<PAGE>
---------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997.
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 PETROCHEMICAL 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 1600, HOUSTON, TEXAS (ZIP CODE)
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 652-7200
----------
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
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 SEPTEMBER
30, 1997: 79,436,488
---------------------------------------------------
<PAGE>
PART I. FINANCIAL INFORMATION
LYONDELL PETROCHEMICAL COMPANY
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------------- -----------------------------------
PRO PRO
FORMA AS FORMA AS
1996 REPORTED 1996 REPORTED
MILLIONS OF DOLLARS EXCEPT PER SHARE AMOUNTS 1997 (NOTE 1) 1996 1997 (NOTE 1) 1996
- -------------------------------------------- ------- ------- ------- ------- ------- -------
SALES AND OTHER OPERATING REVENUES:
<S> <C> <C> <C> <C> <C> <C>
Unrelated parties $ 648 $ 562 $ 1,179 $ 1,874 $ 1,518 $ 3,446
Related parties 151 120 68 469 356 205
------- ------- ------- ------- ------- -------
799 682 1,247 2,343 1,874 3,651
------- ------- ------- ------- ------- -------
OPERATING COSTS AND EXPENSES:
Cost of sales
Unrelated parties 475 463 1,063 1,447 1,292 3,120
Related parties 120 97 56 370 307 180
Selling, general and administrative expenses 51 42 57 148 127 174
------- ------- ------- ------- ------- -------
646 602 1,176 1,965 1,726 3,474
------- ------- ------- ------- ------- -------
Operating income 153 80 71 378 148 177
Interest expense (19) (18) (18) (60) (60) (61)
Interest income 4 1 1 10 3 3
Minority interest (5) - - 1 (13) - - (3)
Income (loss) from equity investment 29 (8) - - 56 25 - -
------- ------- ------- ------- ------- -------
Income before income taxes 162 55 55 371 116 116
Provision for income taxes 60 20 20 136 42 42
------- ------- ------- ------- ------- -------
NET INCOME $ 102 $ 35 $ 35 $ 235 $ 74 $ 74
======= ======= ======= ======= ======= =======
EARNINGS PER SHARE $ 1.27 $ .43 $ .43 $ 2.94 $ .92 $ .92
======= ======= ======= ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
1
<PAGE>
LYONDELL PETROCHEMICAL COMPANY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
PRO FORMA
DECEMBER 31 AS REPORTED
SEPTEMBER 30 1996 DECEMBER 31
MILLIONS OF DOLLARS 1997 (NOTE 1) 1996
- ------------------- ------------ ----------- -----------
ASSETS
Current assets:
<S> <C> <C> <C>
Cash and cash equivalents $ 67 $ 56 $ 68
Accounts receivable:
Trade 314 259 394
Related parties 32 96 62
Inventories 258 196 294
Prepaid expenses and other current assets 13 12 13
------- ------- -------
Total current assets 684 619 831
------- ------- -------
Property, plant and equipment 2,146 2,109 4,313
Less accumulated depreciation and amortization (1,269) (1,216) (2,043)
------- ------- -------
877 893 2,270
Investment in affiliate 66 83 - -
Receivable from affiliate 230 177 - -
Deferred charges and other assets 128 118 175
------- ------- -------
Total assets $ 1,985 $ 1,890 $ 3,276
======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable:
Trade $ 197 $ 200 $ 474
Related parties 17 30 1
Notes payable 50 50 60
Current maturities of long-term debt 32 112 112
Other accrued liabilities 114 93 124
------- ------- -------
Total current liabilities 410 485 771
------- ------- -------
Long-term debt 712 744 1,194
Other liabilities and deferred credits 84 70 114
Deferred income taxes 176 157 157
Commitments and contingencies
Minority interest 5 3 609
Stockholders' equity:
Preferred stock, $.01 par value, 80,000,000
shares
authorized, none outstanding
Common stock, $1 par value, 250,000,000 shares
authorized, 80,000,000 issued 80 80 80
Additional paid-in capital 158 158 158
Retained earnings 374 193 193
Treasury stock, at cost, 563,512 shares (14) - - - -
------- ------- -------
Total stockholders' equity 598 431 431
------- ------- -------
Total liabilities and stockholders' equity $ 1,985 $ 1,890 $ 3,276
======= ======= =======
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
LYONDELL PETROCHEMICAL COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30
----------------------------------------------
<S> <C> <C> <C>
PRO FORMA
1996 AS REPORTED
MILLIONS OF DOLLARS 1997 (NOTE 1) 1996
- ------------------- ----- ----- -----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 235 $ 74 $ 74
Adjustments to reconcile net income to net
cash provided by operating activities,
net of the effects of deconsolidation of affiliate:
Depreciation and amortization 66 54 78
Deferred income taxes 12 20 20
Minority interest 13 - - 3
(Increase) decrease in accounts receivable 9 (54) (24)
Increase in inventories (62) (20) (3)
Increase (decrease) in accounts payable (16) 27 9
Net change in other working capital accounts 26 (13) (19)
Other (5) (37) (42)
----- ----- -----
Net cash provided by operating activities 278 51 96
----- ----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (39) (61) (488)
Proceeds from sales of short-term investments - - 76 76
Purchases of short-term investments - - (76) (76)
Contributions and advances to affiliate (54) (121) - -
Distributions from affiliate in excess of earnings 18 42 - -
Deconsolidation of affiliate (12) (4) - -
----- ----- -----
Net cash used in investing activities (87) (144) (488)
----- ----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Minority owner contributions (distributions) (12) - - 106
Net change in short-term debt - - 17 30
Borrowings of long-term debt - - 300 482
Repayments of long-term debt (112) (150) (150)
Repurchase of common stock (14) - - - -
Dividends paid (54) (54) (54)
----- ----- -----
Net cash provided by (used in) financing (192) 113 414
activities ----- ----- -----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1) 20 22
Cash and cash equivalents at beginning of period 68 10 10
----- ----- -----
Cash and cash equivalents at end of period $ 67 $ 30 $ 32
===== ===== =====
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
LYONDELL PETROCHEMICAL 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
footnotes 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, 1996 included in the Lyondell Petrochemical Company ("Company" or
"Lyondell") 1996 Annual Report and the Annual Report on Form 10-K and prior
quarterly reports on Form 10-Q pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. The year-end condensed balance sheet data was derived
from audited financial statements but does not include all disclosures required
by generally accepted accounting principles. Certain amounts from prior periods
have been reclassified to conform to the current period presentation.
Pro Forma Financial Information - The unaudited pro forma financial information
in the accompanying financial statements presents the financial position,
results of operations and cash flows of the Company as of December 31, 1996 and
for the three and nine months ended September 30, 1996 using the equity method
of accounting for Lyondell's investment in LYONDELL-CITGO Refining Company Ltd.
