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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ____________
Commission file number: 1-12091
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MILLENNIUM CHEMICALS INC.
(Exact name of registrant as specified in its charter)
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Delaware 22-3436215
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
20 Wight Avenue, Suite 100
Hunt Valley, MD 21030
(Address of principal executive offices)
410-229-4400
(Registrant's telephone number, including area code)
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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 is required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ].
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 65,628,680 shares
of Common Stock, par value $.01 per share, as of October 31, 2004, excluding
12,267,906 shares held by the registrant, its subsidiaries and certain Company
trusts that are not entitled to vote.
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MILLENNIUM CHEMICALS INC.
TABLE OF CONTENTS
Page
----
Part I FINANCIAL INFORMATION
Item 1 Financial Statements.............................................................. 3
Item 2 Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................... 28
Item 3 Quantitative and Qualitative Disclosures about Market Risk........................ 44
Item 4 Controls and Procedures........................................................... 44
Part II OTHER INFORMATION
Item 1 Legal Proceedings................................................................. 47
Item 6 Exhibits and Reports on Form 8-K.................................................. 47
Signature................................................................................. 48
In this Quarterly Report on Form 10-Q (the "Quarterly Report"), the
terms "our", "we", and "the Company" refer to Millennium Chemicals Inc. and its
consolidated subsidiaries, except as the context otherwise requires.
Non-GAAP Financial Measures
Financial measures based on accounting principles generally accepted in
the United States of America ("GAAP") are commonly referred to as GAAP financial
measures. A non-GAAP financial measure is generally defined by the Securities
and Exchange Commission as one that purports to measure historical or future
financial performance, financial position, or cash flows, but excludes or
includes amounts that would not be so adjusted in the most comparable GAAP
measure. From time to time the Company discloses non-GAAP financial measures,
primarily EBITDA. EBITDA represents income from operations before interest,
taxes, depreciation and amortization, other income items, equity earnings, and
the cumulative effect of accounting changes. EBITDA is a key measure used by the
banking and investing communities in their evaluation of economic performance.
Accordingly, management believes that disclosure of EBITDA provides useful
information to investors because it is frequently cited by financial analysts in
evaluating companies' performance. EBITDA is not a measure of operating
performance computed in accordance with GAAP and should not be considered as a
substitute for GAAP measures. Additionally, these measures may not be comparable
to similarly named measures of other companies.
The Company also periodically reports adjusted net or operating income
(loss) or adjusted EBITDA, excluding designated items. Management believes that
excluding these items generally helps investors to compare operating performance
between two periods. Such adjusted data are not reported without an explanation
of the items that are excluded.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
MILLENNIUM CHEMICALS INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Millions, except share data)
September 30, December 31,
2004 2003
------------ ------------
ASSETS
Current assets
Cash and cash equivalents.................................................... $ 313 $ 209
Trade receivables, net....................................................... 342 277
Inventories.................................................................. 370 457
Other current assets......................................................... 71 65
------ ------
Total current assets....................................................... 1,096 1,008
Property, plant and equipment, net.............................................. 719 766
Investment in Equistar.......................................................... 475 469
Other assets.................................................................... 42 51
Goodwill........................................................................ 104 104
------ ------
Total assets............................................................... $2,436 $2,398
====== ======
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities
Current maturities of long-term debt......................................... $ 6 $ 6
Trade accounts payable....................................................... 268 236
Income taxes payable......................................................... 7 5
Accrued expenses and other liabilities....................................... 161 124
------ ------
Total current liabilities.................................................. 442 371
Long-term debt.................................................................. 1,401 1,461
Deferred income taxes........................................................... 276 272
Other liabilities............................................................... 314 325
------ ------
Total liabilities.......................................................... 2,433 2,429
------ ------
Commitments and contingencies (Note 13)
Minority interest............................................................... 30 27
Shareholders' deficit
Preferred stock (par value $.01 per share, authorized 25,000,000 shares;
none issued and outstanding)............................................... -- --
Common stock (par value $.01 per share, authorized 225,000,000 shares;
issued 77,896,586 shares at September 30, 2004 and December 31, 2003)...... 1 1
Paid in capital.............................................................. 1,286 1,292
Accumulated deficit.......................................................... (951) (962)
Accumulated other comprehensive loss......................................... (139) (141)
Treasury stock, at cost (12,321,355 and 13,905,687 shares at
September 30, 2004 and December 31, 2003, respectively).................... (230) (260)
Unearned restricted shares................................................... (1) (1)
Deferred compensation........................................................ 7 13
------ ------
Total shareholders' deficit................................................ (27) (58)
------ ------
Total liabilities and shareholders' deficit.............................. $2,436 $2,398
====== ======
See Notes to Consolidated Financial Statements (Unaudited).
3
MILLENNIUM CHEMICALS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Millions, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
2004 2003 2004 2003
------------ ------------ ------------ -----------
Net sales........................................................... $ 480 $ 431 $1,433 $1,262
Operating costs and expenses
Cost of products sold............................................ 373 362 1,174 1,019
Depreciation and amortization.................................... 24 28 72 83
Selling, development and administrative expense.................. 33 31 99 98
Asset impairment charges......................................... 3 -- 11 --
Combination costs................................................ 1 -- 5 --
Reorganization and office closure costs.......................... 1 15 3 16
----- ------ ------ ------
Operating income (loss)........................................ 45 (5) 69 46
Interest expense.................................................... (26) (25) (78) (72)
Interest income..................................................... 2 2 5 4
Earnings (loss) on Equistar investment.............................. 22 (12) 36 (69)
Other income (expense), net......................................... 1 2 (1) 1
----- ------ ------ ------
Income (loss) before income taxes, minority interest and cumulative
effect of accounting change...................................... 44 (38) 31 (90)
(Provision for) benefit from income taxes........................... (14) 11 (15) 32
----- ------ ------ ------
Income (loss) before minority interest and cumulative effect of
accounting change................................................ 30 (27) 16 (58)
Minority interest................................................... (2) (1) (5) (5)
----- ------ ------ ------
Income (loss) before cumulative effect of accounting change......... 28 (28) 11 (63)
Cumulative effect of accounting change.............................. -- -- -- (1)
----- ------ ------ ------
Net income (loss)................................................... $ 28 $ (28) $ 11 $ (64)
===== ====== ====== ======
Basic income (loss) per share:
Before cumulative effect of accounting change.................... $0.43 $(0.44) $ 0.17 $(0.98)
From cumulative effect of accounting change...................... -- -- -- (0.02)
----- ------ ------ ------
After cumulative effect of accounting change..................... $0.43 $(0.44) $ 0.17 $(1.00)
===== ====== ====== ======
Diluted income (loss) per share:
Before cumulative effect of accounting change.................... $0.38 $(0.44) $ 0.17 $(0.98)
From cumulative effect of accounting change...................... -- -- -- (0.02)
----- ------ ------ ------
After cumulative effect of accounting change..................... $0.38 $(0.44) $ 0.17 $(1.00)
===== ====== ====== ======
See Notes to Consolidated Financial Statements (Unaudited).
4
MILLENNIUM CHEMICALS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Millions)
Nine Months Ended
September 30,
------------------
2004 2003
------ -------
Cash flows from operating activities:
Net income (loss) ................................................ $ 11 $ (64)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Cumulative effect of accounting change ......................... -- 1
Asset impairment charges ....................................... 11 --
Depreciation and amortization .................................. 72 83
Deferred income tax provision (benefit) ........................ 8 (43)
(Earnings) loss on Equistar investment ......................... (36) 69
Minority interest .............................................. 5 5
Other, net ..................................................... 1 --
Changes in assets and liabilities:
Increase in trade receivables ................................ (64) (23)
Decrease in inventories ...................................... 87 1
(Increase) decrease in other current assets .................. (9) 27
Decrease in other assets ..................................... 3 2
Increase (decrease) in trade accounts payable ................ 33 (82)
Increase in accrued expenses and other liabilities and
income taxes payable ....................................... 44 (2)
Decrease in other liabilities ................................ (22) (23)
---- -----
Cash provided by (used in) operating activities ................ 144 (49)
---- -----
Cash flows from investing activities:
Capital expenditures ............................................. (38) (29)
Distribution from Equistar ....................................... 30 --
Proceeds from sale of property, plant and equipment .............. 1 --
---- -----
Cash used in investing activities ................................ (7) (29)
---- -----
Cash flows from financing activities:
Dividends to shareholders ........................................ -- (17)
Proceeds from long-term debt, net of financing costs ............. 28 356
Repayment of long-term debt ...................................... (83) (220)
Decrease in notes payable and other financing liabilities ........ -- (17)
Proceeds from exercise of stock options .......................... 15 --
---- -----
Cash (used in) provided by financing activities ................ (40) 102
---- -----
Effect of exchange rate changes on cash ............................. 7 9
---- -----
Increase in cash and cash equivalents ............................... 104 33
Cash and cash equivalents at beginning of year ...................... 209 125
---- -----
Cash and cash equivalents at end of period .......................... $313 $ 158
==== =====
See Notes to Consolidated Financial Statements (Unaudited).
5
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in millions, except share and per share data)
Note 1 - Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange
Commission, the accompanying unaudited interim consolidated financial statements
do not include all of the disclosures normally required by accounting principles
generally accepted in the United States of America for complete financial
statements. The accompanying unaudited consolidated financial statements should
be read in conjunction with the financial statements and disclosures included in
the Annual Report on Form 10-K of Millennium Chemicals Inc. (the "Company") for
the year ended December 31, 2003, as amended by Amendments No. 1 through 4 on
Form 10-K/A filed with the Securities and Exchange Commission (the "Annual
Report on Form 10-K"). In the opinion of management, all adjustments considered
necessary to present fairly the financial position and results of operations for
the interim periods are included in the accompanying unaudited consolidated
financial statements. Certain prior year balances have been reclassified to
conform with the current year presentation.
The unaudited consolidated financial statements include the accounts of
the Company and its majority-owned subsidiaries. Minority interest represents
the minority ownership of the Company's Brazilian subsidiary and the La Porte
Methanol Company. All significant intercompany accounts and transactions have
been eliminated. The Company's 29.5% investment in Equistar Chemicals, LP
("Equistar"), a joint venture between the Company and Lyondell Chemical Company
("Lyondell"), is accounted for by the equity method; accordingly, the Company's
share of Equistar's pre-tax net income or loss is included in net income or
loss.
Note 2 - Agreement for a Stock-for-Stock Business Combination
On March 29, 2004, Lyondell and the Company announced that their
respective Boards of Directors had approved, and the companies had executed an
agreement and plan of merger. The proposed transaction is intended to qualify as
a reorganization for U.S. federal income tax purposes, in which Millennium
shareholders generally will not recognize gain or loss, other than any gain or
loss recognized on the receipt of cash for fractional shares.
The proposed transaction is subject to approval by both companies'
shareholders and other customary conditions. The Company and Lyondell have
obtained amendments to the Company's and Lyondell's respective bank credit
agreements and Lyondell's accounts receivable sales facility to permit the
transaction. The Company and Lyondell will each hold special meetings of
shareholders on November 30, 2004 to consider and vote on the proposed
transaction. The transaction is expected to close after the close of business on
November 30, 2004; however, there can be no assurance that the transaction will
close. The transaction involves the merger of Millennium Subsidiary LLC, a newly
created subsidiary of the Company, into the Company, in which the Company's
Common Stock now held by its public shareholders will be converted into common
stock of Lyondell, and the Company's preferred stock to be issued to Lyondell
immediately before the merger will be converted into common stock of the
Company, as the surviving entity in the merger. As a result of the transaction,
the Company will become a wholly-owned subsidiary of Lyondell. After the closing
of the transaction, the combined company will be called "Lyondell Chemical
Company" and will be headquartered in Houston, Texas.
The Company's shareholders will receive between 0.95 and 1.05 shares of
Lyondell common stock for each share of the Company's Common Stock, depending on
the average of the volume-weighted average price of Lyondell shares for the 20
trading days ending on the third trading day before the consummation of the
transaction. The Company's shareholders will receive 0.95 shares of Lyondell
common stock if the average price of Lyondell shares during the period is $20.50
per share or greater, and 1.05 shares if it is $16.50 per share or less. If the
average price is between these two amounts, the exchange ratio will vary
proportionately. The shares of Lyondell common stock received in exchange for
Company stock will be entitled to receive the same cash dividend as existing
outstanding Lyondell shares. The proposed transaction is scheduled to close
after the close of business on November 30, 2004, after the record date of
Lyondell's regular fourth quarter dividend, and therefore the Company's
shareholders will not receive this dividend. As of October 1, 2004, the
Company's 4.00% convertible senior debentures (the "4.00% Convertible Senior
Debentures") are convertible at a conversion price of approximately $13.63 per
share of the Company's Common Stock. If any of the 4.00% Convertible Senior
Debentures are converted prior to the consummation of the proposed transaction,
the shares of Company Common Stock received upon conversion of such debentures
will be exchanged for Lyondell common stock according to the ratio set forth
above. If not exchanged prior to the closing of the proposed transaction, the
4.00% Convertible Senior Debentures will be convertible into Lyondell common
stock in accordance with the terms of the convertible debenture indenture
following the closing of the transaction.
6
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
For the three months and nine months ended September 30, 2004, the
Company incurred approximately $1 and $5, respectively, of professional services
costs in connection with the proposed combination, which are included in
Combination costs in the accompanying unaudited Consolidated Statements of
Operations.
7
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 3 - Income (Loss) per Share and Stock-Based Compensation
The calculation of basic income (loss) per share follows (shares in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2004 2003 2004 2003
----------- --------- ----------- ---------
Income (loss) before cumulative effect of accounting
change .............................................. $ 28 $ (28) $ 11 $ (63)
Cumulative effect of accounting change .............. -- -- -- (1)
-------- -------- -------- --------
Net income (loss) ................................... $ 28 $ (28) $ 11 $ (64)
======== ======== ======== ========
Weighted-average shares of common stock outstanding
- basic ......................................... 65,428 64,051 64,963 63,960
======== ======== ======== ========
Basic income (loss) per share:
Before cumulative effect of accounting change ..... $ 0.43 $ (0.44) $ 0.17 $ (0.98)
======== ======== ======== ========
After cumulative effect of accounting change ...... $ 0.43 $ (0.44) $ 0.17 $ (1.00)
======== ======== ======== ========
The calculation of diluted income (loss) per share follows (shares in
thousands):
Income (loss) before cumulative effect of
accounting change ................................ $ 28 $ (28) $ 11 $ (63)
Add: interest for 4.00% Convertible Senior
Debentures (net of income taxes) ................. 1 -- -- (b) --
-------- -------- -------- --------
Adjusted income (loss) before cumulative effect
of accounting change ............................. 29 (28) 11 (63)
Cumulative effect of accounting change .............. -- -- -- (1)
-------- -------- -------- --------
Adjusted net income (loss) for purposes of
computing diluted income (loss) per share ...... $ 29 $ (28) $ 11 $ (64)
======== ======== ======== ========
Weighted average shares of common stock
outstanding - basic .............................. 65,428 64,051 64,963 63,960
Potentially dilutive securities:
Options, awards and shares held in trust for
certain employee benefit plans ................. 544 -- (a) 310 -- (a)
4.00% Convertible Senior Debentures .............. 11,004 -- -- (b) --
-------- -------- -------- --------
Weighted average shares of common stock
outstanding-diluted........................... 76,976 64,051 65,273 63,960
======== ======== ======== ========
Diluted income (loss) per share:
Before cumulative effect of accounting change..... $ 0.38 $ (0.44) $ 0.17 $ (0.98)
======== ======== ========= ========
After cumulative effect of accounting change ..... $ 0.38 $ (0.44) $ 0.17 $ (1.00)
======== ======== ========= ========
---------------------------
(a) Approximately 286 and 284 shares of common stock issuable for options,
awards and shares held in trust for certain employee benefit plans for the
three months and nine months ended September 30, 2003, respectively,
were excluded because the effect would be antidilutive.
8
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
(b) Approximately 11,004 shares of common stock issuable for the conversion
of the 4.00% Convertible Senior Debentures for the nine month period
ended September 30, 2004 were excluded because the effect would be
antidilutive due to the income adjustment to add back interest (net of
income taxes) for purposes of calculating diluted income per share.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"), as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure,"
encourages a fair value based method of accounting for employee stock options
and similar equity instruments, which generally would result in the recording of
additional compensation expense in the Company's financial statements. SFAS No.
123, as amended, also allows the Company to continue to account for stock-based
employee compensation using the intrinsic value for equity instruments under
Accounting Principles Board Opinion No. 25 ("APB Opinion No. 25"). The Company
has elected to account for such instruments using APB Opinion No. 25 and related
interpretations, and thus has adopted the disclosure-only provisions of SFAS No.
123, as amended. Accordingly, no compensation cost has been recognized for the
stock option plans in the accompanying financial statements as all options
granted had an exercise price equal to the market value of the underlying Common
Stock on the date of grant.
Disclosure on a pro forma basis of net income (loss) and related
per-share amounts as if the Company had applied the fair value recognition
provisions of SFAS No. 123, as amended, to stock-based employee compensation is
omitted because the pro forma effect on net income (loss) is insignificant.
Note 4 - Recent Accounting Developments
On January 1, 2003, the Company adopted SFAS No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 applies to legal
obligations associated with the retirement of long-lived assets. This standard
requires that the fair value of a liability for an asset retirement obligation
be recognized in the period in which it is incurred and the associated asset
retirement costs be capitalized as part of the carrying amount of the long-lived
asset. Accretion expense and depreciation expense related to the liability and
capitalized asset retirement costs, respectively, are recorded in subsequent
periods. The Company's asset retirement obligations arise from activities
associated with the eventual remediation of sites used for landfills and mining
and include estimated liabilities for closure, restoration, and post-closure
care. The Company is not required to restrict, and has not restricted, any
Company assets for purposes of settling these obligations. As these liabilities
are settled, a gain or loss is recognized for any difference between the
settlement amount and the liability recorded. The amount of the asset retirement
obligations was $12 and $13 at each of September 30, 2004 and December 31, 2003,
respectively. The Company reported an after-tax transition charge of $1 in the
first quarter of 2003 as the cumulative effect of this accounting change. The
impact of adoption was to increase the Company's reported assets and liabilities
by $2 and $3, respectively.
In December 2003, the Financial Accounting Standards Board ("FASB")
issued revised FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities, an interpretation of Accounting Research Bulletin No. 51,
`Consolidated Financial Statements'" ("FIN 46R"). FIN 46R requires the assets,
liabilities, and results of operations of a variable interest entity ("VIE") to
be consolidated in the financial statements of the enterprise considered to be
the primary beneficiary of that entity. The Company evaluated material
relationships with certain entities that were considered potential VIEs. The
Company concluded, with one possible exception discussed below, that those
entities are not VIEs or the Company is not the primary beneficiary of the VIE.
As such, in accordance with FIN 46R, the Company is not required to consolidate
those entities.
The Company evaluated its long-term obligations with one entity that may
be a VIE. The Company has no equity interest in this entity and has confirmed
that the entity is consolidated by an equity owner. The Company has not been
able to obtain the financial information from the entity necessary to determine
whether the Company is the primary beneficiary of the entity. Management of the
entity cited confidentiality considerations with regard to the decision not to
provide the Company with certain financial information. The Company pays
approximately $3 in plant and equipment rental charges on an annual basis to
this entity.
