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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 July 31, 1998
Registration Number 33-85930
---------------------
TRANSAMERICAN REFINING CORPORATION
(Exact name of registrant as specified in its charter)
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<S> <C>
TEXAS 76-0229632
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1300 NORTH SAM HOUSTON PARKWAY EAST
SUITE 320
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)
</TABLE>
(281) 986-8811
(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
September 14, 1998 is 30,000,000.
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TRANSAMERICAN REFINING CORPORATION
TABLE OF CONTENTS
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Page
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PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Balance Sheet as of July 31, 1998 and January 31, 1998 . . . . . . . . . . . . . . . . 2
Condensed Statement of Operations for the three and six months ended July 31, 1998 and 1997 . . . 3
Condensed Statement of Cash Flows for the six months ended July 31, 1998 and 1997 . . . . . . . . 4
Notes to Condensed Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . 18
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
</TABLE>
1
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TRANSAMERICAN REFINING CORPORATION
CONDENSED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
JULY 31, JANUARY 31,
1998 1998
---------- -----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . $ 264 $ 10,021
Restricted cash held in disbursement accounts . . . . . . . . . . . . -- 71,563
Cash restricted for interest . . . . . . . . . . . . . . . . . . . . . 36,680 32,823
Investments held in trust . . . . . . . . . . . . . . . . . . . . . . 9,545 9,114
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . 2,039 870
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,033 --
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,800 1,346
---------- -----------
Total current assets . . . . . . . . . . . . . . . . . . . . . . 90,361 125,737
---------- -----------
Property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . 1,328,808 939,780
Less accumulated depreciation and amortization . . . . . . . . . . . . . 29,722 25,257
---------- -----------
Net property and equipment . . . . . . . . . . . . . . . . . . . 1,299,086 914,523
---------- -----------
Restricted cash held in disbursement accounts . . . . . . . . . . . . . . -- 60,166
Cash restricted for interest . . . . . . . . . . . . . . . . . . . . . . 204 16,348
Investments held in trust . . . . . . . . . . . . . . . . . . . . . . . . -- 8,591
Receivable from affiliates . . . . . . . . . . . . . . . . . . . . . . . 1,890 1,655
Other assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,177 68,429
---------- -----------
$1,431,718 $ 1,195,449
========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 78,647 $ 32,022
Payable to affiliates . . . . . . . . . . . . . . . . . . . . . . . . 10,981 6,976
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . 9,418 9,528
Current maturities of long-term debt . . . . . . . . . . . . . . . . . 7,837 6,710
---------- -----------
Total current liabilities . . . . . . . . . . . . . . . . . . . 106,883 55,236
---------- -----------
Payable to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . 4,907 3,825
Long-term debt, less current maturities . . . . . . . . . . . . . . . . . 227,644 210,666
Notes payable to affiliate . . . . . . . . . . . . . . . . . . . . . . . 822,944 760,266
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,855 5,048
Commitments and contingencies (Note 6) . . . . . . . . . . . . . . . . . -- --
Stockholder's equity:
Common stock, $0.01 par value, 100,000,000 shares authorized,
30,000,000 shares issued and outstanding . . . . . . . . . . . 300 300
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . 565,635 439,566
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . (301,450) (279,458)
---------- -----------
Total stockholder's equity . . . . . . . . . . . . . . . . . . . 264,485 160,408
---------- -----------
$1,431,718 $ 1,195,449
========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
2
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TRANSAMERICAN REFINING CORPORATION
CONDENSED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
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<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
------------------------ ---------------------
1998 1997 1998 1997
--------- -------- -------- ---------
<S> <C> <C> <C> <C>
Revenues:
Product sales . . . . . . . . . . . . . . . . . $ 8,375 $ -- $ 8,375 $ --
Other . . . . . . . . . . . . . . . . . . . . 1,270 -- 3,277 --
--------- -------- -------- ---------
Total revenues . . . . . . . . . . . . . . 9,645 -- 11,652 --
--------- -------- -------- ---------
Costs and expenses:
Costs of products sold . . . . . . . . . . . . . 7,819 -- 7,819 --
Processing arrangements, net . . . . . . . . . . (1,826) (3,062) (1,826) (3,237)
Operations and maintenance . . . . . . . . . 3,131 4,249 5,793 7,862
Depreciation and amortization . . . . . . . . . 1,791 1,714 4,465 3,425
General and administrative . . . . . . . . . . . 5,852 2,280 11,954 5,005
Taxes other than income taxes . . . . . . . . . 1,318 903 2,319 1,806
(Gain) loss on purchase commitments . . . . . . -- (331) -- 4,759
--------- -------- -------- ---------
Total costs and expenses . . . . . . . . . 18,085 5,753 30,524 19,620
--------- -------- -------- ---------
Operating loss . . . . . . . . . . . . . . (8,440) (5,753) (18,872) (19,620)
--------- -------- -------- ---------
Other income (expense):
Interest income . . . . . . . . . . . . . . . . 1,493 916 3,753 1,043
Interest expense, net . . . . . . . . . . . . . (1,050) (3,471) (8,024) (6,767)
Equity in income of TransTexas
before extraordinary item . . . . . . . . . . -- 47,215 (229) 45,165
Other . . . . . . . . . . . . . . . . . . . . -- 696 -- 735
--------- -------- -------- ---------
Total other income (expense) . . . . . . . 443 45,356 (4,500) 40,176
--------- -------- -------- ---------
Income (loss) before extraordinary items
and cumulative effect of change in
accounting principle . . . . . . . . . . . . (7,997) 39,603 (23,372) 20,556
Extraordinary items:
Equity in extraordinary item of TransTexas . . . -- (10,168) -- (10,168)
Loss on the early extinguishment of debt . . . . -- (84,422) (1,294) (84,422)
Cumulative effect of a change in
accounting principle . . . . . . . . . . . . . . -- -- 2,674 --
--------- -------- -------- ---------
Net loss . . . . . . . . . . . . . . . . . $ (7,997) $(54,987) $(21,992) $ (74,034)
========= ======== ======== =========
Basic and diluted net income (loss) per share:
Income (loss) before extraordinary items
and cumulative effect of a change
in accounting principle . . . . . . . . . . $ (0.27) $ 1.32 $ (0.78) $ 0.68
Extraordinary items . . . . . . . . . . . . . . -- (3.15) (0.04) (3.15)
Cumulative effect of a change in
accounting principle . . . . . . . . . . . . -- -- 0.09 --
--------- -------- -------- ---------
$ (0.27) $ (1.83) $ (0.73) $ (2.47)
========= ======== ======== =========
Weighted average number of common
shares outstanding for basic and diluted
net loss per share (thousands) . . . . . . . . . 30,000 30,000 30,000 30,000
========= ======== ======== =========
</TABLE>
See accompanying notes to condensed financial statements.