("LCR") as if the change in accounting method had been effective January 1, 1996
(see Note 3). This unaudited pro forma information may not be indicative of
results that will be obtained in the future. The unaudited pro forma financial
information also includes restatements to divide the petrochemicals segment into
the petrochemicals and polymers segments.
2. COMPANY OPERATIONS
The Company operates in the petrochemicals, polymers and refining segments. In
1996 and prior years, the results of the polymers business were included in the
petrochemicals segment. The petrochemicals business, as reported in 1997 and as
restated on a pro forma basis in 1996, manufactures a wide variety of
petrochemicals including olefins, methanol, methyl tertiary butyl ether ("MTBE")
and aromatics produced at the Channelview petrochemical facility. In December
1996, the Company sold an undivided interest in its methanol facility to MCN
Investment Corporation ("MCNIC") and created Lyondell Methanol Company L.P.
("Lyondell Methanol"), a limited partnership with the minority owner, to own and
operate the methanol facility. The Company's petrochemical products are used
primarily in the production of other chemicals and products, including polymers.
The polymers business manufactures polyolefins, including high-density
polyethylene ("HDPE"), low-density polyethylene and polypropylene, which are
used in the production of a wide variety of consumer and industrial products.
The Company also operates in the refining segment through the Company's equity
interest in LCR, a Texas limited liability company that is owned by subsidiaries
of Lyondell and CITGO Petroleum Corporation ("CITGO"), which manufactures
refined petroleum products, including gasoline, low sulfur diesel, jet fuel,
aromatics and lubricants.
3. EQUITY INTEREST IN LYONDELL-CITGO REFINING COMPANY LTD.
In July 1993, LCR was formed to own and operate the Company's refining business,
including the full-conversion Houston, Texas refinery ("Refinery"). LCR
completed a major upgrade project at the Refinery ("Upgrade Project") during the
first quarter of 1997 which enables the facility to process substantial
additional volumes of very heavy crude oil. As a result of the completion of
the Upgrade Project, effective April 1, 1997, the participation interests
changed from approximately 86 percent and 14 percent to approximately 59 percent
and 41 percent for Lyondell and CITGO, respectively, to reflect CITGO's equity
contribution in the Upgrade Project. CITGO has a one-time option
4
<PAGE>
to increase its participation interest in LCR up to 50 percent by making an
additional equity contribution. Net income before depreciation expense for the
period is allocated to LCR's owners based on participation interests.
Depreciation expense is allocated to the owners based on contributed assets.
Pursuant to contractual arrangements and concurrent with the completion of the
Upgrade Project, the authority and responsibility for certain management
decisions previously decided by majority vote, and therefore controlled by
Lyondell, changed to unanimous vote resulting in expanded joint control of LCR
by Lyondell and CITGO. Consequently, effective January 1, 1997, Lyondell began
accounting for its investment in LCR under the equity method of accounting,
meaning that the operations of LCR are no longer consolidated line by line with
those of Lyondell. In 1997, Lyondell's portion of LCR's net earnings is
included in the consolidated statements of income as income (loss) from equity
investment and Lyondell's portion of LCR's net assets appears on a single line
in the consolidated balance sheets as investment in affiliate. Cash advances to
and distributions from LCR in excess of earnings are reflected as individual
line items in the consolidated statements of cash flows.
Summarized financial information for LCR is as follows (in millions of dollars).
<TABLE>
<CAPTION>
BALANCE SHEETS SEPTEMBER 30 DECEMBER 31
1997 1996
------------------- -------------------
<S> <C> <C>
Total current assets $ 233 $ 273
Property, plant and equipment, net 1,384 1,378
Deferred charges and other assets 48 56
------------------- -------------------
Total assets $1,665 $1,707
=================== ===================
Total current liabilities $ 265 $ 373
Long-term debt 701 627
Other liabilities and deferred credits 50 44
Members' equity 649 663
------------------- -------------------
Total liabilities and members' equity $1,665 $1,707
=================== ===================
</TABLE>
<TABLE>
<CAPTION>
INCOME STATEMENTS FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------------- ---------------------------------
1997 1996 1997 1996
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Sales and other operating revenues $ 634 $ 651 $1,974 $2,049
Cost of sales 561 645 1,825 1,976
Selling, general and administrative expenses 17 14 50 45
-------------- -------------- -------------- --------------
Operating income (loss) $ 56 $ (8) $ 99 $ 28
============== ============== ============== ==============
Net income (loss) $ 44 $ (8) $ 73 $ 28
============== ============== ============== ==============
STATEMENTS OF CASH FLOWS
Depreciation and amortization $ 24 $ 8 $ 66 $ 24
Net changes in working capital (5) 21 (70) 24
Additions to property, plant and equipment (13) (113) (64) (427)
</TABLE>
Included in sales and other operating revenues above are sales to Lyondell of
$41 million and $32 million for the three months ended September 30, 1997 and
1996, respectively, and $148 million and $116 million for the nine months ended
September 30, 1997 and 1996, respectively. In addition, LCR purchased from the
Company $88 million and $53 million, primarily product purchases, for the three
months ended September 30, 1997 and 1996, respectively, and $263 million and
$155 million for the nine months ended September 30, 1997 and 1996,
respectively, which are included in LCR's cost of sales.
5
<PAGE>
4. INVENTORIES
The categories of inventory and their recorded values at September 30, 1997 and
December 31, 1996 were:
PRO FORMA AS REPORTED
SEPTEMBER 30 DECEMBER 31 DECEMBER 31
MILLIONS OF DOLLARS 1997 1996 1996
- ------------------- ------------ ----------- -----------
Petrochemicals $ 161 $ 98 $ 172
Polymers 74 74 - -
Crude oil and refined products - - - - 81
Materials and supplies 23 24 41
------------ ----------- -----------
Total inventories $ 258 $ 196 $ 294
============ =========== ===========
5. CAPITALIZED INTEREST
The Company's policy is to capitalize interest expense incurred on debt during
the construction of major projects that exceed one year. Total interest expense
incurred during the three months and the nine months ended September 30, 1997
was approximately $19 million and $60 million, respectively, of which none was
capitalized. Total interest expense incurred during the three months and the
nine months ended September 30, 1996 was approximately $28 million and $84
million, respectively. Approximately $10 million and $23 million was
capitalized, including $8 million and $19 million by LCR, during the three
months and nine months ended September 30, 1996, respectively.
6. COMMITMENTS AND CONTINGENCIES
The Company has various purchase commitments for materials, supplies and
services incident to the ordinary conduct of business. In the aggregate, such
commitments are not at prices in excess of current market.
