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 001-12138
PDV America, Inc.
(Exact name of registrant as specified in its charter)
Delaware 51-0297556
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
750 Lexington Avenue, New York, New York 10022
----------------------------------------------
(Address of principal executive office) (Zip Code)
(212) 753-5340
--------------
(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.
Common Stock, $1.00 par value 1,000
----------------------------- -----
(Class) (Outstanding at October 31, 1998)
Page 1 of 27 Pages
<PAGE>
PDV AMERICA, INC.
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
Page
FACTORS AFFECTING FORWARD LOOKING STATEMENTS..............................3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets --
September 30, 1998 and December 31, 1997.......................4
Condensed Consolidated Statements of Income --
Three-Month Periods Ended September 30, 1998 and 1997
Nine-Month Periods Ended September 30, 1998 and 1997...........5
Condensed Consolidated Statements of Cash Flows --
Nine-Month Periods Ended September 30, 1998 and 1997...........6
Notes to the Condensed Consolidated Financial Statements.......7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations..............15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................26
Item 6. Exhibits and Reports on Form 8-K..............................26
SIGNATURES...............................................................27
2
<PAGE>
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
product and capital resources available to the Companies (as defined herein) are
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 Companies' 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 PDV America, Inc.
believes that the expectations reflected by such forward looking statements are
reasonable based on information currently available to the Companies, no
assurances can be given that such expectations will prove to have been correct.
3
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS (UNAUDITED)
PDV AMERICA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------ -----
(Unaudited)
ASSETS:
CURRENT ASSETS
Cash and cash equivalents $ 351,152 $ 35,268
Accounts receivable, net 622,696 666,264
Due from affiliates 29,693 55,883
Inventories 1,024,503 1,000,498
Current portion of notes receivable from PDVSA -- 250,000
Prepaid expenses and other 26,962 20,872
---------- ----------
TOTAL CURRENT ASSETS 2,055,006 2,028,785
NOTES RECEIVABLE FROM PDVSA 750,000 750,000
PROPERTY, PLANT AND EQUIPMENT - NET 3,418,687 3,427,983
RESTRICTED CASH 9,436 6,920
INVESTMENTS IN AFFILIATES 825,646 841,323
OTHER ASSETS 244,916 188,511
---------- ----------
TOTAL ASSETS $7,303,691 $7,243,522
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY:
CURRENT LIABILITIES
Short-term bank loans $ -- $ 3,000
Accounts payable 455,828 491,977
Due to affiliates 199,117 231,152
Taxes other than income 551,194 180,143
Taxes currently payable 23,949 --
Other current liabilities 217,192 275,086
Current portion of long-term debt 65,828 345,099
Current portion of capital lease obligation 13,879 13,140
---------- ----------
TOTAL CURRENT LIABILITIES 1,526,987 1,539,597
LONG-TERM DEBT 1,987,444 2,047,708
CAPITAL LEASE OBLIGATION 109,456 116,586
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS 203,560 199,765
OTHER NONCURRENT LIABILITIES 251,804 234,710
DEFERRED INCOME TAXES 579,421 487,727
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY 29,100 28,337
COMMITMENTS AND CONTINGENCIES
SHAREHOLDER'S EQUITY
Common stock, $1.00 par,
1,000 shares authorized,
issued and outstanding 1 1
Additional capital 1,482,435 1,482,435
Retained earnings 1,133,483 1,106,656
---------- ----------
TOTAL SHAREHOLDER'S EQUITY 2,615,919 2,589,092
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $7,303,691 $7,243,522
========== ==========
(See Notes to the Condensed Consolidated Financial Statements.)