3
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TRANSAMERICAN REFINING CORPORATION
CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
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SIX MONTHS ENDED
JULY 31,
----------------------
1998 1997
--------- ---------
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Operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (21,992) $ (74,034)
Adjustments to reconcile net loss to net cash used by operating activities:
Loss on early extinguishment of debt . . . . . . . . . . . . . . . . . . . 1,294 84,422
Cumulative effect of a change in accounting principle . . . . . . . . . . . (2,674) --
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . 4,465 3,425
Amortization of discount on long-term debt . . . . . . . . . . . . . . . . 5,461 4,627
Amortization of debt issue costs . . . . . . . . . . . . . . . . . . . . . 187 713
Equity in net (earnings) loss of TransTexas . . . . . . . . . . . . . . . . 229 (34,997)
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,169) (351)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,759) --
Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . (8,454) (577)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . (166) (4,867)
Payable to affiliates, net . . . . . . . . . . . . . . . . . . . . . . . 4,852 13,594
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,719 (7,276)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (15) 205
--------- ---------
Net cash used by operating activities . . . . . . . . . . . . . . (32,022) (15,116)
--------- ---------
Investing activities:
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (275,397) (59,317)
Increase in investments held in trust . . . . . . . . . . . . . . . . . . . . (279) --
Decrease in investments held in trust . . . . . . . . . . . . . . . . . . . . 8,439 --
--------- ---------
Net cash used by investing activities . . . . . . . . . . . . . . (267,237) (59,317)
--------- ---------
Financing activities:
Issuance of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . 26,625 675,649
Retirement of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . (7,792) (437,214)
Withdrawals from disbursement accounts . . . . . . . . . . . . . . . . . . . . 131,729 66,003
Disbursements of cash restricted for interest . . . . . . . . . . . . . . . . 12,287 --
Repayment of advances and notes payable to affiliate . . . . . . . . . . . . . (4,646) (170,020)
Capital contributions from parent . . . . . . . . . . . . . . . . . . . . . . 125,091 (66,000)
Advances from affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,704 15,026
Debt issue costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,148) (2,303)
Principal payments on capital lease obligations . . . . . . . . . . . . . . . (348) (438)
--------- ---------
Net cash provided by financing activities . . . . . . . . . . . . 289,502 80,703
--------- ---------
Increase (decrease) in cash and cash equivalents . . . . . . . . (9,757) 6,270
Beginning cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . 10,021 613
--------- ---------
Ending cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . $ 264 $ 6,883
========= =========
Noncash financing and investing activities:
Accounts payable for property and equipment . . . . . . . . . . . . . . . . . $ 55,731 $ 9,116
Product financing arrangements . . . . . . . . . . . . . . . . . . . . . . . . 15,274 --
Accrued interest on long-term debt capitalized in property and equipment . . . 57,689 30,426
Debt issue costs allocated from affiliate . . . . . . . . . . . . . . . . . . -- 24,893
</TABLE>
See accompanying notes to condensed financial statements.
4
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TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED 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 TransAmerican Refining Corporation ("TARC" or the
"Company") as of July 31, 1998 and the results of its operations and cash flows
for the interim periods ended July 31, 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 financial statements
and notes included in TARC's annual report on Form 10-K for the fiscal year
ended January 31, 1998. Unless otherwise noted, all capitalized terms used
herein but not otherwise defined are as defined in TARC's annual report on Form
10-K for the fiscal year ended January 31, 1998. TARC is a subsidiary of
TransAmerican Energy Corporation ("TEC"), which is a wholly owned subsidiary of
TransAmerican Natural Gas Corporation ("TransAmerican"). TransTexas Gas
Corporation ("TransTexas") is a subsidiary of TEC.
Weighted average shares outstanding exclude potential common shares of
approximately 2,686,000 and 7,458,000 for the three and six months ended
July 31, 1998 and 1997, respectively.
RECENTLY ISSUED PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities.
The Company will adopt SFAS 133 effective February 1, 2000. TARC is uncertain
as to the impact on its financial statements of the adoption of SFAS 133.
2. ACCOUNTING CHANGES
Effective May 1, 1998, TARC changed its method of accounting for turnaround
costs. Turnaround costs consist of required periodic maintenance on major
processing units including the shutdown and restart of the units. Previously,
TARC estimated the costs of a scheduled turnaround and ratably accrued these
costs over the period until the next scheduled turnaround. To provide for
better matching of turnaround costs with revenues and to be more consistent with
industry standards, TARC changed its method of accounting for turnaround costs
to one that results in the amortization of incurred costs on a straight-line
basis over the period of time estimated to lapse until the next scheduled
turnaround. The cumulative effect of this accounting change through January 31,
1998, was a decrease in net loss for the six months ended July 31, 1998 of $2.7
million or $0.09 per common share. Excluding the cumulative effect, the
change decreased net loss for the three and six months ended July 31, 1998 by
$0.2 million and $0.4 million, respectively, or $0.01 per common share.
Pro forma amounts assuming the change in accounting principle is applied
retroactively are as follows: (in thousands of dollars except per share
amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
------------------------- ------------------------
1998 1997 1998 1997
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Income (loss) before extraordinary items $(7,997) $ 39,794 $(23,372) $ 20,938
Basic and diluted net income (loss) per share
before extraordinary items:
As reported (0.27) 1.32 (0.78) 0.68
Pro forma (0.27) 1.33 (0.78) 0.69
Net loss (7,997) (54,796) (24,666) (73,652)
Basic and diluted net loss per share:
As reported (0.27) (1.83) (0.73) (2.47)
Pro forma (0.27) (1.82) (0.82) (2.46)
</TABLE>
5
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TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
TARC's inventories consist primarily of feedstocks and refined products and
are stated at the lower of cost or market. Effective May 1, 1998, the Company
changed its method of inventory pricing for feedstocks and refined products from
the average cost method to the first-in-first-out method. Historically, sales of
refined products have been limited and sporadic due to intermittent operations
of the refinery during periods of construction and expansion. Upon completion
of the Capital Improvement Program, the refinery will be capable of producing
multiple refined products from a variety of feedstocks. The Company believes
the change from the average cost method to the first-in-first-out method will
enable the Company to more efficiently value its inventory and match revenues
and costs. Furthermore, the Company believes the first-in-first-out method is
more widely used than the average cost method in the refining industry and
desires to present more comparative information. There was no cumulative effect
of this accounting change for any period presented.
3. CAPITAL IMPROVEMENT PROGRAM
TARC's refinery is located in the Gulf Coast region along the Mississippi
River, approximately 20 miles from New Orleans, Louisiana. TARC's business
strategy is to modify, expand and reactivate its refinery and to maximize its
refining margins by converting low-cost, heavy, sour crude oils into light
petroleum products including primarily gasoline and heating oil.
In February 1995, TARC began a construction and expansion program (the
"1995 Program") designed to reactivate the refinery and increase its
complexity. From February 1995 through May 1997, TARC spent approximately $251
million on the 1995 Program, procured a majority of the equipment required and
completed substantially all of the process design engineering and a substantial
portion of the remaining engineering necessary for its completion.
In June 1997, in connection with the TEC Notes Offering, the TARC
Intercompany Loan and the TARC Notes Tender Offer, TARC adopted a revised
capital improvement program designed to increase the capacity and complexity of
the refinery ("Capital Improvement Program"). The most significant projects
include: (i) converting the visbreaker unit into a delayed coking unit to
process vacuum tower bottoms into lighter petroleum products, (ii) modernizing
and upgrading a fluid catalytic cracking unit to increase gasoline production
capacity and allow the direct processing of low-cost atmospheric residual
feedstocks, and (iii) upgrading and expanding hydrotreating, alkylation and
sulfur recovery units to increase sour crude processing capacity. In addition,
TARC is in the process of expanding, modifying and adding other processing
units, tankage and offsite facilities as part of the Capital Improvement
Program. The Capital Improvement Program includes expenditures necessary to
ensure that the refinery is in compliance with certain existing air and water
discharge regulations and that gasoline produced will comply with federal
standards. TARC is acting as general contractor, but has engaged a number of
specialty consultants and engineering and construction firms to assist it in
completing the individual projects that comprise the Capital Improvement
Program. Each of these firms was selected because of its specialized expertise
in a particular process or unit integral to the Capital Improvement Program.