At its inception, LCR entered into a long-term crude oil supply contract ("Crude
Supply Contract") with Lagoven, S.A. ("LAGOVEN"), an affiliate of CITGO. LCR is
required to purchase, and LAGOVEN is required to sell, sufficient crude oil to
satisfy LCR's coking capacity, or a minimum of 200,000 barrels per day and up to
230,000 barrels per day of very heavy Venezuelan crude oil. LAGOVEN has the
right, but not the obligation, to supply incremental amounts above 230,000
barrels per day. Depending on market conditions, breach or termination of the
Crude Supply Contract could adversely affect the Company through its investment
in LCR. Although the parties have negotiated alternative arrangements in the
event of certain force majeure conditions, including governmental or other
actions restricting or otherwise limiting LAGOVEN's ability to perform its
obligations, any such alternative arrangements may not be as beneficial as the
Crude Supply Contract. There can be no assurance that alternative crude oils
with similar margins would be available for purchase by LCR. Furthermore, the
breach or termination of the Crude Supply Contract would require LCR to return
to the practice of purchasing all of its crude oil feedstocks in the merchant
market and would again subject LCR to significant volatility and price
fluctuations.
In connection with the transfer of assets and liabilities from Atlantic
Richfield Company ("ARCO") to the Company, the Company agreed to assume certain
liabilities arising out of the operation of the Company's integrated
petrochemicals and petroleum processing business prior to July 1, 1988. In
connection with the transfer of such liabilities, the Company and ARCO entered
into an agreement ("Cross-Indemnity Agreement") whereby the Company agreed to
defend and indemnify ARCO against certain uninsured claims and liabilities which
ARCO may incur relating to the operation of the business of the Company prior to
July 1, 1988, including certain liabilities which may arise out of pending and
future lawsuits.
ARCO indemnified the Company under the Cross-Indemnity Agreement with respect to
other claims or liabilities and other matters of litigation not related to the
assets or business included in the consolidated financial statements. ARCO has
also indemnified the Company for all federal taxes which might be assessed upon
audit of the operations
6
<PAGE>
of the Company included in the consolidated financial statements prior to
January 12, 1989, and for all state and local taxes for the period prior to July
1, 1988. Effective in September 1997, the Company and ARCO entered into an
amendment to the Cross-Indemnity Agreement ("Revised Cross-Indemnity
Agreement"). For current and future cases related to Company products and
Company operations, ARCO and the Company will bear a proportionate share of
judgment and settlement costs according to a formula which allocates
responsibility based on years of ownership during the relevant time period. The
party with the most significant potential liability exposure will be responsible
for case management and associated costs although provisions have been made to
allow the non-case managing party to protect its interests. Under the Revised
Cross-Indemnity Agreement, both ARCO and the Company waive any claim for
reimbursement under the existing Cross-Indemnity Agreement for any prior defense
and settlement costs associated with waste site matters, and the Company will
assume responsibility for its proportionate share of future costs for waste site
matters not covered by ARCO insurance. Subject to the uncertainty inherent in
all litigation, management believes the resolution of the matters pursuant to
the Revised Cross-Indemnity Agreement will not have a material adverse effect
upon the consolidated financial statements or liquidity of the Company.
In addition to lawsuits for which the Company has indemnified ARCO, the Company
is also subject to various lawsuits and proceedings. Subject to the uncertainty
inherent in all litigation, management believes the resolution of these
proceedings will not have a material adverse effect upon the consolidated
financial statements or liquidity of the Company.
The Company's policy is to be in compliance with all applicable environmental
laws. The Company is subject to extensive environmental laws and regulations
concerning emissions to the air, discharges to surface and subsurface waters and
the generation, handling, storage, transportation, treatment and disposal of
waste materials. Some of these laws and regulations are subject to varying and
conflicting interpretations. In addition, the Company cannot accurately predict
future developments, such as increasingly strict requirements of environmental
laws, inspection and enforcement policies and compliance costs therefrom which
might affect the handling, manufacture, use, emission or disposal of products,
other materials or hazardous and non-hazardous waste.
Subject to the terms of the Cross-Indemnity Agreement, the Company is currently
contributing funds to the cleanup of one waste site (Brio, located near Houston,
Texas) under the Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA") as amended and the Superfund Amendments and
Reauthorization Act of 1986. The Company is also subject to certain assessment
and remedial actions at the Refinery under the Resource Conservation and
Recovery Act ("RCRA"). In addition, the Company has negotiated an order with
the Texas Natural Resource Conservation Commission ("TNRCC") for assessment and
remediation of groundwater and soil contamination at the Refinery.
During July 1994, the Company reported results of an independent investigation
conducted by the Audit Committee of the Board of Directors regarding the
compliance status of two process waste-water streams under the applicable
Benzene National Emissions Standard for Hazardous Air Pollutants ("NESHAPS")
regulations and certain issues raised by an employee. Noncompliance with the
Benzene NESHAPS regulations and the related reporting requirements can result in
civil penalties and, under certain circumstances, substantial civil and,
potentially, criminal penalties. The Company received a notice of violation
from the TNRCC regarding the two streams and paid a fine of $10,200. In
addition, the Company incurred approximately $2 million in capital costs in
connection with these waste-water streams to achieve ongoing compliance with the
Benzene NESHAPS regulations. Although the Criminal Enforcement Division of the
EPA is conducting a formal investigation, the Company does not believe any
aspects of the matters described above will subject the Company to criminal
liability or have a material adverse effect on the consolidated financial
statements or liquidity of the Company.
As of September 30, 1997 the Company has accrued $13 million related to future
CERCLA, RCRA and TNRCC assessment and remediation costs, of which $3 million is
included in current liabilities while the remaining amounts are expected to be
incurred over the next two to seven years. In the opinion of management, there
is currently no material range of loss in excess of the amount recorded.
However, it is possible that new information about the sites for which the
reserve has been established, new technology or future developments such as
involvement in other
7
<PAGE>
CERCLA, RCRA, TNRCC or other comparable state law investigations, could require
the Company to reassess its potential exposure related to environmental matters.
In the opinion of management, any liability arising from the matters discussed
in this Note is not expected to have a material adverse effect on the
consolidated financial statements or liquidity of the Company. 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 the Company'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.
7. STOCKHOLDERS' EQUITY
Dividends - The Company paid regular quarterly dividends of $.225 per share of
common stock during the first three quarters of 1997. Additionally, on October
24, 1997, the Board of Directors declared a regular quarterly dividend of $.225
per share of common stock, payable December 15, 1997 to stockholders of record
on November 25, 1997.
Earnings per Share - Earnings per share for all periods presented are computed
based on the weighted average number of shares outstanding for the periods,
which was 79,973,792 shares and 79,991,168 shares for the three and nine months
ended September 30, 1997, respectively, and 80,000,000 shares for the 1996
periods.
Treasury Stock - Treasury stock is acquired under a resolution the Board of
Directors adopted in September 1997 authorizing the Company to purchase from
time to time shares of the Company's common stock not to exceed $75 million in
the aggregate. The Company purchased 563,512 shares through September 30, 1997
for approximately $14 million.