4
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<TABLE>
<CAPTION>
PDV AMERICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in Thousands)
THREE-MONTH PERIODS NINE-MONTH PERIODS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Net sales $ 2,681,613 $ 3,513,032 $ 8,292,442 $ 10,098,632
Sales to affiliates 50,285 51,073 132,689 168,591
------------ ------------ ------------ ------------
2,731,898 3,564,105 8,425,131 10,267,223
Equity in earnings of affiliates, net 25,533 25,688 66,991 45,822
Interest income from PDVSA 16,369 19,432 55,232 58,294
Other income (expense), net (4,470) (11,032) (6,587) (9,254)
------------ ------------ ------------ ------------
2,769,330 3,598,193 8,540,767 10,362,085
------------ ------------ ------------ ------------
COST OF SALES AND EXPENSES:
Cost of sales and operating expenses 2,523,825 3,313,878 7,812,545 9,747,413
Selling, general and administrative
expenses 63,456 59,434 185,430 156,152
Interest expense:
Capital leases 3,469 3,818 10,766 11,778
Other 41,368 50,693 128,182 148,164
Minority interest in earnings of
consolidated subsidiary 404 498 764 1,230
------------ ------------ ------------ ------------
2,632,522 3,428,321 8,137,687 10,064,737
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES 136,808 169,872 403,080 297,348
INCOME TAXES 51,439 65,541 151,753 99,976
------------ ------------ ------------ ------------
NET INCOME $ 85,369 $ 104,331 $ 251,327 $ 197.372
============ ============ ============ ============
</TABLE>
(See Notes to the Condensed Consolidated Financial Statements.)
5
<PAGE>
<TABLE>
<CAPTION>
PDV AMERICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in Thousands)
NINE-MONTH PERIODS
ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 806,183 $ 108,423
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (164,213) (190,322)
Proceeds from notes receivable from PDVSA 250,000 --
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) --
Investments in and advances to affiliates (5,030) (717)
Proceeds from sale of investment 7,160 --
Other 17,947 21,697
--------- ---------
Net cash provided by (used in) investing activities 83,548 (212,430)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments of revolving bank loans (173,000) (5,000)
Net (repayments of) proceeds from short-term bank loans (3,000) 32,000
Proceeds from issuance of tax-exempt bonds 47,200 --
Proceeds from issuance of taxable bonds 100,000 --
Payments on term bank loan (58,823) (22,059)
Dividend to parent (224,500) --
Payments of Senior Notes (250,000) --
Payments on senior notes of UNO-VEN -- (135,000)
Repayments of other debt (5,334) (5,357)
Capital contribution from parent -- 250,000
Payments of capital lease obligations (6,390) (5,521)
--------- ---------
Net cash (used in) provided by financing activities (573,847) 109,063
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 315,884 5,056
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 35,268 32,844
--------- ---------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 351,152 $ 37,900
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest (net of amount capitalized) $ 141,582 $ 159,267
========= =========
Income taxes, net of refunds received $ 47,097 $ 25,227
========= =========
</TABLE>
(See Notes to the Condensed Consolidated Financial Statements.)
6
<PAGE>
PDV AMERICA, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1998
1. Basis of Presentation
The financial information for PDV America, Inc. ("PDV America" 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 PDV America's Annual Report for the fiscal year ended
December 31, 1997 on Form 10-K, dated March 30, 1998, for additional
information.
On April 21, 1997, Propernyn B.V. ("Propernyn"), a Dutch limited
liability company whose ultimate parent is Petroleos de Venezuela, S.A.
("PDVSA"), and which held all of the Company's common stock, contributed its
shares of the Company to PDV Holding, Inc. ("PDV Holding"), a corporation
organized under the laws of Delaware, a subsidiary of Propernyn.
The condensed consolidated financial statements include the
accounts of the Company, its wholly owned subsidiaries (including CITGO
Petroleum Corporation and its wholly owned subsidiaries ("CITGO")), Cit-Con Oil
Corporation, which is 65 percent owned by CITGO, and VPHI Midwest, Inc.
("Midwest") and its wholly owned subsidiary, PDV Midwest Refining, L.L.C.
("PDVMR") (collectively, the "Companies").