The Capital Improvement Program is being executed in two phases. Phase I
of the Capital Improvement Program includes the completion and start-up of
several units, including the Delayed Coking Unit, one of the refinery's major
conversion units. Phase II of the Capital Improvement Program includes the
completion and start-up of the Fluid Catalytic Cracking Unit utilizing MSCC(SM)
technology and the installation of additional equipment expected to further
improve operating margins by allowing for a significant increase in the
refinery's capacity to produce gasoline. In June 1997, TARC estimated that
Phase I would be completed at a cost of $223 million, would be tested and
operational by September 30, 1998 and would result in the refinery having the
capacity to process up to 200,000 Bpd of sour crude oil. In June 1997, TARC
estimated that Phase II would be completed at a cost of $204 million and would
be tested and operational by July 31, 1999.
TARC's current estimates indicate that actual expenditures may exceed the
original budget by $221 million to $245 million (of which $131 million to $134
million is allocated to Phase I), depending upon the extent to which an
unallocated contingency amount of $24 million is used. TARC spent approximately
$468.3 million on the Capital Improvement Program during the period between June
1997 and July 31, 1998. As of July 31, 1998, TARC had
6
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TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
commitments to spend another $58.5 million on the Capital Improvement Program.
TARC intends to fund the remaining Capital Improvement Program costs with
proceeds from the issuance of additional debt and equity securities and other
sources of capital, including cash flow from Phase I operations. TARC is
engaged in negotiations with an investor group which, if consummated, would
result in additional construction capital of approximately $100 million and a
change of control of the refinery. Consummation of any such transaction will be
contingent upon obtaining the consent of the holders of the TEC Notes and
TARC's Senior Subordinated Notes. There can be no assurance that additional
financing to fund completion of the Capital Improvement Program will be obtained
or, if such financing is obtained, what the terms thereof will be. Under certain
circumstances involving a change of control, TARC may not be able to recover all
of its investment in the refinery.
TARC achieved Mechanical Completion of the Delayed Coking Unit, the HDS
Unit and the related portion of the Sulfur Recovery System in June 1998. If
adequate financing is obtained on a timely basis, TARC believes that the
remainder of Phase I (other than the No. 2 Reformer) will reach Mechanical
Completion in November 1998. TARC intends to defer additional expenditures on
the No. 2 Reformer until the fourth quarter of fiscal 1999. TARC believes that
both Phase I and Phase II will be completed in advance of the respective
completion dates required by the TEC Notes Indenture. The foregoing estimates,
as well as other estimates and projections herein, are subject to substantial
revision upon the occurrence of future events, such as unavailability of
financing, engineering problems, work stoppages and further cost overruns, over
which TARC may not have any control, and there can be no assurance that any such
projections or estimates will prove accurate.
TARC believes, based on current estimates of refining margins and costs of
the expansion and modification of the refinery, that future undiscounted cash
flows will be sufficient to recover the cost of the refinery over its estimated
useful life. Management believes there have been no events or changes in
circumstances that would require the recognition of an impairment loss. However,
due to the inherent uncertainties in estimating future refining margins, and in
constructing and operating a large scale refinery, there can be no assurance
that TARC will ultimately recover the cost of the refinery. Management believes
that the book value of the refinery is in excess of its current estimated fair
market value.
TARC has historically incurred losses and negative cash flow from
operations as a result of limited refinery operations that did not cover the
fixed costs of maintaining the refinery, increased working capital requirements
(including debt service) and losses on refined product sales and processing
arrangements. As described above, TARC must raise additional funds in order to
complete the Capital Improvement Program. There is no assurance that TARC can
raise additional funds, complete the Capital Improvement Program, fund its
future working capital requirements or achieve positive cash flow from
operations. As a result, there is substantial doubt about TARC's ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
4. DISBURSEMENT ACCOUNTS
Pursuant to a disbursement agreement dated June 13, 1997, as amended
December 30, 1997 (the "Disbursement Agreement") among TARC, TEC, Firstar Bank
of Minnesota, N.A., as trustee (the "TEC Indenture Trustee"), Firstar Bank of
Minnesota, N.A., as disbursement agent (the "Disbursement Agent"), and Baker &
O'Brien, Inc., as construction supervisor (the "Construction Supervisor"), $208
million of the net proceeds from the sale of the TEC Notes was placed into
accounts (collectively, the "TARC Disbursement Account") to be held and
invested by the Disbursement Agent until disbursed. In addition, proceeds to
TEC and TARC of approximately $201 million from the TransTexas share repurchase
program were deposited in the TARC Disbursement Account. On December 30, 1997,
TARC deposited $119 million of the net proceeds from the issuance of its Series
A Senior Subordinated Notes into the TARC Disbursement Account for use in the
Capital Improvement Program. All funds in the TARC Disbursement Account are
pledged as security for the repayment of the TEC Notes. TEC disbursements for
TARC expenditures are treated as capital contributions.
The Disbursement Agent makes disbursements for the Capital Improvement
Program out of the TARC Disbursement Account in accordance with requests made
by TARC and approved by the Construction Supervisor. The Construction
Supervisor is required to review each such disbursement request by TARC.
Disbursements from the TARC Disbursement Account are generally restricted to
reimbursement for expenses incurred in connection with the Capital Improvement
Program. Disbursements for general and administrative expenses ($1.5 million
monthly) and, upon
7
<PAGE> 9
TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
Mechanical Completion of certain units, for feedstock purchases (up to a
maximum aggregate of $50 million) are also permitted. Interest income from the
TARC Disbursement Account may be used for the Capital Improvement Program or
disbursed to fund administrative and other costs of TARC and TEC. As of July
31, 1998, $469 million had been disbursed to TARC out of the TARC
Disbursement Account for use in the Capital Improvement Program and for
feedstock purchases and $22.5 million for general and administrative expenses.
In addition, special disbursements have been made in the amounts of $7 million
to pay accounts payable and $19 million for payments of interest on, and the
redemption, repurchase and defeasance of the TARC Notes.
5. INVENTORIES
The major components of inventories are as follows (in thousands of
dollars):
July 31, January 31,
1998 1998
------- ----------
Refinery feedstocks and blendstocks $21,926 $ --
Intermediate and refined products 10,107 --
------- ----------
$32,033 $ --
======= ==========
6. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
EEOC. On September 30, 1997, the U.S. Equal Employment Opportunity
Commission ("EEOC") issued a Determination (the "Determination") as a result of
the Commissioner's Charge that had been filed in August 1995 against TARC and
Southeast Louisiana Contractors of Norco, Inc. ("Southeast Contractors")
pursuant to Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C.
Section 2000e et seq. ("Title VII"). In the Determination, the EEOC stated
that it found reasonable cause to believe that each of TARC and Southeast
Contractors had discriminated based on race and gender in its hiring and
promotion practices. Each violation of Title VII (for each individual
allegedly aggrieved), if proven, potentially could subject TARC and Southeast
Contractors to liability for (i) monetary damages for backpay and front pay in
an undetermined amount, and for compensatory damages and punitive damages in an
amount not to exceed $300,000 per plaintiff, (ii) injunctive relief, (iii)
attorney's fees, and (iv) interest. During the period covered by the
Commissioner's Charge and the Determination, TARC and Southeast Contractors
estimate that they received a combined total of approximately 23,000 to 30,000
employment applications and hired (or rehired) a combined total of
approximately 3,400 to 4,100 workers, although the total number of individuals
who ultimately are covered in any conciliation proposal or any subsequent
lawsuit may be higher. TARC and Southeast Contractors deny engaging in any
unlawful employment practices. TARC and Southeast Contractors intend
vigorously to defend against the allegations contained in the Commissioner's
Charge and the findings set forth in the Determination in any proceedings in
state or federal court. If TARC or Southeast Contractors is found liable for
violations of Title VII based on the matters asserted in the Determination,
TARC can make no assurance that such liability would not have a material
adverse effect on its financial position, results of operations or cash flows.
