TRANSTEXAS GAS CORP, 10-Q, 1998-06-15

TRANSTEXAS GAS CORP
10-Q, 1998-06-15
CRUDE PETROLEUM & NATURAL GAS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended April 30, 1998

Commission File Number 1-12204

---------------------------

TRANSTEXAS GAS CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 76-0401023
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1300 NORTH SAM HOUSTON PARKWAY EAST
SUITE 310
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)

(281) 987-8600
(Registrant's telephone number, including area code)

---------------------------

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
---- ----

The number of shares of common stock of the registrant outstanding on
June 15, 1998 was 57,515,566.

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TRANSTEXAS GAS CORPORATION

TABLE OF CONTENTS

PAGE
----
<S> <C>
PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements:
Report of Independent Accountants............................................................ 2

Condensed Consolidated Balance Sheet as of April 30, 1998 and January 31, 1998............... 3

Condensed Consolidated Statement of Operations for the three months ended
April 30, 1998 and 1997.................................................................. 4

Condensed Consolidated Statement of Cash Flows for the three months ended
April 30, 1998 and 1997.................................................................. 5

Notes to Condensed Consolidated Financial Statements......................................... 6

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................................... 14

Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 19

PART II.
OTHER INFORMATION

Item 1. Legal Proceedings............................................................................... 20

Item 6. Exhibits and Reports on Form 8-K................................................................ 20

Signature.................................................................................................. 21

</TABLE>

<PAGE> 3

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

REPORT OF INDEPENDENT ACCOUNTANTS

To the Stockholders and Board of Directors
of TransTexas Gas Corporation

We have reviewed the accompanying condensed consolidated balance sheet of
TransTexas Gas Corporation as of April 30, 1998 and the related condensed
consolidated statements of operations and cash flows for the three months ended
April 30, 1998 and 1997. These financial statements are the responsibility of
the Company's management.

We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
for them to be in conformity with generally accepted accounting principles.

We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of January 31, 1998, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for the year then ended (not presented herein); and in our report
dated April 30, 1998, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of January 31, 1998, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.

COOPERS & LYBRAND L.L.P.

Houston, Texas
June 10, 1998

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TRANSTEXAS GAS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)

APRIL 30, JANUARY 31,
1998 1998
----------- -----------
<S> <C> <C>

ASSETS
Current assets:
Cash and cash equivalents ........................................................ $ 49,627 $ 38,502
Accounts receivable .............................................................. 35,231 17,056
Inventories ...................................................................... 18,632 16,437
Other current assets ............................................................. 5,622 10,719
----------- -----------
Total current assets ........................................................ 109,112 82,714
----------- -----------

Property and equipment .............................................................. 1,459,946 1,418,293
Less accumulated depreciation, depletion and amortization ........................... 726,286 716,695
----------- -----------

Net property and equipment -- based on the full cost method of accounting for
gas and oil properties of which $87,802 and $104,389 was excluded from
amortization at April 30, 1998 and January 31, 1998, respectively .............. 733,660 701,598
----------- -----------
Due from affiliates ................................................................. 1,513 1,488
Other assets, net ................................................................... 29,942 30,835
----------- -----------
$ 874,227 $ 816,635
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Current maturities of long-term debt ............................................. $ 9,325 $ 10,181
Accounts payable ................................................................. 55,159 52,075
Accrued interest payable to affiliate ............................................ 20,017 6,762
Accrued liabilities .............................................................. 35,461 35,818
----------- -----------
Total current liabilities ................................................... 119,962 104,836
----------- -----------

Long-term debt, less current maturities ............................................. 21,589 9,199
Production payments, less current portion ........................................... 40,179 4,121
Notes payable to affiliate .......................................................... 490,336 486,991
Subordinated notes .................................................................. 115,815 115,815
Revolving credit agreement .......................................................... 7,935 7,917
Deferred income taxes ............................................................... 35,833 39,497
Payable to affiliates ............................................................... 3,002 3,002
Other liabilities ................................................................... 21,742 20,620

Commitments and contingencies (Note 3) .............................................. -- --

Stockholders' equity:
Common stock, $0.01 par value, authorized 100,000,000
shares, issued and outstanding 57,515,566 shares ................................ 740 740
Additional paid-in capital ....................................................... 26,834 26,834
Retained earnings ................................................................ 252,665 259,468
----------- -----------
280,239 287,042
Treasury stock, at cost, 16,484,434 shares ....................................... (262,405) (262,405)
----------- -----------
Total stockholders' equity .................................................. 17,834 24,637
----------- -----------
$ 874,227 $ 816,635
=========== ===========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

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TRANSTEXAS GAS CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)

THREE MONTHS ENDED
APRIL 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Revenues:
Gas, condensate and natural gas liquids ...................... $ 19,330 $ 72,882
Transportation ............................................... -- 9,291
Gain on the sale of assets ................................... 12,327 --
Other ........................................................ 1,810 178
------------ ------------
Total revenues ............................................. 33,467 82,351
------------ ------------

Costs and expenses:
Operating .................................................... 6,512 27,142
Depreciation, depletion and amortization ..................... 11,846 33,557
General and administrative ................................... 5,645 15,140
Taxes other than income taxes ................................ 976 5,214
------------ ------------
Total costs and expenses ................................... 24,979 81,053
------------ ------------
Operating income ........................................... 8,488 1,298
------------ ------------

Other income (expense):
Interest income .............................................. 574 1,694
Interest expense, net ........................................ (19,529) (25,358)
------------ ------------
Total other income (expense) ............................... (18,955) (23,664)
------------ ------------
Loss before income taxes ................................... (10,467) (22,366)
Income taxes (benefit) .......................................... (3,664) (7,828)
------------ ------------
Net loss ................................................... $ (6,803) $ (14,538)
============ ============

Basic and diluted net loss per share ............................ $ (0.12) $ (0.20)
============ ============

Weighted average number of shares outstanding for basic
and diluted net loss per share ............................... 57,515,566 74,000,000
============ ============
</TABLE>

See accompanying notes to condensed consolidated financial statements.