8. EQUISTAR CHEMICALS, LP
On July 28, 1997, the Company and Millennium Chemicals Inc. ("Millennium")
announced an agreement to form a new joint venture company named Equistar
Chemicals, LP ("Equistar"), which will be operated as a limited partnership.
Equistar will be owned 57 percent by the Company and 43 percent by Millennium
and will own and operate the existing petrochemicals and polymers businesses to
be contributed by the two companies. Not included in Equistar are Lyondell's
approximately 59 percent interest in LCR and its 75 percent interest in Lyondell
Methanol. Equistar will assume primary responsibility for $745 million of
existing Lyondell debt. Lyondell also will remain liable on this debt. In
addition, Lyondell will provide a $345 million note payable within three years
to Equistar. The transaction, which has been unanimously approved by the Boards
of Directors of both companies, is subject to approval by both companies'
stockholders and satisfaction of certain other conditions. Stockholder meetings
for both parties will be held on November 20, 1997. Equistar is expected to
commence operations on December 1, 1997. After closing, Lyondell will begin
accounting for its investment in the venture under the equity method of
accounting, similar to the accounting for its investment in LCR. Lyondell will
record a charge to expense of approximately $35 million in the fourth quarter of
1997 as a result of severance and other costs related to the transfer of its
assets to Equistar.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
In 1996, Lyondell Petrochemical Company ("Company" or "Lyondell") operated in
two segments: the petrochemicals segment, which included the results of
operations of the Company's petrochemicals and polymers business, and the
refining segment. Beginning in 1997, the petrochemicals segment was split into
the petrochemicals and polymers segments. The petrochemicals segment consists
of olefins including ethylene, propylene, butadiene, butylenes and specialty
products; aromatics produced at the Channelview, Texas petrochemicals facility
("Channelview Facility") including benzene and toluene; methanol; methyl
tertiary butyl ether ("MTBE"); and refinery blending stocks. In December 1996,
the Company sold an undivided interest in its methanol facility to MCN
Investment Corporation ("MCNIC") and created Lyondell Methanol Company L.P.
("Lyondell Methanol"), a partnership with the minority owner, to own and operate
the methanol facility.
The polymers segment consists of polyolefins including high-density polyethylene
("HDPE"), low-density polyethylene and polypropylene produced at production
facilities in Matagorda ("Matagorda Facility") and Victoria ("Victoria
Facility"), Texas and the Bayport facility in Pasadena, Texas ("Bayport
Facility").
The Company's operations in the refining segment are conducted through its
interest in LYONDELL-CITGO Refining Company Ltd. ("LCR"), a Texas limited
liability company owned by subsidiaries of the Company and CITGO Petroleum
Corporation ("CITGO"). The refining segment consists of refined petroleum
products, including gasoline, low sulfur diesel, and jet fuel; aromatics
produced at LCR's Houston, Texas refinery ("Refinery"), including benzene,
toluene, paraxylene and orthoxylene; lubricants, including industrial
lubricants, motor oils, white oils and process oils; carbon black oil; sulfur;
residual oil; petroleum coke fuel; olefins feedstocks; and crude oil resales.
LCR completed a major upgrade project at the Refinery ("Upgrade Project") during
the first quarter of 1997 to enable the facility to process substantial
additional volumes of very heavy crude oil.
The following table sets forth sales volumes for the Company's major products
for the periods indicated. Sales volumes, including intersegment sales, include
production, purchases of products for resale, propylene production from the
product flexibility unit, products received on exchange and draws from
inventory. Refined products volumes include all activity at LCR.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------------- ---------------------------------
1997 1996 1997 1996
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
SELECTED PETROCHEMICAL PRODUCTS (MILLIONS)
Ethylene, propylene and other olefins (lbs.) 2,307 1,937 6,567 5,948
Methanol (gallons) 57 54 178 163
Aromatics (gallons) 53 45 143 141
POLYMERS PRODUCTS (MILLIONS)
Polyethylene and polypropylene (lbs.) 561 526 1,615 1,609
REFINED PRODUCTS (THOUSAND BARRELS PER DAY)
Gasoline 101 100 105 107
Diesel and heating oil 58 48 63 47
Jet fuel 16 23 15 25
Aromatics 12 9 11 9
Other refined products 94 73 88 77
-------------- -------------- -------------- --------------
Total refined products volumes 281 253 282 265
============== ============== ============== ==============
</TABLE>
9
<PAGE>
Summarized below is the segment data for the Company. Intersegment sales from
the petrochemicals segment to the polymers segment include ethylene and
propylene produced at the Channelview Facility. Intersegment sales between the
petrochemicals and refining segments in 1996 include olefins feedstocks and
benzene produced at the Refinery and gasoline blending stocks and hydrogen
produced at the Channelview Facility. Intersegment sales were made at prices
based on current market values.
Effective January 1, 1997, Lyondell began accounting for its investment in LCR
under the equity method of accounting, meaning that the operations of LCR are no
longer consolidated line by line with those of Lyondell. In 1997, Lyondell's
portion of LCR's net earnings is included in the consolidated statements of
income as income (loss) from equity investment and Lyondell's portion of LCR's
net assets appears on a single line in the consolidated balance sheets as
investment in affiliate. Cash advances to and distributions from LCR in excess
of earnings are reflected as individual line items in the consolidated
statements of cash flows. Therefore, the results of operations of the refining
segment, which consists primarily of the Company's interest in LCR, do not
appear line by line in the tables below for 1997.
