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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, 1996
Registration Number 33-85930
-------------------------------
TRANSAMERICAN ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 76-0441642
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1300 EAST NORTH BELT
SUITE 200
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)
(713) 986-8822
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant 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 20, 1996 was 9,000.
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TRANSAMERICAN ENERGY CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
PART I.
FINANCIAL INFORMATION
<S> <C>
Introduction
Item 1. Financial Statements
Condensed Consolidated Balance Sheet as of July 31, 1996 and January 31, 1996 . . . . . . . . . 2
Condensed Consolidated Statement of Operations for the three and six months ended July 31, 1996
and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Statement of Cash Flows for the six months ended July 31, 1996
and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . 5-24
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . 25-36
PART II.
OTHER INFORMATION
Item 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Item 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37-39
Item 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
Index to Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
</TABLE>
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PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands of dollars, except share amounts)
(Unaudited)
<TABLE>
<CAPTION>
July 31, January 31,
1996 1996
------------ -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 42,237 $ 14,114
Interest reserve account - TransTexas 46,000 46,000
Long-term debt proceeds held in collateral account - TARC 404 14,840
Accounts receivable 39,321 36,372
Receivable from affiliates 3,677 3,000
Inventories 29,025 48,652
Other current assets (Note 3) 36,578 56,300
---------- ----------
Total current assets 197,242 219,278
---------- ----------
Property and equipment 2,596,653 2,438,926
Less accumulated depreciation, depletion and amortization 1,371,969 1,302,972
---------- ----------
Net property and equipment -- based on the full cost method of accounting for gas and oil
properties of which $145,135 and $136,360 was excluded from amortization at
July 31, 1996 and January 31, 1996, respectively 1,224,684 1,135,954
---------- ----------
Long-term debt proceeds held in collateral account - TARC -- 9,565
Due from affiliates 20,494 26,846
Other assets, net 39,809 64,779
---------- ----------
$1,482,229 $1,456,422
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
Current liabilities:
Current maturities of long-term debt $ 4,439 $ 1,335
Accounts payable 43,368 63,302
Payable to affiliate 1,908 2,260
Product financing arrangements 12,922 37,206
Accrued liabilities 97,091 89,316
---------- ----------
Total current liabilities 159,728 193,419
---------- ----------
Due to affiliates 23,554 18,992
Long-term debt, less current maturities 1,147,458 1,119,079
Revolving credit agreement 7,948 20,365
Production payment -- 31,036
Deferred revenue 75,384 32,850
Deferred income taxes 29,012 40,256
Other liabilities 17,815 36,358
Redeemable preferred stock $0.01 par value, 10,000 shares authorized; Series A - 1,000
shares issued and outstanding 96 96
Commitments and contingencies (Note 2) -- --
Stockholder's equity (deficit):
Common stock, $0.01 par value, 100,000 shares authorized; 9,000 shares issued and
outstanding -- --
Additional paid-in capital 136,226 175,019
Accumulated deficit (102,992) (211,048)
---------- ----------
33,234 (36,029)
Less advances to affiliates (12,000) --
---------- ----------
Total stockholder's equity (deficit) 21,234 (36,029)
---------- ----------
$1,482,229 $1,456,422
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands of dollars, except share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- ------------------------
1996 1995 1996 1995
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
Revenues:
Gas, condensate and natural gas liquids $ 76,737 $ 67,217 $156,245 $131,022
Transportation 8,675 8,736 16,870 17,626
Product sales -- 68,434 10,857 68,992
Gain on asset sales -- -- 7,762 --
Other 158 178 357 234
-------- -------- -------- --------
Total revenues 85,570 144,565 192,091 217,874
-------- -------- -------- --------
Costs and expenses:
Operating 29,810 97,929 73,390 119,163
Depreciation, depletion and amortization 33,262 30,519 65,165 62,768
General and administrative 16,022 17,800 25,663 24,555
Taxes other than income taxes 9,672 5,941 15,255 9,832
Litigation settlement (96,000) -- (96,000) --
-------- -------- -------- --------
Total costs and expenses (7,234) 152,189 83,473 216,318
-------- -------- -------- --------
Operating income (loss) 92,804 (7,624) 108,618 1,556
-------- -------- -------- --------
Other income (expense):
Interest income 844 3,496 2,121 5,882
Interest expense, net (30,747) (31,053) (54,121) (51,010)
Gain on sale of TransTexas Stock -- -- 56,162 --
Other 65 5,378 328 2,335
-------- -------- -------- --------
Total other income (expense) (29,838) (22,179) 4,490 (42,793)
-------- -------- -------- --------
Income (loss) before income taxes 62,966 (29,803) 113,108 (41,237)
Income tax expense (benefit) 6,162 (4,203) 7,788 (2,284)
-------- -------- -------- --------
Income (loss) before extraordinary item 56,804 (25,600) 105,320 (38,953)
Extraordinary item - loss on early extinguishment of debt -
TransTexas, net of tax -- (56,637) -- (56,637)
-------- -------- -------- ---------
Net income (loss) $ 56,804 $(82,237) $105,320 $(95,590)
======== ======== ======== ========
Net income (loss) per common share $ 6,312 $ (9,137) $ 11,702 $(12,722)
======== ======== ======== ========
Weighted average number of
shares outstanding 9,000 9,000 9,000 7,514
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands of dollars)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
July 31,
-----------------------------------
1996 1995
------------ --------------
<S> <C> <C>
Operating activities:
Net income (loss) $ 105,320 $ (95,590)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Extraordinary item -- 56,637
Litigation, net 5,000 7,000
Depreciation, depletion and amortization 65,165 62,768
Amortization of discount on long-term debt 40 7,673
Amortization of debt issue costs 7,002 2,815
Gain on sales of assets (7,762) --
Deferred income taxes (11,244) 6,679
Gain on sale of TransTexas stock (56,162) --
Inventory writedown 921 1,265
Proceeds from volumetric production payments 58,621 --
Amortization of deferred revenue (16,087) --
Changes in assets and liabilities:
Accounts receivable (3,508) 4,925
Inventories (5,578) (11,356)
Other current assets 22,899 (10,032)
Accounts payable (1,406) (20,400)
Accrued liabilities (3,125) (15,331)
Payable to affiliates (11,763) (12,585)
Other assets (2,161) (3,367)
Other liabilities (21,452) (66)
---------- ----------
Net cash provided (used) by operating activities 124,720 (18,965)
---------- ----------
Investing activities:
Capital expenditures (191,354) (217,982)
Proceeds from sales of assets 69,971 --
Deposits to interest reserve account (46,000) (44,722)
Withdrawals from interest reserve account 46,000 --
Advances to TransAmerican from TransTexas (9,500) --
Production payment from affiliate -- 3,547
---------- ----------
Net cash used by investing activities (130,883) (259,157)
---------- ----------
Financing activities:
Issuance of long-term debt and warrants 25,000 310,750
Principal payments on long-term debt (17,044) (20,000)
Long-term debt proceeds held in collateral account (26,549) (173,000)
Withdrawals from collateral account 50,550 32,143
Issuance of Senior Secured Notes -- 800,000
Retirement of Senior Secured Notes -- (542,500)
Issuance of redeemable preferred stock -- 96
Issuance of dollar-denominated production payment -- 49,500
Repayments of production payment (32,800) (7,866)
Net proceeds from sale of TransTexas stock 42,607 --
Principal payments on capital lease obligations (517) --
Revolving credit agreement, net (12,417) (8,701)
Dividend payment on preferred stock (19) --
Advances from TransAmerican and affiliates to TARC 11,656 635
Repayment of advances from TransAmerican to TARC (1,925) (40,000)
Debt issue costs (4,256) (34,937)
---------- ----------
Net cash provided by financing activities 34,286 366,120
---------- ----------
Increase in cash and cash equivalents 28,123 87,998
Beginning cash and cash equivalents 14,114 866
---------- ----------
Ending cash and cash equivalents $ 42,237 $ 88,864
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
ORGANIZATION. TransAmerican Energy Corporation (the "Company") was formed on
July 12, 1994 to hold 55 million shares of common stock (74.3% of outstanding
shares) of TransTexas Gas Corporation ("TransTexas") and all of the outstanding
capital stock of TransAmerican Refining Corporation ("TARC"). TransAmerican
contributed 55 million shares of TransTexas common stock and all of the capital
stock of TARC to the Company in connection with the public offering of TARC's
senior secured notes (the "TARC Notes"). The Company then contributed 15
million of these shares (20.3% of the total outstanding) of TransTexas common
stock to TARC. In March 1996, TARC sold 4.55 million shares (6.2% of the total
outstanding) of TransTexas common stock in public offerings. The condensed
consolidated financial statements include the financial statements of
TransTexas and TARC on a wholly-owned basis. Once TransTexas is in a positive
equity position, 19.8% of the results of its operations will be allocated to
nonaffiliates. Capitalized terms used herein are as defined in the respective
Transition Reports on Form 10-K of TransTexas, TARC and the Company for the
transition period ended January 31, 1996.