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TRANSTEXAS GAS CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)

THREE MONTHS ENDED
APRIL 30,
----------------------
1998 1997
--------- ---------

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Operating activities:
Net loss ............................................................... $ (6,803) $ (14,538)
Adjustments to reconcile net loss to net cash provided (used) by
operating activities:
Depreciation, depletion and amortization ............................ 11,846 33,557
Amortization of debt issue costs .................................... 831 706
Accretion on subordinated notes ..................................... -- 3,294
Gain on the sale of assets .......................................... (12,327) --
Deferred income taxes ............................................... (3,664) 4,175
Amortization of deferred revenue .................................... -- (8,378)
Changes in assets and liabilities:
Accounts receivable ............................................... (4,857) 48,333
Receivable from affiliates ........................................ -- (649)
Inventories ....................................................... (2,195) (2,683)
Other current assets .............................................. 5,097 11,235
Accounts payable .................................................. (2,568) 19,689
Accrued interest payable to affiliate ............................. 13,255 --
Accrued liabilities ............................................... (194) 17,123
Transactions with affiliates, net ................................. (25) (19,108)
Other assets ...................................................... 62 105
Other liabilities ................................................. 622 (824)
--------- ---------
Net cash provided (used) by operating activities ............... (920) 92,037
--------- ---------

Investing activities:
Capital expenditures ................................................... (61,359) (104,001)
Proceeds from the sale of assets ....................................... 22,112 --
--------- ---------
Net cash used by investing activities .......................... (39,247) (104,001)
--------- ---------

Financing activities:
Issuance of production payments ........................................ 39,100 20,977
Principal payments on production payments .............................. (2,705) (9,471)
Issuance of long-term debt ............................................. 14,000 8,300
Principal payments on long-term debt ................................... (2,466) (1,432)
Issuance of note payable to affiliate .................................. 3,345 --
Revolving credit agreement, net ........................................ 18 (17,882)
Debt issue costs ....................................................... -- (422)
--------- ---------
Net cash provided by financing activities ...................... 51,292 70
--------- ---------
Increase (decrease) in cash and cash equivalents ............... 11,125 (11,894)
Beginning cash and cash equivalents ....................................... 38,502 23,561
--------- ---------
Ending cash and cash equivalents .......................................... $ 49,627 $ 11,667
========= =========

Noncash operating and investing activities:
Accounts payable for property and equipment ............................ $ 38,318 $ 39,730
========= =========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

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TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. GENERAL

In the opinion of management, all adjustments, consisting of normal
recurring accruals, have been made that are necessary to fairly state the
financial position of TransTexas Gas Corporation ("TransTexas" or the "Company")
as of April 30, 1998 and the results of its operations and cash flows for the
interim periods ended April 30, 1998 and 1997. The results of operations for
interim periods should not be regarded as necessarily indicative of results that
may be expected for the entire year. The financial information presented herein
should be read in conjunction with the consolidated financial statements and
notes included in TransTexas' annual report on Form 10-K for the year ended
January 31, 1998. Unless otherwise noted, the term "TransTexas" refers to
TransTexas Gas Corporation and its subsidiaries. TransTexas is a subsidiary of
TransAmerican Energy Corporation ("TEC"), which is a wholly owned subsidiary of
TransAmerican Natural Gas Corporation ("TransAmerican"). TransAmerican Refining
Corporation ("TARC") is a wholly owned subsidiary of TEC.

LIQUIDITY

Cash flow from operations is sensitive to the level of capital
expenditures and the prices TransTexas receives for its natural gas. TransTexas
makes substantial capital expenditures for the exploration and development of
natural gas reserves. TransTexas historically has financed its capital
expenditures, debt service and working capital requirements with cash from
operations, public and private offerings of debt and equity securities, the sale
of production payments, asset sales, an accounts receivable revolving credit
facility and other financings.

During the three months ended April 30, 1998, total capital expenditures
were $61 million, including $7 million for lease acquisitions, $49 million for
drilling and development and $5 million for TransTexas' gas gathering and
pipeline system and other equipment and seismic acquisitions. Subject to cash
availability, capital expenditures for fiscal 1999 are estimated to be
approximately $188 million, which amount is in excess of projected cash flow
from operations. A reduction in planned capital spending could result in less
than anticipated cash flow from operations in fiscal 1999 and later years, which
could have a material adverse effect on TransTexas. To finance its capital
expenditure and working capital requirements, TransTexas will be required to
supplement its anticipated cash flow from operations with a combination of asset
sales, including assets of its drilling services division, and financings which
may include borrowings or production payments. TransTexas' debt covenants may
limit its ability to obtain additional financing or to sell properties, and
there is no assurance that adequate funds can be obtained on a timely basis from
such sources.

RECENTLY ISSUED PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131"), which establishes
standards for reporting information about operating segments. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The adoption of this statement is not
expected to have a material impact on TransTexas' financial statements.

In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes
standards for reporting and display of comprehensive income and its components
in financial statements. This statement was adopted by TransTexas effective
February 1, 1998. The adoption of this statement did not have a material impact
on TransTexas' financial statements.

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TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

2. GAIN ON THE SALE OF ASSETS

On April 30, 1998, TransTexas sold its oilfield stimulation, cementing and
coiled tubing equipment and related facilities to an unaffiliated third party
for a sales price of $30 million, subject to post-closing adjustments.
TransTexas recorded an $10.3 million pre-tax gain as a result of this sale.

On May 26, 1998, TransTexas entered into an asset purchase agreement with
an unaffiliated third party for the sale of its drilling rigs and related
facilities for a sales price of $75 million to be paid in cash at closing. The
closing, which is subject to several conditions, is expected to occur by the end
of July 1998.

TransTexas has also entered into a letter of intent to sell its remaining
drilling services assets. There can be no assurance that a definitive agreement
will be entered into.

Additional adjustments to the Lobo Sale purchase price resulted in a
pre-tax gain on the sale of assets of $2.0 million during the three months ended
April 30, 1998.

3. COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

ARABIAN OFFSHORE PARTNERS. On June 27, 1997, Arabian Offshore Partners
filed a lawsuit against TransTexas in the 14th Judicial District Court, Dallas
County, Texas, seeking $20 million in damages in connection with TransTexas'
refusal to proceed with the acquisition of two jack-up drilling rigs.
TransTexas' motion for summary judgment was granted on January 13, 1998. The
plaintiffs have appealed.

FINKELSTEIN. On April 22, 1991, H. S. Finkelstein filed a suit against
TransAmerican and various affiliates in the 49th Judicial District Court, Zapata
County, Texas, alleging an improper calculation of overriding royalties
allegedly owed to the plaintiff and seeking damages and attorneys' fees in
excess of $33.7 million. On November 18, 1993, the plaintiff added TransTexas as
an additional defendant. The parties arbitrated this matter in January 1997. In
May 1998, the arbitration panel awarded $13 million to plaintiff. TransTexas
is evaluating its prospects for appeal.