In March 2004, the Emerging Issues Task Force ("EITF") of the FASB issued
EITF Issue No. 03-6, "Participating Securities and the Two-Class Method under
FASB Statement No. 128, Earnings per Share" ("EITF 03-6"). EITF 03-6 addresses a
number of questions regarding the computation of earnings per share by companies
that have issued securities other than common stock that contractually entitle
the holder to participate in dividends and earnings of the company when, and if,
it declares dividends on its common stock. EITF 03-6 became effective for
periods beginning after March 31, 2004. EITF 03-6 had no impact on the Company's
financial statements, as the Company has not issued securities for which
EITF 03-6 would apply.
9
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
("the Act") was signed into law on December 8, 2003. In January 2004, the FASB
issued FASB Staff Position ("FSP") No. FAS 106-1, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003" ("FSP No. FAS 106-1"), which permitted a sponsor of a
postretirement healthcare plan that provides a prescription drug benefit to make
a one-time election to defer recognition and accounting for the effects of the
Act and the disclosures related to its plans as required by SFAS No. 132
(Revised 2003), "Employers' Disclosures about Pensions and Other Postretirement
Benefits" until the FASB developed and issued authoritative guidance on
accounting for the Federal subsidies provided by the Act. The Act introduced a
prescription drug benefit under Medicare ("Medicare Part D") as well as a
Federal subsidy to sponsors of retiree healthcare benefit plans that provide a
medical benefit that is at least actuarially equivalent to Medicare Part D. The
Company elected to make the one-time deferral. On May 19, 2004, the FASB issued
FSP No. FAS 106-2 of the same title, which provided final guidance on the
accounting for subsidies under the Act and became effective for the Company's
third quarter financial report ending September 30, 2004. The effects of the Act
were not significant and will be reflected in its next measurement of plan
obligations as required by SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions". This measurement of plan
obligations will occur on the earlier of December 31, 2004 or the effective date
of the announced stock-for-stock business combination with Lyondell. See Note 2
regarding the announced stock-for-stock business combination.
In September 2004, the EITF issued EITF 04-8, "The Effect of Contingently
Convertible Debt on Diluted Earnings per Share." Contingently convertible debt
instruments are financial instruments that are generally convertible into common
shares of the issuer after the common stock price has exceeded a predetermined
threshold for a specified time period. Prior to the issuance of EITF 04-8,
companies were allowed to exclude the potentially dilutive effect of the
conversion feature from diluted earnings per share until the market price
contingency was met. EITF 04-8 will require companies to include the impact of
contingently convertible debt in their diluted earnings per share computation
regardless of whether the market trigger has been reached. EITF 04-8 is expected
to be effective for periods ending after December 15, 2004. Diluted earnings per
share for prior periods must be retroactively restated to conform to EITF 04-8.
EITF 04-8 will have no impact on the Company's financial statements as the
shares of common stock that would be issued upon conversion of the Company's
4.00% Convertible Senior Debentures are already included in the Company's
diluted earnings per share computation when not antidilutive.
Note 5 - Asset Impairment Charges
In the three months and nine months ended September 30, 2004, the Company
recorded asset impairment charges of $3 and $11, respectively, primarily related
to the write-off of expenditures for property, plant and equipment at the
Company's Le Havre, France titanium dioxide ("TiO[u]2") manufacturing plant. In
the fourth quarter of 2003, the carrying value of the property, plant and
equipment at this plant was determined to be impaired, and a charge was required
to write down the basis in those assets to zero. Capital expenditures at this
plant for the three months and nine months ended September 30, 2004 were
capitalized as property, plant and equipment and then immediately written off as
asset impairment charges as a result of evaluating those assets for impairment
under the guidance of SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets" ("SFAS No. 144"). Because the basis of all of the
property, plant and equipment for the Le Havre, France TiO[u]2 plant was written
down to zero, no depreciation expense for this plant was recorded in
manufacturing and other costs of sales for the three months and nine months
ended September 30, 2004.
Note 6 - Reorganization and Office Closure Costs
On July 21, 2003, the Company announced that it would implement a program
to reduce costs. This program included a reduction of approximately 5% in the
number of the Company's employees worldwide. The Company closed its executive
offices in Red Bank, New Jersey, effective September 1, 2003, and relocated its
headquarters to Hunt Valley, Maryland, where the Company had existing
administrative offices. In addition, the Company announced the suspension of
payment of dividends on its Common Stock.
The Company has recorded cumulative charges related to the program of $21
(including $1 and $3 for the three months and nine months ended September 30,
2004, respectively), of which $20 was for severance-related costs and $1 was for
contractual commitments for ongoing lease costs, net of expected sublease
income, associated with the closure of the Red Bank, New Jersey office for the
remaining term of the lease agreement ("Red Bank Office lease costs"). All costs
associated with this program are accounted for in accordance with SFAS No. 112,
"Employer's Accounting for Postemployment Benefits" or SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities," as appropriate.
Cumulative cash payments of $24 for the implementation of this program, of which
$23 were for severance-related costs and $1 was for Red Bank Office lease costs,
were made through September 30, 2004, including $1 and $10 in the three months
and nine months ended September 30, 2004, respectively. Substantially all of
10
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
the remainder of the cash payments relating to this program, which are estimated
to be approximately $3, will be disbursed during the next several quarters. No
significant charges associated with this program are expected in future periods.
Accrued liabilities associated with this program and included in Accrued
expenses and other liabilities were $2 at September 30, 2004. The cumulative
charges of $21 associated with the cost reduction program are less than the
cumulative cash payments of $24 because some of the cash payments made under the
program, primarily for retirement benefits, were related to expenses and
liabilities that were recorded through the normal course of business in periods
prior to the implementation of this program in mid-2003.
Note 7 - European Receivables Securitization Program
From March 2002 until November 2003, the Company had been transferring
its interest in certain European trade receivables to an unaffiliated third
party as its basis for issuing commercial paper under a revolving securitization
arrangement (annually renewable for a maximum of five years on April 30 of each
year at the option of the third party) with maximum availability of 70 million
euro, which was treated, in part, as a sale under accounting principles
generally accepted in the United States of America. In November 2003, the
Company terminated this securitization arrangement and there were no balances
outstanding at September 30, 2004 or December 31, 2003. The cumulative gross
proceeds from this securitization arrangement through September 30, 2003 were
$253. Cash flows from this securitization arrangement were reflected as
operating activities in the Consolidated Statement of Cash Flows. The aggregate
loss on sales associated with this arrangement was $1 and $2 for the three
months and nine months ended September 30, 2003, respectively, and was included
in Selling, development and administrative ("S,D&A") expense. Servicing
liabilities associated with the transaction were insignificant.
Note 8 - Inventories
Inventories are stated at the lower of cost or market value.
September 30, December 31,
2004 2003
---------------- ---------------
Finished products........................................ $ 183 $ 258
In-process products...................................... 31 38
Raw materials............................................ 90 96
Maintenance parts and supplies........................... 66 65
---------------- ---------------
$ 370 $ 457
================ ===============
11
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 9 - Long-Term Debt and Credit Arrangements
The maturities of the Company's long-term debt through 2009 and
thereafter are as follows:
October 1- Total at Total at
December 31, September 30, December 31,
2004 2005 2006 2007 2008 2009 Thereafter 2004 2003
---------- ------ ------ ------ ------ ------ ---------- ------------- ------------
Revolving Loans ............ $-- $-- $-- $-- $ -- $-- $ -- $ -- $ 52
7.00% Senior Notes ......... -- -- 500 -- -- -- -- 500 500
7.625% Senior Debentures ... -- -- -- -- -- -- 250 250 250
9.25% Senior Notes ......... -- -- -- -- 475 -- -- 475 475
4.00% Convertible Senior
Debentures .............. -- -- -- -- -- -- 150 150 150
Other long-term debt ....... 3 5 5 3 1 1 3 21 23
--- --- ---- --- ---- --- ---- ------ ------
Maturities of long-term debt $3 $5 $505 $3 $476 $ 1 $403 1,396 1,450
=== === ==== === ==== === ====
Non-cash components of
long-term debt........... 11 17
------ ------
Total debt.................. 1,407 1,467
Less: current maturities of
long-term debt........... (6) (6)
------ ------
Total long-term debt........ $1,401 $1,461
====== ======
On November 25, 2003, the Company received approximately $125 in gross
proceeds and, on December 2, 2003, received an additional $25 in gross proceeds
from the sale by Millennium Chemicals Inc. ("Millennium Chemicals") of $150
aggregate principal amount of the 4.00% Convertible Senior Debentures, which are
guaranteed by Millennium America Inc. ("Millennium America"), a wholly-owned
indirect subsidiary of Millennium Chemicals. The gross proceeds of the sale were
used to repay all of the $47 of outstanding borrowings at that time under the
term loan portion (the "Term Loan") of the Company's five-year credit agreement
expiring June 18, 2006, as amended, (the "Credit Agreement") and $103 of
outstanding borrowings under the revolving loan portion (the "Revolving Loans")
of its Credit Agreement, which currently has a maximum availability of $150. The
Company used $4 of cash to pay the fees relating to the sale of the 4.00%
Convertible Senior Debentures. Under the terms of the agreements relating to the
sale of the 4.00% Convertible Senior Debentures, Millennium Chemicals and
Millennium America agreed to: (1) file with the Securities and Exchange
Commission on or before March 24, 2004 a registration statement covering the
resale of the debentures and the common stock issuable upon conversion thereof
pursuant to Rule 415 under the Securities Act, and (2) use reasonable efforts to
cause this registration statement to be declared effective under the Securities
Act of 1933, as amended (the "Securities Act"), on or before May 23, 2004. On
March 23, 2004, Millennium Chemicals and Millennium America, as guarantor,
initially filed a registration statement with the Securities and Exchange
Commission, and on June 16, 2004; August 19, 2004; September 23, 2004 and
September 24, 2004 filed amendments to this registration statement. The
Securities and Exchange Commission declared this registration statement
effective on September 24, 2004. Accordingly, Millennium Chemicals ceased
accruing the additional interest on the debentures required under the agreement.
This interest had accrued from May 24, 2004 until August 21, 2004, at an
annualized rate of 0.25% and from August 22, 2004 until September 23, 2004 at an
annualized rate of 0.50%.
On April 25, 2003, the Company received approximately $107 in net
proceeds ($109 in gross proceeds) from the issuance and sale by Millennium
America of $100 additional principal amount at maturity of its 9.25% Senior
Notes due June 15, 2008 (the "9.25% Senior Notes"), which are guaranteed by
Millennium Chemicals. The net proceeds were used to repay all of the $85 of
outstanding borrowings at that time under the Revolving Loans and for general
corporate purposes. Under the terms of this issuance and sale, Millennium
America and Millennium Chemicals entered into an exchange and registration
rights agreement with the initial purchasers of the $100 additional principal
amount of these 9.25% Senior Notes. Pursuant to this agreement, each of
Millennium America and Millennium Chemicals agreed to: (1) file with the
Securities and Exchange Commission on or before July 24, 2003 a registration
statement relating to a registered exchange offer for the notes, and (2) use its
reasonable efforts to cause this exchange offer registration statement to be
declared effective under the Securities Act on or before October 22, 2003. On
June 13, 2003, Millennium America and Millennium Chemicals, as guarantor,
initially filed a registration statement with the Securities
12
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
and Exchange Commission, and on December 15, 2003; June 25, 2004; July 6, 2004;
August 19, 2004; September 23, 2004 and September 24, 2004 filed amended
registration statements. The exchange offer registration statement was declared
effective on September 24, 2004 and the exchange offer was completed on
October 28, 2004. Upon completion of the exchange offer, Millennium America
ceased accruing the additional interest it had been obligated to pay since
October 23, 2003, at the annualized rate of approximately 1.00% to each holder
of $100 additional principal amount of notes.
The Company had $26 of outstanding undrawn standby letters of credit and
no outstanding borrowings under the Revolving Loans and, accordingly, had $124
of unused availability under such facility at September 30, 2004. In addition to
letters of credit outstanding under the Credit Agreement, the Company also had
outstanding undrawn standby letters of credit and bank guarantees under other
arrangements of $6 at September 30, 2004. The Company had unused availability
under short-term uncommitted lines of credit, other than the Credit Agreement,
of $42 at September 30, 2004.
The Revolving Loans are available in U.S. dollars, British pounds and
euros. The Revolving Loans may be borrowed, repaid and reborrowed from time to
time. The Revolving Loans include a $50 letter of credit subfacility and a
swingline facility in the amount of $25. As of September 30, 2004, $26 was
outstanding under the letter of credit subfacility, and no amount under the
swingline facility. The Term Loans were entirely prepaid on November 25, 2003,
which effectively retired the Term Loans as any such amounts prepaid may not be
reborrowed. The interest rates on the Revolving Loans are floating rates based
upon margins over LIBOR, NIBOR, or the Administrative Agent's prime lending
rate, as the case may be. Such margins, as well as the facility fee, are based
on the Company's Leverage Ratio. The Leverage Ratio is the ratio of Total
Indebtedness to cumulative EBITDA for the prior four fiscal quarters, each as
defined in the Credit Agreement.
The Credit Agreement contains various restrictive covenants and requires
that the Company meet certain financial performance criteria. Compliance with
these covenants is monitored frequently in order to assess the likelihood of
continued compliance. As a result of the restatement of its prior financial
statements, the Company obtained a waiver on July 29, 2004 under the Credit
Agreement relating to certain representations under the Credit Agreement
regarding such prior financial statements. The Company was in compliance with
all covenants under the Credit Agreement in effect at September 30, 2004.
The financial covenants in the Credit Agreement require the Company to
maintain a Senior Secured Leverage Ratio, defined as the ratio of Senior Secured
Indebtedness, as defined, to cumulative EBITDA for the prior four fiscal
quarters, each as defined, of no more than 1.25 to 1.00 for each of the
remaining quarters of 2004 and 1.00 to 1.00 for the first quarter of 2005 and
thereafter, and an Interest Coverage Ratio, defined as the ratio of cumulative
EBITDA for the prior four fiscal quarters to Net Interest Expense, for the same
period, each as defined, of no less than 1.40 to 1.00 for the third quarter of
2004; 1.50 to 1.00 for the fourth quarter of 2004; and 1.75 to 1.00 for the
first quarter of 2005 and thereafter. The covenants in the Credit Agreement also
limit, among other things, the ability of the Company and/or certain
subsidiaries of the Company to: (i) incur debt and issue preferred stock; (ii)
create liens; (iii) engage in sale/leaseback transactions; (iv) declare or pay
dividends on, or purchase, the Company's stock; (v) make restricted payments;
(vi) engage in transactions with affiliates; (vii) sell assets; (viii) engage in
mergers or acquisitions; (ix) engage in domestic accounts receivable
securitization transactions; and (x) enter into restrictive agreements. In
addition, in the event the Company sells certain assets as specified in the
Credit Agreement and the Leverage Ratio is equal to or greater than 3.75 to
1.00, the outstanding Revolving Loans must be prepaid with a portion of the Net
Cash Proceeds, as defined, of such sale and the maximum availability under the
Credit Agreement would be decreased by 50% of the aggregate Net Cash Proceeds
received from such asset sales in excess of $100. Any sale involving Equistar or
certain inventory or accounts receivable would reduce the maximum availability
under the Credit Agreement by 100% of such Net Cash Proceeds received. The
obligations under the Credit Agreement are collateralized by: (1) a pledge of
100% of the stock of the Company's existing and future domestic subsidiaries and
65% of the stock of certain of the Company's existing and future foreign
subsidiaries, in both cases other than subsidiaries that hold immaterial assets
(as defined in the Credit Agreement); (2) all the equity interests held by the
Company's subsidiaries in Equistar and the La Porte Methanol Company (which
pledges are limited to the right to receive distributions made by Equistar and
the La Porte Methanol Company, respectively); and (3) all present and future
accounts receivable, intercompany indebtedness and inventory of the Company's
domestic subsidiaries, other than subsidiaries that hold immaterial assets. In
connection with the announced stock-for-stock business combination with Lyondell
(see Note 2), the Company obtained an amendment to its Credit Agreement on July
7, 2004, which will allow the consummation of the announced stock-for-stock
business combination with Lyondell and modifies the definition of EBITDA to
exclude certain transaction costs related to this business combination.
13
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Millennium America also has outstanding $500 aggregate principal amount
of 7.00% Senior Notes due November 15, 2006 (the "7.00% Senior Notes") and $250
aggregate principal amount of 7.625% Senior Debentures due November 15, 2026
(the "7.625% Senior Debentures" and, together with the 7.00% Senior Notes and
the 9.25% Senior Notes, the "Senior Notes"), that are fully and unconditionally
guaranteed by Millennium Chemicals. The indenture under which the 7.00% Senior
Notes and 7.625% Senior Debentures were issued contains certain covenants that
limit, among other things: (i) the ability of Millennium America and its
Restricted Subsidiaries (as defined) to grant liens or enter into sale/leaseback
transactions; (ii) the ability of the Restricted Subsidiaries to incur
additional indebtedness; and (iii) the ability of Millennium America and
Millennium Chemicals to merge, consolidate or transfer substantially all of
their respective assets. This indenture allows Millennium America and its
Restricted Subsidiaries, as defined, to grant security on loans of up to 15% of
Consolidated Net Tangible Assets ("CNTA"), as defined, of Millennium America and
its consolidated subsidiaries. Accordingly, based upon CNTA and secured
borrowing levels at September 30, 2004, any reduction in CNTA below
approximately $1,000 would decrease the Company's availability under the
Revolving Loans by 15% of any such reduction. CNTA was approximately $2,000 at
September 30, 2004. The 7.00% Senior Notes and the 7.625% Senior Debentures can
be accelerated by the holders thereof if any other debt in excess of $20 is in
default and is accelerated.
The 9.25% Senior Notes were issued by Millennium America and are
guaranteed by Millennium Chemicals. The indenture under which the 9.25% Senior
Notes were issued contains certain covenants that limit, among other things, the
ability of the Company and/or certain subsidiaries of the Company to: (i) incur
additional debt; (ii) issue redeemable stock and preferred stock; (iii) create
liens; (iv) redeem debt that is junior in right of payment to the 9.25% Senior
Notes; (v) sell or otherwise dispose of assets, including capital stock of
subsidiaries; (vi) enter into arrangements that restrict dividends from
subsidiaries; (vii) enter into mergers or consolidations; (viii) enter into
transactions with affiliates; and (ix) enter into sale/leaseback transactions.
In addition, this indenture contains a covenant that would prohibit the Company
from (i) paying dividends or making distributions on its common stock; (ii)
repurchasing its common stock; and (iii) making other types of restricted
payments, including certain types of investments, if such restricted payments
would exceed a "restricted payments basket." Although the Company has no
intention at the present time to pay dividends or make distributions, repurchase
its Common Stock, or make other restricted payments, the Company would be
prohibited by this covenant from doing so at the present time. The indenture
also requires the calculation of a Consolidated Coverage Ratio, defined as the
ratio of the aggregate amount of EBITDA, as defined, for the four most recent
fiscal quarters to Consolidated Interest Expense, as defined, for the four most
recent quarters. The Company must maintain a Consolidated Coverage Ratio of 2.25
to 1.00. Currently, the Company's Consolidated Coverage Ratio is below this
threshold and, therefore, the Company is subject to certain restrictions that
limit the Company's ability to incur additional indebtedness, pay dividends,
repurchase capital stock, make certain other restricted payments, and enter into
mergers or consolidations. However, if the 9.25% Senior Notes were to receive
investment grade credit ratings from both Moody's Investors Service ("Moody's")
and Standard & Poor's ("S&P") and meet certain other requirements as specified
in the indenture, certain of these covenants would no longer apply. The 9.25%
Senior Notes can be accelerated by the holders thereof if any other debt in
excess of $30 is in default and is accelerated.