The following unaudited pro forma financial information presents the results of
operations of the Company for the periods ended September 30, 1996 using the
equity method of accounting for Lyondell's investment in LCR as if the change in
accounting method had been effective January 1, 1996. The unaudited pro forma
financial information also includes restatements to split the petrochemicals
segment into the petrochemicals and polymers segments. This unaudited pro forma
information may not be indicative of results that will be obtained in the
future. The narrative discussion which follows compares 1997 operating results
to the pro forma financial information for the comparable periods in 1996 as
comparisons to historical 1996 operating results are not considered meaningful.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
----------------------------------------- ------------------------------------
PRO AS PRO AS
FORMA REPORTED FORMA REPORTED
MILLIONS OF DOLLARS 1997 1996 1996 1997 1996 1996
- ------------------- ---- ----- -------- ---- ----- --------
<S> <C> <C> <C> <C> <C> <C>
SALES AND OTHER OPERATING REVENUES:
Petrochemicals segment $ 707 $ 582 $ 681 $2,054 $1,611 $1,873
Polymers segment 216 216 - - 637 570 - -
Refining segment - - - - 650 - - - - 2,046
Intersegment sales (124) (116) (84) (348) (307) (268)
----- ----- ------ ------ ------ ------
$ 799 $ 682 $1,247 $2,343 $1,874 $3,651
===== ===== ====== ====== ====== ======
COST OF SALES:
Petrochemicals segment $ 551 $ 519 $ 559 $1,662 $1,463 $1,595
Polymers segment 168 157 - - 503 443 - -
Refining segment - - - - 644 - - - - 1,973
Intersegment purchases (124) (116) (84) (348) (307) (268)
----- ----- ------ ------ ------ ------
$ 595 $ 560 $1,119 $1,817 $1,599 $3,300
===== ===== ====== ====== ====== ======
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Petrochemicals segment $ 7 $ 9 $ 28 $ 23 $ 25 $ 83
Polymers segment 20 19 - - 60 58 - -
Refining segment - - - - 15 - - - - 48
Unallocated 24 14 14 65 44 43
----- ----- ------ ------ ------ ------
$ 51 $ 42 $ 57 $ 148 $ 127 $ 174
===== ===== ====== ====== ====== ======
OPERATING INCOME:
Petrochemicals segment $ 149 $ 54 $ 94 $ 369 $ 123 $ 195
Polymers segment 28 40 - - 74 69 - -
Refining segment - - - - (9) - - - - 25
Unallocated (24) (14) (14) (65) (44) (43)
----- ----- ------ ------ ------ ------
$ 153 $ 80 $ 71 $ 378 $ 148 $ 177
===== ===== ====== ====== ====== ======
INCOME (LOSS) FROM EQUITY INVESTMENT:
Refining segment $ 29 $ (8) $ - - $ 56 $ 25 $ - -
===== ===== ====== ====== ====== ======
</TABLE>
10
<PAGE>
Summarized below are reported intersegment sales for Lyondell's segments.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------------------- ---------------------------------------
PRO AS PRO AS
FORMA REPORTED FORMA REPORTED
MILLIONS OF DOLLARS 1997 1996 1996 1997 1996 1996
- ------------------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Petrochemicals segment to polymers segment $ 124 $ 116 $ 348 $ 307
Petrochemicals segment to refining segment - - - - $ 53 - - - - $ 154
Refining segment to petrochemicals segment - - - - 31 - - - - 114
----------- ----------- ----------- ----------- ----------- -----------
$ 124 $ 116 $ 84 $ 348 $ 307 $ 268
=========== =========== =========== =========== =========== ===========
</TABLE>
RESULTS OF OPERATIONS
OVERVIEW
Net income for the third quarter of 1997 was $102 million or $1.27 per share
compared to net income of $35 million or $.43 per share for the third quarter of
1996. The $67 million increase was primarily due to improved margins for
olefins as a result of lower feedstock costs as well as higher sales volumes.
Income from equity investment in LCR substantially improved as higher volumes of
very heavy crude oil, which carry higher margins, were processed by LCR in 1997.
In addition, the methanol business had improved margins in 1997 due to higher
industry sales prices.
Net income for the first nine months of 1997 was $235 million or $2.94 per share
compared to net income of $74 million or $.92 per share for the first nine
months of 1996. The $161 million increase was primarily due to improved margins
for olefins and polymers as a result of higher sales prices. Improved
performance at LCR as a result of processing higher volumes of very heavy crude
oil and higher olefins sales volumes also contributed to the increase. In
addition, methanol performance improved as a result of higher sales margins
generated by higher industry sales prices, as well as increased sales volumes
due to seasonal demand from downstream products in the gasoline and housing end-
use markets.
Net income was $9 million higher for the third quarter of 1997 compared to the
second quarter of 1997. The increase in net income was primarily due to
improved margins for LCR from the higher volumes of very heavy crude oil which
were processed and higher olefins sales volumes.
PETROCHEMICALS SEGMENT
SELECTED PRICING INFORMATION The following graphs present industry pricing
information for the periods shown below.
Chart 1 - Month-end average delivered-contract, monthly low price agreement
prices for Ethylene as reported by CMAI Monomers Market Report from
January 1996 through September 1997. Chart indicates increasing prices
in 1996 with an annual average of the month-end prices of 23.33 cents
per pound. In 1997, prices rose slightly in February where they
remained steady from February through May before returning to the
levels seen in January for June through September. The nine month
average of the month-end prices in 1997 was 27.69 cents per pound, up
5 cents per pound from the same period in 1996. Selected month-end
average prices are as follows: January 1996 - 19.75 cents per pound,
September 1996 - 25.75 cents per pound, January 1997 - 27.25 cents per
pound, September 1997 - 27.25 cents per pound.
Chart 2 - Month-end average spot price WTS low prices for Crude Oil as reported
by Platts Oilgram Price Report from January 1996 through September
1997. Chart indicates increasing prices for 1996 with the chart's
peak occurring at $24.32 per barrel in December 1996. Prices decrease
in 1997 through April, rise in May, fall again in June, and remain
flat through September. Both 1996 and 1997 saw volatile prices.
Selected month-end average prices are as follows: January 1996 -
$18.39 per barrel, September 1996 - $23.21 per barrel, January 1997 -
$23.90 per barrel, September 1997 - $18.95 per barrel.
OPERATING INCOME Operating income for the third quarter of 1997 increased $95
million compared to the third quarter of 1996. This increase was primarily due
to improved margins for olefins as a result of lower feedstock costs and
increased olefins sales volumes. In addition, methanol performance improved as
a result of higher sales margins generated by higher industry sales prices and
increased sales volumes.
11
<PAGE>
Operating income for the first nine months of 1997 was $369 million compared to
$123 million for the same period in 1996. This increase in operating income in
1997 was primarily due to improved margins for olefins as a result of increased
olefins sales prices resulting from strong demand from the polyolefins markets.
Methanol performance improved as a result of higher sales margins generated by
higher industry sales prices, as well as increased sales volumes due to seasonal
demand from downstream products in the gasoline and housing end-use markets.
Operating income for the third quarter of 1997 increased $12 million over the
second quarter of 1997 primarily due to higher sales volumes for olefins as
demand remained strong through the third quarter of 1997.
Lyondell's olefins feedstocks are primarily condensates and other petroleum
liquids which tend to follow the cost trends of crude oil. During 1996 the
price of crude oil increased steadily which resulted in higher feedstock costs
for the petrochemicals business, however, crude oil prices began dropping in
1997 and have remained below 1996 prices through the third quarter of 1997. The
sales prices for various olefins products are primarily driven by two factors.
The first factor is the demand for ethylene, propylene and other by-products as
a result of economic conditions in end-use markets for these commodities such as
the auto industry, housing construction and consumer durable and non-durable
goods. The second factor driving sales prices is the underlying cost of the
feedstock. Strong demand was the primary factor which has driven 1997 prices
for these products above 1996 levels.