RINEHEART. On October 8, 1996, Carlton Gene Rineheart, et al., and as
representative of a class of persons similarly situated, filed suit against 84
individuals and corporations, including TARC, in the U.S. District Court,
Middle District of Louisiana alleging negligent and improper storage, handling,
treatment, and disposal of hazardous materials from 1976 to the present at two
sites in Iberville Parish, Louisiana. The suit claims damages for physical,
mental, and property damage in the communities of Bayou Sorrel, Bayou Pigeon
and Indian Village. TARC intends to vigorously defend this claim.
SHELL OIL. On September 27, 1996, Shell Oil filed a third party suit
against TARC in the U.S. District Court, Eastern District of Louisiana for
contribution and/or indemnity relating to alleged environmental contamination
of Bayou Trapagnier and surrounding lands near Norco, Louisiana. In March
1997, TARC obtained a voluntary dismissal from Shell. Shell proceeded to trial
on the main case and settled with the plaintiffs during trial by purchasing
their land for $5 million. On June 27, 1997, Shell amended its third party
action to bring TARC back into the case. However, TARC has not yet been served
in the case. If TARC is served, it will defend the case vigorously.
GENERAL. The litigation matters discussed above amount to significant
potential liability which, if adjudicated in a manner adverse to TARC in one
reporting period, could have a material adverse effect on TARC's financial
position, results of operations or cash flow for that period. TARC is also a
named defendant in other ordinary course, routine
8
<PAGE> 10
TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
litigation incidental to its business. Although the outcome of these lawsuits
cannot be predicted with certainty, TARC does not expect these matters to have
a material adverse effect on its financial position.
ENVIRONMENTAL MATTERS
COMPLIANCE MATTERS. TARC is subject to federal, state and local laws,
regulations and ordinances ("Pollution Control Laws"), which regulate
activities such as discharges to air and water, as well as handling and
disposal practices for solid and hazardous wastes. TARC believes that it is
now, and has included in the Capital Improvement Program sufficient capital
additions to remain, in substantial compliance with applicable Pollution
Control Laws. However, Pollution Control Laws that may be enacted in the
future, as well as increasingly strict enforcement of existing Pollution
Control Laws, may require TARC to make additional capital expenditures in order
to comply with such laws and regulations. To ensure continuing compliance,
TARC has made environmental compliance and permitting issues an integral part
of its refinery's start-up plans and has budgeted for such capital expenditures
in the Capital Improvement Program. However, there is no assurance that TARC
will remain in compliance with environmental regulations.
TARC uses (and in the past has used) certain materials, and generates (and
in the past has generated) certain substances or wastes, that are or may be
deemed hazardous substances or wastes. In the past, the refinery has been the
subject of certain environmental enforcement actions, and has incurred certain
fines, as a result of certain of TARC's operations. TARC also was previously
subject to enforcement proceedings relating to its prior production of leaded
gasoline and air emissions. TARC believes that, with minor exceptions, all of
these past matters were resolved prior to or in connection with the resolution
of the bankruptcy proceedings of its predecessor in interest, TransAmerican, or
are no longer applicable to TARC's operations. As a result, TARC believes that
such matters will not have a material adverse effect on TARC's future financial
position, results of operations or cash flow.
In September 1997, TARC purchased a tank storage facility located adjacent
to the refinery for a cash purchase price of $40 million (which does not
include a $3.1 million liability recorded for environmental remediation, as
discussed below). Environmental investigations conducted by the previous owner
of the facilities have indicated soil and groundwater contamination in several
areas on the property. As a result, the former owner submitted to the
Louisiana Department of Environmental Quality (the "LDEQ") plans for the
remediation of any significant indicated contamination in such areas. TARC has
analyzed these investigations and has carried out further Phase II
Environmental Assessments to verify their results. TARC intends to incorporate
any required remediation into its ongoing work at the refinery. In connection
with the purchase of the facilities, TARC agreed to indemnify the seller for
all cleanup costs and certain other damages resulting from contamination of the
property, and created a $5 million escrow account to fund required remediation
costs and indemnification claims by the seller. As a result of TARC's Phase II
Environmental Assessment, TARC believes that the amount in escrow should be
sufficient to fund the remediation costs associated with identified
contamination; however, because the LDEQ has not yet approved certain of the
remediation plans, there can be no assurance that the funds set aside in the
escrow account will be sufficient to pay all required remediation costs. As of
July 31, 1998, TARC has recognized a liability of $3.1 million for this
contingency.
REQUIREMENTS UNDER THE FEDERAL CLEAN AIR ACT. The National Emission
Standards for Hazardous Air Pollutants for Benzene Waste Operations (the
"Benzene Waste NESHAPS"), promulgated in January 1993 pursuant to the Clean Air
Act, regulate benzene emissions from numerous industries, including petroleum
refineries. The Benzene Waste NESHAPS require all existing, new, modified, or
reconstructed sources to reduce benzene emissions to a level that will provide
an ample margin of safety to protect public health. TARC will be required to
comply with the Benzene Waste NESHAPS as its refinery operations start up.
TARC believes that compliance with the Benzene Waste NESHAPS will not have a
material adverse effect on TARC's financial position, results of operations or
cash flow. Until the refinery is in full operation, however, there can be no
assurance that the regulations will not have such an effect.
9
<PAGE> 11
TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
In addition, the EPA promulgated National Emission Standards for Hazardous
Air Pollutants for Hazardous Organics (the "Hazardous Organic NESHAPS")
regulations for petroleum refineries under the Clean Air Act in 1995, and
subsequently has amended such regulations. These regulations set Maximum
Achievable Control Technology ("MACT") standards for petroleum refineries. The
LDEQ has incorporated MACT standards into TARC's air permits under federal and
state air pollution prevention laws. TARC believes that compliance with the
Hazardous Organics NESHAPS will not have a material adverse effect on TARC's
financial position, results of operations or cash flow. Until the refinery is
in full operation, however, there can be no assurance that the regulations will
not have such an effect.
The EPA has promulgated federal regulations pursuant to the Clean Air Act
to control fuels and fuel additives (the "Gasoline Standards") that could have
a material adverse effect on TARC. Under these regulations, only reformulated
gasoline can be sold in certain domestic geographic areas in which the EPA has
mandated or approved its use. Reformulated gasoline must contain a minimum
amount of oxygen, have a lower vapor pressure, and have reduced sulfur,
olefins, benzene and aromatics compared to the average 1990 gasoline. The EPA
recently promulgated final National Ambient Air Quality Standards ("NAAQS")
that revise the standards for particulate matter and ozone. The number and
extent of the areas subject to reformulated gasoline standards may increase in
the future after the NAAQS are implemented. Conventional gasoline may be used
in all other domestic markets; however, a refiner's post-1994 average
conventional gasoline must not be more polluting than it was in 1990. With
limited exceptions, to determine its compliance as of January 1, 1995, a
refiner must compare its post-1994 and 1990 average values of controlled fuel
parameters and emissions. The Gasoline Standards recognize that many gasoline
refiners may not be able to develop an individual 1990 baseline for a number of
reasons, including, for example, lack of adequate data or the absence or
limited scope of operations in 1990. Under such circumstances, the refiner
must use a statutory baseline reflecting the 1990 industry average. The EPA
has authority, upon a showing of extenuating circumstances by a refiner, to
grant an individual adjusted baseline or other appropriate regulatory relief to
that refiner.
