703 ======= ======= ======= ======= ======= Current maturities of long-term debt $ 7 $ -- $ -- $ -- $ 7 Other current liabilities 391 73 88 -- 552 Long-term debt 3,844 -- 2 -- 3,846 Other liabilities 515 55 13 -- 583 Deferred income taxes 611 133 46 -- 790 Intercompany liabilities (assets) 3,383 (1,101) (2,282) -- -- Minority interest -- -- 176 -- 176 Stockholders' equity 749 2,426 4,960 (7,386) 749 ------- ------- ------- ------- ------- Total liabilities and stockholders' equity $ 9,500 $ 1,586 $ 3,003 $(7,386) $ 6,703 ======= ======= ======= ======= =======
14 CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)--(Continued) STATEMENT OF INCOME For the Three Months Ended March 31, 2002
Non- Consolidated Millions of dollars Lyondell Guarantors Guarantors Eliminations Lyondell ------------------- -------- ----------- ---------- ------------ ------------- Sales and other operating revenues $ 469 $ 165 $ 351 $(311) $ 674 Cost of sales 460 148 292 (311) 589 Selling, general and administrative expenses 26 3 11 -- 40 Research and development expense 7 -- -- -- 7 ----- ----- ----- ----- ----- Operating income (loss) (24) 14 48 -- 38 Interest income (expense), net (95) 2 2 -- (91) Other income (expense), net (10) 4 7 -- 1 Income (loss) from equity 65 -- (21) (65) (21) investments Intercompany income 8 12 18 (38) -- (Benefit from) provision for income taxes (14) 8 13 (25) (18) ----- ----- ----- ----- ----- Net income (loss) $ (42) $ 24 $ 41 $ (78) $ (55) ===== ===== ===== ===== =====
STATEMENT OF INCOME For the Three Months Ended March 31, 2001
Non- Consolidated Millions of dollars Lyondell Guarantors Guarantors Eliminations Lyondell ------------------- -------- ---------- ---------- ------------ ------------ Sales and other operating revenues $ 594 $ 237 $ 406 $(388) $ 849 Cost of sales 569 149 431 (388) 761 Selling, general and administrative expenses 25 2 14 -- 41 Research and development expense 8 -- -- -- 8 Amortization of goodwill 4 2 2 -- 8 ----- ----- ----- ----- ----- Operating income (loss) (12) 84 (41) -- 31 Interest income (expense), net (97) 1 4 -- (92) Other income (expense), net (17) (61) 81 -- 3 Income from equity investments 82 -- 2 (82) 2 Intercompany income (expense) (30) 28 37 (35) -- (Benefit from) provision for income taxes (29) 20 33 (46) (22) ----- ----- ----- ----- ----- Net income (loss) $ (45) $ 32 $ 50 $ (71) $ (34) ===== ===== ===== ===== =====
15 CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)--(Continued) STATEMENT OF CASH FLOWS For the Three Months Ended March 31, 2002
Non- Consolidated Millions of dollars Lyondell Guarantors Guarantors Eliminations Lyondell ------------------- -------- ---------- ---------- ------------ ------------ Net income (loss) $ (42) $ 24 $ 41 $ (78) $ (55) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 29 9 22 -- 60 Deferred income taxes 4 (2) 5 -- 7 Net changes in working capital and other 147 (27) (2) 40 158 ----- ----- ----- ----- ----- Net cash provided by operating activities 138 4 66 (38) 170 ----- ----- ----- ----- ----- Expenditures for property, plant and equipment (8) (1) (2) -- (11) Contributions and advances to affiliates -- -- (38) -- (38) Distributions from affiliates in excess of earnings -- -- -- -- -- ----- ----- ----- ----- ----- Net cash used in investing activities (8) (1) (40) -- (49) ----- ----- ----- ----- ----- Dividends paid (26) -- (38) 38 (26) Repayments of long-term debt (13) -- -- -- (13) ----- ----- ----- ----- ----- Net cash used in financing activities (39) -- (38) 38 (39) ----- ----- ----- ----- ----- Effect of exchange rate changes on cash -- 1 (1) -- -- ----- ----- ----- ----- ----- Increase (decrease) in cash and cash equivalents $ 91 $ 4 $ (13) $ -- $ 82 ===== ===== ===== ===== =====
16 CONDENSED CONSOLIDATING FINANCIAL INFORMATION (UNAUDITED)--(Continued) STATEMENT OF CASH FLOWS--(Continued) For the Three Months Ended March 31, 2001
Non- Consolidated Millions of dollars Lyondell Guarantors Guarantors Eliminations Lyondell ------------------- -------- ---------- ---------- ------------ ------------ Net income (loss) $ (45) $ 32 $ 50 $ (71) $ (34) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 33 9 23 -- 65 Deferred income taxes (27) 1 (3) -- (29) Net changes in working capital and other 86 (40) (160) 71 (43) ----- ----- ----- ----- ----- Net cash provided by (used in) operating activities 47 2 (90) -- (41) ----- ----- ----- ----- ----- Expenditures for property, Plant and equipment (8) (2) (1) -- (11) Contributions and advances to affiliates (12) (15) 7 -- (20) Distributions from affiliates in excess of earnings 3 -- 4 -- 7 ----- ----- ----- ----- ----- Net cash provided by (used in) investing activities (17) (17) 10 -- (24) ----- ----- ----- ----- ----- Dividends paid (27) -- -- -- (27) Repayments of long-term debt (2) -- -- -- (2) Other (3) -- -- -- (3) ----- ----- ----- ----- ----- Net cash used in financing activities (32) -- -- -- (32) ----- ----- ----- ----- ----- Effect of exchange rate changes on cash -- (2) 1 -- (1) ----- ----- ----- ----- ----- Decrease in cash and cash equivalents $ (2) $ (17) $ (79) $ -- $ (98) ===== ===== ===== ===== =====
17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview General--Industrial production in the U.S. grew at an estimated 1.8% annual rate during the first quarter 2002 compared to a 6% contraction in the first quarter 2001. This was reflected in increased demand for some products at Lyondell, Equistar and LCR during the first quarter 2002, leading to higher sales volumes. Nonetheless, the first quarter 2002 demand growth failed to absorb the effects of industry capacity additions during calendar year 2001 or offset the effects of a 3.7% contraction of U.S. industrial production during 2001. Raw material costs in the first quarter 2002 were significantly lower than in the first quarter 2001. The benchmark price of crude oil averaged 24% lower in the first quarter 2002 than in the first quarter 2001. Natural gas prices, which spiked to historically high levels in the first quarter 2001, averaged 67% lower in the first quarter 2002 than in the first quarter 2001, resulting in lower energy costs. Despite increased demand in the first quarter 2002, the ongoing industry overcapacity and the decreases in raw material costs during 2001 and most of the first quarter 2002 put downward pressure on product sales prices. This resulted in sales prices decreasing more than the costs of raw materials. These factors combined to reduce product margins in the first quarter 2002 compared to the first quarter 2001. In addition, in response to political uncertainties in the Middle East and Venezuela, raw material costs rose rapidly toward the end of the first quarter 2002. March 2002 crude oil prices