The consummation of the announced stock-for-stock business combination
with Lyondell will give each holder of the 9.25% Senior Notes the right to
require the Company to purchase all or part of such holder's securities at a
purchase price in cash equal to 101% of the principal amount thereof plus
accrued and unpaid interest to the date of purchase.
The 4.00% Convertible Senior Debentures were issued by Millennium
Chemicals and are guaranteed by Millennium America. Holders may convert their
debentures into shares of the Company's Common Stock at a conversion price,
subject to adjustment upon certain events, of $13.63 per share, which is
equivalent to a conversion rate of 73.3568 shares per one thousand dollar
principal amount of debentures. The conversion privilege may be exercised under
the following circumstances:
o prior to November 15, 2018, during any fiscal quarter commencing
after December 31, 2003, if the closing price of the Company's
Common Stock on at least 20 of the 30 consecutive trading days
ending on the first trading day of that quarter is greater than
125% of the then current conversion price;
o on or after November 15, 2018, at any time after the closing
price of the Company's Common Stock on any date is greater than
125% of the then current conversion price;
o if the debentures are called for redemption;
14
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
o upon the occurrence of specified corporate transactions,
including a consolidation, merger or binding share exchange
pursuant to which the Company's Common Stock would be converted
into cash or property other than securities;
o during the five business-day period after any period of ten
consecutive trading days in which the trading price per one
thousand dollar principal amount of debentures on each day was
less than 98% of the product of the last reported sales price of
the Company's Common Stock and the then current conversion rate;
and
o at any time when the long-term credit rating assigned to the
debentures is either Caa1 or lower, in the case of Moody's, or
B- or lower in the case of S&P, or either rating agency has
discontinued, withdrawn or suspended its rating.
During the thirty consecutive trading days ending October 1, 2004, the
closing price of the Company's Common Stock was greater than 125% of the current
conversion price per share of Common Stock for at least 20 trading days.
Accordingly, on October 1, 2004, the Company announced that the debentures are
currently convertible into shares of the Company's Common Stock under section
15.01(a)(i) of the indenture.
The debentures are redeemable at the Company's option beginning November
15, 2010 at a redemption price equal to 100% of their principal amount, plus
accrued interest, if any. On November 15 in each of 2010, 2013 and 2018, holders
of debentures will have the right to require the Company to repurchase all or
some of the debentures they own at a purchase price equal to 100% of their
principal amount, plus accrued interest, if any. The Company may choose to pay
the purchase price in cash or shares of the Company's Common Stock or any
combination thereof. In the event of a conversion request upon a credit ratings
event as described above, after June 18, 2006, the Company has the right to
deliver, in lieu of shares of Company Common Stock, cash or a combination of
cash and shares of Company Common Stock. After the closing of the proposed
business combination with Lyondell, the Company would deliver shares of Lyondell
common stock rather than Company Common Stock. Holders of the debentures will
also have the right to require the Company to repurchase all or some of the
debentures they own at a cash purchase price equal to 100% of their principal
amount, plus accrued interest, if any, upon the occurrence of certain events
constituting a Fundamental Change, as defined in the indenture. This indenture
also limits the Company's ability to consolidate with or merge with or into any
other person, or sell, convey, transfer or lease properties and assets
substantially as an entirety to another person, except under certain
circumstances. The consummation of the announced stock-for-stock business
combination with Lyondell is not expected to be considered a Fundamental Change,
as defined in the indenture. However, the Company does expect to execute with
the trustee a supplemental indenture providing that each debenture shall be
convertible into Lyondell's common stock at a conversion ratio determined in
accordance with the indenture to reflect the exchange ratio in the business
combination.
Although the Company does not currently pay a dividend to its common
stockholders, Lyondell does currently pay a dividend. If the Company executes a
supplemental indenture with the trustee, as described above, and Lyondell
continues to pay a dividend to its common stockholders, the conversion rate, as
defined, will be adjusted. The conversion rate will be increased by a percentage
calculated by dividing the average of the last reported sales price of
Lyondell's common stock for the ten consecutive trading days prior to the
business day immediately preceding the record date by this average less the
amount in cash per share that Lyondell distributes to holders of its common
stock. At the current market prices of Lyondell's common stock, this percentage
would be approximately 1.0% per quarter.
At September 30, 2004, the Company was in compliance with all covenants
in the indentures governing the 9.25% Senior Notes, 7.00% Senior Notes, 7.625%
Senior Debentures, and 4.00% Convertible Senior Debentures.
The Company, as well as the Senior Notes and the 4.00% Convertible
Senior Debentures, are currently rated BB- by S&P with a stable outlook. Moody's
has assigned the Company a senior implied rating of Ba3, and the Senior Notes
and the 4.00% Convertible Senior Debentures a rating of B1 with a negative
outlook. These ratings are non-investment grade ratings.
On March 29, 2004, S&P placed the Company's ratings on Credit Watch with
negative implications reflecting the future ownership by the highly leveraged
Lyondell and the strong likelihood that the ratings of the Company will be
lowered modestly upon completion of the proposed transaction. On March 30, 2004,
Moody's placed the Company's credit ratings under review for possible downgrade
following the announcement by Lyondell and the Company that the two companies
signed a definitive agreement that, if completed, will result in the combination
of the Company with Lyondell in a stock-for-stock transaction. Moody's cited
concerns over the potential impact that future distributions by the Company, as
an operating subsidiary of Lyondell, to Lyondell will have on the Company's
credit profile over the
15
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
long term, primarily the potential for elevated debt levels over the next
several years while Lyondell seeks to de-lever its balance sheet.
Note 10 - Derivative Instruments and Hedging Activities
The Company is exposed to market risk, such as changes in currency
exchange rates, commodity pricing and interest rates. To manage the volatility
relating to these exposures, the Company selectively enters into derivative
transactions pursuant to the Company's policies for hedging practices.
Designation is performed on a specific exposure basis to support hedge
accounting. The changes in fair value of these hedging instruments are offset in
part or in whole by corresponding changes in the fair value or cash flows of the
underlying exposures being hedged. The Company does not hold or issue derivative
financial instruments for speculative or trading purposes.
Foreign Currency Exposure Management: The Company manufactures and sells
its products in a number of countries throughout the world and, as a result, is
exposed to movements in foreign currency exchange rates. The primary purpose of
the Company's foreign currency hedging activities is to manage the volatility
associated with foreign currency purchases and foreign currency sales. The
Company utilizes forward exchange contracts with various terms. As of September
30, 2004, these contracts had expiration dates no later than April 13, 2005.
The Company utilizes forward exchange contracts with contract terms
normally lasting less than three months to protect against the adverse effect
that exchange rate fluctuations may have on foreign currency denominated trade
receivables and trade payables. These derivatives have not been designated as
hedges for accounting purposes. The gains and losses on both the derivatives and
the foreign currency denominated trade receivables and payables are recorded in
current earnings. Net amounts included in earnings, which offset similar amounts
from foreign currency denominated trade receivables and payables, were
insignificant for each of the three months and nine months ended September 30,
2004 and were a gain of $3 and $6, respectively, for the three months and nine
months ended September 30, 2003.
In addition, the Company utilizes forward exchange contracts that
qualify as cash flow hedges. These are intended to offset the effect of exchange
rate fluctuations on forecasted sales and inventory purchases. Gains and losses
on these instruments are deferred in other comprehensive income ("OCI") until
the underlying transaction is recognized in earnings. The earnings impact is
reported either in Net sales or Cost of products sold to match the underlying
transaction being hedged. Net amounts on forward exchange contracts designated
as cash flow hedges reclassified to earnings to match the gain or loss on the
underlying transaction being hedged were insignificant and a gain of $1,
respectively, for the three months and nine months ended September 30, 2004 and
were a loss of $1 and $5, respectively, for the three months and nine months
ended September 30, 2003. Hedge ineffectiveness had no impact on earnings for
the three months and nine months ended September 30, 2004 and 2003. No forward
exchange contract cash flow hedges were discontinued during the three months and
nine months ended September 30, 2004 and 2003. The Company currently estimates
that the net gains on foreign currency cash flow hedges included in OCI at
September 30, 2004 that will be reclassified to earnings during the next twelve
months is insignificant.
Commodity Price Risk Management: Raw materials used by the Company are
subject to price volatility caused by demand and supply conditions and other
unpredictable factors. The Company selectively uses commodity swap arrangements
and commodity options with various terms to manage the volatility related to
anticipated purchases of natural gas and certain commodities, a portion of which
exposes the Company to natural gas price risk. As of September 30, 2004, there
were no such contracts outstanding. The mark-to-market gains or losses on
qualifying hedges were included in OCI to the extent effective, and reclassified
into Cost of products sold in the period during which the hedged transaction
affected earnings. The mark-to-market gains or losses on ineffective portions of
hedges are recognized immediately in Cost of products sold. Net amounts on
commodity swaps designated as cash flow hedges reclassified to Cost of products
sold to match the gain or loss on the underlying transaction being hedged were a
loss of $1 for the three months ended September 30, 2003, and insignificant for
each of the nine months ended September 30, 2004 and 2003. There were no gains
or losses on commodity swaps designated as cash flow hedges reclassified to Cost
of products sold in the three months ended September 30, 2004. Hedge
ineffectiveness had no impact on earnings for the three months and nine months
ended September 30, 2004 and 2003. No commodity swap cash flow hedges were
discontinued in the three months and nine months ended September 30, 2004 or in
the three months ended September 30, 2003, and net losses on commodity swap cash
flow hedges that were discontinued in the nine months ended September 30, 2003
were insignificant. The Company had no gains or losses on commodity swaps
included in OCI at September 30, 2004.
In addition, the Company utilizes commodity swap and option arrangements
to manage price volatility related to anticipated purchases of certain
commodities, a portion of which exposes the Company to natural gas price risk.
These
16
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
derivatives are not designated as hedges for accounting purposes. The gains and
losses on these instruments are recorded in current earnings. Net amounts
included in earnings were insignificant in the nine months ended September 30,
2004 and were net losses of $1 and $2, respectively, in the three months and
nine months ended September 30, 2003. There were no gains or losses on these
commodity swap and options arrangements in the three months ended September 30,
2004.
Interest Rate Risk Management: The Company selectively uses derivative
instruments to manage its ratio of debt bearing fixed interest rates to debt
bearing variable interest rates. On September 10, 2004, the Company terminated
all of its outstanding interest rate swap agreements with a notional amount of
$225 and the Company received proceeds of approximately $3. These interest rate
swap agreements were designated as fair value hedges of underlying fixed-rate
obligations. Gains deferred on these interest rate swap agreements of
approximately $2 result in an increase in the carrying value of long-term debt
and will be recognized as a reduction in Interest expense ratably over
approximately 2 years, the remaining term of the underlying fixed rate
obligations previously hedged. Subsequent to the termination, the Company
entered into new interest rate swaps with a total notional amount of $100, which
are designated as fair value hedges of underlying fixed-rate obligations and are
outstanding at September 30, 2004. The valuation of these outstanding interest
rate swap agreements at September 30, 2004, which required the recognition of a
swap liability and a corresponding decrease in the carrying value of the
long-term debt, was insignificant. The gains and losses on both the interest
rate swaps and the hedged portion of the underlying debt are recorded in
Interest expense. Hedge ineffectiveness had no impact on earnings for the three
months and nine months ended September 30, 2004 and 2003.
17
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 11 - Pension and Other Postretirement Benefits
The following table provides the components of net periodic benefit cost
and the amount of contributions for pensions:
Pension Benefits
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net periodic benefit cost
Service cost, including interest.............. $ 3 $ 3 $ 10 $ 10
Interest on PBO............................... 13 13 39 39
Return on plan assets......................... (16) (17) (48) (51)
Amortization of unrecognized net loss......... 4 2 10 5
Curtailment................................... -- 3 -- 3
--------------- --------------- --------------- ---------------
Net periodic benefit cost..................... 4 4 11 6
Defined contribution plan..................... 1 1 3 3
--------------- --------------- --------------- ---------------
Net periodic benefit cost..................... $ 5 $ 5 $ 14 $ 9
=============== =============== =============== ===============
Company pension trust contributions.............. $ 3 $ 1 $ 9 $ 5
=============== =============== =============== ===============
The Company expects to contribute approximately $12 to pension plan
trusts during 2004.
The following table provides the components of net periodic benefit cost
and the amount of benefits paid for other postretirement benefits:
Other Postretirement Benefits
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
----------------------------- -------------------------------
2004 2003 2004 2003
------------- --------------- --------------- ---------------
Net periodic benefit (income) cost
Service cost, including interest............. $ -- $ -- $ -- $ --
Interest on PBO.............................. 1 2 2 4
Amortization of prior service credit......... (2) (1) (5) (2)
Curtailment.................................. -- (1) -- (1)
------------- ------------- ------------- ---------------
Net periodic benefit (income) cost........... $ (1) $ -- $ (3) $ 1
============= ============= ============= ===============
Other postretirement benefits paid.............. $ 2 $ 3 $ 8 $ 9
============= ============= ============= ===============
As a result of rising medical benefit costs and competitive business
conditions, the Company announced in the first quarter of 2004 that, effective
April 1, 2004, it planned to reduce the level of retiree medical benefits
provided to essentially all of its retirees by offering a monthly subsidy to
retirees that enroll in designated preferred provider organization plans or
Medicare supplement insurance plans. This change reduced the Company's
accumulated postretirement benefit obligation by approximately $45. Beginning in
2004, the Company is recognizing this reduction ratably over approximately
thirteen years through other postretirement employee benefit ("OPEB") net
periodic benefit cost. Estimated OPEB net periodic benefit cost for the year
ending December 31, 2004, after giving effect to this change, will be income of
approximately $4 compared to a benefit cost of $2 for the year ended December
31, 2003. The Company estimates that cash payments for retiree medical and
insurance benefits for the year ending December 31, 2004 will be approximately
$9, compared to payments of $12 made for the year ended December 31, 2003, as
the Company transitions to the subsidy plan. Cash payments for retiree medical
and insurance benefits in subsequent years are estimated to be significantly
less than in 2003.
18
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 12 - Comprehensive Income (Loss)
The following table sets forth the components of other comprehensive
income (loss) and total comprehensive income (loss):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------- ------------- ------------- --------------
Net income (loss)....................................... $ 28 $ (28) $ 11 $ (64)
Other comprehensive income (loss)
Net gains (losses) on derivative financial
instruments.......................................... -- 1 1 (2)
Currency translation adjustment...................... 13 7 1 66
------------- ------------- ------------- --------------
Total comprehensive income (loss)....................... $ 41 $ (20) $ 13 $ --
============= ============= ============= ==============
Note 13 - Commitments and Contingencies
Legal and Environmental: The Company and various Company subsidiaries are
defendants in a number of pending legal proceedings relating to present and
former operations. These include several proceedings alleging injurious exposure
of plaintiffs to various chemicals and other materials on the premises of, or
manufactured by, the Company's current and former subsidiaries. Typically, such
proceedings involve claims made by many plaintiffs against many defendants in
the chemical industry. Millennium Petrochemicals Inc., a wholly-owned operating
subsidiary of the Company ("Millennium Petrochemicals"), is one of a number of
defendants in 125 active premises-based asbestos cases (i.e., where the alleged
exposure to asbestos-containing materials was to employees of third-party
contractors or subcontractors on the premises of certain current or former
Company facilities, and did not relate to any products manufactured or sold by
the Company or any of its predecessors). Of the cases filed against Millennium
Petrochemicals, only three assert specific damage amounts other than asserting
damages in excess of the statutory minimum. The three cases that do assert a
specific amount of damages each assert a minimum of $200,000 exemplary damages.
Millennium Petrochemicals is responsible for these premises-based cases as a
result of its indemnification obligations under the Company's agreements with
Equistar; however, Equistar will be required to indemnify Millennium
Petrochemicals for any such claims filed on or after December 1, 2004 related to
the assets or businesses contributed by Millennium Petrochemicals to Equistar.
In addition to the cases referenced above, Millennium Petrochemicals is one of a
number of defendants in 10 premises-based asbestos cases filed in Indiana
relating to an alleged former company facility. These cases are not subject to
the above-described Equistar indemnification obligation. Millennium Inorganic
Chemicals Inc., a wholly-owned operating subsidiary of the Company ("Millennium
Inorganic Chemicals"), is one of a number of defendants in 100 premises-based
asbestos cases filed since 2003 in Baltimore County, Maryland, all of which
assert damages in excess of the statutory minimum. Approximately half of these
claims are on the active docket and half are on an inactive docket of claims for
which no legal obligations attach and no defense costs are being incurred. With
respect to the active docket, at the current rate, cases filed in 2003 are not
likely to be scheduled to be tried for at least 10 years. To date, no
premises-based asbestos case has been tried in the State of Maryland. A defunct
indirect Company subsidiary is among a number of defendants in 100 asbestos
cases in Texas, where the alleged exposure was to persons on the premises of
facilities where vessels formerly fabricated by this defunct subsidiary were
situated. All of these cases assert unspecified monetary damages in excess of
the statutory minimum.
Together with other alleged past manufacturers of lead-based paint and
lead pigments for use in paint, the Company, a current subsidiary, as well as
alleged predecessor companies, have been named as defendants in various legal
proceedings alleging that they and other manufacturers are responsible for
personal injury, property damage, and remediation costs allegedly associated
with the use of these products. The plaintiffs in these legal proceedings
include municipalities, counties, school districts, individuals and the State of
Rhode Island, and seek recovery under a variety of theories, including
negligence, failure to warn, breach of warranty, conspiracy, market share
liability, fraud, misrepresentation and public nuisance. The majority of these
legal proceedings assert unspecified monetary damages in excess of the statutory
minimum and, in certain cases, contain general language requesting equitable
relief from defendants such as abatement of lead-based paint in buildings. Legal
proceedings relating to lead pigment or paint are in various procedural stages
or pre-trial, post-trial and post-dismissal appellate settings.
19
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
The Company's defense costs to date for lead-based paint and lead pigment
litigation largely have been covered by insurance. The Company has not accrued
any liabilities for any lead-based paint and lead pigment litigation. The
Company has insurance policies that potentially provide approximately $1,000 in
indemnity coverage for lead-based paint and lead pigment litigation. That
estimate of indemnity coverage would depend upon the timing of any request for
indemnity and the solvency of the various insurance carriers that are part of
the coverage block at the time of such a request. As a result of insurance
coverage litigation initiated by the Company, an Ohio trial court issued a
decision in 2002 effectively requiring certain insurance carriers to resume
paying defense costs in the lead-based paint and lead pigment cases. Indemnity
coverage was not at issue in the Ohio court's decision. The insurance carriers
may appeal the Ohio decision regarding defense costs, and they have in the past
and may in the future attempt to deny indemnity coverage if there is ever a
settlement or an adverse judgment in any lead-based paint or lead pigment case.
In 1986, a predecessor of a company that is now a subsidiary of the
Company sold its recently acquired Glidden Paints business. As part of that
sale, the seller agreed to indemnify the purchaser against certain claims made
during the first eight years after the sale; the purchaser agreed to indemnify
the seller against such claims made after the eight-year period. With the
exception of two cases, all pending lead-based paint and lead pigment litigation
involving the Company and its subsidiaries, including the Rhode Island case, was
filed after the eight-year period. Accordingly, the Company believes that it is
entitled to full indemnification from the purchaser against lead-based paint and
lead pigment cases filed after the eight-year period. The purchaser disputes
that it has such an indemnification obligation, and claims that the seller must
indemnify it. Because the Company's defense costs to date largely have been
covered by insurance and there never has been a settlement paid by, nor any
judgment rendered against, the Company (or any other company sued in any
lead-based paint or lead pigment litigation), the parties' indemnification
claims have not been ruled on by a court.