HEIN MINERALS. On April 3, 1998, Henry and Luz A. Hein Minerals, L.C.
("Hein") filed suit in the 49th Judicial District Court, Zapata County, Texas,
against TransAmerican, TransTexas, TransTexas Transmission Corporation ("TTC")
and Conoco, Inc. Plaintiff alleges that a 1990 mineral lease from plaintiffs to
TransAmerican, comprising approximately 2,000 acres, was breached by failure to
release certain acreage from the lease. Plaintiff alleges trespass, tortious
interference, conversion, fraud, breach of fiduciary duty, breach of contract,
conversion and slander of title, and claim damages including $10 per day per
acre that was not released. TransTexas intends to vigorously defend against
these claims.

ZURICH. On May 5, 1998, The Home Insurance Company and Zurich Insurance
Company filed suit against TransTexas in the United States District Court,
Southern District of New York, to enforce a $10 million arbitration award
relating to workers' compensation policies. TransTexas filed a motion to dismiss
on June 4, 1998, and intends to vigorously defend this claim.

GENERAL. The resolution in any reporting period of one or more of the
foregoing matters in a manner adverse to TransTexas could have a material
adverse effect on TransTexas' results of operations and cash flows for that
period. TransTexas is also a named defendant in other ordinary course, routine
litigation incidental to its business. Although the outcome of these other
lawsuits cannot be predicted with certainty, TransTexas does not expect these
matters to have a material adverse effect on its financial position. As of April
30, 1998, the possible range of

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TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

estimated losses related to all of the aforementioned claims, in addition to the
estimates accrued by TransTexas, is $0 to $20 million. Litigation expense,
including legal fees, totaled approximately $0.1 million and $5 million for the
three months ended April 30, 1998 and 1997, respectively.

ENVIRONMENTAL MATTERS

TransTexas' operations and properties are subject to extensive federal,
state, and local laws and regulations relating to the generation, storage,
handling, emission, transportation, and discharge of materials into the
environment. Permits are required for various of TransTexas' operations, and
these permits are subject to revocation, modification, and renewal by issuing
authorities. TransTexas also is subject to federal, state, and local laws and
regulations that impose liability for the cleanup or remediation of property
that has been contaminated by the discharge or release of hazardous materials or
wastes into the environment. Governmental authorities have the power to enforce
compliance with their regulations, and violations are subject to fines or
injunctions, or both. Certain aspects of TransTexas' operations may not be in
compliance with applicable environmental laws and regulations, and such
noncompliance may give rise to compliance costs and administrative penalties. It
is not anticipated that TransTexas will be required in the near future to expend
amounts that are material to the financial condition or operations of TransTexas
by reason of environmental laws and regulations, but because such laws and
regulations are frequently changed and, as a result, may impose increasingly
strict requirements, TransTexas is unable to predict the ultimate cost of
complying with such laws and regulations.

PRODUCTION PAYMENTS

In April 1997, TransTexas sold to an unaffiliated third party a term
overriding royalty in the form of a dollar-denominated production payment in
certain of TransTexas' producing properties for net proceeds of $20 million. The
production payment calls for the repayment of the primary sum plus an amount
equivalent to a 16% annual interest rate on the unpaid portion of such primary
sum. As of April 30, 1998, the remaining outstanding balance was $2.1 million.

In February 1998, TransTexas entered into a production payment drilling
program agreement with an unaffiliated third party for the reimbursement of
certain drilling costs with respect to wells drilled by TransTexas. Pursuant to
the agreement, upon the approval of the third party of a recently drilled or
currently drilling well for inclusion in the program, the third party will
commit to the reimbursement of all or a portion of the cost of such well, up to
an aggregate maximum for all such wells of $75 million. The program wells are
subject to a dollar-denominated production payment equal to the primary sum of
such reimbursed costs, plus an amount equivalent to a 15% annual interest rate
on the unpaid portion of such primary sum. As of April 30, 1998, the outstanding
balance on the production payment was $39.1 million.

POTENTIAL TAX LIABILITY

Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and a contingent
liability for interest of $102 million owed by TransAmerican. TransAmerican has
taken the federal tax position that the entire amount of this debt cancellation
is excluded from its income under the cancellation of indebtedness provisions
(the "COD Exclusion") of the Internal Revenue Code of 1986, as amended, and has
reduced its tax attributes (including its net operating loss and credit
carryforwards) as a consequence of the COD Exclusion. No federal tax opinion was
rendered with respect to this transaction, however, and TransAmerican has not
obtained a ruling from the Internal Revenue Service (the "IRS") regarding this
transaction. TransTexas believes that there is substantial legal authority to
support the position that the COD Exclusion applies to the cancellation of
TransAmerican's indebtedness. However, due to factual and legal uncertainties,
there can be no assurance that the IRS will not challenge this position, or that
such challenge would not be upheld. Under the Tax Allocation Agreement (defined
below), TransTexas has agreed to pay an amount equal to any federal tax
liability

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TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

(which would be approximately $25.4 million) attributable to the inapplicability
of the COD Exclusion. Any such tax would be offset in future years by
alternative minimum tax credits and retained loss and credit carryforwards to
the extent recoverable from TransAmerican. As a member of the TNGC Consolidated
Group (defined below), each of TransTexas, TEC and TARC will be severally liable
for any tax liability resulting from the above-described transactions. The IRS
has commenced an audit of the consolidated federal income tax returns of the
TNGC Consolidated Group for its taxable years ended July 31, 1995 and 1994. At
this time, it is not possible to predict the scope of the IRS' review or whether
any tax deficiencies will be proposed by the IRS as a result of its review.

Based upon independent legal advice, TransTexas has determined that it
will not report any significant federal income tax liability as a result of the
Lobo Sale. There are, however, significant uncertainties regarding TransTexas'
tax position and no assurance can be given that its position will be sustained
if challenged by the IRS. TransTexas is part of an affiliated group for tax
purposes (the "TNGC Consolidated Group"), which includes TNGC Holdings
Corporation, the sole stockholder of TransAmerican ("TNGC"), TransAmerican, TEC
and TARC. No letter ruling has been or will be obtained from the IRS regarding
the Lobo Sale by any member of the TNGC Consolidated Group. If the IRS were to
successfully challenge TransTexas' position, each member of the TNGC
Consolidated Group would be severally liable under the consolidated tax return
regulations for the resulting taxes, in the estimated amount of up to $250
million (assuming the use of existing tax attributes of the TNGC Consolidated
Group), possible penalties equal to 20% of the amount of the tax, and interest
at the statutory rate (currently 8%) on the tax and penalties (if any). The Tax
Allocation Agreement has been amended so that TransAmerican will become
obligated to fund the entire tax deficiency (if any) resulting from the Lobo
Sale. There can be no assurance that TransAmerican would be able to fund any
such payment at the time due and the other members of the TNGC Consolidated
Group, thus, may be required to pay the tax. TransTexas has reserved
approximately $75 million with respect to the potential tax liability for
financial reporting purposes to reflect a portion of the federal tax liability
that TransAmerican might not be able to pay. If TransTexas were required to pay
this tax deficiency, it is likely that it would be required to sell significant
assets or raise additional debt or equity capital to fund the payment.