averaged 18% higher than in February 2002, while March 2002 natural gas prices averaged 20% higher than in February 2002. This also had a negative effect on first quarter 2002 margins due to lags in implementing sales price increases in response to cost increases. Net Loss--The first quarter 2002 net loss of $55 million increased from a net loss of $34 million in the first quarter 2001, which included goodwill amortization of $5 million after tax. Excluding the goodwill amortization, the $26 million increase in the first quarter 2002 net loss was primarily attributable to Lyondell's equity investment in Equistar and a lower tax benefit. Equistar experienced a higher net loss in the first quarter 2002 due to lower prices, margins and volumes in its petrochemicals segment compared to the first quarter 2001. The higher petrochemicals segment losses in the first quarter 2002 were only partly offset by improved operating results in Equistar's polymers segment. Lyondell's operating results and its income from its equity investment in LCR in the first quarter 2002 were comparable to the first quarter 2001. The lower tax benefit was due to a lower estimated tax benefit rate for 2002. RESULTS OF OPERATIONS Lyondell Chemical Company Revenues, Operating Costs and Expenses--Lyondell's operating results are reviewed below in the discussion of the intermediate chemicals and derivatives segment. Loss from Equity Investment in Equistar--Lyondell's equity investment in Equistar resulted in a loss of $45 million in the first quarter 2002 compared to a loss of $22 million in the first quarter 2001. The $23 million increase in the loss was due to lower prices, margins and sales volumes in Equistar's petrochemicals segment in the first quarter 2002 compared to the first quarter 2001, which was attributable to ongoing industry overcapacity, as well as the negative effects of certain above-market fixed price contracts. The increased petrochemicals segment loss was only partly offset by improved operating results in Equistar's polymers segment, primarily reflecting higher polymers margins in the first quarter 2002 compared to the first quarter 2001. In addition, the first quarter 2001 included Lyondell's $9 million share of shutdown costs for Equistar's Port Arthur polymer facility, which was permanently closed in February 2001. 18 Income from Equity Investment in LCR--Lyondell's income from its equity investment in LCR was $27 million in both the first quarter 2002 and the first quarter 2001. Compared to the first quarter 2001, the benefits of lower natural gas costs and lower interest expense in the first quarter 2002 were offset by the negative effects of rapidly rising crude oil costs late in the first quarter 2002. Income Tax--The effective tax rate for 2002 is estimated to be a benefit of 25% compared to a benefit of 39% used in the first quarter 2001. Both rates reflected a tax benefit from domestic operating losses expected for the year. The lower 2002 rate reflects the effect of taxes on foreign income. First Quarter 2002 versus Fourth Quarter 2001 For the first quarter 2002, Lyondell reported a net loss of $55 million, which was comparable to a fourth quarter 2001 net loss of $53 million. Lyondell's after-tax loss from its equity investment in Equistar increased $12 million in the first quarter 2002 and was substantially offset by increased after-tax income of $11 million from its equity investment in LCR. In addition, as a result of a 25% estimated tax benefit rate in the first quarter 2002 compared to a 35% rate in the fourth quarter 2001, Lyondell had an $8 million lower tax benefit from its first quarter 2002 pretax loss. The effect of the lower tax benefit was substantially offset by an increase in Lyondell's operating income. The increased loss at Equistar reflected higher first quarter 2002 losses in the petrochemicals segment, partly offset by improved polymers segment results. The increased earnings at LCR reflected improvement in the first quarter 2002 compared to the fourth quarter 2001, which included a major planned maintenance turnaround. The fourth quarter 2001 net loss also included an extraordinary charge of $5 million after tax due to early debt retirement and a goodwill amortization charge of $5 million after tax. These were offset by a $10 million after-tax benefit resulting from a reduction of the third quarter 2001 provision of $51 million after tax for estimated costs of exiting the ADI business. Intermediate Chemicals and Derivatives Segment Overview--The intermediate chemicals and derivatives ("IC&D") segment benefited from stronger domestic demand during the first quarter 2002, including increased demand in urethanes end-use markets such as automotive, housing, and home furnishings. This resulted in generally higher sales volumes in the first quarter 2002 compared to the first quarter 2001. In the U.S., the benchmark cost of propylene, a key raw material, averaged 12% lower in the first quarter 2002 than in the fourth quarter 2001 and 29% lower than in the first quarter 2001. Lyondell also benefited from lower energy costs due to the significant decrease in natural gas costs in the U.S., compared to the first quarter 2001 when these natural gas costs spiked to historically high levels. Despite increased demand in the first quarter 2002, some industry overcapacity and the decreases in raw material costs combined to put downward pressure on product sales prices. Sales prices decreased more than the costs of raw materials, reducing product margins in the first quarter 2002 compared to the first quarter 2001. In addition, in response to rapidly rising crude oil costs in the latter part of the quarter, propylene costs increased by 7% in March 2002 compared to February 2002, putting further downward pressure on first quarter 2002 margins. The following table sets forth volumes, including processing volumes, included in sales and other operating revenues for this segment. Co-product tertiary butyl alcohol ("TBA") is principally used to produce the derivative MTBE. Bayer's ownership interest in the U.S. PO manufacturing joint venture ("PO Joint Venture") entered into by Lyondell and Bayer as part of a March 31, 2000 asset sale transaction, represents ownership of an in kind portion of the PO production of the PO Joint Venture. Bayer's share of the PO production from the PO Joint Venture will increase from approximately 1.53 billion pounds annually in 2002 to approximately 1.6 billion pounds annually in 2004 and thereafter. Lyondell takes in kind the remaining PO production and all styrene monomer ("SM") and TBA 19 co-product production from the PO Joint Venture. Bayer's PO volumes are not included in sales and are excluded from the table.
