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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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 1-14380
CITGO PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 73-1173881
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
</TABLE>
<TABLE>
<S> <C>
ONE WARREN PLACE,
6100 SOUTH YALE AVENUE,
TULSA, OKLAHOMA 74136
(Address of principal executive office) (Zip Code)
</TABLE>
(918) 495-4000
(Registrant's telephone number, including area code)
N.A.
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
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<S> <C>
COMMON STOCK, $1.00 PAR VALUE 1,000
(Class) (outstanding at October 31, 1998)
</TABLE>
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CITGO PETROLEUM CORPORATION
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
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PAGE
----
<S> <C> <C>
FACTORS AFFECTING FORWARD LOOKING STATEMENTS......................... 1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)............................
Condensed Consolidated Balance Sheets -- September 30, 1998
and December 31, 1997....................................... 2
Condensed Consolidated Statements of Income -- Three-Month
and Nine-Month Periods Ended September 30, 1998 and 1997.... 3
Condensed Consolidated Statement of Shareholder's
Equity -- Nine-Month Period Ended September 30, 1998........ 4
Condensed Consolidated Statements of Cash
Flows -- Nine-Month Periods Ended September 30, 1998 and
1997........................................................ 5
Notes to the Condensed Consolidated Financial Statements.... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 18
Item 6. Exhibits and Reports on Form 8-K............................ 19
SIGNATURES........................................................... 20
</TABLE>
<PAGE> 3
FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Specifically, all statements under the caption "Item 2 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations"
relating to Year 2000 matters, capital expenditures and investments related to
environmental compliance and strategic planning, purchasing patterns of refined
products and capital resources available to the Company (as defined herein) are
forward looking statements. In addition, when used in this document, the words
"anticipate," "estimate," "prospect" and similar expressions are used to
identify forward-looking statements. Such statements are subject to certain
risks and uncertainties, such as increased inflation, continued access to
capital markets and commercial bank financing on favorable terms, increases in
regulatory burdens, changes in prices or demand for the Company's products as a
result of competitive actions or economic factors and changes in the cost of
crude oil, feedstocks, blending components or refined products. Such statements
are also subject to the risks of increased costs in related technologies and
such technologies producing anticipated results. Should one or more of these
risks or uncertainties, among others, materialize, actual results may vary
materially from those estimated, anticipated or projected. Although CITGO
believes that the expectations reflected by such forward looking statements are
reasonable based on information currently available to the Company, no
assurances can be given that such expectations will prove to have been correct.
1
<PAGE> 4
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................. $ 278,758 $ 24,363
Accounts receivable....................................... 618,787 657,864
Due from affiliates....................................... 17,816 23,498
Inventories............................................... 874,573 857,598
Prepaid expenses and other................................ 6,727 9,658
---------- ----------
Total current assets.............................. 1,796,661 1,572,981
PROPERTY, PLANT AND EQUIPMENT -- Net........................ 2,849,567 2,849,262
RESTRICTED CASH............................................. 9,436 6,920
INVESTMENTS IN AFFILIATES................................... 798,543 813,923
OTHER ASSETS................................................ 210,989 168,949
---------- ----------
$5,665,196 $5,412,035
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Short-term bank loans..................................... $ -- $ 3,000
Accounts payable.......................................... 390,178 469,556
Payables to affiliates.................................... 208,084 197,852
Taxes other than income................................... 551,194 180,143
Other..................................................... 214,908 240,270
Current portion of long-term debt......................... 65,828 95,240
Current portion of capital lease obligation............... 13,879 13,140
---------- ----------
Total current liabilities......................... 1,444,071 1,199,201
LONG-TERM DEBT.............................................. 1,135,983 1,158,528
CAPITAL LEASE OBLIGATION.................................... 109,456 116,586
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS................. 203,560 199,765
OTHER NONCURRENT LIABILITIES................................ 211,283 205,533
DEFERRED INCOME TAXES....................................... 489,715 423,242
MINORITY INTEREST........................................... 29,100 28,337
COMMITMENTS AND CONTINGENCIES
SHAREHOLDER'S EQUITY:
Common stock -- $1.00 par value, 1,000 shares authorized,
issued and outstanding................................. 1 1
Additional capital........................................ 1,255,009 1,255,009
Retained earnings......................................... 787,018 825,833
---------- ----------
Total shareholder's equity........................ 2,042,028 2,080,843
---------- ----------
$5,665,196 $5,412,035
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
2
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CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ------------------------
1998 1997 1998 1997
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Net sales................................. $2,671,800 $3,504,752 $8,266,979 $10,080,047
Sales to affiliates....................... 46,508 51,073 128,912 168,591
---------- ---------- ---------- -----------
2,718,308 3,555,825 8,395,891 10,248,638
Equity in earnings (losses) of
affiliates -- net...................... 24,347 23,892 61,957 42,708
Other income (expense) -- net............. (2,982) (14,150) (3,156) (12,590)
---------- ---------- ---------- -----------
2,739,673 3,565,567 8,454,692 10,278,756
COST OF SALES AND EXPENSES:
Cost of sales and operating expenses
(including purchases of $1,096,498,
$1,289,172, $3,329,432 and $3,482,985
from affiliates)....................... 2,540,806 3,327,669 7,869,555 9,766,847
Selling, general and administrative
expenses............................... 59,421 55,940 173,701 149,542
Interest expense, excluding capital
lease.................................. 22,383 28,699 64,691 85,530
Capital lease interest charge............. 3,469 3,818 10,766 11,778
Minority interest......................... 404 498 764 1,230
---------- ---------- ---------- -----------
2,626,483 3,416,624 8,119,477 10,014,927
---------- ---------- ---------- -----------
INCOME BEFORE INCOME TAXES.................. 113,190 148,943 335,215 263,829
INCOME TAXES................................ 41,880 56,598 124,030 85,949
---------- ---------- ---------- -----------
NET INCOME.................................. $ 71,310 $ 92,345 $ 211,185 $ 177,880
========== ========== ========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
3
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CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK
--------------- ADDITIONAL RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997................ 1 $1 $1,255,009 $825,833 $2,080,843
Net Income.............................. -- -- -- 211,185 211,185
Dividends declared and paid............. -- -- -- (250,000) (250,000)
-- -- ---------- -------- ----------
BALANCE, SEPTEMBER 30, 1998............... 1 $1 $1,255,009 $787,018 $2,042,028
== == ========== ======== ==========
</TABLE>
See Notes to condensed consolidated financial statements.