TARC filed a petition with the EPA requesting an individual baseline
adjustment or other appropriate regulatory relief based on extenuating
circumstances. The extenuating circumstances upon which TARC relied in its
petition include the fact that the refinery was not in operation in 1990 (and
thus there is no 1990 average for purposes of the necessary comparison) and the
fact that the start-up of the refinery is to occur on a phased-in basis. The
EPA has denied TARC's request for an individual baseline adjustment and other
regulatory relief. TARC will continue to pursue regulatory relief with the
EPA. However, there can be no assurance that regulatory relief will be
granted. There can be no assurance that any action taken by the EPA will not
have a material adverse effect on TARC's future financial position, results of
operations or cash flow.
Title V of the Clean Air Act requires states to implement an Operating
Permit Program that codifies all federally enforceable limitations that are
applicable to a particular source. The EPA has approved Louisiana's Title V
Operating Permit Program. The Title V Operating Permit is necessary for TARC
to produce at projected levels upon completion of the Capital Improvement
Program. TARC has submitted its Title V Operating Permit Application covering
the refinery and the adjacent tank storage facility. TARC believes that its
application will be approved. However, there can be no assurance that it will
be approved as submitted or that additional expenditures required pursuant to
Title V Operating Permit obligations will not have a material adverse effect on
TARC's financial position, results of operations or cash flow.
CLEANUP MATTERS. TARC also is subject to federal, state and local laws,
regulations and ordinances that impose liability for the costs of clean up
related to, and certain damages resulting from, past spills, disposals or other
releases of hazardous substances ("Hazardous Substance Cleanup Laws"). Over
the past several years, TARC has been, and to a limited extent continues to be,
engaged in environmental cleanup or remedial work relating to or arising out of
operations or activities at the refinery. In addition, TARC has been engaged
in upgrading its solid waste facilities, including the closure of several waste
management units. Similar to numerous other industrial sites in the state, the
10
<PAGE> 12
TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
refinery has been listed by the LDEQ on the Federal Comprehensive Environmental
Response, Compensation and Liability Information System, as a result of TARC's
prior waste management activities (as discussed below).
In 1991, the EPA performed a facility assessment at the refinery pursuant
to the Federal Resource Conservation and Recovery Act ("RCRA"). The EPA
performed a follow up assessment in March 1996, but has not yet issued a report
of its investigations. In July 1996, the EPA and the LDEQ agreed that the LDEQ
would serve as the lead agency with respect to the investigation and
remediation of areas of concern identified in the investigations. TARC, under
a voluntary initiative approved by the LDEQ, submitted a work plan to the LDEQ
to determine which areas may require further investigation and remediation.
TARC submitted further information in January 1998 which was requested by the
LDEQ. Based on the workplan submitted and additional requests by the LDEQ,
TARC believes that any further action will not have a material adverse effect
on its financial position, results of operations or cash flow.
TARC has been identified as a potentially responsible party ("PRP") under
the Comprehensive Environmental Response, Compensation, and Liability Act of
1980, as amended ("CERCLA" or "Superfund"), for the cleanup of contamination
from hazardous substances at three Superfund sites (i.e. sites on the National
Priorities List ("NPL")) to which it has been alleged that TARC, or its
predecessors, sent hazardous substances in the past. CERCLA requires cleanup
of sites from which there has been a "release" or threatened release of
"hazardous substances" (as such terms are defined under CERCLA). CERCLA
requires the EPA to include sites needing long-term study and cleanup on the
NPL based on their potential effect on public health or the environment.
CERCLA authorizes the EPA to take any necessary response actions at NPL sites
and, in certain circumstances, to order PRPs liable for the release to take
such actions. PRPs are broadly defined under CERCLA to include past and
present owners and operators of a site, as well as generators and transporters
of wastes to a site from which hazardous substances are released.
The EPA may seek reimbursement of expenditures of federal funds from PRPs
under Superfund. Courts have interpreted CERCLA to impose strict, joint and
several liability upon all persons liable for the entire amount of necessary
cleanup costs. As a practical matter, at sites where there are multiple PRPs
for a cleanup, the costs of cleanup typically are allocated according to a
volumetric or other standard among the parties. CERCLA also provides that
responsible parties generally may recover a portion of the costs of cleaning up
a site from other responsible parties. Thus, if one party is required to clean
up an entire site, that party can seek contribution or recovery of such costs
from other responsible parties. A number of states have laws similar to
Superfund, pursuant to which cleanup obligations, or the costs thereof, also
may be imposed.
At one Superfund site, TARC has submitted information to the EPA
indicating that it should have no liability for this matter, and negotiations
with the EPA in this regard are continuing. With respect to the remaining two
sites, TARC's liability for each such matter has not been determined, and TARC
anticipates that it may incur costs related to the cleanup (and possibly
including additional costs arising in connection with any recovery or other
actions brought pursuant or relating to such matters) at each such site. After
a review of the data available to TARC regarding the basis of TARC's alleged
liability at each site, and based on various factors, which depend on the
circumstances of the particular Superfund site (including, for example, the
relationship of TARC to each such site, the volume of wastes TARC is alleged to
have contributed to each such site in comparison to other PRPs without giving
effect to the ability of any other PRPs to contribute to or pay for any
liabilities incurred, and the range of likely cleanup costs at each such site),
TARC believes that its ultimate environmental liabilities will not be
significant; however, it is not possible to determine the ultimate
environmental liabilities, if any, that may arise from the matters discussed
above.
PURCHASE COMMITMENTS
TARC has various purchase commitments for materials, supplies and services
incidental to the ordinary course of business and for the Capital Improvement
Program. As of July 31, 1998, TARC had commitments for refinery construction
and maintenance of approximately $58.5 million. TARC is acting as general
contractor and can generally cancel or postpone capital projects.
11
<PAGE> 13
TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
PROCESSING AGREEMENTS
In April 1996, TARC entered into a processing agreement with a third party
to process feedstocks. Under the terms of the agreement, the processing fee
earned from the third party is based on the margin earned by the third party, if
any, after deducting all of its related costs such as feedstock acquisition,
hedging, transportation, processing and inspections plus a commission for each
barrel processed. During the three months ended July 31, 1998 and 1997, TARC
processed approximately 0.8 million barrels and 0.4 million barrels,
respectively, pursuant to processing agreements. Income from this processing
agreement was $1.8 million and $3.1 million for the three months ended July 31,
1998 and 1997, respectively.
POTENTIAL EFFECTS OF A CHANGE OF CONTROL
Pursuant to the terms of the TARC Intercompany Loan, upon the occurrence
of a Change of Control, TEC would have the right to require TARC to repay the
principal of the TARC 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 accreted value of the
outstanding principal amount of the TARC 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 TARC Intercompany
Loan in the case of certain changes or other events in respect of the ownership
or control of TEC 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 TARC's or TransTexas' capital stock,
respectively, but less than 50% of the total voting stock or economic value of
TARC or TransTexas, respectively, unless (in the case of either (i) or (ii)
above) 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 the event of a change of control under the TEC Notes Indenture,
there can be no assurance that TransTexas or TARC 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.
REGISTRATION RIGHTS AGREEMENT
TARC had an obligation under its Registration Rights Agreement with the
holders of its Senior Subordinated Notes to have its registration statement on
Form S-4 relating to the Exchange Offer for the Senior Subordinated Notes
declared effective by the Securities and Exchange Commission by July 28, 1998.
As a result of its failure to meet its obligation under the Registration Rights
Agreement, TARC will incur $10,000 per week in additional interest from July 28,
1998 until such date as the registration statement is declared effective.