The respective bond indenture agreements of TransTexas and TARC each
contain substantial restrictions which essentially prevent the Company from
using the assets of one entity to satisfy the liabilities of the other and
substantially limit transactions between affiliates. Accordingly, the
condensed consolidated financial statements should be read in conjunction with
the separate condensed financial statements of TransTexas and TARC filed on
their respective quarterly reports on Form 10-Q for the three months ended
July 31, 1996.
Below is selected financial information for each consolidated entity (in
millions of dollars):
<TABLE>
<CAPTION>
July 31, 1996
--------------------------------------------------------------
Consolidation
Balance Sheet Data TARC TransTexas Entries Consolidated
------------------ ---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
Working capital $ (35.7) $ 73.2 $ -- $ 37.5
Total assets 541.3 944.6 (3.7) 1,482.2
Long-term debt 340.1 819.8 -- 1,159.9
Long-term payable to affiliates (1) 13.5 12.1 (2.0) 23.6
Stockholder's equity (deficit) (2) 114.0 (114.3) 21.5 21.2
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended July 31, 1996
--------------------------------------------------------------
Consolidation
Operations Data TARC TransTexas Entries Consolidated
--------------- ---------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
Revenues $ 10.9 $ 182.7 $ (1.5) $ 192.1
Operating income (loss) (23.7) 132.5 (0.2) 108.6
Net income (loss) 42.0 74.6 (11.3) 105.3
Cash Flow Data
---- ---- ----
Operating activities $ (16.5) $ 141.3 $ (0.1) $ 124.7
Investing activities (61.6) (69.3) -- (130.9)
Financing activities 75.8 (41.5) -- 34.3
</TABLE>
(1) Excludes deferred taxes of TransTexas for $29.0 million payable to
TransAmerican
(2) Includes $12.0 million of advances by TransTexas to affiliates classified
as a component of equity.
INTERIM FINANCIAL INFORMATION. The condensed consolidated financial statements
reflect all adjustments, consisting of normal recurring accruals, which are, in
the opinion of management, necessary for a fair presentation of the results for
5
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
the interim periods. Interim results of operations are not necessarily
indicative of the results that may be expected for the year ending January 31,
1997. The financial information presented herein should be read in conjunction
with the financial statements and notes included in the Company's Transition
Report on Form 10-K, for the Transition Period ended January 31, 1996.
LIQUIDITY. A primary source of funds to meet TransTexas' debt service and
capital requirements is net cash flow provided by operating activities, which
is extremely sensitive to the prices TransTexas receives for its natural gas.
TransTexas has entered into hedge agreements to reduce its exposure to price
risk in the spot market for natural gas. However, a substantial portion of
TransTexas' production will remain subject to such price risk. Additionally,
significant capital expenditures are required for drilling and development,
lease acquisitions, pipeline and other equipment additions. Since July 31,
1995, TransTexas has utilized asset sales and various financings, in addition
to cash flow from operating activities, to meet its working capital
requirements. TransTexas anticipates that it will utilize additional financing
or sales of assets as allowed by the indenture (the "TransTexas Indenture")
governing TransTexas' Senior Secured Notes (the "TransTexas Notes"), to fund
planned levels of operations through January 1997. No assurance, however, can
be given that TransTexas' cash flow from operating activities and other sources
of cash will be sufficient to meet planned capital expenditures, contingent
liabilities, and debt service in the future.
On July 2, 1996, TransTexas consummated the sale, effective as of May
1, 1996, of producing properties in Zapata County, Texas for consideration of
approximately $62 million. On June 17, and August 13, 1996, TransTexas
consummated the sales, effective as of February 1, 1996, of certain other
producing properties in Webb County, Texas for consideration of approximately
$9.95 million and $21.5 million, respectively. The purchase price for each of
the properties discussed above was or is subject to adjustment for gas sales
between the effective date and the closing date. TransTexas retained or will
retain the proceeds of all such gas sales.
TransTexas has engaged an investment banking firm to assist in the
potential sale or sale-leaseback of all or a portion of TransTexas' pipeline
system. TransTexas has also engaged an investment banking firm to assist in
the sale of its interest in the Lodgepole area. On August 29, 1996, TransTexas
announced that it has engaged two investment banking firms to assist in the
sale of TransTexas' remaining Lobo Trend producing properties in Webb and
Zapata counties, Texas, and associated undeveloped acreage. If such a sale is
consummated, TransTexas intends to use the proceeds, along with proceeds from
any sales of its pipeline system and Lodgepole area properties, for general
corporate purposes and a possible repurchase of the TransTexas Notes.
On June 28, 1996, TransTexas consummated a settlement of litigation
pursuant to which TransTexas and another plaintiff received approximately $125
million. TransTexas' share of the settlement proceeds was $96 million.
TARC is currently engaged in an expansion and modification of its
refinery (the "Capital Improvement Program"). The current budget for the Capital
Improvement Program calls for total expenditures of approximately $434 million.
TARC estimates that expenditures of between $146 million and $151 million in
addition to the current budget will be required to complete the Capital
Improvement Program. A significant portion of the additional expenditures will
relate to the Delayed Coking Unit, the FCC Unit and the offsite facilities. In
connection with the issuance of the TARC Notes, $173 million of the proceeds
thereof were deposited into a cash collateral account, designated for use in the
Capital Improvement Program. In March 1996, TARC sold 4.55 million shares of
TransTexas common stock and $26.6 million of the proceeds thereof were deposited
in the cash collateral account.
As of July 31, 1996, expenditures on the Capital Improvement Program
funded or approved for reimbursement from the cash collateral account totaled
approximately $205 million. Approximately $0.4 million remained in the cash
collateral account as of July 31, 1996. Giving effect to current estimates,
additional funding of $374 million to $379 million will be required to complete
the Capital Improvement Program, of which approximately $41 million is
anticipated to be funded by the South Louisiana Port Commission ("Port
Commission") tax exempt bonds (described below). Additional funds necessary
to complete the Capital Improvement Program may be provided from (i) the sale
of additional shares of TransTexas common stock held by TARC, (ii) the sale of
common stock of TARC, (iii) equity investments in TARC (including the sale of
preferred stock of TARC to the Company, funded by the sale of TransTexas
6
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
common stock held by the Company), (iv) capital contributions or loans by
TransAmerican, or (v) other sources of financing, the access to which could
require the consent of the holders of the TARC Notes. TARC has entered into
preliminary discussions with potential third party investors, including
strategic equity investors, financial investors and foreign producers of crude
oil. Sales of shares of TransTexas common stock may result in deconsolidation
of TransTexas from the consolidated group for federal income tax purposes.