Methanol is a component of products used by the housing and plastic packaging
industry, as well as being a primary component of MTBE, a product used to blend
low-emission reformulated gasoline. Methanol prices gradually increased
throughout 1996 due to strong demand by the end-use markets and supply
constraints due to industry operating problems and have remained at a steady
level above 1996 prices through the third quarter of 1997. The price of natural
gas, the principal methanol feedstock, increased throughout 1996 and into
January 1997 as a result of the tight supply and demand balance in the fuels
market. Natural gas prices were higher in the third quarter of 1997 compared to
the second quarter of 1997 due to increased seasonal demand entering the winter
months.
REVENUES Sales and other operating revenues, including intersegment sales, were
$707 million in the third quarter of 1997 compared to $582 million in the third
quarter of 1996, an increase of $125 million. This increase is due to higher
by-product sales prices. In addition, olefins sales volumes were at record
levels, and were improved compared to the third quarter of 1996 which was
negatively impacted by the ARCO PipeLine fire at the Channelview Facility that
forced a shut down of the olefins units for approximately two weeks and other
units for several days.
Sales and other operating revenues for the first nine months of 1997 increased
$443 million over the first nine months of 1996. This increase was primarily
due to increased olefins sales prices, which showed significant improvement over
the first nine months of 1996 as strong demand from the polyolefins markets
resulted in a tighter balance of supply and demand for olefins, and also as cost
increases for olefins feedstocks over the course of 1996 were reflected in
olefins product prices in 1997. In addition, olefins sales volumes, primarily
for propylene, increased due to strong demand in the downstream markets. Sales
prices for methanol increased in 1997 due to a tighter supply and demand
situation caused by unscheduled industry downtime. Methanol sales volumes
increased in the first nine months of 1997 in response to higher demand
generated for downstream products by the gasoline end-use markets and the
housing and plastic packaging industries.
COST OF SALES Cost of sales was $551 million in the third quarter of 1997
compared to $519 million in the third quarter of 1996, an increase of $32
million. Cost of sales increased $199 million when comparing the first nine
months of 1997 to the same period in 1996. These increases were primarily due
to increased sales volumes of olefins and methanol. Olefins feedstock costs
fluctuated during the two nine month periods, however, crude oil prices on
average were slightly lower for the first nine months of 1997 compared to 1996.
Olefins feedstock costs dropped significantly from the first quarter of 1997 to
the middle of the third quarter of 1997 due to declining prices for crude oil,
which impact olefins feedstock costs, but began to increase in the latter part
of the third quarter of 1997. Natural gas feedstock costs for methanol were
higher due to seasonal winter fuel demand, which was stronger in the first nine
months of 1997 compared to the same period in 1996.
12
<PAGE>
SELLING EXPENSES Selling expenses were $2 million lower in the third quarter of
1997 compared to the third quarter of 1996 and $2 million lower when comparing
the first nine months of 1997 and 1996. Selling expenses for the petrochemicals
segment consist primarily of terminal expenses related to storage and
distribution of finished goods and rail freight costs of finished product. The
decreases were primarily due to increased freight reimbursements on exchanges
and lower distribution expense.
POLYMERS SEGMENT
OPERATING INCOME Operating income for the third quarter of 1997 was $28 million
compared to $40 million in the third quarter of 1996. The $12 million decrease
was primarily due to lower polymers sales margins due to decreases in polymers
sales prices as a result of industry oversupply conditions despite strong
demand, especially in polypropylene.
Operating income for the first nine months of 1997 compared to the first nine
months of 1996 increased $5 million. This increase was primarily due to higher
polymers sales margins as a result of increases in polymers sales prices offset
by lower sales volumes and higher feedstock costs. Industry sales price
increases became effective towards the end of the first quarter of 1997, but
dropped in the third quarter of 1997. Sales volumes were lower due to lower
production levels at the Matagorda Facility as a result of the planned
turnaround completed in March 1997. Feedstock costs were higher during the
first nine months of 1997 as compared to the same period in 1996 due to tighter
supply and demand in the olefins markets.
Operating income for the third quarter of 1997 declined by $2 million over the
second quarter of 1997 due to sales price decreases that became effective during
the third quarter of 1997 offset by increased sales volumes, particularly of
HDPE, and product mix.
Lyondell's polymers feedstocks are primarily ethylene and propylene. During
1996 and 1997 the industry sales price of ethylene has increased steadily which
resulted in higher feedstock costs for the polymers business. The sales prices
for various polymers products are primarily driven by two factors. One is the
supply and demand balance for the products as a result of economic conditions in
end-use markets such as the auto industry, housing construction and consumer
durable and non-durable goods. Secondarily, sales prices are driven by the
underlying cost of the feedstock.
REVENUES Sales and other operating revenues were $216 million in the third
quarter of 1997 as well as the third quarter of 1996. The increased sales
volumes as a result of increased production capacity due to the planned
turnaround at the Matagorda Facility completed in March 1997 was offset by lower
sales prices, particularly polypropylene. Sales and other operating revenues
for the first nine months of 1997 compared to the first nine months of 1996
increased $67 million. This increase was primarily due to higher polymers sales
prices, which were partially offset by decreased volumes as a result of the
planned turnaround at the Matagorda Facility.
COST OF SALES Cost of sales was $168 million in the third quarter of 1997
compared to $157 million in the third quarter of 1996, an increase of $11
million. Cost of sales for the first nine months of 1997 compared to the first
nine months of 1996 increased $60 million. These increases were primarily due
to increased feedstock costs caused by tight supply and demand in the olefins
markets.
SELLING EXPENSES Selling expenses were relatively flat in the third quarter of
1997 compared to the third quarter of 1996 and when comparing the first nine
months of 1997 and 1996. For the polymers business, the cost of transporting
finished products to customers by rail, including rail freight costs and rail
car lease expense, is classified as selling expense.
REFINING SEGMENT
GENERAL At its inception, LCR entered into a long-term crude oil supply
contract ("Crude Supply Contract") with Lagoven, S.A. ("LAGOVEN"), an affiliate
of CITGO. LCR is required to purchase, and LAGOVEN is required to sell,
sufficient crude oil to satisfy LCR's coking capacity, or a minimum of 200,000
barrels per day and up to 230,000
13
<PAGE>
barrels per day of very heavy Venezuelan crude oil. LAGOVEN has the right, but
not the obligation, to supply incremental amounts above 230,000 barrels per day.
In addition, under terms of a long-term product sales agreement ("Products
Agreement"), CITGO purchases substantially all of the refined products produced
at the Refinery. Both LAGOVEN and CITGO are direct or indirect wholly-owned
subsidiaries of Petroleos de Venezuela, S.A., the national oil company of
Venezuela.