For the three months ended March 31, -------------------------- In millions 2002 2001 ----------- -------- --------- PO, PO derivatives, TDI (pounds) 785 722 Co-products: SM (pounds) 786 789 MTBE and other TBA derivatives (gallons) 267 245
Revenues--Revenues of $674 million in the first quarter 2002 decreased from $849 in the first quarter 2001, or nearly 21%, due to lower sales prices, partly offset by higher sales volumes. The lower sales prices in the first quarter 2002, to a large extent, reflected significantly lower raw material costs compared to the first quarter 2001. Sales volumes for PO and derivatives, which includes TDI, increased 9% primarily due to higher demand for PO and TDI in urethanes end-use markets and higher BDO volumes as new contracts were initiated in support of BDO 2, the new BDO facility scheduled for completion in mid-2002. These higher volumes were partly offset by lower deicer sales volumes due to the relatively mild 2001/2002 winter. Sales volumes also increased 9% for TBA and derivatives, primarily MTBE. Sales of MTBE in the spot market increased due to industry outages during the first quarter 2002. First quarter 2002 SM volumes were comparable to the first quarter 2001. Operating Income--Operating income was $38 million in the first quarter 2002 compared to $31 million in the first quarter 2001. The increase was primarily due to the elimination of goodwill amortization. Higher margins for MTBE were offset by lower margins for PO and derivatives and SM. MTBE margins increased in the first quarter 2002 as the costs of butane and methanol, key raw materials, decreased more than the price of MTBE. PO and derivatives product margins decreased as average product prices decreased faster than decreases in raw material costs, primarily propylene, reflecting some overcapacity in PO and PO derivatives supply. The lower SM margins were due to regional differences in SM margins. SM sales volumes in lower margin regions of the world increased in proportion to total SM sales during the first quarter 2002, lowering the average SM margins. First Quarter 2002 versus Fourth Quarter 2001 Operating income in the first quarter 2002 was $38 million compared to $41 million in the fourth quarter 2001. The fourth quarter 2001 included a $15 million pretax benefit resulting from a reduction of the third quarter 2001 provision of $78 million for estimated costs of exiting the ADI business, partly offset by goodwill amortization of $7 million. Excluding these items, fourth quarter 2001 operating income would have been $33 million. The improvement from the adjusted $33 million in the fourth quarter 2001 to $38 million in the first quarter 2002 was due to higher MTBE margins, partly offset by lower SM margins. The higher MTBE margins were consistent with the seasonality of the business. Spot market U.S. Gulf Coast MTBE raw material margins increased from 23 cents per gallon in the fourth quarter 2001 to 38 cents per gallon in the first quarter 2002, partially due to unusually low butane prices early in the quarter and strengthening of MTBE prices later in the quarter. Sales volumes for MTBE decreased 6% in the first quarter 2002 compared to the fourth quarter 2001 due to a scheduled turnaround of the Channelview, Texas MTBE production unit and a build up of MTBE inventory in the first quarter 2002 in anticipation of the summer driving season. SM volumes were essentially unchanged in the first quarter 2002 reflecting continued weak demand in the SM market. SM margins decreased in the first quarter 2002 compared to the fourth quarter 2001, due to regional differences in SM margins. PO and derivatives volumes increased 6% as demand from the urethane end-use market increased. BDO volumes increased as new contracts were initiated in support of BDO 2, the new BDO facility, which is scheduled for completion in mid-year 2002. Margins in the PO and derivatives business were largely unchanged in the first quarter 2002 compared to the fourth quarter 2001. 20 Equistar Chemicals, LP Overview General--U.S. demand for ethylene in the first quarter 2002 grew an estimated 2% compared to the first quarter 2001 and 3% compared to the fourth quarter 2001. Nonetheless, the first quarter 2002 demand growth failed to absorb the effects of an estimated 7.6% increase in worldwide ethylene industry capacity during calendar 2001 or to offset the effects of a 10% contraction in U.S. ethylene demand in 2001. Raw material costs in the first quarter 2002 were significantly lower than in the first quarter 2001. The benchmark price of crude oil averaged 24% lower in the first quarter 2002 than in the first quarter 2001. Natural gas prices, which spiked to historically high levels in the first quarter 2001, averaged 67% lower in the first quarter 2002, resulting in lower energy costs. Despite increased demand in the first quarter 2002, the ongoing industry overcapacity and the decreases in raw material costs during 2001 and most of the first quarter 2002 put downward pressure on product sales prices. This resulted in sales prices decreasing more than the costs of raw materials. Average benchmark sales prices for ethylene were 41% lower in the first quarter 2002 compared to the first quarter 2001, while average benchmark prices for co-product propylene were 29% lower in the first quarter 2002 compared to the first quarter 2001. These factors combined to reduce Equistar's margins in the first quarter 2002 compared to the first quarter 2001. In addition, in response to political uncertainties in the Middle East and Venezuela, raw material costs rose rapidly toward the end of the first quarter 2002. March 2002 crude oil prices averaged 18% higher than in February 2002, while March 2002 natural gas prices averaged 20% higher than in February 2002. This also had a negative effect on Equistar's first quarter 2002 margins due to lags in implementing sales price increases in response to cost increases. Net Loss--Equistar had a loss before cumulative effect of accounting change of $126 million in the first quarter 2002 compared to a net loss of $77 million in the first quarter 2001. The first quarter 2001 included $22 million of shutdown costs for Equistar's Port Arthur facility and $8 million of goodwill amortization. Excluding the effect of the first quarter 2001 shutdown costs and the goodwill amortization, the net loss increased by $79 million, reflecting a significant decrease in petrochemicals segment operating results partly offset by improvement in polymers segment results. The decrease in petrochemicals segment profitability was due to lower prices and margins, lower sales volumes and the negative effects of certain above-market fixed price contracts. Polymers segment results, however, improved due to higher margins as raw materials costs decreased more than sales prices. RESULTS OF OPERATIONS First Quarter 2002 versus Fourth Quarter 2001 Equistar had a loss before cumulative effect of accounting change of $126 million in the first quarter 2002 compared to a loss of $94 million in the fourth quarter 2001, which included $8 million of goodwill amortization. Excluding the effect of the fourth