TNGC, TransAmerican and its existing subsidiaries, including TARC, TEC and
TransTexas, are parties to a tax allocation agreement, as amended (the "Tax
Allocation Agreement"), the general terms of which require TransAmerican and all
of its subsidiaries to file federal income tax returns as members of a
consolidated group to the extent permitted by law. Filing on a consolidated
basis allows income and tax of one member to be offset by losses and credits of
another and allows deferral of certain intercompany gains; however, each member
is severally liable for the consolidated federal income tax liability of the
consolidated group.

The Tax Allocation Agreement requires each of TransAmerican's subsidiaries
to pay to TransAmerican each year its allocable share of the federal income tax
liabilities of the consolidated group ("Allocable Share"). The Tax Allocation
Agreement provides for a reallocation of the group's consolidated federal income
tax liabilities among the members if the IRS or the courts ultimately
re-determine the group's regular tax or alternative minimum tax liability. In
the event of an IRS audit or examination, the Tax Allocation Agreement generally
gives TransAmerican the authority to compromise or settle disputes and to
control litigation, subject to the approval of TARC, TEC or TransTexas, as the
case may be, where such compromise or settlement affects the determination of
the separate tax liability of that company.

Under the Tax Allocation Agreement, each subsidiary's Allocable Share for
each tax year will generally equal the amount of federal income tax it would
have owed had it filed a separate federal income tax return for each year except
that each subsidiary will be able to utilize net operating losses and credits of
TransAmerican and the other members of the consolidated group effectively to
defer payment of tax liabilities that it would have otherwise owed had it filed
a separate federal income tax return. Each subsidiary will essentially pay the
deferred taxes at the time TransAmerican (or the member whose losses or credits
are utilized by such subsidiary) begins generating taxable income or tax. This
will have the effect of deferring a portion of such subsidiary's tax liability
to future years. The parties to the Tax Allocation Agreement amended such
agreement in connection with the Lobo Sale to include additional affiliates as
parties, and further amended the Tax Allocation Agreement in June 1997 to
allocate to TransAmerican, as among the parties, any

<PAGE> 11

TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

tax liability associated with the Lobo Sale.

Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation occurred during
the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the IRS
successfully challenged TransTexas' position on the Lobo Sale. Each member of a
consolidated group filing a consolidated federal income tax return is severally
liable to the IRS for the consolidated federal income tax liability of the
consolidated group. There can be no assurance that each TNGC Consolidated Group
member will have the ability to satisfy any tax obligation attributable to these
transactions at the time due and, therefore, other members of the group,
including TEC, TransTexas or TARC, may be required to pay the tax.

TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of April 30, 1998, TransTexas had
paid $5.4 million of these franchise taxes and estimates that it will pay
approximately $6.0 million during fiscal 1999.

POTENTIAL EFFECTS OF A CHANGE OF CONTROL

The Subordinated Notes Indenture provides that, upon the occurrence of a
Change of Control, each holder of the Subordinated Notes will have the right to
require TransTexas to repurchase such holder's Subordinated Notes at 101% of the
principal amount thereof plus accrued and unpaid interest. Pursuant to the terms
of the TransTexas Intercompany Loan, upon the occurrence of a Change of Control,
TEC would have the right to require TransTexas to repay the principal of the
TransTexas Intercompany Loan in an amount equal to a pro rata share of the
amount TEC is required to pay under the TEC Notes Indenture. Such pro rata share
would be calculated using the ratio of the outstanding principal amount of the
TransTexas Intercompany Loan to the sum of (i) the outstanding principal amount
of the TransTexas Intercompany Loan plus (ii) the accreted value of the
outstanding principal amount of the TARC Intercompany Loan.

A Change of Control would be deemed to occur under the Subordinated Notes
Indenture in the case of certain changes or other events in respect of the
ownership of TransTexas, including any circumstances pursuant to which any
person or group other than John R. Stanley (or his heirs, his estate, or any
trust in which he or his immediate family members have, directly or indirectly,
a beneficial interest in excess of 50%) and his subsidiaries or the TEC
Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the Subordinated Notes is downgraded or
withdrawn. A Change of Control would be deemed to occur under the TransTexas
Intercompany Loan in the case of certain changes or other events in respect of
the ownership or control of TEC, TransTexas or TARC, including any circumstance
pursuant to which (i) any person or group, other than John R. Stanley (or his
heirs, his estate, or any trust in which he or his immediate family members
have, directly or indirectly, a beneficial interest in excess of 50%) and his
subsidiaries or the TEC Indenture Trustee is or becomes the beneficial owner of
more than 50% of the total voting power of TEC's then outstanding voting stock,
or (ii) TEC or any of its subsidiaries own some of TransTexas' or TARC's capital
stock, respectively, but less than 50% of the total voting stock or economic
value of TransTexas or TARC, respectively, unless the TEC Notes have an
investment grade rating for the period of 120 days thereafter. The term
"person," as used in the definition of Change of Control, means a natural
person, company,

<PAGE> 12

TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

government or political subdivision, agency or instrumentality of a government
and also includes a "group," which is defined as two or more persons acting as a
partnership, limited partnership or other group.

In addition, certain changes or other events in respect of the ownership
or control of TransTexas that do not constitute a Change of Control under the
Subordinated Notes Indenture or the TEC Notes Indenture may result in a "change
of control" of TransTexas under the terms of the BNY Facility and certain
equipment financing. Such an occurrence could create an obligation for
TransTexas to repay such other indebtedness. At April 30, 1998, TransTexas had
approximately $36.2 million of indebtedness subject to such right of repayment
or repurchase. In the event of a Change of Control under the Subordinated Notes
Indenture or the TEC Notes Indenture or a "change of control" under the terms of
other outstanding indebtedness, there can be no assurance that TransTexas will
have sufficient funds to satisfy any such payment obligations. A change of
control or other event that results in deconsolidation of TransTexas and
TransAmerican for federal income tax purposes could result in acceleration of a
substantial amount of federal income taxes.

LOBO SALE

Pursuant to the Lobo Sale, TransTexas is required to indemnify the buyer
for certain liabilities related to the assets owned by TTC. Although TransTexas
does not anticipate that it will incur any material indemnity liability, no
assurance can be given that TransTexas will have sufficient funds to satisfy any
such indemnity obligation or that any payment thereof will not have a material
adverse effect on its ability to fund its debt service, capital expenditure and
working capital requirements.