The Company's businesses are subject to extensive federal, state, local
and foreign laws, regulations, rules and ordinances concerning, among other
things, emissions to the air, discharges and releases to land and water, the
generation, handling, storage, transportation, treatment and disposal of wastes
and other materials and the remediation of environmental pollution caused by
releases of wastes and other materials (collectively, "Environmental Laws"). The
operation of any chemical manufacturing plant and the distribution of chemical
products entail risks under Environmental Laws, many of which provide for
substantial fines and criminal sanctions for violations. There can be no
assurance that significant costs or liabilities will not be incurred with
respect to the Company's operations and activities. In particular, the
production of TiO[u]2, TiCl[u]4, vinyl acetate monomer ("VAM"), acetic acid,
methanol and certain other chemicals involves the handling, manufacture or use
of substances or compounds that may be considered to be toxic or hazardous
within the meaning of certain Environmental Laws, and certain operations have
the potential to cause environmental or other damage. Significant expenditures
including facility-related expenditures could be required in connection with any
investigation and remediation of threatened or actual pollution, triggers under
existing Environmental Laws tied to production or new requirements under
Environmental Laws.
The Company cannot predict whether future developments or changes in laws
and regulations concerning environmental protection will affect its earnings or
cash flow in a materially adverse manner or whether its operating units,
Equistar or La Porte Methanol Company will be successful in meeting future
demands of regulatory agencies in a manner that will not materially adversely
affect the consolidated financial position, results of operations or cash flows
of the Company. For example, the eight-county Houston/Galveston region has been
designated a severe non-attainment area for ozone by the U.S. Environmental
Protection Agency (the "EPA") under a "one-hour" ozone standard. Emission
reduction controls for nitrogen oxides ("NOx"), which contribute to ozone
formation, must be installed at each of Equistar's six plants located in the
Houston/Galveston region prior to a November 2007 compliance deadline for the
one-hour ozone standard. Revised rules adopted by the regulatory agencies
changed the required NOx emission reduction levels from 90% to 80%. Under the
revised 80% standard, Equistar estimates that the incremental capital
expenditures would range between $165 and $200. Equistar's cumulative capital
expenditures through September 30, 2004 totaled $96. This estimate could be
affected by increased costs for stricter proposed controls over highly reactive,
volatile organic compounds ("HRVOCs"). The regulatory agency for the state of
Texas, the Texas Commission on Environmental Quality, ("TCEQ"), plans to
finalize the HRVOC rules by December 2004. Equistar is still assessing the
impact of the proposed HRVOC revisions. In addition, in April 2004, the EPA
designated the eight-county Houston/Galveston region a moderate non-attainment
area under an "eight-hour" ozone standard. As a result, the TCEQ must submit a
plan to the EPA in 2007 to demonstrate compliance with the eight-hour ozone
standard in 2010. The TCEQ is continuing with its current plan to revise the
HRVOC rules in 2004. The timing and amount of the estimated expenditures are
subject to these regulatory and other uncertainties, as well as to obtaining the
necessary permits and approvals. There can be no assurance as to the ultimate
cost of implementing any plan developed to comply with the final ozone
standards.
20
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Certain Company subsidiaries have been named as defendants, potentially
responsible parties (the "PRPs"), or both, in a number of environmental
proceedings associated with waste disposal sites or facilities currently owned,
operated or used by the Company's current or former subsidiaries or
predecessors. The Company's estimated individual exposure for potential cleanup
costs, damages for personal injury or property damage related to these
proceedings has been estimated to be between $0.01 for several small sites and
$17 for the Kalamazoo River Superfund Site in Michigan.
A subsidiary of the Company was named as one of four PRPs at the
Kalamazoo River Superfund Site. The site involves contamination of river
sediments and floodplain soils with polychlorinated biphenyls. In October 2000,
the Kalamazoo River Study Group (the "KRSG"), of which one of the Company's
subsidiaries is a member, submitted to the State of Michigan a Draft Remedial
Investigation and Draft Feasibility Study, which evaluated a number of remedial
options for the river. The cost for these remedial options ranged from $0 to
$2,500; however, the Company strongly believes that the likelihood of the cost
being either $0 or $2,500 is remote. At the end of 2001, the EPA took
responsibility for the site at the request of the State. Based upon an interim
allocation, the Company previously paid 35% of costs related to studying and
evaluating the environmental condition of the river. That percentage has now
increased to 55%, again on an interim basis, in part reflecting the bankruptcy
of one PRP and the consolidation (by acquisition) of two other PRPs. Guidance as
to how the EPA will likely proceed with any further evaluation and remediation
at the Kalamazoo site is not expected until 2005 at the earliest, as the agency
has deferred cleanup planning to allow several interim measures to go forward.
The EPA has initiated a process that will lead to a facilitation ("the
Facilitation") beginning in the Fall of 2004 among the agency, the Company,
another KRSG member, the Michigan Departments of Environmental Quality and
Natural Resources, and certain federal natural resource trustees. The
Facilitation participants have selected co-facilitators and determined the
governing principles of the Facilitation. One of the goals of the Facilitation
is to determine what additional investigation and data are needed to further
develop cleanup options for downstream portions of the Kalamazoo River.
Another interim measure initiated by the EPA is the development of a
computer model that will be designed to identify polychlorinated biphenyls
sources on the Kalamazoo River and determine how polychlorinated biphenyls move
and where they are deposited in the river to assist in remedial planning. Some
results, but not all, are expected by the end of 2005. At the point in time when
the EPA announces how it intends to proceed, the Company's estimate of its
liability at the Kalamazoo site will be re-evaluated. The Company's ultimate
liability for the Kalamazoo site will depend on many other factors that have not
yet been determined, including the ultimate remedy selected by the EPA, the
number and financial viability of the other members of the KRSG as well as of
other PRPs outside the KRSG, and the determination of the final allocation among
the members of the KRSG and other PRPs. Recently, the EPA identified a number of
private entities and municipalities and sent them formal requests for
information regarding their possible connection with the Kalamazoo site. The EPA
is in the process of evaluating the responses to the information requests and
considering whether to send information requests to other parties.
On January 16, 2002, Slidell Inc. ("Slidell") filed a lawsuit against
Millennium Inorganic Chemicals alleging breach of contract and other related
causes of action, including a violation of the Uniform Trade Secret Act, arising
out of a contract between the two parties for the supply of packaging equipment.
In the suit, Slidell seeks unspecified monetary damages in excess of the
statutory minimum. The Company believes it has substantial defenses to each of
the causes of actions alleged and has filed a counterclaim against Slidell for
recovery of money it has already paid for the equipment plus other direct
damages arising out of Slidell's breach of its contractual obligations. The
trial in this matter was expected to take place in the fourth quarter of 2004,
but was recently postponed and is now tentatively set for trial on January 16,
2005.
The Company believes that the reasonably probable and estimable range of
potential liability for environmental and other legal contingencies,
collectively, but which primarily relates to environmental remediation
activities, is between $44 and $72 and has accrued $57 as of September 30, 2004.
Expenses or benefits associated with these contingencies, including changes in
estimated costs to resolve these contingencies, are included in the Company's
S,D&A expense. Expenses resulting from changes in estimated liabilities for
these contingencies for the three months and nine months ended September 30,
2004 were $2 and $8, respectively, and for the three months and nine months
ended September 30, 2003 were insignificant. The Company expects that cash
expenditures related to these potential liabilities will be made over a number
of years, and will not be concentrated in any single year. This accrual also
reflects the fact that certain Company subsidiaries have contractual obligations
to indemnify other parties against certain environmental and other liabilities.
For example, the Company agreed as part of its spin-off from Hanson plc
("Hanson") to indemnify Hanson and certain of its subsidiaries against certain
of such contractual indemnification
21
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
obligations, and Millennium Petrochemicals agreed as part of the December 1,
1997 formation of Equistar to indemnify Equistar for certain liabilities related
to the assets contributed by Millennium Petrochemicals to Equistar in excess of
$7, which threshold was exceeded in 2001. The terms of these indemnification
agreements do not limit the maximum potential future payments to the indemnified
parties. The maximum amount of future indemnification payments is dependent upon
many factors and is not practicable to estimate.
No assurance can be given that actual costs for environmental matters
will not exceed accrued amounts or that estimates made with respect to
indemnification obligations will be accurate. In addition, it is possible that
costs will be incurred with respect to contamination, indemnification
obligations or other environmental matters that currently are unknown or as to
which it is currently not possible to make an estimate.
Note 14 - Operations by Business Segment
The Company's principal operations are managed and grouped as three
separate business segments: Titanium Dioxide and Related Products, Acetyls and
Specialty Chemicals. Operating income and expense not identified with the three
separate business segments, including certain of the Company's S,D&A expense not
allocated to its three business segments, employee-related costs from
predecessor businesses and certain other expenses, are grouped under the heading
Other. The following is a summary of the Company's operations by business
segment:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net sales
Titanium Dioxide and Related Products............. $ 342 $ 293 $ 1,038 $ 874
Acetyls........................................... 115 115 322 316
Specialty Chemicals............................... 23 23 73 72
-------------- -------------- -------------- --------------
Total........................................... $ 480 $ 431 $ 1,433 $ 1,262
============== ============== ============== ==============
Operating income (loss)
Titanium Dioxide and Related Products............. $ 26 $ 7 $ 48 $ 51
Acetyls........................................... 19 6 30 18
Specialty Chemicals............................... 1 (1) 5 3
Other............................................. (1) (17) (14) (26)
-------------- -------------- -------------- --------------
Total........................................... $ 45 $ (5) $ 69 $ 46
============== ============== ============== ==============
Depreciation and amortization
Titanium Dioxide and Related Products............. $ 20 $ 24 $ 58 $ 69
Acetyls........................................... 2 2 8 8
Specialty Chemicals............................... 2 2 6 6
-------------- -------------- -------------- --------------
Total........................................... $ 24 $ 28 $ 72 $ 83
============== ============== ============== ==============
Capital expenditures
Titanium Dioxide and Related Products............. $ 14 $ 9 $ 35 $ 26
Acetyls........................................... -- 1 2 1
Specialty Chemicals............................... 1 -- 1 2
-------------- -------------- -------------- --------------
Total........................................... $ 15 $ 10 $ 38 $ 29
============== ============== ============== ==============
September 30, December 31,
2004 2003
------------- ---------------
Goodwill
Titanium Dioxide and Related Products............. $ 56 $ 56
Acetyls........................................... 48 48
-------------- --------------
Total........................................... $ 104 $ 104
============== ==============
22
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 15 - Information on Equistar
The following is summarized financial information for Equistar:
September 30, December 31,
2004 2003
------------- --------------
Current assets.......................................................... $ 1,491 $ 1,261
Noncurrent assets....................................................... 3,634 3,767
------------- --------------
Total assets......................................................... $ 5,125 $ 5,028
============= ==============
Current liabilities..................................................... $ 815 $ 754
Noncurrent liabilities.................................................. 2,692 2,673
Partners' capital....................................................... 1,618 1,601
------------- --------------
Total liabilities and partners' capital.............................. $ 5,125 $ 5,028
============= ==============
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------- -------------- ------------ ---------------
Net sales................................................ $ 2,439 $ 1,642 $ 6,500 $ 4,880
Operating income (loss).................................. 129 12 289 (60)
Net income (loss)........................................ 72 (40) 120 (235)
On March 31, 2003, Equistar completed transactions involving a 15-year
propylene supply arrangement and the sale of a polypropylene production facility
in Pasadena, Texas. Equistar received total cash proceeds of $194, including the
value of the polypropylene inventory sold. Approximately $159 of the total cash
proceeds represented a partial prepayment for product to be delivered under a
long-term supply arrangement, primarily at cost-based prices. Equistar will
recognize this deferred revenue over 15 years, as the associated product is
delivered. Equistar's results for the nine months ended September 30, 2003,
include a $12 loss on the sale of the polypropylene production facility.
In April 2003, Equistar issued $450 of 10.625% senior notes due in 2011.
The proceeds, net of associated fees, were used to prepay $300 of 8.5% notes due
in the first quarter of 2004, approximately $122 of the $296 of the then
outstanding term loans under Equistar's credit facility and prepayment premiums
of approximately $17. Equistar's results for the nine months ended September 30,
2003, include $19 of debt prepayment costs, consisting of the $17 prepayment
premium and the write-off of $2 of unamortized debt issuance costs related to
the prepaid term loan.
In August 2004, Equistar made cash distributions to its owners, totaling
$100. The Company received $30 for its share of this cash distribution.
Note 16 - Supplemental Financial Information
Millennium America is a holding company for all of the Company's
operating subsidiaries other than its operations in the United Kingdom, France,
Brazil and Australia. Millennium America is the issuer of the 7% Senior Notes,
the 7.625% Senior Debentures, and the 9.25% Senior Notes, and is the principal
borrower under the Credit Agreement. Millennium Chemicals is the issuer of the
4% Convertible Senior Debentures. Millennium America fully and unconditionally
guarantees all obligations under the Credit Agreement and the 4.00% Convertible
Senior Debentures. The 7% Senior Notes, the 7.625% Senior Debentures and the
9.25% Senior Notes, as well as outstanding amounts under the Credit Agreement,
are fully and unconditionally guaranteed by Millennium Chemicals. Accordingly,
the following Condensed Consolidating Balance Sheets at September 30, 2004 and
December 31, 2003, the Condensed Consolidating Statements of Operations for the
three months and nine months ended September 30, 2004 and 2003, and the
Condensed Consolidating Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003, are provided for the Company as supplemental
financial information to the Company's consolidated financial statements to
disclose the financial position, results of operations and cash flows of (i)
Millennium Chemicals, (ii) Millennium America, and (iii) all subsidiaries of
Millennium Chemicals other than Millennium America (the "Non-Guarantor
Subsidiaries"). The investment in subsidiaries of Millennium America and
Millennium Chemicals are accounted for by the equity method; accordingly, the
shareholders' deficit of Millennium America and Millennium Chemicals are
presented as if each of those companies and their respective subsidiaries were
reported on a consolidated basis.
23
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 16 - Supplemental Financial Information - Continued
Millennium
Condensed Consolidating Millennium Millennium Non-Guarantor Chemicals Inc.
Balance Sheets America Inc. Chemicals Inc. Subsidiaries Eliminations and Subsidiaries
------------ -------------- ------------ ------------ ----------------
September 30, 2004
------------------
ASSETS
Inventories ......................... $ -- $ -- $ 370 $ -- $ 370
Other current assets ................ 106 -- 620 -- 726
Property, plant and equipment, net .. -- -- 719 -- 719
Investment in Equistar .............. -- -- 475 -- 475
Investment in subsidiaries .......... 364 132 -- (496) --
Other assets ........................ 8 3 31 -- 42
Goodwill ............................ -- -- 104 -- 104
Due from parent and affiliates, net.. 645 -- -- (645) --
------- ------- ------- ------- -------
Total assets ..................... $ 1,123 $ 135 $ 2,319 $(1,141) $ 2,436
======= ======= ======= ======= =======
LIABILITIES AND SHAREHOLDERS'
(DEFICIT) EQUITY
Current maturities of long-term debt $ -- $ -- $ 6 $ -- $ 6
Other current liabilities ........... 33 2 401 -- 436
Long-term debt ...................... 1,238 150 13 -- 1,401
Deferred income taxes ............... -- -- 276 -- 276
Other liabilities ................... -- -- 314 -- 314
Due to parent and affiliates, net ... -- 10 635 (645) --
------- ------- ------- ------- -------
Total liabilities ................ 1,271 162 1,645 (645) 2,433
Minority interest ................... -- -- 30 -- 30
Shareholders' (deficit) equity ...... (148) (27) 644 (496) (27)
------- ------- ------- ------- -------
Total liabilities and
shareholders' (deficit) equity.. $ 1,123 $ 135 $ 2,319 $(1,141) $ 2,436
======= ======= ======= ======= =======
December 31, 2003
-----------------
ASSETS
Inventories ......................... $ -- $ -- $ 457 $ -- $ 457
Other current assets ................ 24 1 526 -- 551
Property, plant and equipment, net .. -- -- 766 -- 766
Investment in Equistar .............. -- -- 469 -- 469
Investment in subsidiaries .......... 369 95 -- (464) --
Other assets ........................ 12 3 36 -- 51
Goodwill ............................ -- -- 104 -- 104
Due from parent and affiliates, net . 733 -- -- (733) --
------- ------- ------- ------- -------
Total assets ..................... $ 1,138 $ 99 $ 2,358 $(1,197) $ 2,398
======= ======= ======= ======= =======
LIABILITIES AND SHAREHOLDERS'
(DEFICIT) EQUITY
Current maturities of long-term debt $ -- $ -- $ 6 $ -- $ 6
Other current liabilities ........... 9 1 355 -- 365
Long-term debt ...................... 1,295 150 16 -- 1,461
Deferred income taxes ............... -- -- 272 -- 272
Other liabilities ................... -- -- 325 -- 325
Due to parent and affiliates, net ... -- 6 727 (733) --
------- ------- ------- ------- -------
Total liabilities ................ 1,304 157 1,701 (733) 2,429
Minority interest ................... -- -- 27 -- 27
Shareholders' (deficit) equity ...... (166) (58) 630 (464) (58)
------- ------- ------- ------- -------
Total liabilities and
shareholders' (deficit) equity . $ 1,138 $ 99 $ 2,358 $(1,197) $ 2,398
======= ======= ======= ======= =======
24
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 16 - Supplemental Financial Information - Continued
Millennium
Condensed Consolidating Millennium Millennium Non-Guarantor Chemicals Inc.
Statements of Operations America Inc. Chemicals Inc. Subsidiaries Eliminations and Subsidiaries
------------ -------------- ------------ ------------ ----------------
Three Months Ended
September 30, 2004
------------------
Net sales .................... $ -- $ -- $ 480 $ -- $ 480
Cost of products sold ........ -- -- 373 -- 373
Depreciation and amortization -- -- 24 -- 24
Selling, development and
administrative expense .... -- -- 33 -- 33
Asset impairment charges ..... -- -- 3 -- 3
Combination costs ............ -- -- 1 -- 1
Reorganization and office
closure costs ............. -- -- 1 -- 1
----- ----- ----- ----- -----
Operating income .......... -- -- 45 -- 45
Interest (expense) income, net (23) (2) 1 -- (24)
Intercompany interest income
(expense), net ............ 25 -- (25) -- --
Earnings on Equistar
investment ................ -- -- 22 -- 22
Equity in earnings of
subsidiaries .............. 20 26 -- (46) --
Other expense, net ........... -- -- (1) -- (1)
Provision for (benefit from)
income taxes .............. (1) 4 (17) -- (14)
----- ----- ----- ----- -----
Net income ................ $ 21 $ 28 $ 25 $ (46) $ 28
===== ===== ===== ===== =====
Three Months Ended
September 30, 2003
------------------
Net sales .................... $ -- $ -- $ 431 $ -- $ 431
Cost of products sold ........ -- -- 362 -- 362
Depreciation and amortization -- -- 28 -- 28
Selling, development and
administrative expense .... -- 1 30 -- 31
Reorganization and office
closure costs ............. -- -- 15 -- 15
----- ----- ----- ----- -----
Operating loss ............ -- (1) (4) -- (5)
Interest (expense) income,
net ....................... (24) -- 1 -- (23)
Intercompany interest income
(expense), net ............ 25 -- (25) -- --
Loss on Equistar investment .. -- -- (12) -- (12)
Equity in loss of subsidiaries (10) (28) -- 38 --
Other income, net ............ -- -- 1 -- 1
Benefit from income taxes .... -- 1 10 -- 11
----- ----- ----- ----- -----
Net loss .................. $ (9) $ (28) $ (29) $ 38 $ (28)
===== ===== ===== ===== =====
25
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 16 - Supplemental Financial Information - Continued
Millennium
Condensed Consolidating Millennium Millennium Non-Guarantor Chemicals Inc.