quarter 2001 goodwill amortization, the $40 million increase in the net loss reflected a decrease in petrochemicals segment operating results partly offset by improvement in polymers segment operating results. The decrease in petrochemicals segment profitability was due to lower prices and margins. Polymers segment results improved on higher margins as raw materials costs decreased more than sales prices. Both petrochemicals and polymers segment sales volumes increased in the first quarter 2002 compared to the fourth quarter 2001. The petrochemicals segment had an operating loss of $24 million in the first quarter 2002 compared to operating income of $50 million in the fourth quarter 2001. Margins in the first quarter 2002 decreased from the fourth quarter 2001 as ethylene prices declined in the first quarter 2002, while raw material and energy costs increased. First quarter 2002 average benchmark prices for ethylene were 19.3 cents per pound compared to 20.9 cents per pound in the fourth quarter 2001, an 8% decrease. Costs of raw materials increased due to rising ethane and naphtha 21 prices during the first quarter 2002. Benchmark prices of co-product propylene decreased an estimated 2.0 cents per pound, or 12%, in the first quarter 2002, further contributing to lower margins. Equistar's costs were also higher due to certain fixed price natural gas and NGL supply contracts entered into in early 2001. In the first quarter 2002, Equistar's costs under these fixed-price contracts were approximately $33 million higher than market-based contracts would have been. These fixed-price contracts largely expired at the end of the first quarter 2002. Sales volumes for petrochemical products increased 6.5% in the first quarter 2002 compared to the fourth quarter 2001 as aggressive inventory reductions by customers in the fourth quarter 2001 ended and there were some indications of improved demand in the first quarter 2002. The polymers segment operating loss of $21 million in the first quarter 2002 improved from an operating loss of $48 million in the fourth quarter 2001 due to improved margins and higher volumes. Margins in the polymers segment improved somewhat as decreasing prices for ethylene, a major raw material, more than offset lower sales prices. Estimated benchmark polymer sales prices fell approximately 0.5 cents per pound in the first quarter 2002 compared to the above-noted decrease of 1.6 cents per pound for ethylene over the same period. Polymer sales volume increases in the first quarter 2002 reflected the end of aggressive inventory reductions by customers in late December 2001 as well as some evidence of improved demand late in the first quarter 2002. Total Equistar polymer sales volumes increased approximately 3% versus the fourth quarter 2001. Segment Data The following tables reflect selected actual sales volume data, including intersegment sales volumes, and summarized financial information for Equistar's business segments.
For the three months ended March 31, ---------------------------- In millions 2002 2001 ----------- ------------- ------------- Selected petrochemicals products: Olefins (pounds) 4,137 4,241 Aromatics (gallons) 86 90 Polymers products (pounds) 1,508 1,441 Millions of dollars ------------------- Sales and other operating revenues: Petrochemicals segment $ 993 $ 1,689 Polymers segment 410 542 Intersegment eliminations (267) (458) ------- ------- Total $ 1,136 $ 1,773 ======= ======= Operating income (loss): Petrochemicals segment $ (24) $ 115 Polymers segment (21) (89) Unallocated and unusual charges (30) (62) ------- ------- Total $ (75) $ (36) ======= =======
Petrochemicals Segment Revenues--Revenues of $1.0 billion in the first quarter 2002 decreased 41% compared to revenues of $1.7 billion in the first quarter 2001 primarily due to lower sales prices and, to a lesser extent, lower sales volumes. Benchmark ethylene prices averaged 41% lower in the first quarter 2002 compared to the first quarter 2001. Sales volumes decreased 3% in the first quarter 2002 compared to the first quarter 2001. Operating Income--The operating loss of $24 million in the first quarter 2002 compares to operating income of $115 million in the first quarter 2001. The $139 million decrease is primarily due to lower product margins as sales prices decreased much more than raw material costs. As noted above, raw material and energy costs actually rose 22 rapidly in March 2002 after declining steadily since the first quarter 2001. This negatively affected first quarter 2002 margins, as sales prices could not be increased timely in response to the cost increases. Costs were also higher due to certain fixed price natural gas and NGL supply contracts entered into in early 2001. In the first quarter 2002, Equistar's costs under these fixed-price contracts were approximately $33 million higher than market-based contracts would have been. These fixed-price contracts largely expired by the end of the first quarter 2002. Polymers Segment Revenues--Revenues of $410 million in the first quarter 2002 decreased 24% compared to revenues of $542 million in the first quarter 2001. The decrease was due to lower sales prices partly offset by a 5% increase in sales volumes. First quarter 2002 average sales prices decreased in response to lower raw material costs, primarily ethylene and propylene. The higher sales volumes reflected improvement in demand. Operating Income--For the first quarter 2002, the polymers segment had an operating loss of $21 million compared to an operating loss of $89 million in the first quarter 2001. The reduced operating loss was due to improvement in polymer margins and, to a lesser extent, higher sales volumes. Margins improved in the first quarter 2002 compared to the first quarter 2001 as sales prices decreased less than the decreases in polymer raw material costs, primarily ethylene and propylene. Benchmark ethylene and propylene costs were 41% and 29% lower, respectively, in the first quarter 2002 compared to the first quarter 2001. Unallocated Items The following discusses significant changes in expenses that were not allocated to the petrochemicals or polymers segments. Unusual Charges--Equistar discontinued production at its higher-cost Port Arthur, Texas polyethylene facility in February 2001 and shut down the facility. During the first quarter 2001, Equistar recorded a $22 million charge, which included environmental remediation liabilities of $7 million, other exit costs of $3 million and severance and pension benefits of $7 million for approximately 125 people employed at the Port Arthur facility. The remaining $5 million balance primarily related to the write down of certain assets. 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. See Note 2 of Notes to Consolidated Financial Statements. In addition, as a result of implementing SFAS No. 142, earnings in 2002 and subsequent years will be favorably affected by $33 million annually because of the elimination of goodwill and its related amortization. 