4
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CITGO PETROLEUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES........................ $ 726,931 $ 268,182
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (144,367) (183,639)
Proceeds from sales of property, plant and equipment...... 3,364 12,057
(Increase) decrease in restricted cash.................... (2,516) 2,547
Investments in LYONDELL-CITGO Refining Company Ltd........ -- (45,635)
Loans to LYONDELL-CITGO Refining Company Ltd.............. (19,800) --
Sale of Petro-Chemical Transport.......................... 7,160 --
Investments in and advances to other affiliates........... (5,030) (1,417)
--------- ---------
Net cash used in investing activities............. (161,189) (216,087)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments of) proceeds from short-term bank loans... (3,000) 45,000
Net repayments of revolving bank loans.................... (135,000) (80,000)
Payments on term bank loan................................ (58,823) (22,059)
Proceeds from issuance of tax-exempt bonds................ 47,200 --
Proceeds from issuance of taxable bonds................... 100,000 --
Capital contribution received from parent................. -- 20,000
Dividends paid to parent.................................. (250,000) (6,000)
Payments of capital lease obligations..................... (6,390) (5,521)
Repayments of other debt.................................. (5,334) (5,357)
--------- ---------
Net cash used in financing activities................ (311,347) (53,937)
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 254,395 (1,842)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 24,363 26,856
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 278,758 $ 25,014
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest, net of amounts capitalized................... $ 61,622 $ 82,863
========= =========
Income taxes, net of refund of $450 in 1997............ $ 46,788 $ 24,813
========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES:
Noncash dividend paid to parent........................... $ -- $ (365)
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
5
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CITGO PETROLEUM CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
1. BASIS OF PRESENTATION
The financial information for CITGO Petroleum Corporation ("CITGO" or "the
Company") subsequent to December 31, 1997 and with respect to the interim three
and nine-month periods ended September 30, 1998 and 1997 is unaudited. In the
opinion of management, such interim information contains all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the results of such periods. The results of operations for the
three and nine-month periods ended September 30, 1998 and 1997 are not
necessarily indicative of the results to be expected for the full year.
Reference is made to CITGO's Annual Report for the fiscal year ended December
31, 1997 on Form 10-K, dated March 26, 1998, for additional information.
The condensed consolidated financial statements include the accounts of
CITGO, its wholly owned subsidiaries, and Cit-Con Oil Corporation, which is 65
percent owned by CITGO (collectively, "the Company").
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." The Company had
no items of other comprehensive income during the three and nine-month periods
ended September 30, 1998 and 1997.
Certain reclassifications have been made to the September 30, 1997
financial statements to conform with the classifications used at September 30,
1998.
2. INVENTORIES
Inventories at September 30, 1998 have been written down to estimated net
realizable value and results of operations for the three and nine-month periods
ending September 30, 1998 include corresponding charges of $12 million and $22
million, respectively. Inventories, primarily at LIFO, consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
(000'S OMITTED)
<S> <C> <C>
Refined products............................................ $657,461 $662,061
Crude oil................................................... 162,975 138,049
Materials and supplies...................................... 54,137 57,488
-------- --------
$874,573 $857,598
======== ========
</TABLE>
6
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CITGO PETROLEUM CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
3. LONG-TERM DEBT
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
(000'S OMITTED)
<S> <C> <C>
Revolving bank loan......................................... $ -- $ 135,000
Term bank loan.............................................. -- 58,823
7.875% Senior Notes $200 million face amount, due 2006...... 199,768 199,745
Private Placement:
8.75% Series A Senior Notes due 1998...................... 18,750 18,750
9.03% Series B Senior Notes due 1998 to 2001.............. 114,286 114,286
9.30% Series C Senior Notes due 1998 to 2006.............. 102,273 102,273
Master Shelf Agreement:
8.55% Senior Notes due 2002............................... 25,000 25,000
8.68% Senior Notes due 2003............................... 50,000 50,000
7.29% Senior Notes due 2004............................... 20,000 20,000
8.59% Senior Notes due 2006............................... 40,000 40,000
8.94% Senior Notes due 2007............................... 50,000 50,000
7.17% Senior Notes due 2008............................... 25,000 25,000
7.22% Senior Notes due 2009............................... 50,000 50,000
Tax Exempt Bonds:
Pollution control revenue bonds due 2004.................. 15,800 15,800
Port facilities revenue bonds due 2007.................... 11,800 11,800
Louisiana wastewater facility revenue bonds due 2023...... 3,020 3,020
Louisiana wastewater facility revenue bonds due 2024...... 20,000 20,000
Louisiana wastewater facility revenue bonds due 2025...... 40,700 40,700
Louisiana wastewater facility revenue bonds due 2026...... 2,000 2,000
Gulf Coast solid waste facility revenue bonds due 2025.... 50,000 50,000
Gulf Coast solid waste facility revenue bonds due 2026.... 50,000 50,000
Gulf Coast solid waste facility revenue bonds due 2028.... 25,000 --
Industrial development facilities revenue bonds due
2028................................................... 22,200 --
Port of Corpus Christi sewage and solid waste disposal
revenue bonds due 2026................................. 25,000 25,000
Taxable Bonds:
Louisiana wastewater facility revenue bonds due 2026...... 118,000 118,000
Gulf Coast environmental facilities revenue bonds due
2028................................................... 100,000 --
Cit-Con bank credit agreement............................... 23,214 28,571
---------- ----------
1,201,811 1,253,768
Less current portion of long-term debt...................... (65,828) (95,240)
---------- ----------
$1,135,983 $1,158,528
========== ==========
</TABLE>
On April 29, 1998, CITGO issued $25 million of Gulf Coast Industrial
Development Authority Solid Waste Disposal Revenue Bonds due 2028.
On May 13, 1998, CITGO terminated its $675 million revolving bank loan and
replaced it with (i) a $400 million, five year, revolving bank loan and (ii) a
$150 million, 364 day, revolving bank loan.
7
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CITGO PETROLEUM CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
On August 26, 1998, CITGO issued $22.2 million of Industrial Development
Corporation of Port of Corpus Christi -- Environmental Facilities Revenue Bonds
due 2028. Also on that date, CITGO issued $100 million of Gulf Coast Industrial
Development Authority -- Environmental Facilities Revenue Bonds due 2028.
On September 3, 1998, CITGO terminated its term bank loan.