Prior to May 1, 1997, Midwest had a 50 percent interest in The
Uno-Ven Company ("UNO-VEN"), an Illinois general partnership. Beginning May 1,
1997, pursuant to a distribution of assets from UNO-VEN, PDVMR now owns such
former UNO-VEN assets (as defined in the related Partnership Interest Retirement
Agreement), and such assets are now operated by CITGO under an operating
agreement between PDVMR and CITGO. Accordingly, the 1997 consolidated financial
statements reflect the equity in earnings of UNO-VEN for the period from
January 1, 1997 to April 30, 1997 and the results of operations and cash flows
of PDVMR on a consolidated basis from May 1, 1997.
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.
7
<PAGE>
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
$14.6 million and $24.8 million, respectively. Inventories, primarily at LIFO,
consist of the following:
September 30, December 31,
1998 1997
------------- ------------
(Unaudited)
(000's Omitted)
Refined products......................... $719,790 $734,261
Crude oil................................ 238,496 196,349
Materials and supplies................... 66,217 69,888
---------- ----------
$1,024,503 $1,000,498
========== ==========
8
<PAGE>
3. Long-term Debt
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----- -----
(Unaudited)
(000's Omitted)
<S> <C> <C>
Senior Notes:
7.25% Senior Notes $250 million face amount due 1998 $ -- $ 249,859
7.75% Senior Notes $250 million face amount due 2000 250,000 250,000
7.875% Senior Notes $500 million face amount due 2003 497,611 497,330
Revolving Bank Loans:
Bank of America -- 135,000
Chase 84,000 122,000
Term Bank Loan -- 58,823
Shelf Registration:
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
Illinois pollution control revenue bonds due 2008 19,850 19,850
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
----------- -----------
2,053,272 2,392,807
Less Current Portion of Long-term Debt (65,828) (345,099)
----------- -----------
$ 1,987,444 $ 2,047,708
=========== ===========
</TABLE>
9
<PAGE>
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.
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 Companies.
The Companies are vigorously contesting or pursuing, as applicable, such
lawsuits and claims and believe that their positions are sustainable. The
Companies have recorded accruals for losses they consider to be probable and
reasonably estimable. However, due to the 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 Companies, and in amounts in excess of the Companies'
accruals, it is reasonably possible that such determinations could have a
material adverse effect on the Companies' results of operations in a given
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 Companies, management of the Companies
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 Companies
and, therefore, should not have a material adverse effect on the Companies'
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 plaintiffs' request for a rehearing of this ruling.
10
<PAGE>
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, the Company, 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 transferred to 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 judgment filed by CITGO and the other defendants; the union
has appealed this ruling.
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. CITGO 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 Companies'
financial condition or results of operations. CITGO 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 CITGO 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 10
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 CITGO 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
CITGO 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. CITGO and other defendants appealed the trial court's certification
of the class action to the Texas Supreme Court.
11
<PAGE>
In 1997, CITGO 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 CITGO'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 CITGO. For
these reasons, CITGO 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 CITGO'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, CITGO 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.
CITGO has offers open to purchase the remaining properties.
Environmental Compliance and Remediation -- The Companies are
subject to various federal, state and local environmental laws and regulations
which may require the Companies to take action to correct or improve the effects
on the environment of prior disposal or release of petroleum substances by the
Companies or other parties. Management believes the Companies are in compliance
with these laws and regulations in all material respects. Maintaining compliance
with environmental laws and regulations in the future could require significant
capital expenditures and additional operating costs.
At September 30, 1998, the Companies had $57.5 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
Companies' sites, including, but not limited to, the Companies' 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 -- The Companies
enter into petroleum futures contracts primarily to reduce their inventory
exposure to market risk. The Companies also buy and sell 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, therefore, will
generally be offset
12
<PAGE>
by gains and losses on the Companies' 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.
The Companies have only limited involvement with other derivative
financial instruments and generally do not use them for trading purposes.
Generally, they are used to manage well-defined interest rate and commodity
price risks arising out of the Companies' core activities. The Companies have
entered into various interest rate swap and cap agreements to manage their risk
related to interest rate changes on their debt. The fair value of the interest
rate swap agreements in place at September 30, 1998, based on the estimated
amount that the Companies would receive or pay to terminate the agreements as of
that date and taking into account current interest rates, was an unrealized loss
of $3.8 million. In connection with the determination of said fair market value,
the Companies consider the creditworthiness of the counterparties, but no
adjustment was determined to be necessary as a result.