23 LYONDELL-CITGO Refining LP Refining Segment Overview--In January 2002, PDVSA Petroleo, S.A. ("PDVSA Oil") declared itself in a force majeure situation and stated that crude oil deliveries could be reduced by up to 20.3% beginning March 1, 2002. Beginning March 2002, PDVSA Oil reduced deliveries of extra heavy Venezuelan crude oil to LCR under the Crude Supply Agreement based on the declared force majeure. See Note 10 of Notes to Consolidated Financial Statements. These shortfalls were largely offset by Crude Supply Agreement crude oil inventories that were accumulated during a major planned maintenance turnaround in the fourth quarter 2001 and processed in the first quarter 2002. However, LCR experienced a 10-day period of reduced operating rates in the first quarter 2001 due to an unplanned outage of one of its production units. As a result, processing of crude oil under the Crude Supply Agreement averaged 229,000 barrels per day in the first quarter 2002, only slightly lower than the 231,000 barrels per day processed in the first quarter 2001, when deliveries were at the contractual rate of 230,000 barrels per day. LCR was also favorably affected in the first quarter 2002 by the significant decrease in natural gas costs, compared to the first quarter 2001 when natural gas costs spiked to historically high levels. Compared to the first quarter 2001, LCR's operating costs decreased approximately $11 million due to the lower natural gas costs. A weaker gasoline market during most of the first quarter 2002 reduced the margins that LCR realized on its spot purchases of crude oil, compared to the first quarter 2001 when the gasoline market and margins on spot purchases were relatively higher. In the first quarter 2002, LCR's margins were negatively affected by a rapid increase in crude oil prices in March 2002. However, this was partly offset by improvement in spot margins. First Quarter 2002 versus First Quarter 2001 The following table sets forth, in thousands of barrels per day, sales volumes for LCR's refined products and processing rates for the periods indicated:
For the three months ended March 31, ------------------------------ 2002 2001 ------------- ------------- Refined products Gasoline 105 106 Diesel and heating oil 80 71 Jet fuel 22 20 Aromatics 8 10 Other refined products 115 104 --- --- Total refined products volumes 330 311 === === Crude processing rates: Crude supply agreement--coked 229 231 Other heavy crude oil--coked 6 23 Other crude oil 26 5 --- --- Total crude oil 261 259 === ===
Revenues--Revenues for LCR, including intersegment sales, were $707 million in the first quarter 2002, a 22% decrease compared to first quarter 2001 revenues of $910 million. The decrease was primarily due to lower sales prices for refined products, partly offset by a 6% increase in sales volumes. The lower sales prices reflected generally lower gasoline and other fuels prices in the first quarter 2002 compared to the first quarter 2001. Total crude processing rates were comparable, averaging 261,000 barrels per day in the first quarter 2002 and 259,000 barrels per day in the first quarter 2001, but below the refinery's capacity of 268,000 barrels per day. Despite good operational reliability during the first quarter 2002, processing of spot volumes during the early part of the quarter 24 was not profitable and LCR reduced the total crude processing rates in the quarter. In the first quarter 2001, processing rates were negatively affected by a 10-day period of reduced operating rates due to an unplanned outage of one of the production units. The volume of heavy crude oil coked decreased significantly in the first quarter 2002 compared to the first quarter 2001 due to the nonavailability of extra heavy crude oil on the spot market. Interest Expense--LCR's interest expense was $8 million in the first quarter 2002 compared to $16 million in the first quarter 2001. Debt issuance cost amortization and interest rates were higher in the first quarter 2001 as a result of the refinancing of LCR's debt in May and September 2000. LCR's debt was refinanced again in July 2001 on a more favorable basis. Net Income--LCR's net income was $41 million in the first quarter 2002 and was comparable to $42 million in the first quarter 2001. During the first quarter 2002, the favorable effects of lower energy costs as well as lower interest expense compared to the first quarter 2001 offset the negative effects of rapidly rising crude oil prices in March 2002. First Quarter 2002 versus Fourth Quarter 2001 LCR's net income in the first quarter 2002 was $41 million compared to $17 million in the fourth quarter 2001, which included the effects of a major scheduled maintenance turnaround. Total crude processing rates during the first quarter 2002 were 261,000 barrels per day compared to 207,000 barrels per day in the fourth quarter 2001. Crude Supply Agreement processing volumes in the first quarter 2002 averaged 229,000 barrels per day, while spot processing volumes averaged 32,000 barrels per day. Although the force majeure declaration by PDVSA Oil impacted March 2002 deliveries, these reductions were largely offset by Crude Supply Agreement inventories carried into the first quarter 2002 as a result of the fourth quarter 2001 scheduled maintenance turnaround. Despite good operational reliability during the first quarter 2002, processing of spot volumes during the early part of the quarter was not profitable and LCR, therefore, reduced the total crude processing rates in the quarter. FINANCIAL CONDITION Operating Activities--Lyondell's operating activities provided cash of $170 million in the first quarter 2002 compared to the first quarter 2001 when operations used cash of $45 million. The significant improvement in the first quarter 2002 compared to the first quarter 2001 was due to $97 million of federal income tax refunds relating to 2001 income tax benefits that were received in the first quarter 2002, an increase in Lyondell's working capital during the first quarter 2001 and lower payments of interest and compensation- related liabilities during the first quarter 2002. The income tax benefit was reflected in prepaid expenses and other current assets at December 31, 2001. The net effect of changes in the major components of working capital - receivables, inventory and payables - was negligible in the first quarter 2002, as decreases in receivables and inventory were offset by a decrease in payables. By contrast, in the first quarter 2001, inventory increased $92 million due to a planned build up of MTBE inventory in anticipation of the summer driving season. A similar build up did not occur in the first quarter 2002 due to a scheduled maintenance turnaround at the Channelview, Texas MTBE facility. Other assets and liabilities provided cash of $40 million in the first quarter 2002 whereas they used $21 million of cash in the first quarter 2001. The favorable cash effect in the first quarter 2002 is primarily due to lower cash payments for interest and annual compensation-related expenses. Annual compensation-related payments decreased due to lower 2001 operating results. 25 Investing Activities--The following table summarizes the capital expenditures of Lyondell and its affiliates as well as their 2002 budgeted capital spending.