There is no assurance that sufficient funds will be available from these sources
on a timely basis or upon terms acceptable to TARC or TransAmerican. If this
financing is not available in the near future or if significant engineering
problems, work stoppages, personnel shortages or cost overruns occur, TARC
likely will not be able to complete and test Phase I of the Capital Improvement
Program by February 15, 1997. If required financing is obtained on a timely
basis, completion by February 15, 1997 will still prove very difficult. TARC
has identified and is considering steps to optimize construction completion,
including the retention of field supervisors, direct hiring of field supervisors
and field labor by TARC's major contractors, adding additional shifts, and
modularization and outsourcing of certain construction items. Under the
indenture governing the TARC Notes (the "TARC Indenture"), the failure of TARC
to complete and test Phase I by February 15, 1997 would constitute an Event of
Default at such date. Such date, however, may be extended, without an Event of
Default, to May 15, 1997 or further extended to August 15, 1997 if TARC's fixed
charge coverage ratio is 1.25 to 1 for the three month periods ended December
31, 1996 and March 31, 1997, respectively. TARC is actively pursuing
transactions that could allow it to meet the requisite ratio.
If an Event of Default occurs and is continuing, unless the principal
of all of the TARC Notes shall have already become due and payable, either the
TARC Indenture Trustee or the Holders of 25% in aggregate principal amount of
TARC Notes then outstanding, by notice in writing to TARC (and to the TARC
Indenture Trustee if given by Holders) (an "Acceleration Notice"), may declare
all principal of the TARC Notes and accrued interest to be due and payable
immediately.
Prior to the declaration of acceleration of the TARC Notes, the Holders
of a majority in aggregate principal amount of the TARC Notes at the time
outstanding may waive on behalf of all the Holders any default, except a
default in the payment of principal of, premium, if any, or interest on any
TARC Note not yet cured, or a default with respect to any covenant or provision
which cannot be modified or amended without the consent of the Holder of each
outstanding TARC Note affected.
Pursuant to a cash collateral and disbursement agreement (the
"Disbursement Agreement") among the Indenture Trustee, First Union National
Bank, as disbursement agent (the "Disbursement Agent"), and Baker & O'Brien,
Inc., as construction supervisor (the "Construction Supervisor"), $173 million
of the net proceeds from the sale of the TARC Notes pursuant to the 1995
Offering was placed in an account (the "Collateral Account"), held and invested
by the Disbursement Agent until needed from time to time to fund the Capital
Improvement Program. In addition, TARC is required to deposit the first $50
million of proceeds from a Revolving Credit Facility in the Collateral Account
if TARC obtains such facility. The Disbursement Agent invests the assets of
the Collateral Account in cash, Cash Equivalents and Marketable Securities.
Interest income, if any, earned on the invested proceeds will be added to the
balance of the Collateral Account. The Disbursement Agent disburses funds from
the Collateral Account only upon satisfaction of the disbursement conditions
set forth in the Disbursement Agreement. All funds in the Collateral Account
are pledged as security for the repayment of the TARC Notes.
The Disbursement Agent makes disbursements out of the Collateral
Account in accordance with a budget prepared by TARC and approved by the
Construction Supervisor. The budget consists of an itemized schedule setting
forth on a line item basis the additional expenditures estimated to be incurred
in connection with the Capital Improvement Program, the total cost of which may
not exceed $434 million, subject to certain exceptions. See "Capital
Improvement Program." TARC may amend the budget only with the approval of the
Construction Supervisor. The Construction Supervisor will approve an amended
budget if it satisfies all of the requirements of the original budget or
certain other conditions are satisfied. If the Capital Improvement Program
runs over budget, the Disbursement Agreement gives priority to expenditures for
Phase I of the Capital Improvement Program.
Under the Disbursement Agreement, the Construction Supervisor is
responsible for review and approval of
7
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
TARC's plans and specifications and budget for the Capital Improvement Program.
The Construction Supervisor is required to perform weekly inspections of TARC's
refinery and to advise the Disbursement Agent and the Indenture Trustee on the
progress of the Capital Improvement Program. In addition, the Construction
Supervisor is required to review each request by TARC for a disbursement from
the Collateral Account to pay for the Capital Improvement Program. No
disbursements may be made from the Collateral Account to fund the Capital
Improvement Program unless the Construction Supervisor determines (i) that the
disbursement has been requested to pay for expenses that are in accordance with
the plans and specifications approved by the Construction Supervisor, (ii) that
the expense for which a disbursement has been requested does not exceed the
amount for such item as set forth in the budget approved by the Construction
Supervisor, and (iii) that transactions for which a disbursement has been
requested were made on an arm's length basis, as represented by TARC.
TARC and the Port Commission have reached an agreement in principle
which would allow the issuance of approximately $75 million in Port Commission
tax exempt bonds, the proceeds of which may be used to construct tank storage
facilities, docks and air and waste water treatment facilities. A portion of
these facilities was included in the Capital Improvement Program at a estimated
cost of $41 million. The issuance of the tax exempt bonds could provide an
alternate source of financing for the construction of such facilities. The
Port Commission would own the facilities built with the proceeds of the bonds,
and TARC would operate the facilities pursuant to a long-term (30-year) lease.
There can be no assurance that the issuance of the tax-exempt bonds, which may
require the consent of the holders of the TARC Notes, will occur.
TARC has incurred losses and negative cash flows 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 and losses on
refined product sales and processing agreements due to financing costs and low
margins. Based on recent refining margins, projected levels of operations and
debt service requirements, such negative cash flows are likely to continue
unless TARC is successful in its pursuit of fixed fee crude processing
transactions. In order to operate the refinery and service its debt, TARC must
raise debt or equity capital in addition to the funds required to complete the
Capital Improvement Program. There is no assurance that the necessary
additional funding for the refinery expansion and working capital can be
obtained or that profitable operations will be ultimately achieved. As a result
there is substantial doubt about TARC's ability to continue as a going concern.
If TARC (i) does not complete the Capital Improvement Program in a timely
manner, (ii) incurs significant cost overruns, (iii) does not ultimately achieve
profitable operations, or (iv) ceases to continue operations, TARC's investment
in the refinery may not be recovered. The consolidated financial statements
do not include any adjustments as a result of such uncertainties.
Additionally, the Company has pledged its entire ownership interest of
the common stock of TransTexas as collateral for the TARC Notes. In the event
TARC does not continue as a going concern, it is likely that the Company will
lose its entire investment in TransTexas. Therefore, if the Company is unable
to recover its investment in TARC and it loses its investment in TransTexas,
there is substantial doubt in the Company's ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of these uncertainties.
RECENTLY ISSUED PRONOUNCEMENT. In March 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The Company adopted the requirements of SFAS No. 121
as of February 1, 1996. Gas and oil properties accounted for under the full
cost method continue to be subject to a ceiling test limitation on capitalized
costs specified by Securities and Exchange Commission regulations. The Company
currently believes, based on estimates of refining margins and current estimates
for costs of the Capital Improvement Program 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 constructing and operating a large scale refinery and
the uncertainty regarding TARC's ability to complete the Capital Improvement
Program, there can be no assurance that TARC will ultimately recover the cost
of the refinery.
2. COMMITMENTS AND CONTINGENCIES
As part of the transfer of the natural gas exploration, production and
transmission businesses of TransAmerican to TransTexas (the "Transfer"),
TransTexas has succeeded to the potential liability, if any, of TransAmerican
and certain subsidiaries in connection with the lawsuits described below.
TransTexas has assumed liability for the proceeding
8
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
described in Note 8 under "Ginther/Warren" and liability for other litigation
up to $15 million plus the difference, if any, between $10 million and the
costs (if less than $10 million) incurred to resolve the disputed claims.
Pursuant to an agreement among TransTexas, TransAmerican and certain of its
subsidiaries, as amended (the "Transfer Agreement"), TransAmerican has agreed
to indemnify TransTexas against all losses incurred by TransTexas in excess of
$25 million in connection with (a) disputed claims in TransAmerican's
bankruptcy and (b) other litigation assumed by TransTexas and other agreements
related to TransAmerican's plan of reorganization (other than settlements and
judgments paid from escrowed cash established in connection with
TransAmerican's plan of reorganization). Effective with the settlement of the
Terry/Penrod litigation described in Note 8, TransAmerican will be required to
indemnify TransTexas for all future losses incurred in connection with
litigation or bankruptcy claims assumed in the Transfer. Any indemnification
payments received from TransAmerican for which TransTexas is the primary
obligor will be considered a contribution of capital. There can be no
assurance that TransAmerican will have the financial ability to meet all of its
indemnification obligations.