The impact of these instruments on costs of sales and operating expenses
and pretax earnings was immaterial for all periods presented. Management
considers the market risk to the Companies 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 25,000 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.
6. Changes in Shareholder's Equity
The Company declared and paid dividends to its parent company, PDV
Holding, totaling $224.5 million in the first nine months of 1998.
In addition, on October 28, 1998, the Company declared and paid a
dividend of $44 million to PDV Holding.
13
<PAGE>
7. Subsequent Events
Subsequent to September 1998, the Company loaned $260 million to an
affiliate, PDVSA Finance, Ltd., in exchange for two promissory notes. The notes
bear interest at 8.558%, require quarterly principal payments beginning in 2009,
and are due in November 2013.
14
<PAGE>
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 the Company should be read in conjunction with the unaudited
condensed consolidated financial statements of the Company included elsewhere
herein. Reference is made to the Company's Annual Report for the fiscal year
ended December 31, 1997 on Form 10-K, dated March 30, 1998, for additional
information and a description of factors which may cause substantial
fluctuations in the earnings and cash flows of the Company.
In the third quarter ended September 30, 1998, the Company
generated net income of $85.4 million on revenue of $2.8 billion compared to net
income of $104.3 million on revenues of $3.6 billion for the same period last
year. In the nine-month period ended September 30, 1998, the Company generated
net income of $251.3 million on revenue of $8.5 billion compared to net income
of $197.4 million on revenues of $10.4 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, in June 1997, of a significant tax
issue with the Internal Revenue Service ("IRS") which reduced the income tax
expense that the Companies recorded for such nine-month period.
CITGO's revenue accounted for approximately 99% of PDV America's
consolidated revenues in the first nine months of 1998 and 1997. PDVMR's sales
of $296 million for the three-month period ended September 30, 1998 and $773
million for the nine-month period ended September 30, 1998 were primarily to
CITGO and, accordingly, these were eliminated in consolidation. However, the
operations of PDVMR, including its investment in a needle-coker company
("Needle-Coker"), contributed approximately $78 million to the Companies'
consolidated gross margin and $78 million to PDV America's consolidated income
before interest and taxes for the nine months ended September 30, 1998.
15
<PAGE>
Results of Operations
The following table summarizes the sources of PDV America's sales
revenues and sales volumes for the three- and nine-month periods ended September
30, 1998 and 1997:
<TABLE>
<CAPTION>
PDV America's Sales, Revenues and Volumes
Three Months Nine Months Three Months Nine Months
Ended September 30, Ended September 30, Ended September 30, Ended September 30,
-------- -------- ------- ------- ------ ------- ------ --------
1998 1997 1998 1997 1998 1997 1998 1997
-------- -------- ------- ------- ------ ------- ------ --------
($ 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 products
sales $ 2,664 $ 3,506 $ 8,225 $10,114 6,100 5,486 17,346 15,583
Other sales 68 58 200 153
------- ------- ------- ------- ------- ------- -------
Total sales $ 2,732 $ 3,564 $ 8,425 $10,267 6,100 5,486 17,346 15,583
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
The following table summarizes PDV America's cost of sales and operating
expenses for the three- and nine-month periods ended September 30, 1998 and
1997:
PDV America's Cost of Sales and Operating Expenses
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- --------------------
1998 1997 1998 1997
------ ------ -------- --------
($ in millions) ($ in millions)
<S> <C> <C> <C> <C>
Crude oil $ 676 $1,045 1,983 2,682
Refined products 1,261 1,577 3,973 5,264
Intermediate feedstocks 217 304 714 851
Refining and manufacturing costs 234 247 711 677
Other operating costs and expenses
and inventory changes 136 141 432 273
------ ------ ------ ------
Total cost of sales and operating $2,524 $3,314 $7,813 $9,747
expenses ====== ====== ====== ======
</TABLE>
Sales revenues and volumes. Sales decreased $832 million, or
approximately 23%, in the three-month period ended September 30, 1998 and by
$1,842 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
16
<PAGE>
in the first nine months of 1997 to 17,346 million gallons in the first nine
months of 1998. The decreases in most product sales prices, partially offset by
the increase in most 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 volume 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 volume 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 $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 sales 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
17
<PAGE>
increase in gasoline sales revenue is the result of a 75% increase in volume
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 decreased by $0.2 million for the three-month period and
increased $21.2 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.