The Upgrade Project was completed one month ahead of schedule in the first
quarter of 1997. The completion enabled LCR to begin to take full benefit of
the Crude Supply Contract in March 1997 and process increasing volumes of very
heavy crude oil. The following table sets forth processing rates at the
Refinery for the periods indicated. Refinery runs for the 1996 periods
presented are primarily heavy crude oil (API 22), whereas the 1997 refinery runs
reflect higher volumes of very heavy crude oil (API 17) processed.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
----------------------------------- ------------------------------------
1997 1996 1997 1996
--------------- --------------- --------------- ----------------
<S> <C> <C> <C> <C>
REFINERY RUNS (THOUSAND BARRELS PER DAY)
Blended crude oil:
Crude Supply Contract - coked 213 117 183 119
Other crude oil - coked - - 4 16 4
Other crude oil 4 87 15 104
--------------- --------------- --------------- ----------------
Total blended crude oil 217 208 214 227
Unfinished stock 66 47 66 42
--------------- --------------- --------------- ----------------
Total 283 255 280 269
=============== =============== =============== ================
</TABLE>
INCOME FROM EQUITY INVESTMENT IN LYONDELL-CITGO REFINING COMPANY LTD. As a
result of the completion of the Upgrade Project, the Company's participation
interest changed to approximately 59 percent for the second and third quarters
of 1997 from approximately 86 percent for the first quarter of 1997. This
compares to approximately 87 percent for the first three quarters of 1996. The
income from equity investment in LCR represents the Company's share of the
results of LCR's operations for the periods presented. Net income before
depreciation expense for the period is allocated to LCR's owners based on
participation interests. Depreciation expense is allocated to the owners based
on contributed assets. Had the Company followed the equity method of accounting
for its investment in LCR during 1996, the Company would have recorded a pro
forma equity loss of $8 million and pro forma equity income of $25 million for
the three months and nine months ended September 30, 1996, respectively.
In comparing the third quarter of 1997 to the third quarter of 1996, the
increase in income from equity investment in LCR is due to increased operating
income of $64 million offset by higher interest expense and Lyondell's decreased
participation percentage. The change in operating income reflects higher margins
on increased volumes of very heavy crude oil coked under the Crude Supply
Contract, offset by increased production costs.
Upon the completion of the Upgrade Project, LCR began processing increased
volumes of very heavy crude oil, which is purchased at a lower cost under the
Crude Supply Contract resulting in higher margins. Operational problems
experienced in late June 1997 with the new crude unit, as well as the fluid
catalytic cracking unit, were related in part to the startup of the new units.
These problems resulted in reduced crude processing rates for most of July 1997.
Crude processing rates returned to normal levels for the remainder of the third
quarter of 1997. Processing very heavy crude oil resulted in higher margins for
the third quarter of 1997 despite lower revenues and higher production costs.
Total revenues for the third quarter of 1997 compared to the third quarter of
1996 were down for LCR as a result of lower refined products pricing.
Production costs were higher in the third quarter of 1997 versus the same period
in 1996 due to higher depreciation expense associated with the Upgrade Project,
higher personnel compensation primarily related to salary increases and
incentive compensation, and higher maintenance costs associated with the
operating problems experienced near the end of June 1997. LCR incurred $11
million of interest cost in the third quarter of 1997, all of which was
expensed.
14
<PAGE>
Income from equity investment in LCR for the first nine months of 1997 compared
to the same period in 1996 increased $31 million primarily due to LCR's
improved operating income offset by higher interest expense as described above.
LCR's operating income improved in the first nine months of 1997 compared to
1996 due to improved margins caused primarily by higher volumes of very heavy
crude oil coked under the Crude Supply Contract. These improved margins were
offset partially by higher production costs, primarily depreciation expense, and
lower paraxylene margins.
Comparing the third quarter of 1997 to the second quarter of 1997, income from
equity investment in LCR increased $14 million, excluding a $6 million non-
recurring re-allocation of depreciation expense between the owners recorded in
the second quarter of 1997, due to increased operating income of $24 million.
The increase in operating income was caused primarily by higher volumes of very
heavy crude oil coked in the third quarter of 1997 as compared to the second
quarter of 1997 when the new crude unit, as well as the fluid catalytic cracking
unit, experienced operational problems. These problems, which were related in
part to the startup of the new units, resulted in reduced crude processing rates
that continued through most of July 1997.
UNALLOCATED
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and
administrative expenses were $10 million higher comparing the third quarter of
1997 to the third quarter of 1996 and $21 million higher for the first nine
months of 1997 compared to the same period for 1996. These increases were
primarily due to higher employee compensation costs. Additionally, computer and
telecommunications costs and related amortization increased as a result of the
implementation of new software and other upgrades in 1997. Expenses for the
first nine months of 1997 also increased due to higher non-recurring executive
compensation in the first quarter of 1997.
INTEREST EXPENSE Interest expense was flat comparing the third quarter and
first nine months of 1997 to the same periods in 1996 due to lower levels of
long-term debt outstanding offset by less interest capitalized and higher levels
of short-term borrowings in 1997. Interest expense in the third quarter of 1997
decreased from the second quarter of 1997 as overall short-term borrowing levels
were lower in the third quarter of 1997.
INTEREST INCOME Interest income increased in the third quarter and the first
nine months of 1997 as compared to the same periods in 1996 as more interest
income was earned on loans to LCR. Interest income was $1 million higher
comparing the third quarter of 1997 to the second quarter of 1997 due to
increased loans to LCR.
MINORITY INTEREST Minority interest was $5 million and $13 million for the
third quarter and first nine months of 1997, respectively. This represents the
allocated share of Lyondell Methanol net income to MCNIC, the minority owner of
Lyondell Methanol. Minority interest of $1 million and $(3) million as reported
for the third quarter and first nine months of 1996, respectively, represents
CITGO's allocated share of LCR's net loss or income for the periods,
respectively.
INCOME TAXES The effective income tax rates for the third quarter of 1997 and
during the first nine months of 1997 were 36.9 percent and 36.6 percent,
respectively. The effective income tax rates for the same periods in 1996 were
35.8 percent and 36.1 percent, respectively. State income tax was the primary
difference between the effective tax rates and the 35 percent federal statutory
rate.
FINANCIAL CONDITION
Operating Activities - Lyondell's cash provided by operating activities was $278
million for the first nine months of 1997 compared to $51 million for the first
nine months of 1996. Net income in the first nine months of 1997 compared to
the same period in 1996 increased by $161 million resulting in increased cash
flow.
Investing Activities - Cash used in investing activities during the first nine
months of 1997 included capital expenditures of $39 million for projects at the
various petrochemical facilities. In 1997 the Company loaned LCR $53 million
for the Upgrade Project and working capital needs and made other equity
contributions to LCR totaling
15
<PAGE>
$1 million. In 1996 the Company loaned LCR $113 million for the Upgrade Project
and environmental and other capital expenditures and made other equity
contributions to LCR totaling $8 million for capital expenditures. LCR
distributed cash in excess of earnings of $18 million to the Company during the
first nine months of 1997 and $42 million during the same period in 1996.