LEGAL PROCEEDINGS
FINKELSTEIN. On April 15, 1990, H. S. Finkelstein filed suit against
TransAmerican in the 49th Judicial District Court, Zapata County, Texas,
alleging that TransAmerican failed to pay royalties and improperly marketed oil
and gas produced from certain leases. On September 27, 1994, the plaintiff
added TransTexas as an additional defendant. On January 6, 1995, a judgment
against TransAmerican and TransTexas was entered for approximately $18 million
in damages, interest and attorneys' fees. TransTexas and TransAmerican
posted a supersedeas bond and appealed the judgment to the Fourth Court of
Appeals, San Antonio, Texas. The Fourth Court of Appeals affirmed the judgment
on April 3, 1996. TransTexas and TransAmerican filed a motion for rehearing.
On August 14, 1996, the Fourth Court of Appeals reversed the trial court
judgment and rendered judgment in favor of TransAmerican and TransTexas. On
August 29, 1996, the plaintiff filed a motion for stay and a motion for
rehearing with the court. On April 22, 1991, the plaintiff filed a separate
suit against TransAmerican and various affiliates in the 49th Judicial
District Court, Zapata County, Texas, alleging an improper calculation of
overriding royalties allegedly owed to the plaintiff and seeking damages
in an unspecified amount. On November 18, 1993, the plaintiff added
TransTexas as an additional defendant. The parties have agreed to binding
arbitration in this matter, which is set for January 6, 1997.
COASTAL. On October 28, 1991, Coastal filed an action against TransAmerican
that was consolidated in the 49th Judicial District Court, Webb County, Texas,
alleging breach of contract and tortious interference related to two gas sales
contracts and a transportation agreement, seeking unspecified actual and
punitive damages and injunctive relief. On April 22, 1994, the court entered a
judgment adverse to TransAmerican and TransTexas requiring them to pay $1.3
million plus $0.7 million in attorney's fees to Coastal. On May 29, 1996, the
Court of Appeals affirmed the judgments. TransAmerican and TransTexas continue
to appeal this judgment. Coastal has abstracted the judgment in Webb and
Zapata Counties. While this matter is being judicially resolved, TransTexas is
continuing to furnish gas to Coastal.
ALAMEDA. On May 22, 1993, Alameda Corporation ("Alameda") sued TransAmerican
and John R. Stanley in the 215th Judicial District Court of Harris County,
Texas, claiming that TransAmerican failed to account to Alameda for a share of
the proceeds TransAmerican received in a settlement during 1990 of litigation
with El Paso Natural Gas Company ("El Paso") and that TransAmerican has been
unjustly enriched by its failure to share these proceeds with Alameda. The
court granted Mr. Stanley's motion for summary judgment. On September 20,
1995, the jury rendered a verdict in favor of TransAmerican. Alameda has
appealed to the Fourteenth Court of Appeals.
ASPEN. TransAmerican brought suit, in the 215th Judicial District Court, Harris
County, Texas, on September 29, 1993, against Aspen Services, Inc. ("Aspen"),
seeking an audit and accounting of drilling costs that Aspen had charged while
providing drilling services to TransAmerican. The parties' drilling agreement
provided, among other things, that Aspen would receive payment for its
drilling-related costs from the production and sale of gas from the wells that
were drilled, and that the revenues that TransAmerican would otherwise receive
from the wells would be reduced by the amounts received by Aspen. Aspen, under
provisions of the parties' drilling agreement, requested that TransAmerican's
audit be made subject to arbitration, and the court agreed. While the audit was
in progress, Aspen asserted additional costs that it contended should be added
to the production payment account. One category of such costs, relating to
overhead expenses, amounted to approximately $2.6 million. On July 31, 1996,
the arbitrators issued a decision in which they rejected all of Aspen's overhead
charges, and accepted
9
<PAGE> 11
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
and rejected various charges contested by TransAmerican, with the net result of
a credit in TransAmerican's favor of approximately $80,000. Aspen also filed,
in the court proceeding, on July 19, 1995, a counterclaim and third party claim
against TransAmerican, TransTexas, and affiliated entities, asserting, among
other things, that these entities failed to make certain payments and market
gas from these wells. Aspen is seeking damages in an unspecified amount, as
well as certain equitable claims. TransTexas and its affiliates are vigorously
contesting this claim. The parties' drilling contract was not transferred to
TransTexas in the Transfer. The properties relating to the drilling contract,
however, were transferred to TransTexas. TransAmerican is entitled to any
settlement or damages awarded to it in this matter.
KATHRYN M. On June 8, 1995, Kathryn M., Inc., et al., filed suit against
TransAmerican in the 333rd Judicial District Court (subsequently transferred to
the 334th Judicial District Court), Harris County, Texas, alleging that the
plaintiffs, as nonparticipating royalty interest owners in the La Perla Ranch
leases, are entitled to receive a portion of the settlement proceeds received by
TransAmerican from El Paso. On April 16, 1996, the Zimmerman Group and the
Curran Trust intervened, making the same claims as the Mosbacher children.
TransAmerican filed its motion for summary judgment. Plaintiffs also filed a
motion for partial summary judgment based on the Finkelstein case. On August 2,
1996, the court denied TransAmerican's motion and plaintiff's motion. Trial is
set for January 27, 1997.
MCNAMARA. On June 28, 1996, TransTexas consummated a settlement of litigation
with Tennessee Gas Pipeline Company ("Tennessee") that was filed on October 14,
1993, in the 244th Judicial Court of Ector County, Texas ("Tennessee lawsuit")
pursuant to which TransTexas and another Plaintiff (ICA Energy, Inc.) received
approximately $125 million from Tennessee. TransTexas' share of the settlement
proceeds was $96 million. On July 2, 1996, John McNamara, Jr. et al. ("The
Hubberd Trusts") filed a new suit against TransTexas in the 241st District Court
of Webb County, Texas asserting that TransTexas had breached its duties to The
Hubberd Trusts under certain oil and gas leases and that TransTexas owed the
Hubberd Trusts 25% of the gross settlement proceeds, or approximately $31.25
million. However, in August of 1995, The Hubberd Trusts had already intervened
in the Tennessee lawsuit wherein The Hubberd Trusts asserted the exact same
claims as those asserted in the 241st District Court proceeding. Accordingly,
TransTexas has already denied any liability to The Hubberd Trusts and
counterclaimed that The Hubberd Trusts are not due any portion of the settlement
proceeds received in the Tennessee lawsuit. On July 5, 1996, TransTexas filed a
plea-in-abatement requesting that the 241st District Court proceeding be
dismissed based upon the dominant jurisdiction that already existed in the
Tennessee lawsuit. On July 15, 1996, the Court in the Tennessee lawsuit issued
a temporary injunction granting TransTexas' request that The Hubberd Trusts be
prevented and enjoined from pursuing their claims relating to the Tennessee
settlement proceeds in the 241st District Court. The Hubberd Trusts have filed
their notice of appeal to this temporary injunction.
BRIONES. In an arbitration proceeding, Jesus Briones, a lessor, claimed that a
TransTexas well on adjacent lands had been draining natural gas from a portion
of his acreage leased to TransTexas on which no well had been drilled. On
October 31, 1995, the Arbitrator decided that drainage had occurred. On June 3,
1996, the Arbitrator issued a letter indicating that drainage damages would be
awarded to Briones in the amount of approximately $1.4 million. The Arbitrator
entered his award of damages on June 27, 1996. On July 3, 1996, TransTexas filed
a petition in the 49th Judicial District Court, Zapata County, Texas to vacate
the Arbitrator's award.
FROST. On November 10, 1994, Frost National Bank filed suit in the 111th
Judicial District Court, Webb County, Texas, against TransTexas seeking a
declaratory judgment determination that TransTexas failed to properly and
accurately calculate royalties under a lease. Plaintiff has demanded $10
million plus interest. This litigation is in the discovery stage.