4. COMMITMENTS AND CONTINGENCIES
Litigation and Injury Claims -- Various lawsuits and claims arising in the
ordinary course of business are pending against the Company. The Company is
vigorously contesting or pursuing, as applicable, such lawsuits and claims and
believes that its positions are sustainable. The Company has recorded accruals
for losses it considers to be probable and reasonably estimable. However, due to
uncertainties involved in litigation, there are cases, including the significant
matters noted below, in which the outcome is not reasonably predictable, and the
losses, if any, are not reasonably estimable. If such lawsuits and claims were
to be determined in a manner adverse to the Company, and in amounts in excess of
the Company's accruals, it is reasonably possible that such determinations could
have a material adverse effect on the Company's results of operations in a
reporting period. The term "reasonably possible" is used herein to mean that the
chance of a future transaction or event occurring is more than remote but less
than likely. However, based upon management's current assessments of these
lawsuits and claims and that provided by counsel in such matters, and the
capital resources available to the Company, management of the Company believes
that the ultimate resolution of these lawsuits and claims would not exceed by a
material amount, the aggregate of the amounts accrued in respect of such
lawsuits and claims and the insurance coverages available to the Company and,
therefore, should not have a material adverse effect on the Company's financial
condition, results of operations or liquidity.
Litigation is pending in the U.S. District Court for the Western District
of Louisiana against CITGO by a number of current and former employees and
applicants on behalf of themselves and a class of similarly situated persons
asserting claims under federal and state laws of racial discrimination in
connection with the employment practices at CITGO's Lake Charles refining
complex; the plaintiffs seek injunctive relief and monetary damages. The U.S.
Fifth Circuit Court of Appeals has upheld the trial court's denial of class
certification and denied the plaintiff's request for a rehearing of this ruling.
In a case currently pending in the United States District Court for the
Northern District of Illinois, Oil Chemical and Atomic Workers, Local 7-517
("Local 7-517") amended its complaint against UNO-VEN to assert claims against
CITGO, PDVSA, PDV America, PDVMR, and Unocal pursuant to Section 301 of the
Labor Management Relations Act ("LMRA"). This complaint alleges that CITGO and
the other defendants constitute a single employer, joint employers or alter-egos
for purposes of the LMRA, and are therefore bound by the terms of a collective
bargaining agreement between UNO-VEN and Local 7-517 covering certain production
and maintenance employees at a Lemont, Illinois, petroleum refinery. On May 1,
1997, in a transaction involving the former partners of UNO-VEN, the Lemont
refinery was acquired by PDVMR. Pursuant to an operating agreement with PDVMR,
CITGO became the operator of the Lemont refinery, and employed the substantial
majority of employees previously employed by UNO-VEN pursuant to its initial
terms and conditions of employment, but did not assume the existing labor
agreement. The union seeks compensation for monetary differences in medical,
pension and other benefits between the CITGO and UNO-VEN plans and reinstatement
of all of the UNO-VEN benefit plans. The union also seeks to require CITGO to
abide by the terms of the collective bargaining agreement between the union and
UNO-VEN. On June 18, 1998 the trial court granted the motions for summary
judgement filed by CITGO and the other defendants; the union has appealed this
ruling.
8
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CITGO PETROLEUM CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
On May 12, 1997, an explosion and fire occurred at CITGO's Corpus Christi
refinery. There were no reports of serious personal injuries. Affected units
were shut down for repair and returned to full service in early August 1997. The
Company has property damage, business interruption and general liability
insurance, which related to this event. As a result, the property damage and
business interruption did not have a material adverse effect on the Company's
financial condition or results of operations. The Company has received
approximately 7,500 individual claims for personal injury and property damage,
allegedly arising from the incident. Approximately 1,300 of these claims have
been resolved for amounts which individually and collectively are not material.
There are presently five lawsuits against the Company pending in federal and
state courts in Corpus Christi, Texas, alleging property damages, personal
injury and punitive damages allegedly arising from the incident. A trial
involving ten bellweather plaintiffs, out of approximately 400 plaintiffs in one
of the Federal Court lawsuits, ended October 29, 1998. Two of these claims were
dismissed by the judge and the jury found in CITGO's favor in the other eight,
declining to award any damages.
There is a class action lawsuit pending in Corpus Christi, Texas state
court against the Company and other operators and owners of nearby industrial
facilities filed in 1993 for damages to residential properties located in the
vicinity of the industrial facilities. The suit claims that the value of
properties has been reduced, as a result of air, soil and groundwater
contamination occasioned by operations of the industrial facilities owned by the
Company and other defendants. Two related personal injury and wrongful death
lawsuits were also filed in 1996 and are in preliminary stages of discovery at
this time. The Company and other defendants appealed the trial court's
certification of the class action to the Texas Supreme Court.
In 1997, the Company signed an agreement to settle the property damage
class action claims for approximately $17.3 million, the substantial portion of
which related to the purchase of approximately 290 properties in one of the
adjacent neighborhoods. Of this amount, $15.7 million was expensed in 1997. The
Court appointed a guardian to review the proposed settlement terms. The Texas
Supreme Court subsequently decided to consider the Company's appeal of the class
certification; that action raised questions whether the trial court had
authority to proceed with the settlement. Additionally, the trial court sought
to impose additional settlement conditions that were unacceptable to the
Company. For these reasons, the Company opposed approval and enforcement of the
settlement agreement as it was revised and pursued its appeal of the class
certification to the Texas Supreme Court.
The Texas Supreme Court ruled in July 1998 that it declined to hear the
appeal of the class certification and declined to hear the Company's request for
reconsideration of this decision. The case has been remanded to the district
court for trial; however, if the settlement agreement is enforced by the trial
court, the Company could be liable for the balance of the settlement amount
after deductions for amounts it has paid related to its purchase of properties.
CITGO has agreed to purchase 245 of the properties it sought to acquire and will
receive settlements of property damage claims in connection with such purchases.
The Company has offers open to purchase the remaining properties.
Environmental Compliance and Remediation -- The Company is subject to
various federal, state and local environmental laws and regulations which may
require the Company to take action to correct or improve the effects on the
environment of prior disposal or release of petroleum substances by the Company
or other parties. Management believes the Company is in compliance with these
laws and regulations in all material aspects. Maintaining compliance with
environmental laws and regulations in the future could require significant
capital expenditures and additional operating costs.
At September 30, 1998, the Company had $48.7 million of environmental
accruals included in other noncurrent liabilities. Based on currently available
information, including the continuing participation of former owners in
remediation actions, management believes these accruals are adequate.
Conditions, which require additional expenditures, may exist for various Company
sites including, but not limited to, the
9
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CITGO PETROLEUM CORPORATION
NOTES TO THE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)
Company's operating refinery complexes, former refinery sites, service stations
and crude oil and petroleum product storage terminals. The amount of such future
expenditures, if any, is indeterminable.