7. TRANSACTIONS WITH AFFILIATES
Southeast Contractors, a subsidiary of TransAmerican, provides
construction personnel to TARC in connection with the Capital Improvement
Program. These construction workers are temporary employees, and the number
and composition of the workforce will vary throughout the Capital Improvement
Program. Southeast Contractors charges TARC for the direct costs it incurs
(which consist solely of employee payroll and benefits) plus administrative
costs and fees of up to $2.0 million per year. Total labor costs charged by
Southeast Contractors for the three and six months ended July 31, 1998 and 1997
were $44.5 million, $82.0 million, $7.5 million and $9.7 million, respectively,
of which $9.6 million and $2.0 million were payable at July 31, 1998 and
January 31, 1998, respectively.
On June 13, 1997, the Company entered into a services agreement with
TransAmerican, TransTexas and TEC. Under the agreement, TransTexas provides
accounting, legal, administrative and other services to TARC, TEC and
TransAmerican and its affiliates. TransAmerican provides advisory services to
TransTexas, TARC and TEC. TARC
12
<PAGE> 14
TRANSAMERICAN REFINING CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
will pay TransTexas approximately $300,000 per month for services rendered to,
and for allocated expenses paid by TransTexas on behalf of, TARC and TEC. TEC
and its subsidiaries will pay $2.5 million in the aggregate per year to
TransAmerican for advisory services and benefits provided by TransAmerican.
During the three and six months ended July 31, 1998, TARC recognized $1.5
million and $3.0 million in service agreement expense, of which $1.2 million
and $2.8 million was payable to TransTexas and TransAmerican, respectively, as
of July 31, 1998.
TEC has made and continues to make advances to TARC pursuant to a $46
million promissory note due June 14, 2002 which bears interest in an amount
equal to a fixed semi-annual interest payment of $2.8 million, prorated based on
the average outstanding balance of TARC's note to TEC and the average
outstanding balance of all notes between TransTexas and TEC. Interest payments
are due and payable each June 15 and December 15. As of July 31, 1998, the
outstanding balance of the note was $18.1 million.
During the six months ended July 31, 1998, TEC contributed $9.0 million to
TARC for general corporate purposes and $116.1 million for use in the Capital
Improvement Program pursuant to the Disbursement Agreement.
13
<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
financial statements and notes thereto included elsewhere in this report.
RESULTS OF OPERATIONS
GENERAL
TARC's refinery was inoperative from January 1983 through February 1994.
During this period, TARC's revenues were derived primarily from tank rentals
and its expenses consisted of maintenance and repairs, tank rentals, general
and administrative expenses and property taxes. The No. 2 Vacuum Unit was
operated intermittently between March 1994 and January 1997. The No. 2 Vacuum
Unit recommenced operations in May 1998 and the No. 2 Crude Unit commenced
operations in June 1998. TARC does not consider its historical results to be
indicative of future results.
TARC's results of operations are dependent on the operating status of
certain units within its refinery, which determines the types of feedstocks
processed and refined product yields. The results are also affected by the
unit costs of purchased feedstocks and the unit prices of refined products,
which can vary significantly. The Capital Improvement Program is designed to
significantly change TARC's throughput capacity, the feedstocks processed, and
refined product yields.
TARC believes, based on current estimates of refining margins and costs of
the expansion and modification of the refinery, that future undiscounted cash
flows will be sufficient to recover the cost of the refinery over its estimated
useful life. Management believes there have been no events or changes in
circumstances that would require the recognition of an impairment loss.
However, due to the inherent uncertainties in estimating future refining
margins, and in constructing and operating a large-scale refinery, there can be
no assurance that TARC will ultimately recover the cost of the refinery.
Management believes that the book value of the refinery is in excess of its
current estimated fair market value.
THREE MONTHS ENDED JULY 31, 1998, COMPARED WITH THE THREE MONTHS ENDED
JULY 31, 1997
TARC's revenues for the three months ended July 31, 1998 resulted primarily
from sales of vacuum gas oil ("VGO"), naphtha and distillate produced by the No.
2 Vacuum Unit and the No. 2 Crude Unit. The average price of the approximately
481,000 barrels of VGO and naphtha sold was $14.14, and the average price of the
104,000 barrels of distillate sold was $15.16. Other revenues consisted
primarily of rental income from TARC's tank storage facility acquired in
September 1997.
Cost of products sold of $7.8 million for the three months ended July 31,
1998 related to the refining of approximately 585,000 barrels of feedstocks
purchased at an average price of $13.11 per barrel.
During 1998 and 1997, TARC entered into processing arrangements whereby
TARC did not take title to feedstocks or refined products but received a fee
based on margins, if any, realized by the counterparty to the arrangement. TARC
retained all market and production risks related to barrels processed. These
arrangements, which are recorded net in the statement of operations, resulted in
income of $1.8 million and $3.1 million for the three months ended July 31, 1998
and 1997, respectively.
Operations and maintenance expense for the three months ended July 31, 1998
decreased to $3.1 million from $4.2 million for the same period in 1997,
primarily due to increased capitalization of costs related to the Capital
Improvement Program and an allocation of overhead to inventory.
Depreciation and amortization expense for the three months ended July 31,
1998 increased to $1.8 million from $1.7 million for the same period in 1997,
primarily due to depreciation related to the tank storage facility acquired in
September 1997.
14
<PAGE> 16
General and administrative expenses for the three months ended July 31,
1998 increased to $5.9 million from $2.3 million for the same period in 1997.
The increase was primarily due to increased salaries and training for personnel
added in anticipation of the commencement of refinery operations, services
agreement fees and increased professional fees.
Taxes other than income taxes for the three months ended July 31, 1998
increased to $1.3 million from $0.9 million for the same period in 1997,
primarily due to increased franchise taxes.
TARC incurred no income or loss on purchase commitments for the three
months ended July 31, 1998 compared to a $0.3 million gain on purchase
commitments for the same period in 1997.
Interest income for the three months July 31, 1998 increased to $1.5
million from $0.9 million for the same period in 1997, primarily due to the
investment of proceeds from the TARC Intercompany Loan and Senior Subordinated
Notes. Net interest expense, for the three months ended July 31, 1998 decreased
to $1.1 million from $3.5 million for the same period in 1997, due primarily to
increased interest capitalization. During the three months ended July 31, 1998,
TARC capitalized approximately $41.6 million of interest related to Capital
Improvement Program additions compared to $22.8 million for the three months
ended July 31, 1997.
TARC recognized equity in a loss on the early retirement of debt by
TransTexas of $10.2 million for the three months ended July 31, 1997. The loss
on the early retirement of debt of $84.4 million for the three months ended
July 31, 1997 was a result of the completion of the TARC Notes Tender Offer.
SIX MONTHS ENDED JULY 31, 1998, COMPARED WITH THE SIX MONTHS ENDED JULY 31,
1997
TARC's revenues for the six months ended July 31, 1998 resulted primarily
from sales of VGO, naphtha and distillate produced by the No. 2 Vacuum Unit and
the No. 2 Crude Unit. The average price of the approximately 481,000 barrels of
VGO and naphtha sold was $14.14, and the average price of the 104,000 barrels of
distillate sold was $15.16. Other revenues consisted primarily of rental income
from TARC's tank storage facility acquired in September 1997.
Cost of products sold of $7.8 million for the six months ended July 31,
1998 related to the refining of approximately 585,000 barrels of feedstocks
purchased at an average price of $13.11 per barrel.
During 1998 and 1997, TARC entered into processing arrangements whereby
TARC did not take title to feedstocks or refined products but received a fee
based on margins, if any, realized by the counterparty to the arrangement.
TARC retained all market and production risks related to barrels processed.
These arrangements, which are recorded net in the statement of operations,
resulted in income of $1.8 million and $3.2 million for the six
months ended July 31, 1998 and 1997, respectively.