NLRB PROCEEDING. On July 13, 1994, the Oil, Chemical and Atomic Workers
International Union ("OCAW") filed unfair labor practices charges against TARC
with the New Orleans Regional Office of the National Labor Relations Board
("NLRB"). The charge alleges that TARC refused to reinstate 22 former
employees because of their union membership. The NLRB refused to issue a
complaint and the OCAW has appealed the decision to the NLRB General Counsel.
10
<PAGE> 12
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
EEOC. On August 31, 1995, the Equal Employment Opportunity Commission ("EEOC")
filed a Commissioner's charge and initiated a systematic investigation into
TARC's and Southeast Louisiana Contractors of Norco, Inc.'s ("Southeast
Contractors") employment practices. The EEOC is investigating whether TARC is
discriminating on the basis of sex and race. TARC intends to vigorously defend
this allegation.
GATX. On May 14, 1996, GATX Terminals Corporation ("GATX") filed suit against
TARC in the U.S. District Court, Eastern District of Louisiana, alleging breach
of an operating agreement to pay GATX $122,500 per month beginning January 1996.
TARC intends to vigorously defend this action.
GENERAL. TransTexas and TARC are also named defendants in other ordinary
course, routine litigation incidental to their businesses. While the outcome
of these other lawsuits cannot be predicted with certainty, the Company does
not expect these matters to have a material adverse effect on its financial
position. At July 31, 1996, the possible range of estimated losses related to
all of the aforementioned claims in addition to the estimates accrued by
TransTexas and TARC is $0 to $64 million. The resolution in any reporting
period of one or more of these matters in a manner adverse to TARC or
TransTexas could have a material adverse impact on the Company's results of
operations or cash flows for that period.
ENVIRONMENTAL MATTERS
TransTexas' operations and properties are subject to extensive federal,
state, and local laws and regulations relating to the generation, storage,
handling, emission, transportation, and discharge of materials into the
environment. Permits are required for various of TransTexas' operations, and
these permits are subject to revocation, modification, and renewal by issuing
authorities. TransTexas also is subject to federal, state, and local laws and
regulations that impose liability for the cleanup or remediation of property
which has been contaminated by the discharge or release of hazardous materials
or wastes into the environment. Governmental authorities have the power to
enforce compliance with their regulations, and violations are subject to fines
or injunctions, or both. It is not anticipated that TransTexas will be
required in the near future to expend amounts that are material to the
financial condition or operations of TransTexas by reason of environmental laws
and regulations, but because such laws and regulations are frequently changed,
and as a result may impose increasingly strict requirements, TransTexas is
unable to predict the ultimate cost of complying with such laws and
regulations.
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 in
substantial compliance with applicable Pollution Control Laws. However, newly
enacted Pollution Control Laws, as well as increasingly strict enforcement of
existing Pollution Control Laws, will require TARC to make 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 exception, 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 results of
operations, cash flows or financial position.
PENDING REQUIREMENTS UNDER THE FEDERAL CLEAN AIR ACT. The National Emission
Standards for Hazardous Air Pollutants
11
<PAGE> 13
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
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. At this time, TARC cannot estimate the
costs of such compliance. Although TARC does not believe that such costs will
be material, there can be no assurance that such costs will not have a material
adverse effect on its financial position.
In addition, the anticipated promulgation of Hazardous Organic NESHAPS
regulations for refineries under the Clean Air Act could have a material adverse
effect on TARC. The Clean Air Act requires the EPA to set "Maximum Achievable
Control Technology" ("MACT") standards for all categories of major sources of
hazardous air pollutants by November 15, 2000. The EPA promulgated its "Final
Rule for National Emission Standards for Hazardous Air Pollutants; Petroleum
Refineries" on August 18, 1995. This rule sets MACT standards for the petroleum
refining industry. TARC cannot estimate at this time what the effect may be of
the EPA regulations on the refinery. The Louisiana Department of Environmental
Quality has set applicable MACT standards. TARC believes that it is in
compliance with the Louisiana MACT standards and has incorporated the standards
into its Prevention of Significant Deterioration permit.
The EPA 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 benzene and
aromatics compared to the average 1990 gasoline. The number and extent of the
areas subject to reformulated gasoline standards may increase in the future if
the applicable laws and regulations become more stringent or other areas become
subject to the existing program. 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, 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.
If the EPA fails to grant appropriate regulatory relief, TARC will be restricted
in the amount of gasoline it will be able to sell domestically or will incur
additional gasoline blending costs until the Capital Improvement Program is
completed. Upon completion of the Capital Improvement Program, TARC believes
that it will be able to produce conventional gasoline and, to a limited extent,
reformulated gasoline that meets the Gasoline Standards. There can be no
assurance that any action taken by the EPA will not have a material adverse
effect on TARC's future results of operations, cash flows or financial position.
CLEANUP MATTERS. TARC also is subject to federal, state, and local laws,
regulations, and ordinances that impose liability for the costs of cleaning up,
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
refinery has been listed by the Louisiana Department of Environmental Quality
on the Federal Comprehensive Environmental Response, Compensation
12
<PAGE> 14
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
and Liability Information System, as a result of TARC's prior waste management
activities (as discussed below).
In 1991, the EPA performed a refinery facility assessment at TARC's
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
Louisiana Department of Environmental Quality (the "LDEQ") agreed that the LDEQ
would serve as the lead agency. TARC, under a voluntary initiative approved by
the LDEQ, is completing closure of three areas identified in the EPA's
assessment. TARC is unable to predict what the results of the LDEQ
investigations will be, or the effect that any further investigation or
remediation that would be required by the LDEQ will have on TARC's financial
position. As part of the facility assessment, in March 1993 TARC submitted a
"Closure Equivalency Demonstration" for the former sludge drying beds at the
refinery. The LDEQ has not yet made a determination regarding TARC's submission
or issued any further requests relating to this matter. TARC believes that the
sludge drying beds were properly closed in 1985 in accordance with applicable
law and should not require further remediation as a result of the LDEQ's pending
review. However, there can be no assurance that the LDEQ will not require
further work in this regard. TARC is unable to estimate what the costs, if any,
will be if the LDEQ does require further remediation or closure activities.
Certain former employees have alleged that TARC's predecessor
improperly disposed of catalyst containing hazardous substances at the site of
TARC's visbreaker. These employees have further alleged that certain permits
for the refinery were obtained as a result of political contributions made by
TARC. As a result of these allegations, the EPA and the LDEQ commenced an
investigation of the refinery. TARC has denied each of these allegations and
believes that they are wholly without merit. In the early 1980s, TARC's
predecessor disposed of catalyst with the approval of the applicable Louisiana
authorities at off-site and on-site locations; however, no catalyst was
disposed of in the vicinity of the visbreaker. TARC's records confirm that
the State of Louisiana was aware of and approved TARC's disposal of catalyst,
and that the catalyst was not hazardous under any applicable legal standards.
The LDEQ has concluded its investigation without citing any violations by
TARC. TARC also has independently investigated the allegations. Analysis of
soil borings taken from the site of the visbreaker by three independent
laboratories found no evidence of catalyst or other alleged toxic substances in
the samples taken. All permits that have been applied for and obtained by TARC
for its operations have been in accordance with all applicable laws and
regulations. TARC does not expect to incur any liability in connection with
these allegations.
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 four 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.
TARC's liability at one of the four Superfund sites at which it has
been named a PRP was settled in 1990 for a nominal amount, and TARC expects to
incur no further liability in this matter. At a second Superfund site, the EPA
invited TARC to enter into negotiations, TARC attended a scheduled settlement
meeting, and negotiations are continuing. With respect to the remaining two
sites, TARC's liability for each such matter has not been finally determined,
and TARC anticipates that it may incur costs related to the cleanup (and
possibly including additional costs arising in connection with any recovery
action brought pursuant 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 does not believe its
ultimate liabilities will 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, 1996, TARC had commitments for refinery
construction and maintenance of approximately $56.2 million. TARC acts as
general contractor and can generally cancel
13
<PAGE> 15
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
or postpone capital projects.