Cost of sales and operating expenses. Cost of sales and operating
expenses decreased by $790 million or 24%, in the quarter ended September 30,
1998, and decreased $1,934 million or 20%, in the nine-month period ended
September 30, 1998, as compared to the same periods in 1997. Lower crude oil
costs (a decrease from $1,045 million in the third quarter of 1997 to $676
million in the third quarter of 1998) resulted from a decrease in crude prices,
offset by an increase in crude oil volumes purchased. Crude oil costs decreased
from $2,682 million in the nine-month period ended September 30, 1997 to $1,983
million in the first nine months of 1998, the result of a decrease in crude
prices offset by an increase in crude oil volumes purchased. Refined product
purchases decreased 20% in the third quarter of 1998 as compared to the same
quarter in 1997 from $1,577 million to $1,261 million and decreased 25% in the
first
18
<PAGE>
nine months of 1998 as compared to the same period in 1997 from $5,264 million
to $3,973 million. The changes resulted from decreases in prices for the third
quarter and for the first nine months of 1998, as compared to the same periods
in 1997, partially offset by increases in refined product purchase volumes for
the third quarter and for the first nine months of 1998, as compared to the same
periods in 1997. Intermediate feedstock purchases decreased 29% to $217 million
in the third quarter of 1998 from $304 million in the third quarter of 1997, and
decreased 16% to $714 million for the first nine months of 1998 from $851
million for the first nine months of 1997. Intermediate feedstock prices
decreased and volume purchased increased between the quarters ended September
30, 1997 and 1998. Intermediate feedstock prices decreased and volumes purchased
increased between the nine-month periods ended September 30, 1997 and 1998.
Refining and manufacturing costs decreased 5% from $247 million in the third
quarter of 1997 as compared to $234 million in the same period in 1998 and
increased 5% from $677 million during the nine-month period ended September 30,
1997 to $711 in the same period in 1998. This increase, in part, is a result of
the inclusion of PDVMR's refining and manufacturing costs in the consolidated
statement of income of PDV America since May 1, 1997. CITGO incurred additional
expenses in 1997 associated with a fire and explosion that occurred at the
Corpus Christi refinery on May 12, 1997. Depreciation and amortization expense
was essentially flat at approximately $57 million for each of the quarters ended
September 30, 1997 and 1998, respectively, and increased $23 million, from $165
million to $188 million, between the nine-month periods ended September 30, 1997
and 1998, respectively. This increase, in part, is a result of the inclusion of
PDVMR's depreciation and amortization in the consolidated statement of income of
PDV America since May 1, 1997. 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 $14.6 million and $24.8 million, respectively.
The Companies purchase refined products to supplement the
production from their refineries to meet marketing demands and resolve
logistical issues. Refined product purchases represented 50% and 48% of total
cost of sales and operating expenses for the third quarters of 1998 and 1997,
respectively, and 51% and 54% for the first nine months of 1998 and 1997,
respectively. The Companies estimate that margins on purchased products, on
average, are somewhat lower than margins on produced products due to the fact
that the Companies can only receive the marketing portion of the wholesale
margin received on the produced refined products. However, purchased products
are not segregated from the Companies' produced products and margins may vary
due to market conditions and other factors beyond the Companies' control. As
such, it is difficult to measure the effects on profitability of changes in
volumes of purchased products. The Companies anticipate that their purchased
refined product volume requirements will continue to increase to meet marketing
demands. In the near term, other than normal refinery turnaround maintenance,
the Companies do 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 the Companies which would impact the
volume of refined products purchased and profit margins.