Derivative Commodity and Financial Instruments -- CITGO enters into
petroleum futures contracts primarily to reduce its inventory exposure to market
risk. CITGO also buys and sells commodity options for delivery and receipt of
crude oil and refined products. Such contracts are entered into through major
brokerage houses and traded on national exchanges and can be settled in cash or
through delivery of the commodity. Such contracts generally qualify for hedge
accounting and correlate to market price movements of crude oil and refined
products. Resulting gains and losses on such contracts, therefore, will
generally be offset by gains and losses on CITGO's hedged inventory or future
purchases and sales. In the three and nine-month periods ended September 30,
1998, non-hedging activity resulted in an immaterial loss and an immaterial
gain, respectively, that were recorded in those periods.
CITGO has only limited involvement with other derivative financial
instruments and generally does not use them for trading purposes. Generally,
they are used to manage well-defined interest rate and commodity price risks
arising out of CITGO's core activities. CITGO has entered into various interest
rate swap and cap agreements to manage its risk related to interest rate changes
on its debt. The fair value of the interest rate swap agreements in place at
September 30, 1998, based on the estimated amount that CITGO would receive or
pay to terminate the agreements as of that date and taking into account current
interest rates, was an unrealized loss of $3.7 million. In connection with the
determination of said fair market value, the Company considers the
creditworthiness of the counterparties, but no adjustment was determined to be
necessary as a result.
The impact of these instruments on cost of sales and operating expenses and
pretax earnings was immaterial for all periods presented. Management considers
the market risk to the Company related to these instruments to be insignificant
during the periods presented.
5. RELATED PARTY TRANSACTIONS
As previously reported, on April 8, 1998, PDVSA Petroleo y Gas, S.A.,
notified CITGO and other companies to whom it supplies crude oil of reductions
in crude production as well as a declaration of force majeure on its long-term
crude supply contracts pursuant to orders from the government of the Republic of
Venezuela. The impacts on CITGO included (i) a 25 thousand barrel per day
reduction in crude supply to its asphalt refineries; (ii) an increase in the
specific gravity of the crude oil supplied to its other refineries which
precluded optimal use of the Company's refining facilities; and (iii) an
increase in the specific gravity of the crude oil supplied to LYONDELL-CITGO
which precluded optimal use of its refining facilities. However, CITGO is not
currently experiencing these impacts.
In October 1998, the Company declared a $236 million dividend which was
paid in November 1998.
10
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion of the financial condition and results of
operations of CITGO should be read in conjunction with the unaudited condensed
consolidated financial statements of CITGO included elsewhere herein. Reference
is made to CITGO's Annual Report for the fiscal year ended December 31, 1997 on
Form 10-K, dated March 26, 1998, for additional information and a description of
factors which may cause substantial fluctuations in the earnings and cash flows
of CITGO.
In the third quarter ended September 30, 1998, CITGO generated net income
of $71.3 million on revenue of $2.7 billion compared to net income of $92.3
million on revenues of $3.6 billion for the same period last year. In the
nine-month period ended September 30, 1998, CITGO generated net income of $211.2
million on revenue of $8.5 billion compared to net income of $177.9 million on
revenues of $10.3 billion for the same period last year. The decline in net
income in the quarter ended September 30, 1998 compared to the same period in
1997 is due primarily to a decline in gross margin. The improvement in net
income in the nine-month period ended September 30, 1998 compared to the same
period in 1997 is due primarily to an improvement in gross margin. In the
nine-month period ended September 30, 1998, the comparison is also affected by a
favorable resolution of a significant tax issue with the Internal Revenue
Service ("IRS") which reduced the income tax expense that CITGO recorded in the
quarter ended June 30, 1997.
RESULTS OF OPERATIONS
The following table summarizes the sources of CITGO's sales revenues and
sales volumes for the three and nine-month periods ended September 30, 1998 and
1997:
CITGO SALES REVENUES AND VOLUMES
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------- ------------- ---------------
1998 1997 1998 1997 1998 1997 1998 1997
------ ------ ------ ------- ----- ----- ------ ------
($ IN MILLIONS) (MM GALLONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Gasoline............... $1,566 $2,128 $4,882 $ 5,901 3,378 3,180 9,898 8,815
Jet fuel............... 186 241 600 888 463 424 1,347 1,479
Diesel/#2 fuel......... 449 541 1,473 1,815 1,142 1,007 3,512 3,163
Petrochemicals,
industrial products
and other products... 239 318 711 851 774 532 1,851 1,388
Asphalt................ 113 151 223 308 286 280 566 559
Lubricants and waxes... 111 127 336 351 57 63 172 179
------ ------ ------ ------- ----- ----- ------ ------
Total refined
product
sales...... $2,664 $3,506 $8,225 $10,114 6,100 5,486 17,346 15,583
Other sales............ 54 50 171 135
------ ------ ------ ------- ----- ----- ------ ------
Total
sales...... $2,718 $3,556 $8,396 $10,249 6,100 5,486 17,346 15,583
====== ====== ====== ======= ===== ===== ====== ======
</TABLE>
11
<PAGE> 14
The following table summarizes CITGO's cost of sales and operating expenses
for the three-month and nine-month periods ended September 30, 1998 and 1997:
CITGO COST OF SALES AND OPERATING EXPENSES
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
1998 1997 1998 1997
------ ------ ------ ------
($ IN MILLIONS)
<S> <C> <C> <C> <C>
Crude oil.......................................... $ 502 $ 798 $1,496 $2,265
Refined products................................... 1,519 1,916 4,708 5,871
Intermediate feedstocks............................ 209 276 671 805
Refining and manufacturing costs................... 192 195 580 593
Other operating costs and expenses and inventory
changes.......................................... 119 143 415 233
------ ------ ------ ------
Total cost of sales and operating
expenses............................... $2,541 $3,328 $7,870 $9,767
====== ====== ====== ======
</TABLE>
Sales revenues and volumes. Sales decreased $838 million, or approximately
24%, in the three-month period ended September 30, 1998, and by $1,853 million,
or 18%, in the nine-month period ended September 30, 1998 as compared to the
same periods in 1997. Total sales volumes increased by 11% from 5,486 million
gallons in the third quarter of 1997 to 6,100 million gallons in the third
quarter of 1998, and increased by 11% from 15,583 million gallons in the first
nine months of 1997 to 17,346 million gallons in the first nine months of 1998.
The decreases in product sales prices, offset by the increase in most sales
volumes, resulted in the decrease in revenues.