DELIVERY COMMITMENTS

TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 425 MMcf per day to specified delivery points.
TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.0 million during the
three months ended April 30, 1998.

4. OTHER CURRENT ASSETS

The major components of other current assets are as follows (in thousands
of dollars):

APRIL 30, JANUARY 31,
1998 1998
------------ ------------
<S> <C> <C>
Prepayments:
Trade .......................................... $ 1,607 $ 7,120
Insurance ...................................... 2,908 3,171
Other .......................................... 1,107 428
------------ ------------
$ 5,622 $ 10,719
============ ============
</TABLE>

5. ACCRUED LIABILITIES

The major components of accrued liabilities are as follows (in thousands
of dollars):

APRIL 30, JANUARY 31,
1998 1998
------------ ------------

<S> <C> <C>
Royalties ............................................. $ 6,272 $ 7,171
Taxes other than income taxes ......................... 4,925 2,562
Interest .............................................. 6,877 2,544
</TABLE>

<PAGE> 13

TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
<TABLE>

<S> <C> <C>
Payroll ............................................... 5,332 5,185
Litigation settlements and other ...................... 453 1,387
Insurance ............................................. 8,502 9,041
Other ................................................. 3,100 7,928
---------- ----------
$ 35,461 $ 35,818
========== ==========
</TABLE>

6. OTHER LIABILITIES

The major components of other liabilities are as follows (in thousands of
dollars):

APRIL 30, JANUARY 31,
1998 1998
------------ ------------

<S> <C> <C>
Litigation accrual .................................... $ 14,508 $ 15,008
Other ................................................. 7,234 5,612
------------ ------------
$ 21,742 $ 20,620
============ ============
</TABLE>

7. LITIGATION SETTLEMENTS

ALAMEDA. On May 22, 1993, Alameda Corporation ("Alameda") sued
TransAmerican in the 234th Judicial District Court, Harris County, Texas,
claiming that TransAmerican failed to account to Alameda for a share of the
proceeds TransAmerican received in a 1990 settlement of litigation with El Paso
Natural Gas Company ("El Paso"), and that TransAmerican has been unjustly
enriched by its failure to share such proceeds with Alameda. On September 20,
1995, the jury rendered a verdict in favor of TransAmerican. Alameda appealed to
the Fourteenth Court of Appeals, which affirmed the trial court judgment in
favor of TransAmerican. Alameda's motion for rehearing was denied and Alameda
appealed to the Texas Supreme Court. The Texas Supreme Court refused to hear
Alameda's appeal. Alameda filed a motion for rehearing which was denied by the
Texas Supreme Court on May 21, 1998. The judgment in favor of TransAmerican is
final.

FINKELSTEIN. On April 15, 1990, H.S. Finkelstein filed suit against
TransAmerican in the 49th Judicial District Court, Zapata County, Texas,
alleging that TransAmerican failed to pay royalties and improperly marketed oil
and gas produced from certain leases. On September 27, 1994, the plaintiff added
TransTexas as an additional defendant. On January 6, 1995, a judgment against
TransAmerican and TransTexas was entered for approximately $18 million in
damages, interest and attorneys' fees. TransTexas and TransAmerican appealed the
judgment to the Fourth Court of Appeals, San Antonio, Texas, which affirmed the
judgment on April 3, 1996. TransTexas and TransAmerican filed a motion for
rehearing. On August 14, 1996, the Fourth Court of Appeals reversed the trial
court judgment and rendered judgment in favor of TransAmerican and TransTexas.
On August 29, 1996, Finkelstein filed a motion for stay and a motion for
rehearing with the court. On October 9, 1996, the court denied Finkelstein's
motion for rehearing. In November 1996, Finkelstein filed an application for
writ to proceed to with the Supreme Court of Texas. The Texas Supreme Court
denied Finkelstein's application in March 1998. Finkelstein's motion for
rehearing was also denied, and the Appellate Court judgment in favor of
TransAmerican is now final.

8. CREDIT AGREEMENT

TransTexas and BNY Financial Corporation ("BNY") are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of April 30, 1998, outstanding
advances under the BNY Facility totaled approximately $7.9 million. Interest
accrues on advances at the rate of (i) the higher of (a) the prime rate of The
Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1% plus (ii) 1/2 of
1%. Obligations under the BNY Facility are secured by liens on TransTexas'
receivables and inventory. The BNY Facility contains certain financial covenants
including a limitation on net losses.

<PAGE> 14

TRANSTEXAS GAS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)

9. TRANSACTIONS WITH AFFILIATES

On June 13, 1997, a services agreement was entered into among
TransAmerican, TEC, TARC and TransTexas. Under the services agreement,
TransTexas provides accounting, legal, administrative and other services to
TARC, TEC and TransAmerican and its affiliates. TransAmerican will provide
advisory services to TransTexas, TARC and TEC. TARC will pay to TransTexas
approximately $300,000 per month for services rendered and for allocated
expenses paid by TransTexas on behalf of TARC. TransAmerican will pay to
TransTexas approximately $20,000 per month for such services. TEC and its
subsidiaries will pay $2.5 million in the aggregate per year to TransAmerican
for advisory services and benefits provided by TransAmerican. As of April 30,
1998, the receivable from TARC and TransAmerican for such services was $0.3
million.

During fiscal year 1998, TEC made advances to TransTexas pursuant to
promissory notes which mature on June 14, 2002. The notes bear interest in an
amount equal to a fixed semi-annual interest payment of $2.8 million, prorated
based upon the average outstanding balance of all notes (other than the note
evidencing the TransTexas Intercompany Loan) between TransTexas and TEC and the
average outstanding balance of all notes (other than the note evidencing the
TARC Intercompany Loan) between TARC and TEC. During the three months ended
April 30, 1998, TEC advanced $3.3 million to TransTexas under these notes.
On April 30, 1998, the outstanding balance of these notes was $40.3 million.

<PAGE> 15

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto of TransTexas included
elsewhere in this report.

RESULTS OF OPERATIONS

GENERAL

TransTexas' results of operations are dependent upon natural gas
production volumes and unit prices from sales of natural gas, condensate and
NGLs. The profitability of TransTexas also depends on its ability to minimize
finding and lifting costs and maintain its reserve base while maximizing
production. On May 29, 1997, TransTexas consummated a stock purchase agreement
with an unaffiliated buyer (the "Lobo Sale Agreement"), with an effective date
of March 1, 1997, to effect the sale (the "Lobo Sale") of the stock of
TransTexas Transmission Corporation ("TTC"), its subsidiary that owned
substantially all of TransTexas' Lobo Trend producing properties and related
pipeline transmission system, for an adjusted sales price of approximately $1.1
billion. Accordingly, TransTexas' reported results for the three months ended
April 30, 1998 reflect the effects of reduced sales volumes as a result of the
Lobo Sale.