Statements of Operations America Inc. Chemicals Inc. Subsidiaries Eliminations and Subsidiaries
------------ -------------- ------------ ------------ ----------------
Nine Months Ended
September 30, 2004
------------------
Net sales ................... $ -- $ -- $ 1,433 $ -- $ 1,433
Cost of products sold ....... -- -- 1,174 -- 1,174
Depreciation and amortization -- -- 72 -- 72
Selling, development and
administrative expense ... 1 -- 98 -- 99
Asset impairment charges .... -- -- 11 -- 11
Combination costs ........... -- -- 5 -- 5
Reorganization and office
closure costs ............ -- -- 3 -- 3
------ ------- ------- ------- -------
Operating (loss) income .. (1) -- 70 -- 69
Interest (expense) income,
net ...................... (70) (5) 2 -- (73)
Intercompany interest income
(expense), net ........... 76 (1) (75) -- --
Earnings on Equistar
investment ............... -- -- 36 -- 36
Equity in earnings of
subsidiaries ............. -- 12 -- (12) --
Other expense, net .......... -- -- (6) -- (6)
(Provision for) benefit from
income taxes ............. (2) 5 (18) -- (15)
------ ------- ------- ------- -------
Net income ............... $ 3 $ 11 $ 9 $ (12) $ 11
====== ======= ======= ======= =======
Nine Months Ended
September 30, 2003
------------------
Net sales ................... $ -- $ -- $ 1,262 $ -- $ 1,262
Cost of products sold ....... -- -- 1,019 -- 1,019
Depreciation and amortization -- -- 83 -- 83
Selling, development and
administrative expense ... -- 1 97 -- 98
Reorganization and office
closure costs ............ -- -- 16 -- 16
------ ------- ------- ------- -------
Operating (loss) income .. -- (1) 47 -- 46
Interest (expense) income,
net ...................... (69) -- 1 -- (68)
Intercompany interest income
(expense), net ........... 73 (2) (71) -- --
Loss on Equistar investment . -- -- (69) -- (69)
Equity in loss of
subsidiaries ............. (70) (61) -- 131 --
Other expense, net .......... -- -- (4) -- (4)
(Provision for) benefit from
income taxes ............. (1) 1 32 -- 32
Cumulative effect of
accounting change ........ 1 (1) (1) -- (1)
------ ------- ------- ------- -------
Net loss ................. $ (66) $ (64) $ (65) $ 131 $ (64)
====== ======= ======= ======= =======
26
MILLENNIUM CHEMICALS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--(CONTINUED)
(Dollars in millions, except share and per share data)
Note 16 - Supplemental Financial Information - Continued
Millennium
Condensed Consolidating Millennium Millennium Non-Guarantor Chemicals Inc.
Statements of Cash Flows America Inc. Chemicals Inc. Subsidiaries Eliminations and Subsidiaries
--------------- ---------------- --------------- -------------- ----------------
Nine Months Ended
September 30, 2004
------------------
Cash flows from operating activities.. $ 27 $ 1 $116 $ -- $ 144
----- ---- ---- ---- -----
Cash flows from investing activities:
Capital expenditures............... -- -- (38) -- (38)
Distribution from Equistar......... -- -- 30 -- 30
Proceeds from sale of property,
plant and equipment.............. -- -- 1 -- 1
----- ---- ---- ---- -----
Cash used in investing activities.. -- -- (7) -- (7)
----- ---- ---- ---- -----
Cash flows from financing activities:
Proceeds from long-term debt, net
of financing costs............... 27 -- 1 -- 28
Repayment of long-term debt........ (79) -- (4) -- (83)
Intercompany....................... 108 (16) (92) -- --
Proceeds from exercise of stock
options.......................... -- 15 -- -- 15
----- ---- ---- ---- -----
Cash provided by (used in)
financing activities............. 56 (1) (95) -- (40)
----- ---- ---- ---- -----
Effect of exchange rate changes on
cash............................... -- -- 7 -- 7
----- ---- ---- ---- -----
Increase in cash and cash equivalents. 83 -- 21 -- 104
Cash and cash equivalents at
beginning of year................... 20 -- 189 -- 209
----- ---- ---- ---- -----
Cash and cash equivalents at end of
period............................. $ 103 $ -- $210 $ -- $ 313
===== ==== ==== ==== =====
Nine Months Ended
September 30, 2003
------------------
Cash flows from operating activities.. $ 21 $ (2) $(68) $ -- $ (49)
----- ---- ---- ---- -----
Cash flows from investing activities:
Capital expenditures............... -- -- (29) -- (29)
----- ---- ---- ---- -----
Cash used in investing activities.. -- -- (29) -- (29)
----- ---- ---- ---- -----
Cash flows from financing activities:
Dividends to shareholders.......... -- (17) -- -- (17)
Proceeds from long-term debt, net
of financing costs............... 354 -- 2 -- 356
Repayment of long-term debt........ (212) -- (8) -- (220)
Intercompany....................... (163) 19 144 -- --
Decrease in notes payable and
other financing liabilities...... -- -- (17) -- (17)
----- ---- ---- ---- -----
Cash (used in) provided by
financing activities............. (21) 2 121 -- 102
----- ---- ---- ---- -----
Effect of exchange rate changes on
cash............................... -- -- 9 -- 9
----- ---- ---- ---- -----
Increase in cash and cash equivalents. -- -- 33 -- 33
Cash and cash equivalents at
beginning of year................... 6 -- 119 -- 125
----- ---- ---- ---- -----
Cash and cash equivalents at end of
period............................. $ 6 $ -- $152 $ -- $ 158
===== ==== ==== ==== =====
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Millennium Chemicals Inc. (the "Company") restated its Consolidated
Balance Sheet and Statement of Shareholders' Equity at December 31, 2003 to
correct errors in the computation of its deferred income taxes relating to its
Equistar investment. This restatement decreased the Company's liability for
deferred income taxes at December 31, 2003 and decreased Shareholders' deficit
by $15 million. The Company's December 31, 2003 restated financial statements
are included in Amendment No. 2 to its Annual Report on Form 10-K for the year
ended December 31, 2003 filed with the Securities and Exchange Commission on
August 9, 2004.
Disclosure Concerning Forward-Looking Statements
The statements in this Quarterly Report that are not historical facts
are, or may be deemed to be, "forward-looking statements" ("Cautionary
Statements") as defined in the Private Securities Litigation Reform Act of 1995.
Some of these statements can be identified by the use of forward-looking
terminology such as "prospects," "outlook," "believes," "estimates," "intends,"
"may," "will," "should," "anticipates," "expects," or "plans," or the negative
or other variation of these or similar words, or by discussion of trends and
conditions, strategy or risks and uncertainties. In addition, from time to time,
the Company or its representatives have made or may make forward-looking
statements in other filings that the Company makes with the Securities and
Exchange Commission, in press releases or in oral statements made by or with the
approval of one of its authorized executive officers.
These forward-looking statements are only present expectations as at the
time of the filing of this Quarterly Report. Actual events or results may differ
materially. Factors that could cause such a difference include:
o the ability of the Company to complete its proposed business
combination with Lyondell Chemical Company ("Lyondell"), as described
in more detail in "Agreement for a Stock-for-Stock Business
Combination" below;
o the cyclicality and volatility of the chemical industries in which the
Company and Equistar Chemicals, LP ("Equistar") operate, particularly
fluctuations in the demand for ethylene, its derivatives and acetyls
and the sensitivity of these industries to capacity additions;
o general economic conditions in the geographic regions where the
Company and Equistar generate sales, and the impact of government
regulation and other external factors, in particular, the events in
the Middle East;
o the ability of Equistar to distribute cash to its partners and
uncertainties arising from the Company's shared control of Equistar
and the Company's contractual commitments regarding possible future
capital contributions to Equistar;
o changes in the cost of energy and raw materials, particularly natural
gas and ethylene, and the ability of the Company and Equistar to pass
on cost increases to their customers;
o the ability of raw material suppliers to fulfill their commitments;
o the ability of the Company and Equistar to achieve their productivity
improvement, cost reduction and working capital targets, and the
occurrence of operating problems at manufacturing facilities of the
Company or Equistar;
o risks of doing business outside the United States, including currency
fluctuations;
o the cost of compliance with the extensive environmental regulations
affecting the chemical industry and exposure to liabilities for
environmental remediation and other environmental matters relating to
the Company's and Equistar's current and former operations;
o pricing and other competitive pressures;
o legal proceedings relating to present and former operations (including
proceedings based on alleged exposure to lead-based paints and lead
pigments, asbestos and other materials), ongoing or future tax audits,
and other claims; and
o the Company's substantial indebtedness and its impact on the Company's
cash flow, business operations and ability to obtain additional
financing.
28
Some of these Cautionary Statements are discussed in more detail in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in this Quarterly Report. Readers are cautioned not to place undue
reliance on forward-looking or Cautionary Statements, which reflect management's
opinions only as of the date hereof. The Company undertakes no obligation to
update any forward-looking or Cautionary Statement. All subsequent written and
oral forward-looking statements attributable to the Company or persons acting on
behalf of the Company are expressly qualified in their entirety by the
Cautionary Statements in this Quarterly Report. Readers are advised to consult
any further disclosures the Company may make on related subjects in subsequent
10-Q, 8-K and 10-K reports, including amendments thereto, to the Securities and
Exchange Commission.
Agreement for a Stock-for-Stock Business Combination
On March 29, 2004, Lyondell and the Company announced that their Boards
of Directors had approved, and the companies had executed an agreement and plan
of merger. The proposed transaction is intended to qualify as a reorganization
for U.S. federal income tax purposes, in which Millennium shareholders generally
will not recognize gain or loss, other than any gain or loss recognized on the
receipt of cash for fractional shares.
The proposed transaction is subject to approval by both companies'
shareholders and other customary conditions. The Company and Lyondell have
obtained amendments to the Company's and Lyondell's respective bank credit
agreements and Lyondell's accounts receivable sales facility to permit the
transaction. The Company and Lyondell will each hold special meetings of
shareholders on November 30, 2004 to consider and vote on the proposed
transaction. The transaction is expected to close after the close of business on
November 30, 2004; however, there can be no assurance that the transaction will
close. The transaction involves the merger of Millennium Subsidiary LLC, a newly
created subsidiary of the Company, into the Company, in which the Company's
Common Stock now held by its public shareholders will be converted into common
stock of Lyondell, and the Company's preferred stock to be issued to Lyondell
immediately before the merger will be converted into common stock of the
Company, as the surviving entity in the merger. As a result of the transaction,
the Company will become a wholly-owned subsidiary of Lyondell. After the closing
of the transaction, the combined company will be called "Lyondell Chemical
Company" and will be headquartered in Houston, Texas. Dan F. Smith, Lyondell's
current President and Chief Executive Officer, and Dr. William T. Butler,
Lyondell's Chairman of the Board of Directors, will each continue in their
respective roles. Two independent members of the Company's current Board of
Directors, Worley H. Clark, Jr. and David J.P. Meachin, will join the Lyondell
Board of Directors, effective at the time of the closing.
The Company's shareholders will receive between 0.95 and 1.05 shares of
Lyondell common stock for each share of the Company's Common Stock, depending on
the average of the volume-weighted average price of Lyondell shares for the 20
trading days ending on the third trading day before the consummation of the
transaction. The Company's shareholders will receive 0.95 shares of Lyondell
common stock if the average price of Lyondell shares during the period is $20.50
per share or greater, and 1.05 shares if it is $16.50 per share or less. If the
average price is between these two amounts, the exchange ratio will vary
proportionately. The shares of Lyondell common stock received in exchange for
Company stock will be entitled to receive the same cash dividend as existing
outstanding Lyondell shares. The proposed transaction is scheduled to close
after the close of business on November 30, 2004, after the record date of
Lyondell's regular fourth quarter dividend, and therefore the Company's
shareholders will not receive this dividend. As of October 1, 2004, the
Company's 4.00% convertible senior debentures (the "4.00% Convertible Senior
Debentures") are convertible at a conversion price of approximately $13.63 per
share of the Company's Common Stock. If any of the 4.00% Convertible Senior
Debentures are converted prior to the consummation of the proposed transaction,
the shares of Company Common Stock received upon conversion of such debentures
will be exchanged for Lyondell common stock according to the ratio set forth
above. If not exchanged prior to the closing of the proposed transaction, the
4.00% Convertible Senior Debentures will be convertible into Lyondell common
stock in accordance with the terms of the convertible debenture indenture
following the closing of the transaction.
In connection with the proposed transaction, Lyondell filed with the
Securities and Exchange Commission, on September 30, 2004, an amendment to its
registration statement on Form S-4 (as amended, the "Form S-4"), which was
declared effective October 1, 2004. The definitive joint proxy
statement/prospectus was filed with the Securities and Exchange Commission on
October 15, 2004 and mailed to holders of Lyondell's and the Company's common
stock on or about October 25, 2004. Investors and security holders are urged to
read that document and any other relevant documents filed or that will be filed
with the Securities and Exchange Commission, because they contain, or will
contain, important information to an investor. Investors and security holders
may obtain a free copy of the definitive joint proxy statement/prospectus and
other documents filed by Lyondell and the Company with the Securities and
Exchange Commission at the Securities and Exchange Commission web site at
www.sec.gov. The definitive joint proxy statement/prospectus and the other
documents filed by the Company may be obtained free from the Company by calling
29
the Company's Investor Relations Department at (410) 229-8113. The definitive
joint proxy statement/prospectus and the other documents filed by Lyondell may
be obtained free from Lyondell by calling Lyondell's Investor Relations
Department at (713) 309-4590.
The respective executive officers and directors of Lyondell and the
Company and other persons may be deemed to be participants in the solicitation
of proxies in respect of the proposed transaction. Information regarding
Lyondell's and the Company's executive officers and directors is available in
the definitive proxy statement, dated October 2004, filed with the Securities
and Exchange Commission by Lyondell and the Company and in the Form S-4, and
additional information regarding the Company's directors and executive officers
is available in Amendment No. 1 to its Annual Report on Form 10-K for the year
ended December 31, 2003, filed with the Securities and Exchange Commission on
April 27, 2004. Other information regarding the participants in the proxy
solicitation and a description of their direct and indirect interests, by
security holdings or otherwise, are contained in the definitive joint proxy
statement/prospectus and other relevant materials filed with the Securities and
Exchange Commission, as they become available.
For the three months and nine months ended September 30, 2004, the
Company incurred approximately $1 million and $5 million, respectively, of
professional services costs in connection with the proposed combination, which
are included in Combination costs in the accompanying unaudited Consolidated
Statements of Operations.
Cost Reduction Program; Suspension of Dividend
On July 21, 2003, the Company announced that it would implement a program
to reduce costs. This program included a reduction of approximately 5% in the
number of the Company's employees worldwide. The Company closed its executive
offices in Red Bank, New Jersey, effective September 1, 2003, and relocated its
headquarters to Hunt Valley, Maryland, where the Company had existing
administrative offices. In addition, the Company announced the suspension of
payment of dividends on its Common Stock. Given the volatile industry in which
it operates, the Company initiated these actions to reduce expenses and
strengthen its balance sheet.
The Company expects to realize approximately $20 million of annual
operating expense savings from the cost reduction program announced on July 21,
2003. The Company has recorded cumulative charges related to the program of $21
million (including $1 million and $3 million, respectively, for the three months
and nine months ended September 30, 2004), of which $20 million was for
severance-related costs and $1 million was for contractual commitments for
ongoing lease costs, net of expected sublease income, associated with the
closure of the Red Bank, New Jersey office for the remaining term of the lease
agreement ("Red Bank Office lease costs"). Cumulative cash payments of $24
million for the implementation of this program, of which $23 million were for
severance-related costs and $1 million was for Red Bank Office lease costs,
were made through September 30, 2004, including $1 million and $10 million in
the three months and nine months ended September 30, 2004, respectively.
Substantially all of the remainder of the cash payments relating to this
program, which are estimated to be approximately $3 million, will be disbursed
during the next several quarters. No significant charges associated with this
program are expected in future periods. The cumulative charges of $21 million
associated with the cost reduction program are less than the cumulative cash
payments of $24 million because some of the cash payments made under the
program, primarily for retirement benefits, were related to expenses and
liabilities that were recorded through the normal course of business in
periods prior to the implementation of this program in mid-2003.
Operating Results
The Company's principal operations are grouped into three business
segments: Titanium Dioxide and Related Products, Acetyls, and Specialty
Chemicals. Operating income and expense not identified with the three separate
business segments, including certain of the Company's S,D&A expense not
allocated to its three business segments, employee-related costs from
predecessor businesses and certain other expenses, are grouped under the heading
Other. The Company also holds a 29.5% interest in Equistar, which is accounted
for using the equity method (see Note 1 to the unaudited Consolidated Financial
Statements included in this Quarterly Report.) A discussion of Equistar's
financial results for the relevant period is included below, as the Company's
interest in Equistar represents a significant component of the Company's assets
and Equistar's results can have a significant effect on the Company's
consolidated results of operations.
The following information should be read in conjunction with the
Company's Consolidated Financial Statements and Notes thereto and the discussion
included in its Annual Report on Form 10-K for the year ended December 31, 2003,
as amended by Amendments No. 1 through 4 on Form 10-K/A filed with the
Securities and Exchange Commission ("Annual Report on Form 10-K").
30
Results of Consolidated Operations
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ------------ ------------ ------------
(Millions, except share data)
Net sales.................................................. $ 480 $ 431 $1,433 $1,262
Operating income (loss).................................... 45 (5) 69 46
Earnings (loss) on Equistar investment..................... 22 (12) 36 (69)
Income (loss) before income taxes, minority interest and
cumulative effect of accounting change................... 44 (38) 31 (90)
Income (loss) before cumulative effect of accounting change 28 (28) 11 (63)
Net income (loss).......................................... 28 (28) 11 (64)
Basic income (loss) per share:
Before cumulative effect of accounting change............ 0.43 (0.44) 0.17 (0.98)
After cumulative effect of accounting change............. 0.43 (0.44) 0.17 (1.00)
Diluted income (loss) per share:...........................
Before cumulative effect of accounting change............ 0.38 (0.44) 0.17 (0.98)
After cumulative effect of accounting change............. 0.38 (0.44) 0.17 (1.00)
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
The Company reported net income of $28 million or $0.43 per share for the
three months ended September 30, 2004 and a net loss of $28 million or $0.44 per
share for the corresponding period in 2003. The Company's income before income
taxes, minority interest and cumulative effect of accounting change ("pre-tax
income") increased $82 million in the third quarter of 2004 compared to the
corresponding period in 2003, primarily due to a $50 million increase in
operating income and a $34 million improvement in earnings (loss) from the
Company's investment in Equistar, partially offset by a $1 million increase in
net interest expense and a $1 million decrease in other income, net.
The Company's operating income for the third quarter of 2004 of $45
million increased by $50 million, from an operating loss of $5 million in the
third quarter of 2003, due to increases in operating income of $19 million in
the Titanium Dioxide and Related Products business segment, $13 million in the
Acetyls business segment and $2 million in the Specialty Chemicals business
segment, and a $16 million decrease in Other operating loss not identified with
the three business segments. Other operating loss not identified with the three
business segments for the third quarter of 2003 included $15 million of
reorganization and office closure costs compared to $1 million for the third
quarter of 2004 (see "Cost Reduction Program; Suspension of Dividend" above).