Sales volumes of light fuels (gasoline, diesel/#2 fuel and jet fuel)
excluding bulk sales made for logistical reasons decreased by 8% in the third
quarter of 1998 as compared to the third quarter of 1997, and decreased by 5% in
the first nine months of 1998 as compared to the same period in 1997. Gasoline,
diesel/#2 fuel and jet fuel, excluding bulk sales, had sales volume decreases of
7%, 14% and 3%, respectively, in the third quarter of 1998, compared to the
third quarter of 1997. Gasoline, excluding bulk sales, had a sales volume
decrease of 2% in the first nine months of 1998 compared to the first nine
months of 1997. For the nine-month period ended September 30, 1998 versus the
same period in 1997, diesel/#2 fuel and jet fuel, excluding bulk sales, had
sales volume decreases of 7% and 19%, respectively.
Sales prices of gasoline, excluding bulk sales, have decreased for the
three-month period ended September 30, 1998 as compared to the same period in
1997. The average decrease for the third quarter of 1998 over the third quarter
of 1997 is 20 cents per gallon, or a 30% decrease. Sales prices of jet fuel and
diesel/#2 fuel, excluding bulk sales, decreased 14 cents and 15 cents,
respectively, or 26%, in the third quarter of 1998 as compared to the same
period in 1997. For the nine-month period ended September 30, 1998, gasoline,
jet fuel and diesel/#2 fuel prices, excluding bulk sales, decreased
approximately 25% from prices for the same period in 1997.
To meet demand for its products and to manage logistics, timing differences
and product grade imbalances, CITGO purchases and sells in bulk gasoline,
diesel/#2 fuel and jet fuel from and to other refiners and in the spot market.
An affiliate of PDVSA entered into an agreement to acquire a 50% equity interest
in a refinery in Chalmette, Louisiana in October 1997 and has assigned to CITGO
its option to purchase up to 50% of the refined products produced at the
refinery through December 31, 1999. Placing this new supply into the
distribution network has resulted in a sharp increase in the volume of bulk
purchases and sales. Such sales increased by $81 million, or 13%, from $606
million in the three-month period ended September 30, 1997 to $687 million in
the same period in 1998. The increase in revenue for the quarter ended September
30, 1998 is a result of a 61% increase in volumes offset by a 29% decrease in
sales prices between the quarters. Sales revenue of gasoline alone increased by
$49 million, or 14% for the third quarter ended September 30, 1998 as compared
to the same period in 1997. The increase in gasoline sales revenue is the result
of a 62% increase in volumes offset by a 30% decrease in sales prices between
the quarters. Such sales revenue increased by $290 million, or 16%, from $1,870
million in the nine-month period ended September 30, 1997 to
12
<PAGE> 15
$2,160 million in the same period in 1998. The increase in revenue for the
nine-month period ended September 30, 1998 is a result of a 58% increase in
sales volume offset by a 27% decrease in prices between the periods. Sales
revenue of gasoline alone increased by $287 million, or 29% for the nine-month
period ended September 30, 1998 as compared to the same period in 1997. The
increase in gasoline sales revenue is the result of a 75% increase in volumes
offset by a 27% decrease in sales prices between the periods.
Petrochemicals and industrial products sales revenues decreased 37% and
24%, respectively, for the three months ended September 30, 1998 as compared to
the three months ended September 30, 1997, and decreased 25% and 1%,
respectively, for the nine months ended September 30, 1998 versus the nine
months ended September 30, 1997. The petrochemicals revenue decreases were the
result of a 24% decrease in unit sales price, and an 18% decrease in sales
volume for the third quarter of 1998 and a 25% decrease in unit sales price, and
a less than 1% increase in volume for the nine-month period ended September 30,
1998, as compared to the same periods in 1997. The industrial products revenue
decrease for the quarter was the result of a 24% decrease in unit sales prices
and a less than 1% increase in sales volume for the third quarter of 1998 as
compared to the same period in 1997, and the decrease for the nine-month period
was the result of a 19% increase in sales volume and a 17% decrease in unit
sales price for the nine-month period ended September 30, 1998, as compared to
the same period in 1997.
Asphalt sales revenues decreased $38 million and sales volumes increased 2%
in the third quarter of 1998, and sales revenue decreased $85 million and sales
volume increased 1% in the first nine months of 1998, as compared to the same
periods in 1997. Asphalt sales prices decreased 27% in the third quarter of
1998, and 28% in the first nine months of 1998, as compared to the same periods
in 1997.
Equity in earnings (losses) of affiliates -- net. Equity in earnings of
affiliates increased by $0.5 million for the three-month period and increased
$19.3 million for the nine-month period ended September 30, 1998 as compared to
the same periods in 1997. The increase was primarily due to the change in the
equity in the earnings of LYONDELL-CITGO Refining Company Ltd.
("LYONDELL-CITGO"), which increased $20 million, from $29 million in the first
nine months of 1997 to $49 million in the first nine months of 1998. This
increase is due primarily to the change in CITGO's interest in LYONDELL-CITGO
which increased from approximately 13% at March 31, 1997 to approximately 42% on
April 1, 1997 and the improvement in LYONDELL-CITGO's operations since
completion of its refinery enhancement project during the first quarter of 1997.
Other income (expense). Other income (expense) was $(3.2) million for the
nine-month period ended September 30, 1998 as compared to $(12.6) million for
the same period in 1997. The difference is primarily due to a $15.7 million
charge related to the Corpus Christi neighborhood settlement during the third
quarter 1997 (See Note 4 to the Condensed Consolidated Financial Statements for
the Three and Nine-Month Periods ended September 30, 1998, included in Part 1
hereof) and a $6 million dollar write off of a capital project during the third
quarter of 1997. These items were partially offset by a net $8.3 million
property insurance recovery in the third quarter 1997 relating to the Corpus
Christi alkylation unit fire.