For the three months Capital Budget ended March 31, 2002 2002 ------------------------- ------------------------- 100% Lyondell 100% Lyondell Millions of dollars Basis Share Basis Share ------------------- --------- ----------- ----------- ----------- Capital expenditures by: Lyondell $ 11 $ 11 $ 55 $ 55 Equistar 15 6 94 39 LCR 22 13 104 61 ---- ---- Total capital expenditures $ 30 $155 ==== Contributions to PO-11 Joint Venture 75 ---- Total 2002 capital budget $230 ====
The 2002 capital budgets of Lyondell and its affiliates include spending for regulatory compliance, maintenance and cost reduction projects. The following table summarizes Lyondell's distributions from and contributions to its affiliates for the three months ended March 31, 2002.
Affiliate Contributions Millions of dollars Distributions to Affiliates -------------------- ---------------- ---------------- Affiliate: Equistar $-- $-- LCR 24 22 PO-11 Joint Venture -- 12 PO Joint Venture -- 1 LMC -- 3 --- --- Total $24 $38 === ===
In the first quarter 2002, there were no distributions from affiliates in excess of earnings. LCR made cash distributions of $24 million, which were less than Lyondell's $27 million share of LCR's net income for the first quarter 2002. Financing Activities--Lyondell paid a regular quarterly dividend of $.225 per share of common stock, or $26 million, in the first quarter 2002. On May 2, 2002, the board of directors of Lyondell declared a regular quarterly dividend of $.225 per share of common stock, payable June 17, 2002. Lyondell also made debt payments of $13 million during the first quarter 2002 primarily using proceeds of certain asset sales as required by the terms of the credit facility. Deferred Tax Assets--The deferred tax assets classified as current assets decreased by $216 million during the first quarter of 2002. The reduction primarily represents a change in the timing of anticipated realization of the tax benefits of domestic net operating loss ("NOL") carryforwards. These benefits, which are expected to be realized within the next few years, have been reclassified from current assets to long-term net liabilities on the consolidated balance sheet. Entering 2002, based on preliminary evidence of increasing demand, management believed that 2002 operating results sufficient to permit utilization of these NOLs were achievable. However, the rapid escalation of raw material costs late in the first quarter 2002 had a significant negative effect on Lyondell's first quarter 2002 operating results, particularly on the earnings from its equity investment in Equistar. The uncertainties created by the escalation of raw material costs and the political unrest in the Middle East, as well as Venezuela, have compounded the uncertainty as to the timing and extent of the anticipated upturn in world economic activity. Accordingly, the increased demand could be short lived and not representative of a robust improvement in the economy. Based on the above factors, management concluded that it was appropriate to classify the deferred tax assets related to the NOL carryforwards as long term. There was no change in management's expectation that these deferred tax assets will be fully realized. 26 Liquidity and Capital Resources--At March 31, 2002, Lyondell had cash on hand of $228 million. The $500 million revolving credit facility, which matures in July 2003, was reduced to the extent of certain outstanding letters of credit, which totaled $33 million as of March 31, 2002. Lyondell believes that conditions will be such that cash balances, cash generated from operating activities, and funds from lines of credit will be adequate to meet anticipated future cash requirements, including scheduled debt repayments, necessary capital expenditures, ongoing operations and dividends. Long-Term Debt--The credit facility and the indentures under which Lyondell's senior secured notes and senior subordinated notes were issued contain covenants that, subject to exceptions, restrict sale and leaseback transactions, lien incurrence, debt incurrence, dividends, investments, certain payments, sales of assets and mergers and consolidations. In addition, the credit facility requires Lyondell to maintain specified financial ratios and consolidated net worth, in all cases as provided in the credit facility. The breach of these covenants could permit the lenders to declare the loans immediately payable and could permit the lenders under Lyondell's credit facility to terminate future lending commitments. Lyondell was in compliance with all such covenants as of March 31, 2002. Guarantees of Equistar Debt--Lyondell is guarantor of $300 million of Equistar debt and a co-obligor with Equistar for $31 million of debt. Joint Venture Debt--At March 31, 2002, the outstanding debt of Lyondell's joint ventures to parties other than Lyondell was $2.3 billion for Equistar and $501 million for LCR. This debt is not carried on Lyondell's balance sheet because, except for the amounts described in the preceding section, Lyondell has no obligation with respect to that debt. The ability of the joint ventures to distribute cash to Lyondell is reduced by current weak business conditions and their respective debt service obligations. Equistar Liquidity and Capital Resources--Equistar's amended credit facility and the indenture governing Equistar's senior unsecured notes contain covenants that, subject to exceptions, restrict sale and leaseback transactions, investments, certain payments, lien incurrence, debt incurrence, sales of assets and mergers and consolidations. In addition, the credit facility requires Equistar to maintain certain specified financial ratios. The breach of these covenants could permit the lenders to declare the loans immediately payable and could permit the lenders under Equistar's credit facility to terminate future lending commitments. Furthermore, a default under Equistar's debt instruments which results in, or permits, the acceleration of more than $50 million of indebtedness would constitute a cross-default under Lyondell's credit facility. As a result of the poor current business environment, Equistar amended its $800 million credit facility in late March 2002, making certain financial ratio requirements less restrictive. As a result of the amendment, the interest rate on the credit facility was increased by 0.5% per annum. If certain financial ratios are met, the interest rate will only increase by 0.25% per annum. Equistar was in