Net sales of $480 million in the third quarter of 2004 increased by $49
million, or 11%, from the same period in the prior year. The increase was
primarily due to higher sales volumes and the favorable effect of foreign
currency strength against the U.S. dollar in the Titanium Dioxide and Related
Products business segment and higher average selling prices in the Acetyls
business segment.
Manufacturing and other costs of sales were generally lower in the third
quarter of 2004 compared to the corresponding quarter of the prior year.
Manufacturing and other costs of sales in the Titanium Dioxide and Related
Products business segment were lower in the third quarter of 2004 primarily due
to higher fixed cost absorption as a result of higher production volume and
lower raw material and utility costs, partially offset by the unfavorable effect
of translating manufacturing costs incurred in stronger foreign currencies into
U.S. dollars. Manufacturing and other costs of sales in the Acetyls business
segment were higher in the third quarter of 2004 primarily due to higher
feedstock costs.
S,D&A expense of $33 million in the third quarter of 2004 increased by $2
million from the third quarter of 2003.
Asset impairment charges in the third quarter of 2004 of $3 million
primarily related to the write-off of expenditures for property, plant and
equipment at the Company's Le Havre, France titanium dioxide ("TiO[u]2")
31
manufacturing plant. In the fourth quarter of 2003, the carrying value of the
property, plant and equipment at the Le Havre manufacturing plant was determined
to be impaired, and a charge was required to write down the basis in those
assets to zero. Capital expenditures at this plant for the three months ended
September 30, 2004 were capitalized as property, plant and equipment and then
immediately written off as asset impairment charges as a result of evaluating
those assets for impairment under the guidance of Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS No. 144"). Because the basis of all of the
property, plant and equipment for this plant was written down to zero, no
depreciation expense for this plant was recorded in manufacturing and other
costs of sales.
Combination costs in the third quarter of 2004 of $1 million represented
professional services costs incurred in connection with the proposed
stock-for-stock business combination announced on March 29, 2004 that, if
completed, will result in the combination of the Company with Lyondell (see
"Agreement for a Stock-for-Stock Business Combination" above).
The Company reported pre-tax earnings from its investment in Equistar of
$22 million for the three months ended September 30, 2004, an improvement of $34
million compared to the pre-tax loss of $12 million for the three months ended
September 30, 2003. The increase in Equistar's results for the third quarter of
2004 is primarily due to higher selling prices and margins and to higher
sales volume compared to the same period of 2003. The higher selling prices in
the third quarter of 2004 for ethylene and derivatives and for co-products such
as propylene, benzene and fuels more than offset the effect of significantly
higher raw material and energy costs compared to the third quarter of 2003. The
higher raw material and energy costs during the third quarter of 2004 reflected
the effect of 45% higher average benchmark crude oil prices as well as ongoing
high natural gas prices compared to the corresponding period of 2003. As a
result of higher demand, ethylene and derivative sales volume for the third
quarter of 2004 increased by 6% compared to the same period of 2003.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended
September 30, 2003
The Company reported net income of $11 million, or $0.17 per share, for
the nine months ended September 30, 2004 and a net loss of $64 million, or $1.00
per share, for the corresponding period in 2003. The Company's pre-tax income
increased $121 million in the first nine months of 2004 compared to the
corresponding period in 2003, primarily due to a $105 million improvement in
earnings (loss) from the Company's investment in Equistar and a $23 million
increase in operating income, partially offset by a $5 million increase in net
interest expense and a $2 million increase in other expense, net. The net loss
for the first nine months of 2003 included $1 million, or $0.02 per share, for
the cumulative effect of an accounting change as a result of the Company's
adoption of SFAS No. 143, "Accounting for Asset Retirement Obligations" (see
Note 4 to the unaudited Consolidated Financial Statements included in this
Quarterly Report).
The Company's operating income for the nine months ended September 30,
2004 of $69 million increased by $23 million, from $46 million in the same
period of 2003, due to an increase in operating income in the Acetyls and
Specialty Chemicals business segments of $12 million and $2 million,
respectively, and a $12 million decrease in Other operating loss not identified
with the three business segments, partially offset by a decrease in operating
income of $3 million in the Titanium Dioxide and Related Products business
segment. Other operating loss not identified with the three business segments
for the nine months ended September 30, 2003 included $16 million of
reorganization and office closure costs compared to $3 million for the
corresponding period of 2004 (see "Cost Reduction Program; Suspension of
Dividend" above).
Net sales of $1,433 million in the nine months ended September 30, 2004
increased by $171 million, or 14%, from the same period in the prior year. The
increase was primarily due to higher sales volume and the favorable effect of
foreign currency strength against the U.S. dollar in the Titanium Dioxide and
Related Products business segment and higher average selling prices in the
Acetyls business segment.
Manufacturing and other costs of sales were higher in the nine months
ended September 30, 2004 compared to the corresponding nine month period in
2003. Manufacturing and other costs of sales in the Titanium Dioxide and Related
Products business segment were higher in the first nine months of 2004 as a
result of the unfavorable effect of translating local currency manufacturing
costs into a weaker U.S. dollar, partially offset by higher fixed cost
absorption due to higher production volume and lower raw material costs.
Manufacturing and other costs of sales in the Acetyls business segment were
higher in the nine months ended September 30, 2004 primarily due to higher
feedstock costs.
S,D&A expense for the nine months ended September 30, 2004 increased by
$1 million, or 1%, compared to the nine months ended September 30, 2003.
32
Asset impairment charges in the nine months ended September 30, 2004 of
$11 million primarily related to the write-off of expenditures for property,
plant and equipment at the Company's Le Havre, France TiO[u]2 manufacturing
plant. In the fourth quarter of 2003, the carrying value of the property, plant
and equipment at the Le Havre manufacturing plant was determined to be impaired,
and a charge was required to write down the basis in those assets to zero.
Capital expenditures at this plant for the nine months ended September 30, 2004
were capitalized as property, plant and equipment and then immediately written
off as asset impairment charges as a result of evaluating those assets for
impairment under the guidance of SFAS No. 144. Because the basis of all of the
property, plant and equipment for this plant was written down to zero, no
depreciation expense for this plant was recorded in manufacturing and other
costs of sales.
Combination costs in the nine months ended September 30, 2004 of $5
million represented professional services costs incurred in connection with the
proposed stock-for-stock business combination announced on March 29, 2004 that,
if completed, will result in the combination of the Company with Lyondell (see
"Agreement for a Stock-for-Stock Business Combination" above).
The Company reported pre-tax earnings from its investment in Equistar of
$36 million for the nine months ended September 30, 2004, an improvement of $105
million compared to the pre-tax loss of $69 million for the nine months ended
September 30, 2003. The loss in the first nine months of 2003 included the
Company's share of refinancing costs of $6 million and a loss on the sale of a
polypropylene production facility of $4 million. The increase in Equistar's
results for the first nine months of 2004 compared to the same period of 2003 is
primarily due to higher selling prices and margins and to higher sales
volume. The higher selling prices in the first nine months of 2004 for ethylene
and derivatives and for co-products such as propylene, benzene and fuels more
than offset the effect of significantly higher raw material and energy costs
compared to the corresponding period of 2003. The higher raw material and energy
costs during the first nine months of 2004 reflected the effect of 26% higher
average benchmark crude oil prices as well as ongoing high natural gas prices
compared to the corresponding period of 2003. As a result of higher demand,
ethylene and derivative sales volume increased 11% compared to the corresponding
period of 2003.
Outlook for 2004
Operating income for the fourth quarter of 2004 in the Titanium Dioxide
and Related Products business segment is expected to be seasonally lower than
the third quarter of 2004 as the Company expects seasonally lower demand
partially offset by improved pricing. In October of 2004, the average selling
price in U.S. dollar terms increased approximately 5% compared to the average
U.S. dollar selling price in the third quarter of 2004. TiO[u]2 plant operating
rates are expected to be lower than the third quarter of 2004 due to scheduled
plant maintenance activities.
Sales volume in the fourth quarter of 2004 for the Acetyls business
segment is expected to be similar to the third quarter of 2004. However, fourth
quarter results are difficult to forecast due to high and volatile natural gas
prices, which impact both selling prices and cost of goods sold.
Operating income in the fourth quarter of 2004 for the Specialty
Chemicals business segment is expected to be similar to the third quarter of
2004 as business conditions are expected to remain stable.
Industry conditions have continued to strengthen through October 2004.
Product price increase initiatives are underway for almost all Equistar's
products in response to both the strong supply/demand fundamentals and the high
level of and volatility in crude oil and natural gas prices. Solid global sales
volume growth has tightened industry supply/demand conditions, which, in turn,
has led to modest margin improvement despite significant increases in raw
material costs. Subject to the uncertainties of any significant economic
slowdown or global disruption, these industry conditions and resulting improving
cyclical trends are expected to continue. While there is significant uncertainty
related to the potential near-term earnings impacts of raw material price
volatility and seasonality, positive longer-term trends appear to be well
established.
33
Segment Analysis
Titanium Dioxide and Related Products
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ---------------------------
2004 2003 2004 2003
-------------- ------------ ------------ ------------
(Millions)
Net sales.................................................. $342 $293 $1,038 $874
Operating income........................................... 26 7 48 51
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
Operating income in the Titanium Dioxide and Related Products business
segment for the third quarter of 2004 was $26 million, an increase of $19
million, compared to the corresponding quarter of 2003, primarily due to the
favorable effects of lower manufacturing and other costs of sales ($13 million),
higher average selling prices ($8 million), and higher sales volume ($5
million), partially offset by higher S,D&A expense ($4 million). Additionally,
operating income for the third quarter of 2004 included asset impairment charges
of $3 million, primarily related to the write-off of expenditures for property,
plant and equipment at the Company's Le Havre, France manufacturing plant. In
the fourth quarter of 2003, the carrying value of the property, plant and
equipment at the Le Havre manufacturing plant was determined to be impaired, and
a charge was required to write down the basis in those assets to zero. Capital
expenditures at this plant for the three months ended September 30, 2004 were
capitalized as property, plant and equipment and then immediately written off as
asset impairment charges as a result of evaluating those assets for impairment
under the guidance of SFAS No. 144. Because the basis of all the property, plant
and equipment at this plant was written down to zero, no depreciation expense
for this plant was recorded for the three months ended September 30, 2004.
Sales revenue in the third quarter of 2004 of $342 million increased by
$49 million, or 17%, compared to the prior year quarter primarily due to higher
sales volume and the favorable effect of translating sales denominated in
stronger foreign currencies into U.S. dollars. TiO[u]2 sales volume in the third
quarter of 2004 was 15% higher than the prior year quarter. Overall, the Company
estimates that the global TiO[u]2 market demand increased approximately 9% to
11% compared to the third quarter of the prior year due to improved global
economic conditions. The Company's average TiO[u]2 selling price for the third
quarter of 2004 in local currencies was 1% lower than the third quarter of 2003,
and in U.S. dollar terms was 2% higher compared to the third quarter of 2003.
Manufacturing and other costs of sales in the third quarter of 2004 were
lower than the same quarter of 2003 as a result of higher fixed cost absorption
due to higher production volume and lower raw material and utility costs,
partially offset by the unfavorable effect of translating manufacturing costs
incurred in stronger foreign currencies into U.S. dollars. The overall operating
rate of the Company's TiO[u]2 plants was 99% in the third quarter of 2004,
compared to 84% in the same period of 2003. The higher operating rate was
primarily the result of improved reliability and stronger market demand for
TiO[u]2 products. The operating rate for the third quarter of 2004 was based on
an annual nameplate capacity of 670,000 metric tons compared to 690,000 metric
tons in the prior year quarter.
S,D&A expense in the third quarter of 2004 increased by $4 million, or
15%, compared to the same period of 2003, primarily due to higher
employee-related costs and professional services fees.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September
30, 2003
Operating income in the Titanium Dioxide and Related Products business
segment for the nine months ended September 30, 2004 was $48 million, a decrease
of $3 million, or 6%, compared to the corresponding period of 2003 as a result
of the unfavorable effect of higher manufacturing and other costs of sales ($12
million), asset impairment charges ($11 million), higher S,D&A expense ($4
million) and lower average selling prices ($1 million), partially offset by
higher sales volume ($25 million). Operating income for the first nine months of
2004 included asset impairment charges of $11 million, primarily related to the
write-off of expenditures for property, plant and equipment at the Company's Le
Havre, France manufacturing plant. In the fourth quarter of 2003, the carrying
value of the property, plant and equipment at the Le Havre manufacturing plant
was determined to be impaired, and a charge was required to write down the basis
in those assets to zero. Capital expenditures at this plant for the nine months
ended September 30, 2004 were capitalized as property, plant and equipment and
then immediately written off as asset impairment charges as
34
a result of evaluating those assets for impairment under the guidance of SFAS
No. 144. Because the basis of all the property, plant and equipment at this
plant was written down to zero, no depreciation expense for this plant was
recorded for the nine months ended September 30, 2004.
Sales revenue for the nine months ended September 30, 2004 of $1,038
million increased by $164 million, or 19%, compared to the nine months ended
September 30, 2003 primarily due to higher sales volume and the favorable effect
of translating sales denominated in stronger foreign currencies into U.S.
dollars. TiO[u]2 sales volume in the first nine months of 2004 was 19% higher
than in the first nine months of 2003, with increases reported in all major
geographic regions. Overall, the Company estimates that the global TiO[u]2
market demand increased approximately 8% to 10% compared to the first nine
months of the prior year due to improved global economic conditions. The
Company's average TiO[u]2 selling price for the first nine months of 2004 in
local currencies was 5% lower than the same period of 2003, and was 1% lower
than the first nine months of 2003 in U.S. dollar terms.
Manufacturing and other costs of sales in the nine months ended September
30, 2004 were higher than in the corresponding period of 2003 due to the
unfavorable effect of translating manufacturing costs incurred in stronger
foreign currencies into U.S. dollars, partially offset by higher fixed cost
absorption due to higher production volume and lower raw material costs. The
overall operating rate of the Company's TiO[u]2 plants was 95% in the first nine
months of 2004 compared to 89% during the corresponding period of 2003.
Beginning in the second quarter of 2004, the operating rate was based on an
annual nameplate capacity of 670,000 metric tons compared to 690,000 metric tons
in 2003.
S,D&A expense increased in the nine months ended September 30, 2004 by $4
million, or 6%, compared to the nine months ended September 30, 2003, primarily
due to higher employee-related costs and professional services fees.
Acetyls
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------- ------------ ------------ ------------
(Millions)
Net sales.................................................. $115 $115 $322 $316
Operating income........................................... 19 6 30 18
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
Operating income in the Acetyls business segment of $19 million for the
three months ended September 30, 2004 increased by $13 million, compared to
operating income of $6 million for the three months ended September 30, 2003,
primarily due to higher average selling prices ($15 million), partially offset
by higher manufacturing and other costs of sales ($2 million).
Net sales were $115 million in each of the third quarter of 2004 and
2003. The aggregate weighted-average selling price in U.S. dollars for VAM and
acetic acid in the third quarter of 2004 increased 17% compared to the third
quarter of 2003. Aggregate sales volume for VAM and acetic acid for the third
quarter of 2004 was 15% lower than the corresponding period in 2003.
Manufacturing and other costs of sales for VAM and acetic acid in the
third quarter of 2004 were higher than the third quarter of 2003, primarily due
to higher feedstock costs.
S,D&A expense in the third quarter of 2004 was similar to S,D&A expense
in the same period of 2003.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September
30, 2003
Operating income in the Acetyls business segment of $30 million for the
nine months ended September 30, 2004 increased by $12 million, or 67%, compared
to operating income of $18 million in the nine months ended September 30, 2003
as a result of higher average selling prices ($19 million), partially offset by
lower sales volume ($1 million), higher manufacturing and other costs of sales
($5 million) and higher S,D&A expense ($1 million).
Net sales in the nine months ended September 30, 2004 of $322 million
increased $6 million, or 2%, compared to net sales of $316 million in the nine
months ended September 30, 2003. The aggregate weighted-average selling price in
U.S. dollars for VAM and acetic acid increased 7% compared to the corresponding
period in 2003. Aggregate sales volume for VAM and acetic acid in the nine
months ended September 30, 2004 was 2% lower than in the nine months ended
September 30, 2003.
35
Manufacturing and other costs of sales for VAM and acetic acid in the
nine months ended September 30, 2004 were higher primarily due to higher
feedstock costs.
S,D&A expense increased by $1 million in the nine months ended September
30, 2004 compared to the same period of 2003.
Specialty Chemicals
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Millions)
Net sales.................................................. $23 $23 $73 $72
Operating income........................................... 1 (1) 5 3
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
Operating income in the Specialty Chemicals business segment for the
three months ended September 30, 2004 was $1 million, an increase of $2 million,
compared to an operating loss of $1 million for the three months ended September
30, 2003. Higher average selling prices and lower S,D&A expense in the third
quarter of 2004 were partially offset by higher manufacturing and other costs of
sales.
Net sales for the three months ended September 30, 2004 of $23 million
were similar to net sales for the three months ended September 30, 2003. Sales
volume in the third quarter of 2004 was 8% lower than the third quarter of 2003
as sales volume decreased across several product lines. However, the weighted
average selling price for Specialty Chemicals products increased by 10% from the
third quarter of 2003. Despite greater competitive pricing pressure in the third
quarter of 2004 compared to the same period of 2003, proportionally higher sales
volume in higher-priced product lines contributed to the increase in average
selling prices.
Manufacturing and other costs of sales in the third quarter of 2004 were
higher than the third quarter of 2003, primarily due to lower fixed cost
absorption due to lower production volumes caused by decreased plant reliability
and preparation against hurricanes, resulting in unplanned down time and higher
maintenance costs. However, the use of a higher-cost alternative raw material
due to the short supply of crude sulfate turpentine ("CST") in the third quarter
of 2003 did not recur in the third quarter of 2004.
S,D&A expense for the three months ended September 30, 2004 was $1
million lower than the same period of 2003.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September
30, 2003
Operating income in the Specialty Chemicals business segment of $5
million for the nine months ended September 30, 2004 increased by $2 million, or
67%, compared to operating income of $3 million for the nine months ended
September 30, 2003. Higher average selling prices and lower S,D&A expense in the
nine months ended September 30, 2004 were partially offset by higher
manufacturing and other costs of sales.
Net sales for the nine months ended September 30, 2004 of $73 million
increased by $1 million, or 1%, compared to the nine months ended September 30,
2003. Sales volume in the nine months ended September 30, 2004 decreased by 2%
compared to the same period of 2003. However, the weighted average selling price
for Specialty Chemicals products increased by 4% from the nine months ended
September 30, 2003. Despite greater competitive pricing pressure during the nine
months ended September 30, 2004 compared to the same period of 2003,
proportionally higher sales volume in higher-priced product lines contributed to
the increase in average selling prices.
Manufacturing and other costs of sales in the nine months ended September
30, 2004 were higher than the nine months ended September 30, 2003 primarily due
to the higher average cost of CST, overall energy costs and lower fixed cost
absorption due to lower production volumes caused by decreased plant reliability
and preparation against hurricanes resulting in unplanned down time and higher
maintenance costs.
36
S,D&A expense for the nine months ended September 30, 2004 was $2 million
lower than the same period of 2003.