Cost of sales and operating expenses. Cost of sales and operating expenses
decreased by $787 million or 24%, in the quarter ended September 30, 1998, and
decreased $1,897 million or 19%, in the nine-month period ended September 30,
1998, as compared to the same periods in 1997. Lower crude oil costs (a decrease
from $798 million in the third quarter of 1997 to $502 million in the third
quarter of 1998) resulted from a 38% decrease in crude prices, offset by a 1%
increase in crude oil volumes purchased. Crude oil costs decreased from $2,265
million in the nine-month period ended September 30, 1997 to $1,496 million in
the first nine months of 1998, the result of a 36% decrease in crude prices and
a 4% increase in crude oil volumes purchased. Refined product purchases
decreased in the third quarter of 1998 as compared to the same quarter in 1997
(down 21%, from $1,916 million to $1,519 million for the third quarter), and
decreased in the first nine months of 1998 as compared to the same period in
1997 (down 20% from $5,871 million to $4,708 million, for the first nine
months). The changes resulted from decreases in prices (down 30% for the third
quarter and 27% for the first nine months of 1998 as compared to the same
periods in 1997), and changes in refined product purchase volumes (up 13% for
the third quarter and 9% for the first nine months of 1998 as compared to the
same period in 1997). Intermediate feedstock purchases decreased to $209 million
in the third quarter of 1998
13
<PAGE> 16
from $276 million in the third quarter of 1997, and decreased to $671 million
for the first nine months of 1998 from $805 million for the first nine months of
1997, or a decrease of 24% for the quarter and 17% for the
nine-month period ended September 30, 1998. Intermediate feedstock prices
decreased 33%, and volumes purchased increased 14% between the quarters ended
September 30, 1997 and September 30, 1998. Intermediate feedstock prices
decreased 29%, and volumes purchased increased 18% between the nine-month
periods ended September 30, 1997 and September 30, 1998. Refining and
manufacturing costs decreased for both periods in 1998 as compared to 1997, 1%
in the third quarter (from $195 million to $192 million), and 2% in the
nine-month period ended September 30 (from $593 million to $580 million). CITGO
incurred additional expenses in 1997 associated with the fire and explosion
which occurred at the Corpus Christi refinery on May 12, 1997. Depreciation and
amortization expense increased by $4 million, from $50 million to $54 million
between the quarters ended September 30, 1997 and 1998, respectively, and $3
million, from $153 million to $156 million between the nine-month periods ended
September 30, 1997 and 1998, respectively. Inventories at September 30, 1998
have been written down to estimated net realizable value and cost of sales and
operating expenses for the three and nine-month periods ending September 30,
1998 include corresponding charges of $12 million and $22 million, respectively.
CITGO purchases refined products to supplement the production from its
refineries to meet marketing demands and resolve logistical issues. Refined
product purchases represented 60% and 58% of total cost of sales and operating
expenses for the third quarters of 1998 and 1997, and 60% for the first nine
months of both 1998 and 1997. CITGO estimates that margins on purchased
products, on average, are somewhat lower than margins on produced products due
to the fact that CITGO can only receive the marketing portion of the total
wholesale margin received on the produced refined products. However, purchased
products are not segregated from CITGO's produced products and margins may vary
due to market conditions and other factors beyond the Company's control. As
such, it is difficult to measure the effects on profitability of changes in
volumes of purchased products. CITGO anticipates that its purchased refined
product volume requirements will continue to increase to meet marketing demands.
In the near term, other than normal refinery turnaround maintenance, CITGO does
not anticipate operational actions or market conditions which might cause a
material change in purchased product requirements. However, there could be
events beyond the control of CITGO, which would impact the volume of refined
products purchased and profit margins.
Gross margin. The gross margin for the three-month period ended September
30, 1998 was $177 million, or 7%, compared to $228 million, or 6%, for the same
period in 1997. The gross margin for the nine-month period ended September 30,
1998 was $526 million or 6% compared to $482 million or 5% for the nine-month
period ended September 30, 1997. In the quarter ended September 30, 1998, both
the revenue per gallon and cost per gallon components of gross margin declined
by approximately 31%. In the nine-month period ended September 30, 1998, the
revenue per gallon component declined by approximately 26% while the cost per
gallon component declined by approximately 28%. As a result, the gross margin
declined approximately one and one quarter cents on a per gallon basis in the
quarter ended September 30, 1998 compared to the same period in 1997. In the
nine months ended September 30, 1998, the gross margin per gallon was
essentially flat when compared to the same period in 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased in the third quarter of 1998 by 5%, from $56
million in the third quarter of 1997 to $59 million in the third quarter of
1998, and increased 16% from $150 million in the first nine months of 1997 to
$174 million in the same period in 1998. These increases are due primarily to
salary and related burden allocations as well as increases in advertising
expense and depreciation.
Interest expense. Interest expense decreased by approximately $7 million,
or 21% (from $33 million to $26 million), for the third quarter ended September
30, 1998, and decreased year-to-date by approximately $22 million, or 22% (from
$97 million to $75 million), as compared to the same periods in 1997. The
primary reason for the reduction in interest expense is the sharp reduction in
the use of the revolving bank loan in the periods ended September 30, 1998
compared to the same periods ended September 30, 1997.
Income taxes. Income taxes reported were based on an effective tax rate of
37% for the nine-month period ended September 30, 1998 and 33% for the
comparable period in 1997. The prior year effective tax rate
14
<PAGE> 17
was unusually low due to a favorable resolution of a significant tax issue in
the last IRS audit. In addition, the effective tax rate increased slightly due
to a decrease in the effective tax rate impact of the dividend exclusion
deduction, offset in part by a decrease in state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
For the nine-month period ended September 30, 1998, the Company's
consolidated net cash provided by operating activities totaled approximately
$727 million. Net income of $211 million and depreciation and amortization of
$165 million were enhanced by net changes in other items of $351 million. The
more significant changes in other items included an increase in deferred taxes
of $63 million, and increases in current liabilities of $282 million. The
primary element of the increase in current liabilities relates to a deferral of
Federal excise tax deposits.
Net cash used in investing activities totaled $161 million for the
nine-month period ended September 30, 1998 consisting primarily of capital
expenditures of $144 million (compared to $184 million for the same period in
1997) and additional investments in and loans to LYONDELL-CITGO of $20 million
(compared to $46 million for the same period in 1997).
Net cash used in financing activities totaled $311 million for the
nine-month period ended September 30, 1998 consisting primarily of dividends
paid to parent of $250 million, $135 million net repayment on revolving bank
loans and $59 million net repayment on a term loan, partially offset by proceeds
from taxable bonds of $100 million and proceeds from issuance of tax-exempt
revenue bonds of $47 million.
On September 30, 1998, CITGO had a significant cash balance as a result of
a deferral of Federal excise tax deposits authorized by the U.S. Congress. This
deferral ended in early October 1998 and CITGO made a $347 million Federal
excise tax deposit.
As of September 30, 1998, capital resources available to the Company
include cash generated by operations, available borrowing capacity under CITGO's
committed bank facilities of $550 million and $155 million of uncommitted
short-term borrowing facilities with various banks. Additionally, the remaining
$400 million from CITGO's shelf registration with the Securities and Exchange
Commission for $600 million of debt securities may be offered and sold from time
to time. CITGO management believes that the Company has sufficient capital
resources to carry out planned capital spending programs, including regulatory
and environmental projects in the near term, and to meet currently anticipated
future obligations as they arise. CITGO periodically evaluates other sources of
capital in the marketplace and anticipates that long-term capital requirements
will be satisfied with current capital resources and future financing
arrangements, including the issuance of debt securities. The Company's ability
to obtain such financing will depend on numerous factors, including market
conditions and the perceived creditworthiness of the Company at that time.