TransTexas' operating data for the three months ended April 30, 1998 and
1997, is as follows:

THREE MONTHS ENDED
APRIL 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Sales volumes:
Gas (Bcf) (1) ....................................... 7.8 35.4
NGLs (MMgal) ........................................ 2.0 47.4
Condensate (MBbls) .................................. 72 275
Average prices:
Gas (dry) (per Mcf)(2) ............................. $ 2.18 $ 1.67
NGLs (per gallon) ................................... .23 .30
Condensate and oil (per Bbl) ........................ 13.51 20.08
Number of gross wells drilled ......................... 13 29
Percentage of wells completed ......................... 69% 72%
</TABLE>

- -------------------------
(1) Sales volumes for the three months ended April 30, 1997 include 7.2 Bcf
delivered pursuant to volumetric production payments.
(2) Average prices for the three months ended April 30, 1997 include amounts
delivered under volumetric production payments. The average gas price for
TransTexas' undedicated production for this period was $1.80 per Mcf. Gas
prices do not include the effect of hedging agreements.

A summary of TransTexas' operating expenses is set forth below (in
millions of dollars):

THREE MONTHS ENDED
APRIL 30,
---------------------
1998 1997
--------- ---------
<S> <C> <C>
Operating costs and expenses:
Lease ............................................. $ 3.2 $ 7.9
Pipeline and gathering ............................ 2.6 8.2
Natural gas liquids ............................... -- 10.9
Drilling services ................................. 0.7 0.1
--------- ---------
6.5 27.1
Taxes other than income taxes (1) ..................... 1.0 5.2
--------- ---------
Total ............................................. $ 7.5 $ 32.3
========= =========
</TABLE>

<PAGE> 16

- -----------------------------

(1) Taxes other than income taxes include severance, property and other taxes.

TransTexas' average depletion rates have been as follows:

THREE MONTHS ENDED
APRIL 30,
---------------------
1998 1997
--------- ---------

<S> <C> <C>
Depletion rates (per Mcfe) ............................ $ 1.32 $ 1.05
========= =========
</TABLE>

THREE MONTHS ENDED APRIL 30, 1998, COMPARED WITH THE THREE MONTHS ENDED
APRIL 30, 1997

Gas, condensate and NGL revenues for the three months ended April 30, 1998
decreased $53.6 million from the prior period, due primarily to decreases in
gas, condensate and NGLs sales volumes attributable to the divestiture of
producing properties as a result of the Lobo Sale. The average monthly prices
received per Mcf of gas ranged from $2.10 to $2.35 in the three months ended
April 30, 1998, compared to a range of $1.49 to $2.29, excluding amounts
dedicated to volumetric production payments, in the prior period. As of April
30, 1998, TransTexas had a total of 118 producing wells compared to 872
producing wells at April 30, 1997. Transportation revenues decreased $9.3
million over the prior period due primarily to the divestiture of the pipeline
system as a result of the Lobo Sale. Drilling services revenues increased by
$0.9 million for the three months ended April 30, 1998, due primarily to an
increase in services provided to third parties. For the three months ended April
30, 1998, TransTexas recognized a pre-tax gain of $10.3 million on the sale of
certain drilling services division assets and a pre-tax gain of $2.0 million due
to post-closing adjustments to the Lobo Sale purchase price.

Lease operating expenses for the quarter ended April 30, 1998 decreased by
$4.7 million from the prior period due primarily to the Lobo Sale and the
resulting decrease in the number of producing wells. Pipeline and gathering
expenses decreased $5.6 million from the prior period due primarily to the
divestiture of the pipeline system, offset partially by an increase of $1.0
million attributable to contractual transportation charges. NGL costs decreased
by $10.9 million from the prior period primarily due to the Lobo Sale and the
resulting decrease in the volumes of natural gas processed. Drilling service
expenses for the three months ended April 30, 1998 increased $0.6 million
primarily due to increased costs related to providing services to the new
operator of the Lobo Trend properties. Depreciation, depletion and amortization
expense for the three months ended April 30, 1998 decreased $21.7 million due to
the Lobo Sale and the resulting decrease in TransTexas' undedicated natural gas
production, partially offset by a $0.27 increase in the depletion rate. General
and administrative expenses decreased by $9.5 million primarily as a result of a
decrease in litigation expense. Taxes other than income taxes decreased by $4.2
million over the prior period due primarily to decreases in ad valorem,
severance and excise taxes associated with the Lobo Sale and resulting decrease
in the number of producing wells.

Interest income for the three months ended April 30, 1998 decreased by
$1.1 million as compared to the prior period due to lower cash balances
available for investment. TransTexas does not expect to earn significant
interest income during fiscal year 1999. Interest expense decreased by $5.8
million primarily as a result of the retirement of the Senior Secured Notes in
June 1997.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow from operating activities for the three months ended April 30,
1998 decreased by $93.0 million from the prior period due primarily to the
reduction in the level of TransTexas' operations since the Lobo Sale in May
1997. Cash flow from operations is sensitive to the prices TransTexas receives
for its natural gas. TransTexas from time to time enters into commodity price
swap agreements to reduce its exposure to price risk in the spot market for
natural gas. Proceeds from natural gas sales are received at approximately the
same time that production-related burdens, such as royalties, production taxes
and drilling program obligations, are payable.

<PAGE> 17

TransTexas makes substantial capital expenditures for the acquisition,
exploration, development and production of gas and oil properties. TransTexas
historically has financed its capital expenditures, debt service and working
capital requirements from cash flow from operations, public and private
offerings of debt and equity securities, the sale of production payments, asset
sales, an accounts receivable revolving credit facility and other financings.

For the three months ended April 30, 1998, total capital expenditures were
$61 million, including $7 million for lease acquisitions, $49 million for
drilling and development and $5 million for TransTexas' gas gathering and
pipeline system and other equipment and seismic acquisitions. Subject to cash
availability, capital expenditures for fiscal year 1999 are estimated to be
approximately $188 million, which amount is in excess of projected cash flow
from operations for fiscal year 1999. A reduction in planned capital spending
could result in less than anticipated cash flow from operations in fiscal year
1999 and future years which could have a material adverse effect on TransTexas.
To finance these capital expenditure requirements and reduce its working capital
deficit, TransTexas will be required to supplement its anticipated cash flow
from operations with a combination of asset sales, including assets of its
drilling services division, and financings which may include borrowings or
production payments. TransTexas' debt covenants may limit its ability to obtain
additional financings or to sell properties, and there is no assurance that
adequate funds can be obtained on a timely basis from such sources.