Other
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Millions)
Operating loss............................................. $(1) $(17) $(14) $(26)
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
Operating loss not identified with the three separate business segments
for the three months ended September 30, 2004 was $16 million lower than the
three months ended September 30, 2003 primarily due to lower reorganization and
office closure charges of $14 million associated with the Company's cost
reduction program announced in July 2003 (see "Cost Reduction Program;
Suspension of Dividend" above) and a net reduction of $2 million in other
expenses not allocated to the separate business segments.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September
30, 2003
Operating loss not identified with the three separate business segments
for the nine months ended September 30, 2004 was $12 million lower than the nine
months ended September 30, 2003 primarily due to lower reorganization and office
closure charges of $13 million associated with the Company's cost reduction
program announced in July 2003 (see "Cost Reduction Program; Suspension of
Dividend" above). Additionally, the nine months ended September 30, 2004
included expenses of $8 million resulting from changes in estimated liabilities
for legal and environmental contingencies related to predecessor businesses and
$5 million of professional services costs incurred in connection with the
proposed stock-for-stock business combination announced on March 29, 2004 that,
if completed, will result in the combination of the Company with Lyondell (see
"Agreement for a Stock-for-Stock Business Combination" above). These additional
expenses were substantially offset by a net reduction of $12 million in other
expenses not allocated to the separate business segments largely due to the
elimination of costs through the Company's cost reduction programs since 2003.
Equistar
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Millions)
Income (loss), as reported by Equistar..................... $72 $(40) $120 $(235)
=========== ============ ============ ============
Earnings (loss) on Equistar investment, as reported by the
Company................................................. $22 $(12) $ 36 $ (69)
=========== ============ ============ ============
Three Months Ended September 30, 2004 Compared to the Three Months Ended
September 30, 2003
The Company reported pre-tax earnings from its investment in Equistar of
$22 million for the three months ended September 30, 2004, an improvement of $34
million compared to a pre-tax loss of $12 million for the three months ended
September 30, 2003.
Equistar reported net income of $72 million in the third quarter of 2004
compared to a net loss of $40 million in the third quarter of the prior year.
Net loss for the quarter ended September 30, 2003 included an $11 million charge
for the write-off of a polymer research and development facility. The
improvement in Equistar's results for the third quarter of 2004 compared to the
corresponding period in the prior year is primarily due to higher selling prices
and margins, and to higher sales volume compared to the same period of
2003. The higher selling prices in the third quarter of 2004 for ethylene and
derivatives and for co-products such as propylene, benzene and fuels more than
offset the effect of significantly higher raw material and energy costs compared
to the third quarter of 2003. The higher raw material and energy costs during
the third quarter of 2004 reflected the effect of 45% higher average benchmark
crude oil prices as well as ongoing high natural gas prices compared to the
corresponding period of 2003. As a result of
37
higher demand, ethylene and derivative sales volume for the third quarter of
2004 increased by 6% compared to the same period of 2003.
Equistar's Petrochemicals segment reported operating income of $132
million for the third quarter of 2004, an increase of $66 million compared to
operating income of $66 million in the third quarter of 2003. The increase in
operating income was primarily due to higher product margins and higher sales
volume as a result of improved supply/demand fundamentals in the third quarter
of 2004 compared to the third quarter of the prior year. The effect of selling
price increases in response to higher raw material and energy costs were
generally more favorable in the third quarter of 2004 than in the third quarter
of 2003, resulting in higher average product margins in the third quarter of
2004. Revenues for Equistar's Petrochemicals segment increased 53% in the third
quarter of 2004 compared to the corresponding period in the prior year due to
higher average selling prices and a 13% increase in sales volume. Average
benchmark ethylene, propylene and benzene sales prices increased 20%, 59% and
158%, respectively, in the third quarter of 2004 compared to the third quarter
of 2003. Cost of sales increased 51% as a result of the higher cost of raw
materials and higher sales volume. The cost of liquid raw materials was affected
by 45% higher average benchmark crude oil costs in the third quarter of 2004
compared to the corresponding period of 2003.
Equistar's Polymers segment reported operating income of $32 million for
the third quarter of 2004 compared to an operating loss of $19 million in the
third quarter of 2003. The $51 million improvement in operating results in the
third quarter of 2004 was primarily due to higher product margins and higher
sales volume. The third quarter 2003 included an $11 million charge for the
write-off of a polymer research and development facility. Revenues in Equistar's
Polymers segment in the third quarter of 2004 increased 29% compared to the
corresponding period in the prior year, primarily due to higher average selling
prices and higher sales volume. The increase in average selling prices for the
third quarter of 2004 compared to the corresponding period of 2003 reflected
higher demand and higher raw material costs. Sales volume in the third quarter
of 2004 increased 9% compared to the third quarter of 2003, reflecting stronger
demand. Cost of sales increased 22% in the third quarter of 2004 compared to the
third quarter of 2003, as a result of higher raw material costs, primarily
ethylene along with the increase in sales volume. The benchmark cost of ethylene
was 20% higher in the third quarter of 2004 compared to the third quarter of
2003.
Nine Months Ended September 30, 2004 Compared to the Nine Months Ended September
30, 2003
The Company reported pre-tax earnings from its investment in Equistar of
$36 million for the nine months ended September 30, 2004, an improvement of $105
million compared to a pre-tax loss of $69 million for the nine months ended
September 30, 2003.
Equistar reported net income of $120 million for the nine months ended
September 30, 2004 compared to a net loss of $235 million in the nine months
ended September 30, 2003. Net loss for the first nine months of 2003 included
$19 million of refinancing costs, a $12 million loss from the sale of a
polypropylene production facility and a charge of $11 million for the write-off
of a polymer research and development facility. The improvement in Equistar's
results for the first nine months of 2004 compared to the same period of 2003 is
primarily due to higher selling prices and margins, and to higher sales volume.
The higher selling prices in the first nine months of 2004 for ethylene and
derivatives and for co-products such as propylene, benzene, and fuels more
than offset the effect of significantly higher raw material and energy costs
compared to the corresponding period of 2003. The higher raw material and energy
costs during the first nine months of 2004 reflected the effect of 26% higher
average benchmark crude oil prices as well as ongoing high natural gas prices
compared to the corresponding period of 2003. As a result of higher demand,
ethylene and derivative sales volume increased 11% compared to the corresponding
period of 2003.
Equistar's Petrochemicals segment reported operating income of $372
million for the nine months ended September 30, 2004, an increase of $253
million compared to operating income of $119 million for the nine months ended
September 30, 2003. The increase in operating income for the nine months ended
September 30, 2004 was primarily due to higher product margins and higher sales
volume as a result of improved supply/demand fundamentals compared to the nine
months ended September 30, 2003. The effect of selling price increases in
response to higher raw material and energy costs were generally more favorable
in the first nine months of 2004 compared to the same period in 2003, resulting
in higher average product margins in the first nine months of 2004. Revenues for
Equistar's Petrochemicals segment increased 36% in the first nine months of 2004
compared to the corresponding period in the prior year, due to higher
average selling prices and an 11% increase in sales volume. Average benchmark
ethylene, propylene and benzene selling prices increased 11%, 36% and 70%,
respectively, in the first nine months of 2004 compared to the first nine months
of 2003. Cost of sales increased 31% as a result of the higher cost of raw
38
materials and higher sales volume. The cost of liquid raw materials was affected
by 26% higher average benchmark crude oil costs in the first nine months of 2004
compared to the corresponding period of 2003.
Equistar's Polymers segment reported operating income of $12 million for
the nine months ended September 30, 2004 compared to an operating loss of $81
million for the nine months ended September 30, 2003. The $93 million
improvement in operating results in the first nine months of 2004 was primarily
due to higher product margins and higher sales volume. The operating loss for
the first nine months of 2003 included a $12 million loss on the sale of a
polypropylene production facility in Pasadena, Texas and a charge of $11 million
for the write-off of a polymer research and development facility. Revenues in
Equistar's Polymers segment in the first nine months of 2004 increased 24%
compared to the corresponding period in the prior year, primarily due to higher
average selling prices and higher sales volume. The increase in average selling
prices for the first nine months of 2004 compared to the corresponding period
of 2003 reflected higher demand and higher raw material costs. Sales volume in
the first nine months of 2004 increased 13% compared to the corresponding
period in 2003, reflecting stronger demand. Cost of sales for the first nine
months of 2004 increased 20% compared to the first nine months of 2003, as a
result of higher raw material costs, primarily ethylene, along with the
increase in sales volume. The benchmark cost of ethylene was 11% higher in the
first nine months of 2004 compared to the same period in 2003.
Liquidity and Capital Resources
The Company has historically financed its operations primarily through
cash generated from its operations and cash distributions from Equistar, as well
as debt financings. In the first nine months of 2004, both the domestic and
foreign operations financed their operations through cash generated from those
operations. Cash generated from operations is to a large extent dependent on
economic, financial, competitive and other factors affecting the Company's
businesses. The amount of cash distributions received from Equistar is affected
by Equistar's results of operations and current and expected future cash flow
requirements. The Company received cash distributions of $30 million from
Equistar in the third quarter of 2004, the first such distribution received
since 2000.
Cash provided by operating activities for the nine months ended September
30, 2004 was $144 million compared to $49 million of cash used in the nine
months ended September 30, 2003. The $193 million increase in cash provided by
operating activities was primarily due to favorable movements in trade working
capital (defined as trade accounts receivable, inventory and trade accounts
payable) in the first nine months of 2004 compared to unfavorable movements in
the same period of the prior year ($160 million), accrued expenses and other
liabilities ($47 million), higher operating income before depreciation and
amortization ($12 million), and various other net favorable changes
($10 million), partially offset by unfavorable movements in other current assets
in the first nine months of 2004 compared to favorable movements in the same
period of 2003 ($36 million). The favorable movement in trade working capital in
the first nine months of 2004 compared to the same period in 2003 is primarily
due to the timing of vendor payments and higher sales volume for the Company's
products that has reduced product inventories and increased trade receivables.
Cash used in investing activities was $7 million in the nine months ended
September 30, 2004 compared to $29 million in the nine months ended September
30, 2003. Cash used for capital expenditures in the nine months ended September
30, 2004 was $38 million compared to $29 million used for capital expenditures
in the nine months ended September 30, 2003. The low level of capital spending
in the first nine months of both 2004 and 2003 reflects the Company's continued
focus on optimization of its asset base. Capital spending for 2004 is expected
to be approximately $60 million. During the third quarter of 2004, the Company
received a $30 million cash distribution from Equistar. The Company also
received $1 million in proceeds from the sale of property, plant and equipment
during the third quarter of 2004. The Company expects to finance its planned
capital spending using cash generated from operations and through availability
under its Credit Agreement, if necessary.
Cash used in financing activities was $40 million in the nine months
ended September 30, 2004 compared to cash provided by financing activities of
$102 million in the nine months ended September 30, 2003. Financing activities
in the first nine months of 2004 included $55 million of net repayments of debt,
while the first nine months of 2003 included $119 million of net debt proceeds.
In the first nine months of 2004, the Company repatriated cash of approximately
$107 million from Australia and Europe to the US. This cash was used to reduce
outstanding borrowings under the Company's Credit Agreement and for general
corporate purposes. Dividends paid to shareholders totaled $17 million for the
first two quarters of 2003. No dividends were paid in the third quarter of 2003
or in any period of 2004. In July 2003, the Company announced the suspension of
the payment of dividends on its Common Stock, as more fully described in "Cost
Reduction Program; Suspension of Dividend" above. In the first nine months of
2004, the company received proceeds of $15 million from the exercise of stock
options.
39
The maturities of the Company's long-term debt through 2009 and
thereafter are as follows:
October 1- Total at Total at
December 31, September 30, December 31,
2004 2005 2006 2007 2008 2009 Thereafter 2004 2003
------ ---- ------ ----- ------ ----- ---------- ----- -----
(Millions)
Revolving Loans................ $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 52
7.00% Senior Notes............. -- -- 500 -- -- -- -- 500 500
7.625% Senior Debentures....... -- -- -- -- -- -- 250 250 250
9.25% Senior Notes............. -- -- -- -- 475 -- -- 475 475
4.00% Convertible Senior
Debentures.................. -- -- -- -- -- -- 150 150 150
Other long-term debt........... 3 5 5 3 1 1 3 21 23
------ ---- ------ ----- ------ ----- -------- ----- -----
Maturities of long-term debt... $ 3 $ 5 $ 505 $ 3 $ 476 $ 1 $ 403 1,396 1,450
====== ==== ====== ===== ====== ===== ========
Non-cash components of
long-term debt.............. 11 17
------- --------
Total debt..................... 1,407 1,467
Less: current maturities of
long-term debt.............. (6) (6)
------- --------
Total long-term debt........... $ 1,401 $ 1,461
======= ========
On November 25, 2003, the Company received approximately $125 million in
gross proceeds and, on December 2, 2003, received an additional $25 million in
gross proceeds from the sale by Millennium Chemicals Inc. ("Millennium
Chemicals") of $150 million aggregate principal amount of the 4.00% Convertible
Senior Debentures, which are guaranteed by Millennium America Inc. ("Millennium
America"), a wholly-owned indirect subsidiary of Millennium Chemicals. The gross
proceeds of the sale were used to repay all of the $47 million of outstanding
borrowings at that time under the term loan portion (the "Term Loan") of the
Company's five-year credit agreement expiring June 18, 2006, as amended, (the
"Credit Agreement") and $103 million of outstanding borrowings under the
revolving loan portion (the "Revolving Loans") of its Credit Agreement, which
currently has a maximum availability of $150 million. The Company used $4
million of cash to pay the fees relating to the sale of the 4.00% Convertible
Senior Debentures. Under the terms of the agreements relating to the sale of the
4.00% Convertible Senior Debentures, Millennium Chemicals and Millennium America
agreed to: (1) file with the Securities and Exchange Commission on or before
March 24, 2004 a registration statement covering the resale of the debentures
and the common stock issuable upon conversion thereof pursuant to Rule 415 under
the Securities Act, and (2) use reasonable efforts to cause this registration
statement to be declared effective under the Securities Act of 1933, as amended
(the "Securities Act"), on or before May 23, 2004. On March 23, 2004, Millennium
Chemicals and Millennium America, as guarantor, initially filed a registration
statement with the Securities and Exchange Commission, and on June 16, 2004;
August 19, 2004; September 23, 2004 and September 24, 2004 filed amendments to
this registration statement. The Securities and Exchange Commission declared
this registration statement effective on September 24, 2004. Accordingly,
Millennium Chemicals ceased accruing the additional interest on the debentures
required under the agreement. This interest had accrued from May 24, 2004 until
August 21, 2004, at an annualized rate of 0.25% and from August 22, 2004 until
September 23, 2004 at an annualized rate of 0.50%.
On April 25, 2003, the Company received approximately $107 million in net
proceeds ($109 million in gross proceeds) from the issuance and sale by
Millennium America of $100 million additional principal amount at maturity of
its 9.25% Senior Notes due June 15, 2008 (the "9.25% Senior Notes"), which are
guaranteed by Millennium Chemicals. The net proceeds were used to repay all of
the $85 million of outstanding borrowings at that time under the Revolving Loans
and for general corporate purposes. Under the terms of this issuance and sale,
Millennium America and Millennium Chemicals entered into an exchange and
registration rights agreement with the initial purchasers of the $100 million
additional principal amount of these 9.25% Senior Notes. Pursuant to this
agreement, each of Millennium America and Millennium Chemicals agreed to: (1)
file with the Securities and Exchange Commission on or before July 24, 2003 a
registration statement relating to a registered exchange offer for the notes,
and (2) use its reasonable efforts to cause this exchange offer registration
statement to be declared effective under the Securities Act on or before October
22, 2003. On June 13, 2003, Millennium America and Millennium Chemicals, as
guarantor, initially filed a
40
registration statement with the Securities and Exchange Commission, and on
December 15, 2003; June 25, 2004; July 6, 2004; August 19, 2004; September 23,
2004 and September 24, 2004 filed amended registration statements. The exchange
offer registration statement was declared effective September 24, 2004 and the
exchange offer was completed on October 28, 2004. Upon completion of the
exchange offer, Millennium America ceased accruing the additional interest it
had been obligated to pay since October 23, 2003, at the annualized rate of
approximately 1.00% to each holder of $100 million additional principal amount
of notes.
The Company depends on its Credit Agreement as its primary source of
liquidity for its operations and working capital needs. At October 31, 2004, the
Company had $26 million of outstanding undrawn standby letters of credit and no
outstanding borrowings under the Revolving Loans and, accordingly, had $124
million of unused availability under such facility. At that date, in addition to
letters of credit outstanding under the Credit Agreement, the Company also had
outstanding undrawn standby letters of credit and bank guarantees under other
arrangements of $6 million. The Company had unused availability under short-term
uncommitted lines of credit, other than the Credit Agreement, of $42 million at
October 31, 2004.
The Credit Agreement contains various restrictive covenants and requires
that the Company meet certain financial performance criteria. Compliance with
these covenants is monitored frequently in order to assess the likelihood of
continued compliance. As a result of the restatement of its prior financial
statements as discussed above, the Company obtained a waiver on July 29, 2004
under the Credit Agreement relating to certain representations under the Credit
Agreement regarding such prior financial statements. The Company was in
compliance with all covenants under the Credit Agreement in effect at September
30, 2004.
The financial covenants in the Credit Agreement require the Company to
maintain a Senior Secured Leverage Ratio, defined as the ratio of Senior Secured
Indebtedness, as defined, to cumulative EBITDA for the prior four fiscal
quarters, each as defined, of no more than 1.25 to 1.00 for each of the
remaining quarters of 2004 and 1.00 to 1.00 for the first quarter of 2005 and
thereafter, and an Interest Coverage Ratio, defined as the ratio of cumulative
EBITDA for the prior four fiscal quarters to Net Interest Expense, for the same
period, each as defined, of no less than 1.40 to 1.00 for the third quarter of
2004; 1.50 to 1.00 for the fourth quarter of 2004; and 1.75 to 1.00 for the
first quarter of 2005 and thereafter. The covenants in the Credit Agreement also
limit, among other things, the ability of the Company and/or certain
subsidiaries of the Company to: (i) incur debt and issue preferred stock; (ii)
create liens; (iii) engage in sale/leaseback transactions; (iv) declare or pay
dividends on, or purchase, the Company's stock; (v) make restricted payments;
(vi) engage in transactions with affiliates; (vii) sell assets; (viii) engage in
mergers or acquisitions; (ix) engage in domestic accounts receivable
securitization transactions; and (x) enter into restrictive agreements. In
addition, in the event the Company sells certain assets as specified in the
Credit Agreement and the Leverage Ratio, as defined, is equal to or greater than
3.75 to 1.00, the outstanding Revolving Loans must be prepaid with a portion of
the Net Cash Proceeds, as defined, of such sale and the maximum availability
under the Credit Agreement would be decreased by 50% of the aggregate Net Cash
Proceeds received from such asset sales in excess of $100 million. Any sale
involving Equistar or certain inventory or accounts receivable would reduce the
maximum availability under the Credit Agreement by 100% of such Net Cash
Proceeds received. The obligations under the Credit Agreement are collateralized
by: (1) a pledge of 100% of the stock of the Company's existing and future
domestic subsidiaries and 65% of the stock of certain of the Company's existing
and future foreign subsidiaries, in both cases other than subsidiaries that hold
immaterial assets (as defined in the Credit Agreement); (2) all the equity
interests held by the Company's subsidiaries in Equistar and the La Porte
Methanol Company (which pledges are limited to the right to receive
distributions made by Equistar and the La Porte Methanol Company, respectively);
and (3) all present and future accounts receivable, intercompany indebtedness
and inventory of the Company's domestic subsidiaries, other than subsidiaries
that hold immaterial assets. In connection with the announced stock-for-stock
business combination with Lyondell, the Company obtained an amendment to its
Credit Agreement on July 7, 2004, which will allow the consummation of the
announced stock-for-stock business combination with Lyondell and modifies the
definition of EBITDA to exclude certain transaction costs related to this
business combination.