PRICE MANAGEMENT ACTIVITIES
TARC enters into futures contracts, options on futures, swap
agreements and forward sales agreements with the intent to protect against a
portion of the price risk associated with price declines from holding inventory
of feedstocks and refined products or fixed price purchase commitments. For
the six months ended July 31, 1996, TARC indirectly entered into price
management activities through the third party processing agreement discussed
below.
FINANCING ARRANGEMENTS AND PROCESSING AGREEMENT
TARC enters into financing arrangements to maintain an available supply of
feedstocks. Typically, TARC enters into an agreement with a third party to
acquire a cargo of feedstock that is scheduled for delivery to TARC's refinery.
TARC pays through the third party all transportation costs, related taxes and
duties and letter of credit fees for the cargo, plus a negotiated commission.
Prior to arrival at the refinery, another third party purchases the cargo, and
TARC commits to purchase, at a later date, the cargo at an agreed price plus
commission and costs. TARC also places margin deposits with the third party to
permit the third party to hedge its price risk. TARC purchases these cargos in
quantities sufficient to maintain expected operations and is obligated to
purchase all of the cargos delivered pursuant to these arrangements. These
arrangements are accounted for as product financing arrangements and accordingly
the inventory and related obligations are recognized on TARC's balance sheet.
In the event the refinery is not operating, these cargos may be sold on the spot
market. During the six months ended July 31, 1996, approximately 1.1 million
barrels of feedstocks with a cost of $23 million were sold by a third party on
the spot market prior to delivery to TARC without a material gain or loss to
TARC.
In March 1996, TARC entered into a processing agreement with a third party
for the processing of various feedstocks at the refinery. Under the terms of
the agreement, the processing fee earned by TARC 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. This agreement provides for TARC to
process approximately 1.1 million barrels of feedstock. For the six months
ended July 31, 1996, TARC incurred a loss of approximately $1.9 million
related to this processing agreement primarily as a result of price management
decisions.
In April 1996, TARC entered into a similar processing agreement with
another third party to process feedstocks. As of July 31, 1996, TARC had
completed processing approximately 4.3 million barrels of the feedstocks and is
storing approximately 1.1 million barrels of intermediate and refined products
under this agreement. Upon sale of these barrels, TARC and the third party will
complete a settlement of the agreement. As of July 31, 1996, TARC has recorded
a loss of approximately $1.4 million related to this processing agreement.
In July and September 1996, TARC entered into processing agreements with
a third party to process approximately 0.5 million barrels of feedstocks for a
fixed price per barrel. Under the terms of the agreement, TARC is responsible
for only certain quantity and quality yields.
GAS SALES COMMITMENTS
In February 1990, TransAmerican amended a long-term gas sales contract,
whereby TransAmerican potentially increased the price to be received for future
sales under the amended contract. In consideration, TransAmerican agreed to
pay the buyer approximately $0.4 million per month through June 1997. This
commitment was assumed by TransTexas.
TransTexas and PanEnergy Trading and Market Service, Inc. entered into a
long-term firm gas purchase contract on August 31, 1994 under which TransTexas
will deliver 100,000 MMBtu of natural gas per day through August 1997. The
selling price for this gas is determined by certain industry averages as
defined in the contract.
14
<PAGE> 16
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
TransTexas and MidCon Texas Pipeline Corp. entered into a long-term gas
purchase contract on January 10, 1996, under which TransTexas is required to
deliver a total of 100,000 MMBtu per day to four specified delivery points for
a period of five years. The purchase price is determined by an industry index
less $0.09 per MMBtu. Deliveries commenced September 1, 1996.
PRODUCTION PAYMENTS
On February 28, 1995, TransTexas sold to TCW Portfolio No. 1555
Sub-Custody Partnership, L.P. ("TCW"), a term royalty in the form of a
dollar-denominated production payment in certain of TransTexas' properties for
proceeds of $49.5 million, less closing costs of approximately $2 million.
This production payment was terminated in May 1996 with a portion of the
proceeds of the volumetric production payment described below.
In January 1996, TransTexas sold to an unaffiliated third party a term
royalty interest in the form of a volumetric production payment on certain of
its producing properties. For net proceeds of approximately $33 million,
TransTexas conveyed to the third party a royalty on approximately 29 Bcf of
natural gas, which amount can increase if certain minimum monthly volumes are
not delivered to the production payment interest. In February 1996, TransTexas
and the third party amended this purchase agreement to include an additional 14
Bcf which were sold to the third party for a purchase price of approximately
$16 million.
In May 1996, TransTexas sold to an unaffiliated third party an additional
term royalty interest in the form of a volumetric production payment on certain
of TransTexas' producing properties. For net proceeds of approximately $43
million, TransTexas conveyed to the third party a royalty on approximately 37
Bcf of natural gas, which amount can increase if certain minimum monthly volumes
are not delivered to the production payment interest. TransTexas used
approximately $25 million of these net proceeds to terminate the
dollar-denominated production payment described above.
In September 1996, TransTexas sold to an unaffiliated third party a term
royalty in the form of a dollar-denominated production payment in certain of
the Company's properties for proceeds of $13.5 million. The production payment
calls for the repayment of the primary sum plus an amount equivalent to a 16.0%
annual interest rate on the unpaid portion of such primary sum.
HEDGING AGREEMENTS
Beginning in April 1995, TransTexas entered into commodity price swap
agreements (the "Hedge Agreements") to reduce its exposure to price risk in the
spot market for natural gas. Pursuant to the Hedge Agreements, either
TransTexas or the counterparty thereto is required to make a payment to the
other at the end of each month (the "Settlement Date"). The payments will equal
the product of a notional quantity ("Base Quantity") of natural gas and the
difference between a specified fixed price ("Fixed Price") and a market price
("Floating Price") for natural gas. The Floating Price is determined by
reference to natural gas futures contracts traded on the New York Mercantile
Exchange ("NYMEX"). The Hedge Agreements provide for TransTexas to make
payments to the counterparty to the extent that the Floating Price exceeds the
Fixed Price, and for the counterparty to make payments to TransTexas to the
extent that the Floating Price is less than the Fixed Price. For the three and
six months ended July 31, 1996, TransTexas incurred net settlement losses
pursuant to the Hedge Agreements totaling approximately $8.9 million and $18.5
million, respectively. As of July 31, 1996, TransTexas has Hedge Agreements
with Settlement Dates ranging from August 1996 through April 1997 involving
total Base Quantities for all monthly periods of approximately 54.6 TBtu of
natural gas. Fixed Prices for these agreements range from $1.70 to $1.72 per
MMBtu ($1.76 to $1.78 per Mcf). Floating Prices may not exceed a maximum
("Maximum Floating Price") of $2.20 per MMBtu ($2.28 per Mcf). At July 31,
1996, the estimated cost to settle these Hedge Agreements would have been
approximately $24.1 million. These agreements are accounted for as hedges and
accordingly, any gains or losses are deferred and recognized in the month the
physical volumes are delivered. At July 31, 1996, TransTexas maintained $11.1
million in margin accounts related to the Hedge Agreements. TransTexas may be
required to post additional cash margin whenever the daily natural gas futures
prices as reported on the NYMEX, for each of the months in which the swap
agreements are in place, exceed the Fixed Price. The maximum margin call under
each Hedge Agreement will never exceed the product of the Base Quantity for the
remaining months under such Hedge Agreement
15
<PAGE> 17
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
multiplied by the difference between the Maximum Floating Price and the Fixed
Price.
In June 1996, TransTexas entered into a Master Swap Agreement (the "Master
Swap Agreement") with one of its swap counterparties, which replaced a
previously existing master agreement governing the swaps between the two
parties. TransTexas' obligations under the Master Swap Agreement are
collateralized by a mortgage on a substantial portion of TransTexas' producing
properties. In accordance with the TransTexas Indenture, the lien created by
the mortgage collateralizes obligations up to a maximum of $80.8 million (10% of
the SEC PV10 of TransTexas' most recent reserve report). As contemplated by the
TransTexas Indenture, the Trustee under the TransTexas Indenture has
subordinated the lien collateralizing the TransTexas Notes outstanding
thereunder to the lien collateralizing TransTexas' obligations under the Master
swap agreement. The maximum amount of obligations of TransTexas that could be
collateralized by the mortgage, based on the swaps in place under the Master
Swap Agreement as of September 10, 1996, is approximately $7.5 million. Subject
to compliance with certain collateral coverage tests, TransTexas is not required
to provide additional cash margin for any swaps now or hereafter subject to the
Master Swap Agreement.