Cash flow provided by financing activities for the three months ended
April 30, 1998 increased by $51.2 million due primarily to the issuance of a
production payment in February 1998 and the issuance of long-term debt related
to equipment financing.

In March 1998, TransTexas executed an amended and restated note in the
principal amount of approximately $14.9 million consolidating equipment
financing debt previously incurred. Concurrently, TransTexas incurred an
additional $14 million in equipment financing debt, evidenced by a promissory
note. Both notes are secured by a lien on the equipment financed. The notes bear
interest at a rate of 13.87%, payable in monthly installments with a final
installment due on April 1, 2001.

As of April 30, 1998, TEC has advanced an aggregate of approximately $40
million to TransTexas pursuant to promissory notes which mature on June 14,
2002. The notes bear interest in an amount equal to a fixed semi-annual interest
payment of $2.8 million, prorated based on the average outstanding balance of
all notes (other than the note evidencing the TransTexas Intercompany Loan)
between TransTexas and TEC and the average outstanding balance of all notes
(other than the note evidencing the TARC Intercompany Loan) between TARC and
TEC.

TransTexas and BNY Financial Corporation are parties to a Second Amended
and Restated Accounts Receivable Management and Security Agreement (the "BNY
Facility"), dated as of October 14, 1997. As of April 30, 1998, outstanding
advances under the BNY Facility totaled approximately $7.9 million. Interest
accrues on advances at the rate of (i) the higher of (a) the prime rate of The
Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1% plus (ii) 1/2 of
1%. Obligations under the BNY Facility are secured by liens on TransTexas'
receivables and inventory.

Subsequent to the Lobo Sale, TransTexas' exploration and production
activities are no longer concentrated in the Laredo, Texas area nor are they
comparable to those historically conducted. Therefore, the utilization of a
centrally located drilling services operation in Laredo is no longer as
efficient or cost effective. In April 1998, TransTexas sold its oilfield
stimulation, cementing and coiled tubing equipment and related facilities for a
sales price of $30 million, subject to post-closing adjustments. In May 1998,
TransTexas entered into an agreement to sell its drilling rigs and related
assets for a sales price of $75 million. This sale is expected to close in July
1998, subject to certain conditions. TransTexas has also entered into a letter
of intent to sell its remaining drilling services assets.

<PAGE> 18

There can be no assurance that a definitive agreement will be entered into.
TransTexas expects that its future general and administrative expenses and
operating expenses will be reduced as a result of these sales.

CONTINGENT LIABILITIES

TransTexas has significant contingent liabilities, including liabilities
with respect to the litigation matters described in Note 3 of Notes to Condensed
Consolidated Financial Statements. These matters, individually and in the
aggregate, amount to significant potential liability which, if adjudicated in a
manner adverse to TransTexas in one reporting period, could have a material
adverse effect on TransTexas' cash flows or results of operations for that
period.

Pursuant to the Lobo Sale Agreement, TransTexas is required to indemnify
the buyer for certain liabilities related to the assets owned by TTC. Although
TransTexas does not anticipate that it will incur any material indemnity
liability, no assurance can be given that TransTexas will have sufficient funds
to satisfy any such indemnity obligation or that any payment thereof will not
have a material adverse effect on its ability to fund its debt service, capital
expenditure and working capital requirements.

POTENTIAL TAX LIABILITY

Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence of the COD Exclusion.
No federal tax opinion was rendered with respect to this transaction, however,
and TransAmerican has not obtained a ruling from the Internal Revenue Service
(the "IRS") regarding this transaction. TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness. However, due to
factual and legal uncertainties, there can be no assurance that the IRS will not
challenge this position, or that such challenge would not be upheld. Under an
agreement between TransTexas, TransAmerican and certain of TransAmerican's
subsidiaries (the "Tax Allocation Agreement"), TransTexas has agreed to pay an
amount equal to any federal tax liability (which would be approximately $25.4
million) attributable to the inapplicability of the COD Exclusion. Any such tax
would be offset in future years by alternative minimum tax credits and retained
loss and credit carryforwards to the extent recoverable from TransAmerican. As a
member of the TNGC Consolidated Group (defined below), each of TransTexas, TEC
and TARC will be severally liable for any tax liability resulting from the
above-described transactions. The IRS has commenced an audit of the consolidated
federal income tax returns of the TNGC Consolidated Group for its taxable years
ended July 31, 1995 and 1994. At this time, it is not possible to predict the
scope of the IRS' review or whether any tax deficiencies will be proposed by the
IRS as a result of its review.

Based upon independent legal advice, TransTexas has determined that it
will not report any significant federal income tax liability as a result of the
Lobo Sale. There are, however, significant uncertainties regarding TransTexas'
tax position and no assurance can be given that its position will be sustained
if challenged by the IRS. TransTexas is part of an affiliated group for tax
purposes (the "TNGC Consolidated Group"), which includes TNGC Holdings
Corporation, the sole stockholder of TransAmerican. No letter ruling has been or
will be obtained from the IRS regarding the Lobo Sale by any member of the TNGC
Consolidated Group. If the IRS were to successfully challenge TransTexas'
position, each member of the TNGC Consolidated Group would be severally liable
under the consolidated tax return regulations for the resulting taxes, in the
estimated amount of up to $250 million (assuming the use of existing tax
attributes of the TNGC Consolidated Group), possible penalties equal to 20% of
the amount of the tax, and interest at the statutory rate (currently 8%) on the
tax and penalties (if any). The Tax Allocation Agreement has been amended so
that TransAmerican will become obligated to fund the entire tax deficiency (if
any) resulting from the Lobo Sale. There can be no assurance that TransAmerican
would be able to fund any such payment at the time due and the other members of
the TNGC Consolidated Group, thus, may be required to pay the tax. TransTexas
has

<PAGE> 19

reserved approximately $75 million with respect to the potential tax liability
for financial reporting purposes to reflect a portion of the federal tax
liability that TransAmerican might not be able to pay. If TransTexas were
required to pay this tax deficiency, it is likely that it would be required to
sell significant assets or raise additional debt or equity capital to fund the
payment.