In October 1998, the Company declared a $236 million dividend which was
paid in November 1998.
The Company believes that it is in compliance with its obligations under
its debt financing arrangements at September 30, 1998.
DERIVATIVE COMMODITY AND FINANCIAL INSTRUMENTS
CITGO enters into petroleum futures contracts primarily to reduce its
inventory exposure to market risk. CITGO also buys and sells commodity options
for delivery and receipt of crude oil and refined products. Such contracts are
entered into through major brokerage houses and traded on national exchanges and
can be settled in cash or through delivery of the commodity. Such contracts
generally qualify for hedge accounting and correlate to market price movements
of crude oil and refined products. Resulting gains and losses on such contracts,
therefore, will generally be offset by gains and losses on CITGO's hedged
inventory or future purchases and sales. In the three and nine-month periods
ended September 30, 1998, non-hedging activity resulted in an immaterial loss
and an immaterial gain, respectively, that were recorded in those periods.
CITGO has only limited involvement with other derivative financial
instruments and generally does not use them for trading purposes. Generally,
they are used to manage well-defined interest rate and commodity price risks
arising out of CITGO's core activities. CITGO has entered into various interest
rate swap and cap
15
<PAGE> 18
agreements to manage its risk related to interest rate changes on its debt. The
fair value of the interest rate swap agreements in place at September 30, 1998,
based on the estimated amount that CITGO would receive or pay to terminate the
agreements as of that date and taking into account current interest rates, was
an unrealized loss of $3.7 million. In connection with the determination of said
fair market value, the Company considers the creditworthiness of the
counterparties, but no adjustment was determined to be necessary as a result.
The impact of these instruments on cost of sales and operating expenses and
pretax earnings was immaterial for all periods presented. Management considers
the market risk to the Company related to these instruments to be insignificant
during the periods presented.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). The statement establishes accounting
and reporting standards for derivative instruments and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The company has not determined the impact on its financial
statements that may result from adoption of SFAS No. 133, which is required no
later than January 1, 2000.
YEAR 2000 READINESS
General. The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a
two-digit year is commonly referred to as the Year 2000 issue. As the Year 2000
approaches, such systems may be unable to accurately process certain date-based
information.
To mitigate any adverse impact this may cause, CITGO has established a
company wide Year 2000 Project ("Project") to address the issue of computer
programs and embedded computer chips which may be unable to correctly function
with the Year 2000. The Project is proceeding on schedule. In addition, CITGO is
updating major elements of its information systems by implementing programs
purchased from SAP America, Inc. ("SAP"). The first phase of SAP implementation,
which included the financial reporting and materials management systems, was
brought into production on January 1, 1998. Additional SAP modules will be
implemented throughout 1998 and 1999. The total cost of the SAP implementation
is estimated to be approximately $110 million, which includes software,
hardware, reengineering and change management. Management has determined that
SAP is an appropriate solution to the Year 2000 issue related to the systems for
which SAP is implemented. Such systems comprise approximately 80 percent of
CITGO's total information systems. The implementation of SAP is 65 to 70 percent
complete, and is on schedule and on budget as of September 30, 1998. Remaining
business software systems are expected to be made Year 2000 ready through the
Year 2000 Project or they will be replaced.
The Project. CITGO's Year 2000 Project Team is divided into two groups. One
group is working with Information Systems (I.S.) and Information Technology
(I.T.) related matters, while the other is analyzing non-I.S./I.T. business and
asset integrity matters. A risk-based approach toward Year 2000 readiness is
being applied to non-SAP systems and processes, with fix-or-replace decisions
targeted for year-end 1998. The strategy for achieving Year 2000 business and
asset integrity is focused on equipment, software and relationships that are
critical to the Company's primary business operations, including refinery
operations, terminal operations, crude oil purchase and shipment operations, and
refined product distribution operations. The Company engaged third party
consultants to review and validate the methodology and organization of the
Project. The Project strategy involves a number of phases: Inventory and
Assessment of Critical Equipment, Software and Relationships; Contingency
Planning; Remediation; and Readiness.
Inventory and Assessment of business relationships with customers and
suppliers to assure continuity of purchases, sales and inter-company
communications began in June 1998. CITGO now requires that all new contracts
with vendors, suppliers, or business partners include a clause covering Year
2000 readiness. CITGO
16
<PAGE> 19
will also seek evidence of Year 2000 readiness from service providers prior to
procuring new services. The Inventory and Assessment phases of the Project are
scheduled for completion before December 31, 1998.
While the CITGO Project is systematically assessing the Year 2000 readiness
of third party suppliers and customers, there can be no guarantee that third
parties of business importance to the Company will successfully and timely
reprogram, replace, or test all of their own computer hardware, software and
process control systems. CITGO has therefore chosen to continue assessment and
reevaluation of third party relationships beyond the deadline for completion of
other aspects of Inventory and Assessment phases of the Project. Reviews of
third party Year 2000 readiness will continue through 1999.
CITGO has also established a Year 2000 Contingency Planning Team. The
strategy for Contingency Planning includes a review and analysis of existing
Contingency Plans for CITGO refineries, terminals, pipelines and other
operations, in light of potential Year 2000 issues discovered in the Inventory
and Assessment phases of the Project. The Contingency Planning phase will also
evaluate and implement changes to the existing contingency plans. Contingency
plans based on this process are scheduled to be enacted in phases, with
completion scheduled for August 1, 1999. Additional planning is underway for the
Remediation phase of the Project. Remediation is expected to include technical
analysis, testing and, if necessary, retrofitting or replacement of systems and
equipment determined to be incapable of reliable operations in the Year 2000.
Target for completion of the Remediation phase is August 1, 1999. The final
phase of the Project, Readiness, is being conducted concurrent with other
Project phases. As systems, equipment, processes and business relationships are
determined and documented as Year 2000 ready, Project resources are being
shifted to pursue Readiness in remaining areas of the enterprise.
The following is CITGO's definition of Year 2000 Readiness:
- Correctly and accurately handle date information before, during and after
midnight, December 31, 1999.
- Function correctly and accurately, and without disruption, before, during
and after January 1, 2000.
- Respond to two-digit year date input in a way that resolves ambiguity as
to the century in a disclosed, defined and predetermined manner.
- Process all date data to reflect the year 2000 as a leap year.
- Correctly and accurately recognize and process any date with a year
specified as "99" and "00".