Financing Activities - Cash used in financing activities in 1997 consisted
primarily of the retirement of $112 million of long-term debt. Distributions to
MCNIC, the minority owner of Lyondell Methanol, totaled $12 million for the
first nine months of 1997.
The Board of Directors authorized a $75 million stock repurchase program in
September 1997. The Company purchased 563,512 shares of common stock for
approximately $14 million in September 1997.
The Company paid regular quarterly dividends of $.225 per share of common stock
during the first three quarters of 1997. Additionally, on October 24, 1997, the
Board of Directors declared a regular quarterly dividend of $.225 per share of
common stock, payable December 15, 1997 to stockholders of record on November
25, 1997.
In August 1994, Atlantic Richfield Company ("ARCO") completed an offering of
three-year debt securities ("Exchangeable Notes") which were exchangeable upon
maturity on September 15, 1997 into Lyondell common stock or an equivalent cash
value, at ARCO's option. On September 15, 1997, ARCO delivered shares of
Lyondell common stock to the holders of the Exchangeable Notes. The Company
purchased the remaining 383,312 shares of common stock held by ARCO after the
conversion at a price of $25.66 per share. As of September 30, 1997, ARCO owns
no shares of common stock of Lyondell.
CURRENT BUSINESS OUTLOOK
On July 28, 1997, the Company and Millennium Chemicals Inc. ("Millennium")
announced an agreement to form a new joint venture, which will be operated as a
partnership. The partnership, Equistar Chemicals, LP ("Equistar"), will be
owned 57 percent by the Company and 43 percent by Millennium and will own and
operate the existing petrochemicals and polymers businesses to be contributed by
the two companies. The transaction, which has been unanimously approved by the
Boards of Directors of both companies, is subject to approval by both companies'
stockholders and satisfaction of certain other conditions. Equistar is expected
to commence operations on December 1, 1997. Lyondell will record a charge to
expense of approximately $35 million in the fourth quarter of 1997 as a result
of severance and other costs related to the transfer of its assets to Equistar.
During the remainder of 1997, management expects that olefins supply and demand
fundamentals will be weakening versus the conditions that prevailed in the first
nine months of 1997. Additional industry capacity is anticipated to start up in
the fourth quarter of 1997 and fewer industry turnarounds are scheduled, which
may negatively impact pricing of olefins near year-end and into 1998. However,
unplanned industry outages may offset somewhat increased supply and mitigate the
pricing effect. Although olefins profitability would be negatively impacted if
feedstock costs increase, these cost levels have been lower during the fourth
quarter of 1997 than was experienced earlier in the year.
Domestic polymers demand was strong for the first half of 1997, although growth
in 1997 has been weak relative to a strong 1996 growth rate due to higher sales
prices and export demand that is significantly below levels experienced in the
same period in 1996. Additional industry capacity added in the second half of
1997 may negatively impact prices and margins into 1998.
More than 90 percent of LCR's crude oil purchases are made pursuant to the Crude
Supply Contract which significantly reduces the crude oil volume which is
sensitive to market conditions. Following completion of the Upgrade Project, the
benefits of the Crude Supply Contract have resulted in increased profitability
and cash flow to the Company. Since late July 1997, when temporary fluid
catalytic cracking unit operating problems were resolved, throughput rates have
been consistent and strong. These good operating results are expected to
continue to be strong for the remainder of the year and into 1998.
16
<PAGE>
Methanol demand should remain strong through the fourth quarter of 1997.
Additionally, supply should remain tight due to industry operating problems and
delayed plant startups. New industry capacity expected to be added in the
fourth quarter of 1997 is expected to lead to price pressures that could
continue into 1998. Natural gas feedstock prices dropped late in the first
quarter of 1997 but strengthened again during the second and third quarters of
1997. Margins were reduced beginning late in the third quarter of 1997 and
management expects this to continue into 1998.
Profitability and cash flows for the petrochemicals, polymers and refining
businesses are affected by industry supply and demand, feedstock cost
volatility, capital expenditures required to meet more stringent environmental
standards, repair and maintenance costs and downtime of production units due to
maintenance turnarounds. Turnarounds on major units can have significant
financial impacts due to the associated loss of production, resulting in lower
profitability.
Management believes business conditions will be such that cash balances, cash
generated from operating activities and existing lines of credit will be
adequate to meet future cash requirements for scheduled debt repayments,
necessary capital expenditures and to sustain for the reasonably foreseeable
future the regular quarterly dividend. Management anticipates, in general,
increased cash flow from its businesses because of the creation of Equistar and
the LCR venture, which should provide greater financial flexibility to the
Company. Management intends to accelerate cash flow from its investment in LCR
as a result of LCR replacing its current construction financing with longer-term
financing and distributing excess funds to the owners of LCR. Management
intends that cash flow in excess of the amounts needed to fund operations,
capital projects, debt repayments (including the $345 million note payable to
Equistar), and maintain an appropriate capital structure, would be used for
attractive investment opportunities which meet the Company's value creation
criteria or to enhance stockholder value through stock repurchases, increased
dividends or some combination thereof.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained in this report, including those regarding
the Current Business Outlook, 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. The
Company'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 refining and petrochemical industries, uncertainties
associated with the United States and worldwide economies, current and potential
United States governmental regulatory actions, substantial petrochemical
capacity additions resulting in oversupply and declining prices and margins, and
operating interruptions (including leaks, explosions, fires, mechanical failure,
unscheduled downtime, transportation interruptions, and spills and releases and
other environmental risks). Many of such factors are beyond Lyondell's ability
to control or predict. Management cautions against putting undue reliance on
forward-looking statements or projecting any future results based on such
statements or present or prior earnings levels. In addition, the ultimate
benefit from the Equistar transaction will be dependent upon management's
ability to close the transaction in a timely manner, integrate the contributed
businesses and implement Equistar's business plan.
All subsequent written and oral forward-looking statements attributable to the
Company and persons acting on its behalf are qualified in their entirety by the
cautionary statements contained in this section and elsewhere in this report.
17
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
1. There have been no material developments with respect to the Company's
legal proceedings previously reported in the 1996 Annual Report on Form
10-K or subsequent Quarterly Reports on Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule.
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed during the
quarter ended September 30, 1997 and through the date hereof.
Date of Report Item No. Financial Statements
-------------- -------- --------------------
July 28, 1997 5 None
August 14, 1997 5, 7 None
October 17, 1997 7 None
18
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Lyondell Petrochemical Company
Dated: November 12, 1997 /s/ JOSEPH M. PUTZ
------------------------------
Joseph M. Putz
Vice President and Controller
(Duly Authorized Officer and
Principal Accounting Officer)
19
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