LETTER OF CREDIT
In January 1996, TransTexas entered into a reimbursement agreement with an
unaffiliated third party pursuant to which the third party caused a $20 million
letter of credit to be issued to collateralize a supersedeas bond on behalf of
TransTexas in a legal proceeding. Prior to this transaction, the supersedeas
bond had been collateralized by other letters of credit. These letters of
credit were collateralized by $20 million in cash, which was released to
TransTexas. If there is a draw under the letter of credit, TransTexas is
required to reimburse the third party within 60 days. TransTexas has agreed to
issue up to 8.6 million shares of common stock of TransTexas to the third party
if this contingent obligation to such third party becomes fixed and remains
unpaid for 60 days. TransTexas does not believe that this contingency will
occur. If the obligation becomes fixed, and alternative sources of capital are
not available, TransTexas could elect to sell shares of TransTexas' common
stock prior to the maturity of the obligation and use the proceeds of such sale
to repay the third party.
POSSIBLE FEDERAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions of the Internal Revenue Code of 1986, as amended ("COD
Exclusion"). TransAmerican expects that its tax attributes (including its net
operating loss and credit carryforwards) will be substantially reduced as a
consequence of the COD Exclusion. Although TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness, due to factual and
legal uncertainties there can be no assurance that the IRS will not challenge
this position, or that TransTexas' position would be upheld. Under an agreement
between TransTexas, TARC, TransAmerican and certain of TransAmerican's
subsidiaries (the "Tax Allocation Agreement"), TransTexas has agreed to pay an
amount equal to any federal tax liability (which would be approximately $25.4
million) attributable to the inapplicability of the COD Exclusion. Pursuant to
the Tax Allocation Agreement, any such tax would be offset in future years by
alternative minimum tax credits and retained loss and credit carryforwards to
the extent recoverable from TransAmerican.
POTENTIAL EFFECTS OF A CHANGE OF CONTROL
The TransTexas Indenture provides that, upon the occurrence of a Change of
Control (as such term is defined in the TransTexas Indenture), each holder of
the TransTexas Notes will have the right to require TransTexas to repurchase
such holder's TransTexas Notes at 101% of the principal amount thereof plus
accrued and unpaid interest. A Change of Control would be deemed to occur
under the TransTexas Indenture in the case of certain changes or other events
in respect of the ownership or control of TransTexas, including any
circumstance pursuant to which any person or group, other than John R. Stanley
and his wholly-owned subsidiaries or the trustee under the TARC Indenture is
or becomes the beneficial
16
<PAGE> 18
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
owner of more than 50% of the total voting power of TransTexas' then
outstanding voting stock, unless the TransTexas Notes have an investment grade
rating for the period of 120 days thereafter. The term "person," as used in
the definition of Change of Control, means a natural person, company,
government or political subdivision, agency or instrumentality of a government
and also includes a "group," which is defined as two or more persons acting as
a partnership, limited partnership or other group. In addition, certain
changes or other events in respect of the ownership or control of TransTexas
that do not constitute a Change of Control under the TransTexas Indenture may
result in a "change of control" of TransTexas under the terms of TransTexas'
credit facility (the "BNY Facility") and certain equipment financing. Such an
occurrence could create an obligation for TransTexas to repay such other
indebtedness. At July 31, 1996, TransTexas had approximately $16.5 million of
indebtedness (excluding the TransTexas Notes) subject to such right of
repayment or repurchase. In the event of a Change of Control under the
TransTexas Indenture or a "change of control" under the terms of other
outstanding indebtedness, there can be no assurance that TransTexas will have
sufficient funds to satisfy any such payment obligations.
In February 1995, TARC issued the TARC Notes that were initially
collateralized by, among other things, 55 million shares of TransTexas' common
stock. In March 1996, TARC sold 4.55 million shares of TransTexas common stock
to provide additional financing for the Capital Improvement Program. TARC will
require additional financing of $374 million to $379 million to complete the
Capital Improvement Program. If this financing is not available in the near
future, or if significant engineering problems, work stoppages, personnel
shortages or cost overruns occur, TARC likely will not be able to complete and
test the first phase of the Capital Improvement Program by February 15, 1997.
If required financing is obtained on a timely basis, completion by February 15,
1997 will still prove very difficult. TARC has identified and is considering
certain steps to optimize construction completion, including the retention of
field supervisors, direct hiring of field supervisors and field labor by TARC's
major contractors, adding additional shifts, and modularization and outsourcing
of certain construction items. Under the TARC Indenture, the failure of TARC to
complete and test Phase I by February 15, 1997 would constitute an Event of
Default at such date. Such date, however, may be extended, without an Event of
Default, to May 15, 1997 or further extended to August 15, 1997 if TARC's fixed
charge coverage ratio is 1.25 to 1 for the three month periods ended December
31, 1996 and March 31 1997, respectively. Any such Event of Default could
result in the sale, following the occurrence of such Event of Default, of some
or all of the remaining 50.45 million shares of TransTexas common stock pledged
to collateralize the TARC Notes. A foreclosure on such shares would constitute
a "change of control" of TransTexas under the BNY Facility, which may create an
obligation for TransTexas to repay amounts outstanding thereunder, but would not
constitute a Change of Control under the TransTexas Indenture. A sale of such
shares following a foreclosure could result in a Change of Control under the
TransTexas Indenture.
3. INVENTORIES AND OTHER CURRENT ASSETS
The major components of inventories are as follows (in thousands of
dollars):
<TABLE>
<CAPTION>
July 31, January 31,
1996 1996
---------- -----------
<S> <C> <C>
Refinery feedstocks and blendstocks $ 7 $ 628
Intermediate and refined products 16 1,294
Purchase commitments--refinery feedstocks and blendstocks 12,003 3,767
Purchase commitments--intermediate and refined products -- 31,542
Tubular goods and other 16,999 11,421
--------- ---------
$ 29,025 $ 48,652
========= =========
</TABLE>
The major components of other current assets are as follows (in thousands
of dollars):
<TABLE>
July 31, January 31,
1996 1996
--------- -----------
<S> <C> <C>
Prepayments:
Trade $ 4,053 $ 2,394
Drilling 1,316 2,070
</TABLE>
17
<PAGE> 19
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
<TABLE>
<S> <C> <C>
Insurance 3,636 2,457
Margin 45 4,452
Properties held for sale -- 6,000
Restricted cash -- 7,368
Settlement values of commodity price swap agreements 27,215 31,317
Other 313 242
--------- ----------
$ 36,578 $ 56,300
========= ==========
</TABLE>
4. ACCRUED LIABILITIES
The major components of accrued liabilities are as follows (in thousands
of dollars):
<TABLE>
<CAPTION>
July 31, January 31,
1996 1996
--------- -----------
<S> <C> <C>
Royalties $ 11,732 $ 9,793
Taxes other than income taxes 12,897 3,054
Accrued interest 19,364 19,365
Payroll 5,387 6,153
Litigation settlements 1,065 9,553
Settlement values of commodity price swap agreements 27,215 31,317
Insurance 3,618 1,628
Property sales price adjustment 6,935 --
Maintenance turnarounds 1,527 1,145
Other 7,351 7,308
--------- ---------
$ 97,091 $ 89,316
========= =========
</TABLE>
5. SUMMARY FINANCIAL INFORMATION
The following summary financial information of TransTexas Transmission
Corporation ("TTC"), a wholly-owned subsidiary of TransTexas, reflects its
financial position as of July 31, 1996 and January 31, 1996 and its results of
operations for the three and six months ended July 31, 1996 and 1995 (in
thousands of dollars):
<TABLE>
<CAPTION>
July 31, January 31,
1996 1996
---------- ------------
ASSETS
<S> <C> <C>
Total current assets $ 9,622 $ 811
Property and equipment, net 75,737 70,273
Other assets 3 3
--------- ----------
$ 85,362 $ 71,087
========= ==========
LIABILITIES AND EQUITY
Total current liabilities $ 7,207 $ 6,191
Total noncurrent liabilities 29,393 21,016
Total equity 48,762 43,880
--------- ----------
$ 85,362 $ 71,087
========= ==========
</TABLE>
18
<PAGE> 20
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- -----------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 22,448 $ 22,098 $ 53,601 $ 44,808
Operating costs and expenses 22,111 18,730 46,090 36,711
--------- --------- --------- ---------
Operating income 337 3,368 7,511 8,097
Other income (expense) -- -- -- (47)
--------- --------- --------- ---------
Income before income taxes 337 3,368 7,511 8,050
Income taxes 118 1,179 2,629 2,818
--------- --------- --------- ---------
Net income $ 219 $ 2,189 $ 4,882 $ 5,232
========= ========= ========= =========
</TABLE>
Operating expenses for the three and six months ended July 31, 1996
increased by approximately $3.4 million and $9.4 million, respectively, from
the comparable prior year periods primarily due to increases in the spot market
price of natural gas, which resulted in increases in natural gas liquids
("NGLs") and compressor fuel costs. Revenues for the six months ended July
31, 1996 include a gain of approximately $7.5 million on the sale of
TransTexas' interest in the MidCon Texas pipeline and net gains on the
disposition of other equipment.