19
<PAGE>
Gross margin. The gross margin for the three-month period ended
September 30, 1998 was $208 million, or 8%, compared to $250 million, or 7% for
the same period in 1997. The gross margin for the nine-month period ended
September 30, 1998 was $613 million or 7% compared to $520 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-half 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 7%, from
$59 million in the third quarter of 1997 to $63 million in the third quarter of
1998, and increased 16% from $156 million in the first nine months of 1997 to
$185 million in the same period in 1998. These increases are due primarily to
salary and related burden allocations and increases in advertising expense and
depreciation, as well as the inclusion of PDVMR expenses in the consolidated
statement of income of PDV America since May 1, 1997 (which were $8 million and
$4 million for the nine-month periods ended September 30, 1998 and 1997,
respectively).
Interest expense. Interest expense decreased by approximately $10
million, or 18% (from $55 million to $45 million), for the third quarter ended
September 30, 1998, and decreased year-to-date by approximately $21 million, or
13% (from $160 million to $139 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 CITGO's revolving bank loan in the periods ended
September 30, 1998 compared to the same periods ended September 30, 1997, as
well as the repayment of $250 million of the Company's Senior Notes on August 1,
1998.
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 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
$806 million. This amount consists of net income of $251 million, depreciation
and amortization of $197 million and net changes in other items of $358 million.
The more significant changes in other items included an increase in deferred
taxes of $86 million and an increase in current liabilities of $269 million.
20
<PAGE>
The primary element of the increase in current liabilities relates to a deferral
of federal excise tax deposits.
Net cash provided by investing activities totaled $84 million for
the nine-month period ended September 30, 1998, consisting primarily of the
maturity of the $250 million of notes receivable from PDVSA, offset by capital
expenditures of $164 million.
Net cash used in financing activities totaled $574 million for
the nine-month period ended September 30, 1998 consisting primarily of payments
of Senior Notes of $250 million, dividends paid to the parent company of $225
million, $173 million net repayment on revolving bank loans, $59 million payment
on term bank loans, $100 million in proceeds from the issuance of taxable bonds
and $47 million in proceeds from issuance of tax-exempt revenue bonds.
On September 30, 1998, the Companies had a significant cash
balance as a result of a deferral of federal excise tax deposits authorized by
the United States Congress. This deferral ended in early October 1998 and the
Companies subsequently 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, $155 million of uncommitted
short-term borrowing facilities with various banks and $41 million under PDVMR's
committed bank facilities. 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. The Companies'
management believes that it has sufficient capital resources to carry out
planned capital spending programs, including regulatory and environmental
projects in the near term, and to meet recently anticipated future obligations
as they arise. The Companies periodically evaluate other sources of capital in
the marketplace and anticipate 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.
The Companies believe that they are in compliance with their
obligations under their debt financing arrangements at September 30, 1998.
Subsequent to September 1998, the Company loaned $260 million to
an affiliate, PDVSA Finance, Ltd., in exchange for two promissory notes. The
notes bear interest at 8.558%, require quarterly principal payments beginning in
2009, and are due in November 2013.
On October 28, 1998, the Company declared and paid a dividend of
$44 million to PDV Holding.
21
<PAGE>
Derivative Commodity and Financial Instruments
The Companies enter into petroleum futures contracts primarily to
reduce their inventory exposure to market risk. The Companies also buy and sell
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 the Companies' 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.
The Companies have only limited involvement with other derivative
financial instruments and generally do not use them for trading purposes.