Millennium America also has outstanding $500 million aggregate principal
amount of 7.00% Senior Notes due November 15, 2006 (the "7.00% Senior Notes")
and $250 million aggregate principal amount of 7.625% Senior Debentures due
November 15, 2026 (the "7.625% Senior Debentures" and, together with the 7.00%
Senior Notes and the 9.25% Senior Notes, the "Senior Notes"), that are fully and
unconditionally guaranteed by Millennium Chemicals. The indenture under which
the 7.00% Senior Notes and 7.625% Senior Debentures were issued contains certain
covenants that limit, among other things: (i) the ability of Millennium America
and its Restricted Subsidiaries (as defined) to grant liens or enter into
sale/leaseback transactions; (ii) the ability of the Restricted Subsidiaries to
incur additional indebtedness; and (iii) the ability of Millennium America and
Millennium Chemicals to merge, consolidate or transfer substantially all of
their respective assets. This indenture allows Millennium America and its
Restricted Subsidiaries, as defined, to grant security on loans of up to 15% of
Consolidated Net Tangible Assets ("CNTA"), as
41
defined, of Millennium America and its consolidated subsidiaries. Accordingly,
based upon CNTA and secured borrowing levels at September 30, 2004, any
reduction in CNTA below approximately $1 billion would decrease the Company's
availability under the Revolving Loans by 15% of any such reduction. CNTA was
approximately $2 billion at September 30, 2004. The 7.00% Senior Notes and the
7.625% Senior Debentures can be accelerated by the holders thereof if any other
debt in excess of $20 million is in default and is accelerated.
The 9.25% Senior Notes were issued by Millennium America and are
guaranteed by Millennium Chemicals. The indenture under which the 9.25% Senior
Notes were issued contains certain covenants that limit, among other things, the
ability of the Company and/or certain subsidiaries of the Company to: (i) incur
additional debt; (ii) issue redeemable stock and preferred stock; (iii) create
liens; (iv) redeem debt that is junior in right of payment to the 9.25% Senior
Notes; (v) sell or otherwise dispose of assets, including capital stock of
subsidiaries; (vi) enter into arrangements that restrict dividends from
subsidiaries; (vii) enter into mergers or consolidations; (viii) enter into
transactions with affiliates; and (ix) enter into sale/leaseback transactions.
In addition, this indenture contains a covenant that would prohibit the Company
from (i) paying dividends or making distributions on its common stock; (ii)
repurchasing its common stock; and (iii) making other types of restricted
payments, including certain types of investments, if such restricted payments
would exceed a "restricted payments basket." Although the Company has no
intention at the present time to pay dividends or make distributions, repurchase
its Common Stock, or make other restricted payments, the Company would be
prohibited by this covenant from doing so at the present time. The indenture
also requires the calculation of a Consolidated Coverage Ratio, defined as the
ratio of the aggregate amount of EBITDA, as defined, for the four most recent
fiscal quarters to Consolidated Interest Expense, as defined, for the four most
recent quarters. The Company must maintain a Consolidated Coverage Ratio of 2.25
to 1.00. Currently, the Company's Consolidated Coverage Ratio is below this
threshold and, therefore, the Company is subject to certain restrictions that
limit the Company's ability to incur additional indebtedness, pay dividends,
repurchase capital stock, make certain other restricted payments, and enter into
mergers or consolidations. However, if the 9.25% Senior Notes were to receive
investment grade credit ratings from both Moody's Investors Service ("Moody's")
and Standard & Poor's ("S&P") and meet certain other requirements as specified
in the indenture, certain of these covenants would no longer apply. The 9.25%
Senior Notes can be accelerated by the holders thereof if any other debt in
excess of $30 million is in default and is accelerated.
The consummation of the announced stock-for-stock business combination
with Lyondell will give each holder of the 9.25% Senior Notes the right to
require the Company to purchase all or part of such holder's securities at a
purchase price in cash equal to 101% of the principal amount thereof plus
accrued and unpaid interest to the date of purchase.
The 4.00% Convertible Senior Debentures were issued by Millennium
Chemicals and are guaranteed by Millennium America. Holders may convert their
debentures into shares of the Company's Common Stock at a conversion price,
subject to adjustment upon certain events, of approximately $13.63 per share,
which is equivalent to a conversion rate of 73.3568 shares per $1,000 principal
amount of debentures. The conversion privilege may be exercised under the
following circumstances:
o prior to November 15, 2018, during any fiscal quarter commencing after
December 31, 2003, if the closing price of the Company's Common Stock
on at least 20 of the 30 consecutive trading days ending on the first
trading day of that quarter is greater than 125% of the then current
conversion price;
o on or after November 15, 2018, at any time after the closing price of
the Company's Common Stock on any date is greater than 125% of the
then current conversion price;
o if the debentures are called for redemption;
o upon the occurrence of specified corporate transactions, including a
consolidation, merger or binding share exchange pursuant to which the
Company's Common Stock would be converted into cash or property other
than securities;
o during the five business-day period after any period of ten
consecutive trading days in which the trading price per $1,000
principal amount of debentures on each day was less than 98% of the
product of the last reported sales price of the Company's Common Stock
and the then current conversion rate; and
o at any time when the long-term credit rating assigned to the
debentures is either Caa1 or lower, in the case of Moody's, or B- or
lower in the case of S&P, or either rating agency has discontinued,
withdrawn or suspended its rating.
42
During the thirty consecutive trading days ending October 1, 2004, the
closing price of the Company's Common Stock was greater than 125% of the current
conversion price per share of Common Stock for at least 20 trading days.
Accordingly, on October 1, 2004, the Company announced that the debentures are
currently convertible into shares of the Company's Common Stock under section
15.01(a)(i) of the indenture.
The debentures are redeemable at the Company's option beginning November
15, 2010 at a redemption price equal to 100% of their principal amount, plus
accrued interest, if any. On November 15 in each of 2010, 2013 and 2018, holders
of debentures will have the right to require the Company to repurchase all or
some of the debentures they own at a purchase price equal to 100% of their
principal amount, plus accrued interest, if any. The Company may choose to pay
the purchase price in cash or shares of the Company's Common Stock or any
combination thereof. In the event of a conversion request upon a credit ratings
event as described above, after June 18, 2006, the Company has the right to
deliver, in lieu of shares of Company Common Stock, cash or a combination of
cash and shares of Company Common Stock. After the closing of the proposed
business combination with Lyondell, the Company would deliver shares of Lyondell
common stock rather than Company Common Stock. Holders of the debentures will
also have the right to require the Company to repurchase all or some of the
debentures they own at a cash purchase price equal to 100% of their principal
amount, plus accrued interest, if any, upon the occurrence of certain events
constituting a Fundamental Change, as defined in the indenture. This indenture
also limits the Company's ability to consolidate with or merge with or into any
other person, or sell, convey, transfer or lease properties and assets
substantially as an entirety to another person, except under certain
circumstances. The consummation of the announced stock-for-stock business
combination with Lyondell is not expected to be considered a Fundamental Change,
as defined in the indenture. However, the Company does expect to execute with
the trustee a supplemental indenture providing that each debenture shall be
convertible into Lyondell's common stock at a conversion ratio determined in
accordance with the indenture to reflect the exchange ratio in the business
combination.
Although the Company does not currently pay a dividend to its common
stockholders, Lyondell does currently pay a dividend. If the Company executes a
supplemental indenture with the trustee, as described above, and Lyondell
continues to pay a dividend to its common stockholders, the conversion rate, as
defined, will be adjusted. The conversion rate will be increased by a percentage
calculated by dividing the average of the last reported sales price of
Lyondell's common stock for the ten consecutive trading days prior to the
business day immediately preceding the record date by this average less the
amount in cash per share that Lyondell distributes to holders of its common
stock. At the current market prices of Lyondell common stock, this percentage
would be approximately 1.0% per quarter.
At September 30, 2004, the Company was in compliance with all covenants
in the indentures governing the 9.25% Senior Notes, 7.00% Senior Notes, 7.625%
Senior Debentures and 4.00% Convertible Senior Debentures.
The Company, as well as the Senior Notes and the 4.00% Convertible Senior
Debentures are currently rated BB- by S&P with a stable outlook. Moody's has
assigned the Company a senior implied rating of Ba3, and the Senior Notes and
the 4.00% Convertible Senior Debentures a rating of B1 with a negative outlook.
These ratings are non-investment grade ratings.
On March 29, 2004, S&P placed the Company's ratings on Credit Watch with
negative implications reflecting the future ownership by the highly leveraged
Lyondell and the strong likelihood that the ratings of the Company will be
lowered modestly upon completion of the proposed transaction. On March 30, 2004,
Moody's placed the Company's credit ratings under review for possible downgrade
following the announcement by Lyondell and the Company that the two companies
signed a definitive agreement that, if completed, will result in the combination
of the Company with Lyondell in a stock-for-stock transaction. Moody's cited
concerns over the potential impact that future distributions by the Company, as
an operating subsidiary of Lyondell, to Lyondell will have on the Company's
credit profile over the long term, primarily the potential for elevated debt
levels over the next several years while Lyondell seeks to de-lever its balance
sheet.
The Company's focus in 2004 is to sustain the benefits of cost reduction
efforts achieved to date and manage working capital and capital spending to
levels deemed reasonable given the current state of business performance. In the
first quarter of 2004, the Company repatriated approximately $107 million from
its Australian and European businesses to the U.S. This cash was used primarily
to reduce outstanding borrowings under the Company's Credit Agreement and for
general corporate purposes. The Company believes these efforts, along with the
borrowing availability under the Credit Agreement, and considering the
suspension of the payment of dividends on the Company's Common Stock announced
in the third quarter of 2003, will be sufficient to fund the Company's cash
requirements until 2006. At that time, the Company must repay or refinance the
7% Senior Notes and renegotiate or refinance the Credit Agreement.
43
Off-Balance Sheet Financing Arrangements
Millennium had no material off-balance sheet financing arrangements as
described in Item 7 of its Annual Report on Form 10-K.
Critical Accounting Estimates
The preparation of the Company's financial statements requires management
to apply accounting principles generally accepted in the United States of
America to the Company's specific circumstances and make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements, the disclosure of contingent assets and
liabilities at the date of the financial statements and reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
There have been no revisions to the critical accounting estimates as
originally filed in the Company's Annual Report on Form 10-K.
Recent Accounting Developments
See Note 4 to the unaudited Consolidated Financial Statements included in
this Quarterly Report for discussion of recent accounting developments.
Recent Legislative Development
In October 2004, the American Jobs Creation Act of 2004, which, among
other things, overhauls the federal income tax treatment of a wide variety of
nonqualified compensation arrangements was signed into Law. The Company is
assessing the potential impact of this legislation, but does not expect that it
will have any significant impact on the Company or any of its deferred
compensation arrangements.
Item 3. Quantitative and Qualitative Disclosures about Market Risks
See Note 10 to the unaudited Consolidated Financial Statements included
in this Quarterly Report for discussion of the Company's management of foreign
currency exposure, commodity price risk and interest rate risk through its use
of derivative instruments and hedging activities.
Item 4. Controls and Procedures
(a) The Company maintains disclosure controls and procedures that are
designed to provide reasonable assurance that information required to be
disclosed in the Company's filings under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the periods
specified in the rules and forms of the Securities and Exchange
Commission (the "SEC") and that such information is accumulated and
communicated to the Company's management, including its principal
executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure.
As a result of tax integration activities that began in the second
quarter of 2004 with respect to the Company's proposed business
combination with Lyondell, the Company determined at the beginning of
July 2004 that it had made errors in the computation of its tax basis in
Equistar, which in turn had been used to compute the Company's deferred
income taxes. In response to the determination that errors had been made,
the Company performed a thorough analysis and re-computation of the
Company's tax basis in Equistar. In late July 2004, the Company completed
the analysis and re-computation necessary to verify and quantify the
errors and prepare a restatement to correct the errors, which restatement
was reflected in Amendment No. 2 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2003; Amendment No. 1 to the
Company's Quarterly Report on Form 10-Q for the period ended March 31,
2004; and the Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2004, all of which were filed with the SEC on
August 9, 2004.
The restatement of prior periods' financial statements that resulted from
the analysis and re-computation discussed above decreased the Company's
liability for deferred income taxes and shareholders' deficit at June 30,
2004, March 31, 2004, and December 31, 2003 and 2002 by $15 million. The
restatement similarly decreased liabilities for deferred income taxes and
increased shareholders' equity at December 31, 2001 and 2000 by $15
million. The restatement did not affect the Company's cash flow or
operating income in any period.
The errors corrected in the restatement were the result of (i) an
incorrect computation by the Company in 1998 of the Company's original
tax basis in the net assets it contributed to Equistar upon the joint
venture's formation in December 1997 and (ii) incorrect computations by
the Company for 1998 and 1999 of changes in the amount of
44
such tax basis. The Company also discovered a de minimis error made in
2001. The Company believes that the errors were attributable to a
material weakness in internal control over financial reporting relating
to the computation by the Company of deferred income taxes for the
Company's investment in Equistar. The material weakness consisted of (i)
inadequate review and verification by the Company in 1998 of tax basis
data relating to net assets contributed by the Company to Equistar in
December 1997, and (ii) incorrect interpretation by the Company of
Equistar tax return information provided by the "tax matters partner" of
Equistar and used by Millennium to compute changes in its tax basis in
Equistar for 1998 and 1999. Under Equistar's partnership agreement,
Lyondell serves as the tax matters partner and, as such, prepares and
files Equistar's tax returns.
In order to remediate the material weakness in internal control over
financial reporting, the Company documented, in the third quarter of
2004, the procedures that were used to analyze and re-compute the
Company's tax basis in Equistar during July 2004. The Company utilized
these documented procedures in preparing the financial statements
contained in this Quarterly Report on Form 10-Q (the "Third Quarter 2004
Form 10-Q"). The Company currently intends to continue to use these
procedures in preparing its financial statements for subsequent reporting
periods.
These procedures include (i) the detailed review by the Company's
Director-Tax and its Vice President-Tax of estimates of tax return data
provided quarterly by Equistar's tax matters partner, (ii) followed by
discussions of the results of such review with the tax matters partner to
confirm the correctness of the Company's interpretation of the estimated
tax return data provided by the tax matters partner and (iii) thereafter,
review of the results of these procedures by the Company's Corporate
Controller and Chief Financial Officer. Although these procedures were
utilized by the Company in preparing the financial statements included in
this Third Quarter 2004 Form 10-Q, the material weakness will not be
considered remediated until these procedures operate for a period of
time, are tested and it is concluded that such procedures are operating
effectively at the reasonable assurance level.
On November 8, 2004, just before filing the Third Quarter 2004 Form 10-Q,
the Company completed an evaluation under the supervision and with the
participation of the Company's management, including the Company's
principal executive officer and principal financial officer, of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures as of September 30, 2004. Based on this
evaluation, the Company's principal executive officer and principal
financial officer concluded that, solely as a result of the material
weakness referred to above, the Company's disclosure controls and
procedures were not effective at the reasonable assurance level as of
September 30, 2004. However, as a result of the Company's analysis and
re-computation discussed above, as well as its utilization of the
documented procedures in preparing the financial statements contained in
the Third Quarter 2004 Form 10-Q, as described above, management believes
that the financial statements included in the Third Quarter 2004 Form
10-Q fairly present in all material respects the Company's financial
condition, results of operations and cash flows for the fiscal periods
presented.
(b) There were no changes in the Company's internal control over financial
reporting that occurred during the most recent fiscal quarter covered by
this Quarterly Report that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over
financial reporting, other than the formal procedures that were
established and implemented during the third quarter of 2004 for the
regular review of the Company's tax basis in Equistar, as described in
paragraph (a), above.
As a result of Section 404 of the Sarbanes-Oxley Act of 2002 and the
rules issued thereunder (the "Section 404 Requirements"), the Company
will be required to include in its Annual Report on Form 10-K for the
year ending December 31, 2004 a report on management's assessment of the
effectiveness of the Company's internal control over financial reporting.
As part of the process of preparing for compliance with the Section 404
Requirements, the Company initiated in 2003 a review of its internal
control over financial reporting. This review is being conducted under
the direction of the Company's current senior management. As a result,
management has made improvements to the Company's internal control
through the date of the filing of this Third Quarter 2004 Form 10-Q as
part of this review. The Company's management does not believe these
changes have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting. The
Company anticipates that improvements will continue to be made as part
of the ongoing review.
As discussed above, the Company has been working diligently under the
supervision of its current senior management in preparation for
compliance with the Section 404 Requirements. However, given (1) the
complexity and magnitude of the remaining work necessary to comply with
the Section 404 Requirements; (2) the Company's substantial ongoing
work required to manage and execute the proposed business combination
with
45
Lyondell; and (3) the significant changes in procedures and personnel
that will occur if the proposed business combination closes on November
30, 2004 as expected (including the replacement of all the Company's
current executive officers on the closing date), it is possible that
the Company's management may conclude that the Company's internal
controls over financial reporting at December 31, 2004 are not effective
at the reasonable assurance level.
46
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments with respect to the Company's
legal proceedings previously reported in the Annual Report on Form 10-K. The
Company has received requests during the past year from the staff of the
Northeast Regional Office of the Securities and Exchange Commission for the
voluntary production of documents in connection with the informal inquiry into
the previously disclosed restatement of the Company's financial statements for
the years 1998 through 2002 and for the first quarter of 2003. The Company is
complying with all requests received.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits-
31.1 Certificate of Principal Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.*
31.2 Certificate of Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.*
32.1 Certificate of Principal Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 (Furnished, not filed, in
accordance with Item 601(b)(32)(ii) of Regulation S-K, 17 CFR
229.601(b)(32)(ii)).*
32.2 Certificate of Principal Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 (Furnished, not filed, in
accordance with Item 601(b)(32)(ii) of Regulation S-K, 17 CFR
229.601(b)(32)(ii)).*
99.1 Information relevant to forward-looking statements.*
* Filed or furnished herewith.
(b) Reports on Form 8-K.
Current Reports on Form 8-K dated July 29, 2004; August 9, 2004;
September 24, 2004; October 4, 2004, October 28, 2004 and November 9,
2004 were filed or furnished during the quarter ended September 30, 2004
and through the date hereof. Such Current Reports either filed or
furnished information to the Securities and Exchange Commission.
47
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) 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.
MILLENNIUM CHEMICALS INC.
Date: November 9, 2004 By: /s/ JOHN E. LUSHEFSKI
-----------------------------------
John E. Lushefski
Executive Vice President and
Chief Financial Officer
(as duly authorized officer and
principal financial officer)
48
Exhibit Index
Exhibit
Number Description of Document
31.1 Certificate of Principal Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certificate of Principal Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 (Furnished, not filed, in
accordance with Item 601(b)(32)(ii) of Regulation S-K, 17 CFR
229.601(b)(32)(ii)).
32.2 Certificate of Principal Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002 (Furnished, not filed, in
accordance with Item 601(b)(32)(ii) of Regulation S-K, 17 CFR
229.601(b)(32)(ii)).
99.1 Information relevant to forward-looking statements.
STATEMENT OF DIFFERENCES
The section symbol shall be expressed as................................. 'SS'
Characters normally expressed as subscript shall be preceded by.......... [u]