Operations and maintenance expense for the six months ended July 31, 1998
decreased to $5.8 million from $7.9 million for the same period in 1997,
primarily due to the increased capitalization of costs related to the Capital
Improvement Program and an allocation of overhead to inventory.
Depreciation and amortization expense for the six months ended July 31,
1998 increased to $4.5 million from $3.4 million for the same period in 1997,
primarily due to depreciation related to the tank storage facility acquired in
September 1997.
General and administrative expenses increased to $12.0 million for the six
months ended July 31, 1998 from $5.0 million for the same period in 1997. The
increase was primarily due to increased salaries and training for personnel
added in anticipation of the commencement of refinery operations, services
agreement fees and increased professional fees.
Taxes other than income taxes for the six months ended July 31, 1998
increased to $2.3 million from $1.8 million for the same period in 1997,
primarily due to increased franchise taxes.
Loss on purchase commitments of $4.8 million for the six months ended July
31, 1997 related to a commitment to purchase 0.6 million barrels of feedstock.
These barrels have been sold to a third party and the Company has processed the
barrels pursuant to a processing agreement with the third party.
15
<PAGE> 17
Interest income for the six months ended July 31, 1998 increased to $3.8
million from $1.0 million for the same period in 1997, primarily due to the
investment of proceeds from the TARC Intercompany Loan and Senior Subordinated
Notes. Net interest expense for the six months ended July 31, 1998 increased
to $8.0 million from $6.8 million for the same period in 1997, due primarily to
interest on the TARC Intercompany Loan and Senior Subordinated Notes partially
offset by increased interest capitalization. During the six months ended July
31, 1998, TARC capitalized approximately $75.3 million of interest related to
Capital Improvement Program additions compared to $41.6 million for the six
months ended July 31, 1997.
The equity in loss of TransTexas for the six months ended July 31, 1998 of
$(0.2) million reflects TARC's equity interest in TransTexas through April 30,
1998. TARC distributed all of its shares of TransTexas common stock to TEC in
April 1998.
The loss on the early extinguishment of debt of $1.3 million for the six
months ended July 31, 1998 is a result of the redemption of $7.0 million of
TARC Notes in February 1998. For the six months ended July 31, 1997, TARC
recognized equity in a loss on the early retirement of debt by TransTexas of
$10.2 million. The loss on the early retirement of debt of $84.4 million for
the six months ended July 31, 1997 was a result of the completion of the TARC
Notes Tender Offer.
The cumulative effect of a change in accounting principle of $2.7 million
for the six months ended July 31, 1998 relates to TARC's selection of the
deferred method of accounting for turnaround costs as described in Note 2 of
Notes to Condensed Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
TARC estimates that capital expenditures for the Capital Improvement
Program will be $431 million during the fiscal year ending January 31, 1999 and
$53 million during the fiscal year ending January 31, 2000. TARC currently
estimates that Capital Improvement Program costs may increase by $221 million to
$245 million over the $427 million originally estimated, depending upon the
extent to which an unallocated contingency amount of $24 million is used. See
Note 3 of Notes to Condensed Financial Statements. If engineering problems,
further cost overruns or delays occur and other financing sources are not
available, TARC will not be able to complete either phase of the Capital
Improvement Program. TARC has historically incurred losses and negative cash
flow from operating activities as a result of limited refinery operations that
did not cover the fixed costs of maintaining the refinery, increased working
capital requirements (including debt service) and losses on refined product
sales and processing arrangements. As described in Note 3 of Notes to Condensed
Financial Statements, TARC must raise additional funds in order to complete the
Capital Improvement Program. There is no assurance that TARC can raise
additional funds, complete the Capital Improvement Program, fund its future
working capital requirements or achieve positive cash flow from operations.
As a result, there is substantial doubt about TARC's ability to continue as a
going concern. The condensed financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
The TEC Notes Indenture permits TARC to obtain a revolving credit facility
but places certain limitations on TARC's ability to incur other indebtedness.
In order to operate the refinery at expected levels after the completion of
Phase I of the Capital Improvement Program, TARC will require additional
working capital. TARC has not obtained a working capital facility.
During the three months ended July 31, 1998, TARC purchased approximately
3.7 million barrels of feedstocks financed by cash-backed letters of credit
and letters of credit supported by the credit of a third party. Under the
third-party arrangement, if TARC is unable to obtain feedstock disbursements
from the TARC Disbursement Account prior to a draw under the letters of credit,
the third party will take title to the feedstock and TARC will be required to
buy the feedstock from the third party at a price equal to the purchase price
plus interest at a rate of 15% per annum.
As of July 31, 1998, TARC and TEC had deposited an aggregate of $529
million into accounts (collectively, the "TARC Disbursement Account") from which
disbursements were made pursuant to a disbursement agreement, as amended (the
"Disbursement Agreement") among TARC, TEC, Firstar Bank of Minnesota, N.A., as
trustee (the "TEC Indenture Trustee") under the indenture governing the TEC
Notes (the "TEC Notes Indenture"), Firstar Bank of Minnesota, N. A., as
Disbursement Agent, and Baker & O'Brien, Inc., as Construction Supervisor. See
Note 4 of Notes to Condensed Financial Statements. Of these funds, $427 million
was designated for the Capital Improvement Program, approximately $25.5 million
was designated for general and administrative expenses, $7 million was
designated for outstanding accounts payable, $50 million was designated for
working capital upon completion of the Delayed Coking Unit and certain
supporting units and $19 million was designated for the payment of interest on,
or the redemption, purchase, defeasance or other retirement of, the outstanding
TARC Notes. As of July 31, 1998, $469 million had
16
<PAGE> 18
been disbursed to TARC out of the TARC Disbursement Account for use in the
Capital Improvement Program and for feedstock purchases, $22.5 million for
general and administrative expenses, $7 million for accounts payable and $19
million for the payment of interest on, and the redemption, repurchase and
defeasance of the TARC Notes.
In April 1996, TARC entered into a processing agreement with a third party
to process feedstocks. Under the terms of the agreement, the processing fee
earned from the third party is based on the margin earned by the third party, if
any, after deducting all of its related costs such as feedstock acquisition,
hedging, transportation, processing and inspections plus a commission for each
barrel processed. During the three months ended July 31, 1998 and 1997, TARC
processed approximately 0.8 million barrels and 0.4 million barrels,
respectively, pursuant to processing agreements. Income from this processing
agreement was $1.8 million and $3.2 million for the six months ended July 31,
1998 and 1997, respectively.
TARC had an obligation under its Registration Rights Agreement with the
holders of its Senior Subordinated Notes to have its registration statement on
Form S-4 relating to the Exchange Offer for the Senior Subordinated Notes
declared effective by the Securities and Exchange Commission by July 28, 1998.
As a result of its failure to meet its obligation under the Registration Rights
Agreement, TARC will incur $10,000 per week in additional interest from July 28,
1998 until such date as the registration statement is declared effective.
TEC has made and continues to make advances to TARC pursuant to a $46
million promissory note due June 14, 2002 which bears interest in an amount
equal to a fixed semi-annual interest payment of $2.8 million, prorated based on
the average outstanding balance of TARC's note to TEC and the average
outstanding balance of all notes between TransTexas and TEC. Interest payments
are due and payable each June 15 and December 15. As of July 31, 1998, the
outstanding balance under the note was $18.1 million.
During the six months ended July 31, 1998, TEC contributed $9.0 million
to TARC for general corporate purposes and $116.1 million for use in the
Capital Improvement Program pursuant to the Disbursement Agreement.