Costs. The estimated total cost of the Year 2000 Project is no more than
$35 million. This estimate does not include CITGO's potential share of Year 2000
costs that may be incurred by partnerships and joint ventures in which CITGO
participates but is not the managing partner or operator. The total amount
expended through September 30, 1998 was approximately $5 million. Approximately
65% of expenditures were for internal costs to conduct company-wide Inventory
and Assessment phases of the Project. The remaining 35% of the cost was for
consultants in the specialized areas of Project Management, Contingency
Planning, Information Technology, Database Administration and Operations
Analysis, as well as fees paid to third parties for Quality Assessment analysis
of Project organization and methodology.
The costs of the Project are being funded with cash from operations. No
existing or planned I.T. projects have been deferred or delayed due to Year 2000
readiness initiatives. The cost of implementing SAP replacement systems is not
included in these estimates.
The majority of estimated future costs for completing the Project are
anticipated to be directed toward the replacement and repair of systems and
equipment found to be incapable of reliable operation in the Year 2000.
Estimates for replacement and repair costs will be refined over time as the
Remediation phase progresses.
Risks. The failure to correct a material Year 2000 problem could result in
an interruption, or failure of, certain normal business activities or
operations. Because the Company is dependent, to a very substantial degree, upon
the proper functioning of its computer systems and its interaction with third
parties, including
17
<PAGE> 20
vendors and customers and their computer systems, a failure of any of these
systems to be Year 2000 compliant could have a material adverse effect on the
Company. Failure of this kind could, for example, cause disruption in the supply
of crude oil, cause disruption in refinery operations, cause disruption in the
distribution of refined products, lead to incomplete or inaccurate accounting,
recording, or processing of purchases of supplies or sales of refined products,
or result in generation of erroneous results. If not remedied, potential risks
include business interruption, financial loss, regulatory actions, reputational
harm, and legal liability. Such failures could adversely affect CITGO's results
of operations, liquidity and financial condition. Unlike other business
interruption scenarios, Year 2000 implications could include multiple,
simultaneous events which could result in unpredictable outcomes.
Due to the general uncertainty inherent in the Year 2000 problem, resulting
in part from the uncertainty of the Year 2000 readiness of third party suppliers
and customers, CITGO is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
operations, liquidity or financial position. The Year 2000 Project is expected
to significantly reduce the Company's level of uncertainty about the Year 2000
impact. CITGO believes that, with the implementation of new SAP business systems
and completion of the Project as scheduled, the possibility of significant
interruptions of normal operations should be minimized. See also "Factors
Affecting Forward Looking Statements".
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 12, 1997, an explosion and fire occurred at CITGO's Corpus Christi
refinery. There were no reports of serious personal injuries. Affected units
were shut down for repair and returned to full service in early August 1997. The
Company has property damage, business interruption and general liability
insurance, which related to this event. As a result, the property damage and
business interruption did not have a material adverse effect on the Company's
financial condition or results of operations. The Company has received
approximately 7,500 individual claims for personal injury and property damage,
allegedly arising from the incident. Approximately 1,300 of these claims have
been resolved for amounts individually and collectively, which are not material.
There are presently five lawsuits against the Company pending in federal and
state courts in Corpus Christi, Texas, alleging property damages, personal
injury and punitive damages allegedly arising from the incident. A trial
involving ten bellweather plaintiffs, out of approximately 400 plaintiffs in one
of the Federal Court lawsuits, ended October 29, 1998. Two of these claims were
dismissed by the judge and the jury found in CITGO's favor in the other eight,
declining to award any damages.
There is a class action lawsuit pending in Corpus Christi, Texas state
court against the Company and other operators and owners of nearby industrial
facilities filed in 1993 for damages to residential properties located in the
vicinity of the industrial facilities. The suit claims that the value of
properties has been reduced, as a result of air, soil and groundwater
contamination occasioned by operations of the industrial facilities owned by the
Company and other defendants. Two related personal injury and wrongful death
lawsuits were also filed in 1996 and are in preliminary stages of discovery at
this time. The Company and other defendants appealed the trial court's
certification of the class action to the Texas Supreme Court.
In 1997, the Company signed an agreement to settle the property damage
class action claims for approximately $17.3 million, the substantial portion of
which related to the purchase of approximately 290 properties in one of the
adjacent neighborhoods. Of this amount, $15.7 million was expensed in 1997. The
Court appointed a guardian to review the proposed settlement terms. The Texas
Supreme Court subsequently decided to consider the Company's appeal of the class
certification; that action raised questions whether the trial court had
authority to proceed with the settlement. Additionally, the trial court sought
to impose additional settlement conditions that were unacceptable to the
Company. For these reasons, the Company opposed approval and enforcement of the
settlement agreement as it was revised and pursued its appeal of the class
certification to the Texas Supreme Court.
The Texas Supreme Court ruled in July 1998 that it declined to hear the
appeal of the class certification and declined to hear the Company's request for
reconsideration of this decision. The case has been remanded
18
<PAGE> 21
to the district court for trial; however, if the settlement agreement is
enforced by the trial court, the Company could be liable for the balance of the
settlement amount after deductions for amounts it has paid related to its
purchase of properties. CITGO has agreed to purchase 245 of the properties it
sought to acquire and will receive settlements of property damage claims in
connection with such purchases. The Company has offers open to purchase the
remaining properties.
See the Company Quarterly Reports on Form 10-Q for the quarterly periods
ended March 31 and June 30, 1998 for additional information concerning this
matter.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule (filed electronically only)
</TABLE>
(b) Reports on Form 8-K:
None.
19
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
CITGO PETROLEUM CORPORATION
/s/ R. M. BRIGHT
------------------------------------
R. M. Bright
Controller (Chief Accounting
Officer)
Date: November 6, 1998
20
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
27 -- Financial Data Schedule (filed electronically only)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 278,758
<SECURITIES> 0
<RECEIVABLES> 659,352
<ALLOWANCES> 22,749
<INVENTORY> 874,573
<CURRENT-ASSETS> 1,796,661
<PP&E> 3,710,394
<DEPRECIATION> 860,827
<TOTAL-ASSETS> 5,665,196
<CURRENT-LIABILITIES> 1,444,071
<BONDS> 1,135,983
0
0
<COMMON> 1
<OTHER-SE> 2,042,027
<TOTAL-LIABILITY-AND-EQUITY> 5,665,196
<SALES> 8,395,891
<TOTAL-REVENUES> 8,454,692
<CGS> 7,869,555
<TOTAL-COSTS> 8,043,256
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 9,510
<INTEREST-EXPENSE> 75,457
<INCOME-PRETAX> 335,215
<INCOME-TAX> 124,030
<INCOME-CONTINUING> 211,185
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 211,185
<EPS-PRIMARY> .0
<EPS-DILUTED> .0
</TABLE>