compliance with all covenants under its debt instruments as of March 31, 2002. Railcar Leases--Equistar leases railcars, under operating leases, from unaffiliated entities established for the purpose of serving as lessors with respect to these leases. The leases include options for Equistar to purchase the railcars covered by the leases during a lease term. If Equistar does not exercise a purchase option, the affected railcars will be sold upon termination of the lease. In the event the sales proceeds are less than the lessor's unrecovered investment, Equistar will pay the difference to the lessor, but no more than the guaranteed residual value. The total guaranteed residual value under these leases was approximately $208 million at March 31, 2002. One of the railcar leases with a guaranteed residual value of $35 million terminates in December 2002. Equistar has not decided whether to exercise the purchase option under this lease, but does not currently anticipate payment of a material amount under the residual value guarantee provisions. 27 Early in 2002, Equistar's credit rating was lowered by two major rating agencies. The credit rating downgrade permitted the early termination of one of Equistar's railcar leases by the lessor, which could have accelerated the payment of $126 million of minimum lease payments. Equistar renegotiated the lease during the first quarter 2002, resulting in a payment of additional fees and a prepayment of basic rent of $17 million, which reduced the guaranteed residual value to $87 million and will be fully offset by a corresponding reduction in future cash lease payments. Certain of Equistar's railcar operating leases contain financial and other covenants that are substantially the same as those contained in the $800 million credit facility. A breach of these covenants could permit the early termination of these railcar leases by the lessors. Under one of the leases, the covenants were automatically updated with the March 2002 amendment to the credit facility. Equistar also amended the covenants under the remaining railcar lease to incorporate the March 2002 amendment to the $800 million credit facility. The amendment, which was completed in the second quarter 2002, required the payment of additional fees and a payment of $16 million, which reduced the guaranteed residual value to $70 million. The $16 million payment will be partially offset by a corresponding reduction in future lease payments. In addition, the lessor has the option to terminate the lease under certain circumstances by December 31, 2002. LCR Liquidity and Capital Resources--In July 2001, LCR obtained new credit facilities, consisting of a $450 million term loan and a $70 million revolving credit facility, both of which mature in January 2003. As a result, the $450 million term loan was classified as current at March 31, 2002. RECENT DEVELOPMENTS Early in 2002, Lyondell and Occidental agreed in principle to Lyondell's acquisition of Occidental's 29.5% interest in Equistar and to Occidental's acquisition of an equity interest in Lyondell. Upon consummation of these transactions, Occidental would receive the following from Lyondell: .. 30 to 34 million shares of newly issued Lyondell Series B Common Stock, with the final number to be determined at closing of this transaction. These shares would have the same rights as Lyondell's regular common stock with the exception of the dividend. The Series B Common Stock would pay a dividend at the same rate as the regular common stock but, at Lyondell's option, the dividend may be paid in additional shares of Series B Common Stock or in cash. These new Series B shares also would include provisions for conversion to regular common stock three years after issuance or earlier in certain circumstances; .. five-year warrants to acquire five million shares of Lyondell regular common stock at $25 per share, subject to adjustment upon the occurrence of certain events; and .. a contingent payment equivalent in value to 7.38% of Equistar's cash distributions for 2002 and 2003, up to a total of $35 million, payable in cash, Series B Common Stock or regular common stock, as determined by Lyondell. On April 19, 2002, the formal right of first offer process began in connection with certain of the transactions. Under this process, Millennium, the third partner in Equistar, has 45 days to decide whether to participate on a pro rata basis in the acquisition of Occidental's Equistar interest. At the end of the process, Occidental, Lyondell and, if it elects to participate, Millennium are expected to sign definitive documentation. Lyondell's board of directors approved the transactions on May 2, 2002. Closing of the transactions is subject to certain conditions, including approval by Lyondell's shareholders. Lyondell anticipates that these transactions will close during the third quarter of 2002. However, there can be no assurance that the proposed transactions will be completed. CURRENT BUSINESS OUTLOOK Lyondell anticipates modest demand improvement in the second quarter 2002 for many of its IC&D products, as well as improvement in MTBE margins consistent with the historical seasonality of that business. In the Equistar businesses, Lyondell expects modestly improved demand coupled with the expiration of many of its fixed price natural gas and NGL contracts to result in improved results in the second quarter 2002. Such improvement could be offset by any significant increases in raw material costs. According to the January 2002 declaration of force majeure 28 from PDVSA Oil, crude deliveries to LCR under the Crude Supply Agreement may be reduced up to 20.3% from the contract levels of 230,000 barrels per day. Lyondell expects the second quarter 2002 to reflect the full impact of the curtailed deliveries under the Crude Supply Agreement. Lyondell currently expects second quarter 2002 deliveries under the Crude Supply Agreement to average 190,000 barrels per day, while the processing of crude oil purchased in the spot market should average 72,000 barrels per day. RECENT ACCOUNTING STANDARDS Effective January 1, 2002, Lyondell implemented SFAS No. 141, Business Combinations, SFAS No. 142, Goodwill and Other Intangible Assets, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. See Note 2 of Notes to Consolidated Financial. Item 3. Disclosure of Market and Regulatory Risk. Lyondell's exposure to market and regulatory risks is described in Item 7a of its Annual Report on Form 10-K for