Environmental compliance and permitting issues are an integral part of the
capital expenditures anticipated in connection with the expansion and
modification of the refinery. TARC does not expect to incur any additional
significant expenses for environmental compliance during fiscal 1999 other than
those budgeted for the Capital Improvement Program. There is no assurance,
however, that costs incurred to comply with environmental laws will not have a
material adverse effect on TARC's future financial condition, results of
operations or cash flow. TARC also has contingent liabilities with respect to
certain legal proceedings as more fully described in Note 6 of Notes to
Condensed Financial Statements.
IMPACT OF YEAR 2000 ISSUE
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, TARC began
implementation of new client/server based systems which are anticipated to be
completed and tested by January 1999. TARC estimates the cost of upgrading its
computer systems to be approximately $2 million. In addition, TARC is currently
assessing its state of readiness for non-informational technological systems and
the readiness of significant third parties with whom TARC conducts business. As
of July 31, 1998, no contingency plans have been developed to mitigate TARC's
year 2000 issues.
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 Quarterly Report on Form 10-Q regarding
TARC's financial position, business strategy, plans and objectives of
management for future operations and expansion and modification of the
refinery, including but not limited to words such as "anticipates," "expects,"
"believes," "estimates," "intends," "projects" and "likely" indicate
forward-looking statements. TARC's management believes that 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, without limitation,
engineering problems, work stoppages, cost overruns, personnel or materials
shortages, fluctuations in commodity prices for petroleum and refined products,
casualty losses, conditions in the capital markets and competition.
17
<PAGE> 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
See Note 6 of Notes to Condensed Financial Statements for a
discussion of TARC's legal proceedings.
ITEM 5. OTHER INFORMATION.
In a press release dated September 1, 1998, the Company announced
that it had revised its cost estimates for completion of the Capital
Improvement Program. The following table sets forth certain information with
respect to the Capital Improvement Program, including the original budget as of
June 13, 1997, expenditures as of July 31, 1998 and the revised budget as of
July 31, 1998.
<TABLE>
<CAPTION>
ORIGINAL EXPENDITURES TO REVISED
BUDGET (1) JULY 31, 1998 (2) BUDGET (3)
---------- ----------------- ----------
(DOLLARS IN (DOLLARS IN (DOLLARS IN
MILLIONS) MILLIONS) MILLIONS)
<S> <C> <C> <C>
PHASE I:
Crude Unit . . . . . . . . . . . $ 3.0 $ 7.4 $ 8.1
Delayed Coking Unit . . . . . . . 27.0 77.0 82.0
Naphtha Pretreater . . . . . . . 12.0 17.7 25.0
No. 2 Reformer . . . . . . . . . 9.0 1.9 13.0
HDS Unit . . . . . . . . . . . . 24.0 38.2 47.0
Sulfur Recovery System . . . . . 53.0 59.1 70.2
Offsite Facilities/Tankage . . . 46.0 81.2 94.0
Other . . . . . . . . . . . . . . 3.0 0.4 0.5
Engineering and Administrative . 7.0 14.2 14.2
Contingencies(4) . . . . . . . . 39.0 -- 3.0
--------- -------- ---------
Total Phase I . . . . . . 223.0 297.2 357.0
--------- -------- ---------
PHASE II:
FCC Unit . . . . . . . . . . . . 115.0 124.7 197.0
FCC Flue Gas Scrubber . . . . . . 14.0 10.3 15.0
Alkylation Unit . . . . . . . . . 24.0 21.5 43.0
Offsite Facilities/Tankage . . . 26.0 13.5 35.0
Other . . . . . . . . . . . . . . 2.0 -- --
Engineering and Administrative . 3.0 1.2 4.0
Contingencies(4) . . . . . . . . 20.0 -- 21.0
--------- -------- ---------
Total Phase II . . . . . . 204.0 171.1 315.0
--------- -------- ---------
Total Phase I and
Phase II . . . . . . . . $ 427.0 $ 468.3 $ 672.0
========= ======== =========
</TABLE>
- ----------
(1) Budget as of June 13, 1997 for estimated expenditures from June 13,
1997 to completion.
(2) From June 13, 1997 through July 31, 1998.
(3) Revised budget as of July 31, 1998 for estimated expenditures from
June 13, 1997 to completion.
(4) To the extent expenditures have exceeded or are expected to exceed the
approved capital budget for a unit or units, the contingencies portion
of the budget is allocated to specific units. As of July 31, 1998,
the entire contingencies portion of the original budget had been
allocated to specific units.
18
<PAGE> 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
18.1 - Letter dated September 14, 1998 from
PricewaterhouseCoopers LLP regarding
changes in accounting principles.
27.1 - Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended July
31, 1998.
19
<PAGE> 21
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.
TRANSAMERICAN REFINING CORPORATION
(Registrant)
September 14, 1998 By: /s/ R. GLENN MCGINNIS
---------------------------------------------
R. Glenn McGinnis, Chief Executive Officer
September 14, 1998 By: /s/ ED DONAHUE
---------------------------------------------
Ed Donahue, Vice President and Secretary
(Principal Financial and Accounting Officer)
20
<PAGE> 22
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
- ------ -------
<S> <C> <C>
18.1 - Letter dated September 14, 1998 from PricewaterhouseCoopers LLP
regarding changes in accounting principles.
27.1 - Financial Data Schedule.
</TABLE>
<PAGE> 1
EXHIBIT 18.1
TransAmerican Refining Corporation
1300 North Sam Houston Parkway East
Houston, Texas 77032
Gentlemen:
We are providing this letter to you for inclusion as an exhibit to your Form
10-Q filing pursuant to Item 601 of Regulation S-K.
We have read management's justification for the change in accounting method for
inventory pricing from the average cost method to the first-in-first-out method
and the change in accounting method for turnaround costs from the accrual
method to the deferral method contained in TransAmerican Refining Corporation's
(the "Company") Form 10-Q for the quarter ended July 31, 1998. Based on our
reading of the data and discussions with Company officials of the business
judgment and business planning factors relating to the changes, we believe
management's justification to be reasonable. Accordingly, we concur that the
newly adopted accounting principles described above are preferable in the
Company's circumstances to the methods previously applied.
We have not audited any financial statements of the Company as of any date or
for any period subsequent to January 31, 1998, nor have we audited the
application of the changes in accounting principles disclosed in the Company's
Form 10-Q for the quarter ended July 31, 1998; accordingly, our comments are
subject to revision on completion of an audit of the financial statements that
include the accounting changes.
PricewaterhouseCoopers LLP
Houston, Texas
September 14, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
TRANSAMERICAN REFINING CORPORATION'S UNAUDITIED CONDENSED BALANCE SHEET AT JULY
31, 1998 AND THE UNAUDITED CONDENSED STATEMENT OF OPERATIONS FOR THE SIX MONTHS
ENDED JULY 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JUL-31-1998
<CASH> 46,489
<SECURITIES> 0
<RECEIVABLES> 2,039
<ALLOWANCES> 0
<INVENTORY> 32,033
<CURRENT-ASSETS> 90,361
<PP&E> 1,328,808
<DEPRECIATION> 29,722
<TOTAL-ASSETS> 1,431,718
<CURRENT-LIABILITIES> 106,883
<BONDS> 1,050,588
0
0
<COMMON> 300
<OTHER-SE> 264,185
<TOTAL-LIABILITY-AND-EQUITY> 1,431,718
<SALES> 8,375
<TOTAL-REVENUES> 11,652
<CGS> 7,819
<TOTAL-COSTS> 30,524
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,024
<INCOME-PRETAX> (23,372)
<INCOME-TAX> 0
<INCOME-CONTINUING> (23,372)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,294)
<CHANGES> 2,674
<NET-INCOME> (21,992)
<EPS-PRIMARY> (0.73)
<EPS-DILUTED> (0.73)
</TABLE>