Generally, they are used to manage well defined interest rate and commodity
price risks arising out of the Companies' core activities. The Companies have
entered into various interest rate swap and cap agreements to manage their risk
related to interest rate changes on their debt. The fair value of the interest
rate swap agreements in place at September 30, 1998, based on the estimated
amount that the Companies would receive or pay to terminate the agreements as of
that date and taking into account current interest rates, was an unrealized loss
of $3.8 million. In connection with the determination of said fair market value,
the Companies consider the creditworthiness of 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 Companies 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 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 these instruments
at fair value. The Companies have not determined the impact on the financial
statements that may result from the 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
22
<PAGE>
commonly referred to as the Year 2000 issue. As the Year 2000 approaches, such
systems may be unable to accurately process certain data-based information.
To mitigate any adverse impact this may cause, the Companies have
established a company-wide Year 2000 Project ("Project") to address the issue of
computer programs and embedded computer chips that may be unable to correctly
function with data involving the Year 2000. The Project is proceeding on
schedule. In addition, the Companies are updating major elements of their
information systems by implementing programs purchased from SAP America, Inc.
("SAP") and other vendors. The first phase of SAP implementation, which included
part of the financial reporting system and the materials management system, was
initiated on January 1, 1998. Additional SAP modules and other software will be
implemented throughout 1998 and 1999. The total cost of such implementations is
estimated to be approximately $112 million, which includes software, hardware,
re-engineering and change management. Management has determined that SAP
provides an appropriate solution to the Year 2000 issue related to systems for
which SAP is implemented. Such systems comprise approximately 80% of the
Companies' total information systems. The implementation of SAP and other
software programs is 65% to 70% 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 Project or they will be replaced.
The Project. The Companies' Project team is divided into two groups. One
group is working with matters related to information systems ("IS") and
information technology ("IT"), while the other is analyzing non-IS and non-IT
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 the end of 1998. The strategy for achieving Year 2000
business and asset integrity is focused on equipment, software and relationships
that are critical to the Companies' primary business operations, including
refinery operations, terminal operations, crude oil purchase and shipment
operations, and refined product distribution operations. The Companies 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. The Companies now require that all new
contracts with vendors, suppliers or business partners include a clause covering
Year 2000 readiness. The Companies will also seek evidence of Year 2000
readiness from service providers prior to procuring new services. The Inventory
and Assessment phase of the Project is scheduled for completion before December
31, 1998.
While the 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 Companies will successfully and timely
reprogram, replace, or test all of their own computer
23
<PAGE>
hardware, software and process control system. The Companies have 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.
The Companies have also established a Year 2000 Contingency Planning
Team. The strategy for contingency planning includes a review and analysis of
existing contingency plans for the Companies' 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, the Readiness phase, 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 Year 2000 Readiness in remaining areas of
the enterprise.
The following is the Companies' 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 the process any date with a
year specified as "99" and "00".
Costs. The estimated total cost of the Project is no more than $35
million. This estimate does not include the Companies' potential share of Year
2000 costs that may be incurred by partnerships and joint ventures in which the
Companies participate but are 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 the
company-wide Inventory and Assessment phase of the Project. The remaining 35%
of the cost was for consultants in the specialized areas of project management,
contingency planning, information
24
<PAGE>
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 IT 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 Companies are dependent, to a very substantial degree,
upon the proper functioning of their computer systems and their interaction with
third parties, including 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 Companies. Failure of this kind could, for example, cause
disruption in the supply of crude oil, refinery operations, and 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 the Companies' 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 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, the Companies are unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Companies'
operations, liquidity or financial position. The Project is expected to
significantly reduce the Companies' level of uncertainty about the Year 2000
impact. The Companies believe that, with the implementation of new SAP business
systems, other software solutions and the completion of the Project as
scheduled, the possibility of significant interruptions of normal business
operations should be minimized.
25
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For a description of certain recent developments, see Note 4 to
the Condensed Consolidated Financial Statements (unaudited) for the Three-Month
and Nine-Month Periods Ended September 30, 1998, included in Part I hereof.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
27 Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
None.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
PDV AMERICA, INC.
Date: November 13, 1998 /s/ LUIS URDANETA
-------------------------------
Luis Urdaneta
President, Chief Executive and
Financial Officer
Date: November 13, 1998 /s/ JOSE I. MORENO
--------------------------------
Jose I. Moreno
Secretary
27
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