the year ended December 31, 2001. Lyondell's exposure to market and regulatory risks has not changed materially in the quarter ended March 31, 2002, except as noted below. Certain federal and state governmental initiatives in the U.S. have sought either to rescind the oxygenate requirement for reformulated gasoline or to restrict or ban the use of MTBE. On April 25, 2002, the U.S. Senate passed its version of an omnibus energy bill, which, among other things, would ban the use of MTBE as a fuel oxygenate. The Senate bill is not law and needs to be reconciled with the U.S. House of Representatives' omnibus energy bill, which was passed in July 2001. Lyondell's MTBE sales represented approximately 35% of its total 2001 revenues. Lyondell does not expect these initiatives to have a significant impact on MTBE margins and volumes in 2002. Should it become necessary to reduce MTBE production, Lyondell would need to make capital expenditures to convert its MTBE plants to production of alternate gasoline blending components. The profit margins on such alternate gasoline blending components could differ from those historically realized on MTBE. 29 FORWARD-LOOKING STATEMENTS Certain of the statements contained in this report are "forward-looking statements" within the meaning of the federal securities laws. Although Lyondell believes the expectations reflected in such forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties, and Lyondell can give no assurance that such expectations will prove to have been correct. Lyondell's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including: .. the cyclical nature of the chemical and refining industries, .. uncertainties associated with the United States and worldwide economies, .. substantial chemical and refinery capacity additions resulting in oversupply and declining prices and margins, .. the availability and cost of raw materials and utilities, .. access to capital markets, .. technological developments, .. current and potential governmental regulatory actions in the United States and in other countries, .. potential terrorist acts, .. operating interruptions (including leaks, explosions, fires, mechanical failure, unscheduled downtime, labor difficulties, transportation interruptions, spills and releases and other environmental risks), and .. Lyondell's ability to implement its business strategies, including cost reductions. Many of such factors are beyond Lyondell's or its joint ventures' ability to control or predict. Any of these factors, or a combination of these factors, could materially affect Lyondell's or its joint ventures' future results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of Lyondell's or its joint ventures' future performance, and Lyondell's or its joint ventures' actual results and future developments may differ materially from those projected in the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels. All forward-looking statements in this Form 10-Q are qualified in their entirety by the cautionary statements contained in this section and in Lyondell's Annual Report on Form 10-K for the year ended December 31, 2001. 30 PART II. OTHER INFORMATION Item 1. Legal Proceedings There have been no material developments with respect to Lyondell's legal proceedings previously reported in the Annual Report on Form 10-K for the year ended December 31, 2001, except as described below. On April 30, 2002, Lyondell and Bayer AG settled the claims of Bayer AG in relation to its March 2000 purchase of Lyondell's polyols business. Lyondell had received notice of these claims in June 2001, which alleged various breaches of representations and warranties related to the condition of the business and assets and which sought damages in excess of $100 million. The settlement included new or amended commercial agreements between the parties, generally relating to the existing PO partnership. As a whole, the new or amended agreements provide new business opportunities and value for both parties over the next five to ten years. Concurrent with the settlement, Lyondell made a $5 million indemnification payment to Bayer. The settlement had no effect on Lyondell's financial position or results of operations. Item 4. Submission of Matters to a Vote of Security Holders Lyondell held its annual meeting of stockholders on May 2, 2002. The stockholders elected all of Lyondell's eight nominees for director, ratified the appointment of PricewaterhouseCoopers LLP as Lyondell's independent auditors for 2002 and approved the Amended and Restated Lyondell Chemical Company 1999 Long-Term Incentive Plan. The votes were as follows: 1. Election of Directors: Nominee For Withheld ------- --- -------- Carol A. Anderson 97,781,552 3,117,649 William T. Butler 97,967,227 2,931,974 Travis Engen 97,976,945 2,922,256 Stephen F. Hinchliffe, Jr. 97,764,799 3,134,402 David J. Lesar 97,777,309 3,121,892 Dudley C. Mecum II 97,951,590 2,947,611 Dan F. Smith 97,975,685 2,923,516 William R. Spivey 97,775,780 3,123,421 2. Appointment of PricewaterhouseCoopers LLP: For: 97,038,255 Against: 3,790,221 Abstain: 70,724 Broker Non-Votes: 0 3. Approval of the Amended and Restated 1999 Long-Term Incentive Plan: For: 89,028,126 Against: 11,707,816 Abstain: 163,257 Broker Non-Votes: 0 31 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 4.7(a) Amendment No. 1 dated as of March 26, 2002 to the Amended and Restated Credit Agreement dated as of August 24, 2001 among Equistar Chemicals, LP, the lenders from time to time party thereto and Citicorp USA, Inc. and Credit Suisse First Boston, as co-syndication agents; Bank of America, N.A., as servicing agent and as administrative agent and The Chase Manhattan Bank, as collateral agent and as administrative agent 10.11 Amended and Restated Elective Deferral Plan for Non-Employee Directors 10.16 Amended and Restated 1999 Long-Term Incentive Plan 10.30(a) First Amendment to the Amended and Restated Limited Partnership Agreement of PO JV, LP (b) Reports on Form 8-K The following Current Report on Form 8-K was filed during the quarter ended March 31, 2002 and through the date hereof: Date of Report Item No. Financial Statements -------------- -------- -------------------- January 11, 2002 5 No 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Lyondell Chemical Company Dated: May 13, 2002 /s/ CHARLES L. HALL ----------------------------------------- Charles L. Hall Vice President and Controller (Duly Authorized and Principal Accounting Officer) 33