Generally, under the Tax Allocation Agreement, if net operating losses of
TransTexas are used by other members of the TNGC Consolidated Group, then
TransTexas is entitled to the benefit (through reduced current taxes payable) of
such losses in later years to the extent TransTexas has taxable income, remains
a member of the TNGC Consolidated Group and the other group members have the
ability to pay such taxes. If TransAmerican or TEC transfers shares of common
stock of TransTexas (or transfers options or other rights to acquire such
shares) and, as a result of such transfer, Deconsolidation of TransTexas occurs,
TransTexas would not thereafter receive any benefit pursuant to the Tax
Allocation Agreement for net operating losses of TransTexas used by other
members of the TNGC Consolidated Group prior to the Deconsolidation of
TransTexas.

TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of April 30, 1998, TransTexas had
paid approximately $5.4 million of such tax and estimates that approximately $6
million will be paid in fiscal year 1999.

POTENTIAL EFFECTS OF CHANGE OF CONTROL

<PAGE> 20
trust in which he or his immediate family members have, directly or indirectly,
a beneficial interest in excess of 50%) and his subsidiaries or the TEC
Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TEC's then outstanding voting stock, or (ii) TEC or any of
its subsidiaries own some of TransTexas' or TARC's capital stock, respectively,
but less than 50% of the total voting stock or economic value of TransTexas or
TARC, respectively, unless the TEC Notes have an investment grade rating for the
period of 120 days thereafter. The term "person," as used in the definition of
Change of Control, means a natural person, company, government or political
subdivision, agency or instrumentality of a government and also includes a
"group," which is defined as two or more persons acting as a partnership,
limited partnership or other group.

In addition, certain changes or other events in respect of the ownership
or control of TransTexas that do not constitute a Change of Control under the
TEC Notes Indenture or the Subordinated Notes Indenture may result in a "change
of control" of TransTexas under the terms of the BNY Facility and certain
equipment financing. Such an occurrence could create an obligation for
TransTexas to repay such other indebtedness. At April 30, 1998, TransTexas had
approximately $36.2 million of indebtedness subject to such right of repayment
or repurchase. In the event of a Change of Control under the Subordinated Notes
Indenture or the TEC Notes Indenture or a "change of control" under the terms of
other outstanding indebtedness, there can be no assurance that TransTexas will
have sufficient funds to satisfy any such payment obligations. A change of
control or other event that results in deconsolidation of TransTexas and
TransAmerican for federal income tax purposes could result in acceleration
of a substantial amount of federal income taxes.

IMPACT OF YEAR 2000

The year 2000 issue relates to computer programs or computer equipment
designed to use two digits rather than four digits to define the applicable
year. As a result, computer systems with time-sensitive software may not
accurately calculate, store or use a date subsequent to December 31, 1999. This
could result in system failures or miscalculations and disruptions of
operations, including among other things, a temporary inability to process
transactions or engage in other normal business activities.

In June 1997, management began a company-wide program to prepare its
computer systems for year 2000 compliance. In January 1998, TransTexas began
implementation of new client/server based systems which are anticipated to be
completed by January 1999. TransTexas estimates the cost of upgrading its
computer systems to be approximately $2 million. There can be no assurance that
TransTexas will timely complete the implementation of the new systems.

FORWARD-LOOKING STATEMENTS

Forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
are included throughout this report. All statements other than statements of
historical facts included in this report regarding TransTexas' financial
position, business strategy, and plans and objectives of management for future
operations, including, but not limited to words such as "anticipates,"
"expects," "estimates," "believes" and "likely" indicate forward-looking
statements. TransTexas' management believes its current views and expectations
are based on reasonable assumptions; however, there are significant risks and
uncertainties that could significantly affect expected results. Factors that
could cause actual results to differ materially from those in the
forward-looking statements include fluctuations in the commodity prices for
natural gas, crude oil, condensate and natural gas liquids, the extent of
TransTexas' success in discovering, developing and producing reserves,
conditions in the equity and capital markets, competition and the ultimate
resolution of litigation.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

<PAGE> 21

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Notes 3 and 7 to the condensed consolidated financial statements
for a discussion of TransTexas' legal proceedings.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS:

15.1 -- Letter of Independent Accountants regarding awareness of
incorporation by reference.

27.1 -- Financial Data Schedule

(b) REPORTS ON FORM 8-K

There were no reports on Form 8-K filed during the three months ended
April 30, 1998.

<PAGE> 22

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

TRANSTEXAS GAS CORPORATION
(Registrant)

By: /s/ Ed Donahue
--------------------------------
Ed Donahue, Vice President
and Chief Financial Officer

June 15, 1998

<PAGE> 23

INDEX TO EXHIBITS

EXHIBIT
NUMBER EXHIBIT
- -------- -------
<S> <C>
15.1 Letter of Independent Accountants regarding awareness of incorporation
by reference.

27.1 Financial Data Schedule
</TABLE>

<PAGE> 1

EXHIBIT 15.1

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: TransTexas Gas Corporation
Registration Statements on Form S-3 and Form S-4

Ladies and Gentlemen:

We are aware that our report dated June 10, 1998 on our review of interim
condensed consolidated financial information of TransTexas Gas Corporation for
the three months ended April 30, 1998 and 1997 included in this Form 10-Q for
the quarter then ended is incorporated by reference in the Company's
registration statements on Form S-3 (Registration No. 33-91494) and Form S-4
(Registration No. 333-33803), each as filed with the Securities and Exchange
Commission. Pursuant to Rule 436(c) under the Securities Act of 1933, this
report should not be a part of the registration statements prepared or certified
by us within the meaning of Sections 7 and 11 of that Act.

Coopers & Lybrand L.L.P.

Houston, Texas
June 15, 1998

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AT APRIL 30, 1998 AND THE
UNAUDITED CONDENSED STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED APRIL 30,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> APR-30-1998
<CASH> 49,627
<SECURITIES> 0
<RECEIVABLES> 35,231
<ALLOWANCES> 0
<INVENTORY> 18,632
<CURRENT-ASSETS> 109,112
<PP&E> 1,459,946
<DEPRECIATION> 726,286
<TOTAL-ASSETS> 874,227
<CURRENT-LIABILITIES> 119,962
<BONDS> 614,086
0
0
<COMMON> 740
<OTHER-SE> 17,094
<TOTAL-LIABILITY-AND-EQUITY> 874,227
<SALES> 19,330
<TOTAL-REVENUES> 33,467
<CGS> 0
<TOTAL-COSTS> 24,979
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,529
<INCOME-PRETAX> (10,467)
<INCOME-TAX> (3,694)
<INCOME-CONTINUING> (6,803)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,803)
<EPS-PRIMARY> (0.12)
<EPS-DILUTED> (0.12)

</TABLE>