TTC conducts significant intercompany activities with TransTexas Gas
Corporation and TransAmerican. Included in the results of operations of TTC are
the following transactions with affiliates (in thousands of dollars).
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- ------------------------
1996 1995 1996 1995
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues $ 6,711 $ 8,282 $ 13,297 $ 16,812
Operating costs and expenses 16,556 13,787 34,705 27,484
</TABLE>
Affiliated operating costs and expenses for the three months ended July 31,
1996 and 1995 include the cost of natural gas purchased from TransTexas Gas
Corporation of approximately $11 million and $9 million, respectively.
Nonaffiliated revenues include the sales of natural gas liquids and condensate
extracted from this purchased gas totaling $13 million for each of the
respective periods.
Affiliated operating costs and expenses for the six months ended July 31,
1996 and 1995 include the cost of natural gas purchased from TransTexas Gas
Corporation of approximately $23 million and $19 million, respectively.
Nonaffiliated revenues for the respective periods include the sales of natural
gas liquids and condensate extracted from this purchased gas of $27 million and
$26 million.
6. INCOME TAXES
Total income tax expense (benefit) differs from amounts computed by
applying the statutory federal income tax rate to income (loss) before income
taxes. The items accounting for this difference are as follows (in thousands of
dollars):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- -------------------------
1996 1995 1996 1995
---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Federal income tax expense (benefit)
at the statutory rate $ 22,607 $ (30,103) $ 39,588 $ (34,777)
Increase (decrease) in tax resulting from:
Tight sands credit (7,437) 7,842 (7,437) 7,842
Net operating losses (utilized) not utilizable (9,008) 19,160 (24,363) 23,160
Other -- (2,593) -- --
--------- --------- --------- ---------
$ 6,162 $ (5,694) $ 7,788 $ (3,775)
========= ========= ========= =========
</TABLE>
19
<PAGE> 21
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
Total income tax expense for the three and six months ended July 31, 1995
includes the tax benefit of the extraordinary item of $1,491. Due to taxable
income related to litigation settlements and asset sales, TransTexas'
valuation allowance was reversed in the quarter ended July 31, 1996. TransTexas'
current tax portion payable to TransAmerican totaled approximately $12 million
at July 31, 1996.
DECONSOLIDATION
The Company and TARC currently own approximately 54% and 14%,
respectively, of the outstanding common stock of TransTexas. These shares are
pledged as collateral for TARC's outstanding debt securities. TransDakota Oil
Corporation ("TDOC"), another subsidiary of TransAmerican, owns 5% of the
outstanding common stock of TransTexas, which is pledged as collateral for
TDOC's debt securities. TDOC intends to transfer such stock to TransAmerican
in September 1996, in connection with the repayment of such debt securities.
TransAmerican intends to transfer such stock to TransAmerican Exploration
Corporation ("TAEC"), a wholly-owned subsidiary of TransAmerican. TAEC intends
to pledge such stock as collateral for debt securities to be issued by TAEC.
Under certain circumstances, TransAmerican, TAEC, TDOC, TARC or the Company
may sell or otherwise dispose of shares of common stock of TransTexas. If, as a
result of any sale or other disposition of TransTexas' common stock, the direct
and indirect ownership of TransTexas by TransAmerican is less than 80% (measured
by voting power and value), TransTexas will no longer be a member of
TransAmerican's consolidated group for federal tax purposes (the "TransAmerican
Consolidated Group") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement ("Deconsolidation"). Further, if the Company or TARC sells
or otherwise transfers any stock of TARC, or issues any options, warrants or
other similar rights relating to such stock, outside of the TransAmerican
Consolidated Group, then a Deconsolidation of both TARC and TransTexas from the
TransAmerican Consolidated Group would occur. For the taxable year during which
Deconsolidation of TransTexas occurs, which would also be the final year that
TransTexas is a member of the TransAmerican Consolidated Group, TransAmerican
would recognize a previously deferred gain of approximately $266.3 million
associated with the Transfer and would be required to pay federal income tax on
this gain (the tax is estimated to be between $29 million and $56 million if
Deconsolidation occurs in fiscal 1997 and between $24 million and $45 million if
Deconsolidation occurs in fiscal 1998). This analysis is based on TransTexas'
position that the gain from the Transfer, which occurred in 1993, was deferred
under the consolidated return regulations. The deferred gain generally is being
included in TransAmerican's taxable income in a manner that corresponds (as to
timing and amount) with the realization by TransTexas of (and, thus, will be
offset by) the tax benefits (i.e., additional depreciation, depletion and
amortization on, or reduced gain or increased loss from a sale of, the
transferred assets) arising from the additional basis. If, under the terms of
the TARC Notes, it was reasonably certain when the TARC Notes were issued that a
sufficient amount of TransTexas' stock would be disposed in the future to cause
a Deconsolidation of TransTexas from the TransAmerican Consolidated Group, it is
possible that the Deconsolidation of TransTexas would be treated as occurring as
of the date the TARC Notes were issued. However, TARC has advised the Company
that it believes that when the TARC Notes were issued it was not reasonably
certain that a Deconsolidation of TransTexas would occur in the future. Under
the Tax Allocation Agreement, TransTexas is required to pay TransAmerican each
year an amount equal to the lesser of (i) the reduction in taxes paid by
TransTexas for such year as a result of any increase in the tax basis of assets
acquired by TransTexas from TransAmerican that is attributable to the Transfer
and (ii) the increase in taxes paid by TransAmerican for such year and all prior
years attributable to gain recognized by TransAmerican in connection with the
contribution of assets by TransAmerican to TransTexas (less certain amounts paid
by TransTexas for all prior years). TransTexas estimates that if
Deconsolidation occurs in fiscal 1997 or 1998, the amount reimbursed to
TransAmerican would be between $15 million and $26 million and between $4
million
20
<PAGE> 22
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
and $7 million, respectively. The remaining amount of the tax relating to the
gain would be paid to TransAmerican over the lives of the assets transferred.
However, TransTexas could be liable for additional taxes pursuant to the
Tax Allocation Agreement and the several liability provisions of federal tax
law.
Generally, under the Tax Allocation Agreement, if net operating losses of
TransTexas are used by other members of the TransAmerican Consolidated Group,
then TransTexas is entitled to the benefit (through reduced current tax
payable) of such losses in later years to the extent TransTexas has taxable
income, remains a member of the TransAmerican Consolidated Group, and the other
group members have the ability to pay such taxes. If TAEC, TARC, TDOC,
TransAmerican or the Company transfers shares of TransTexas (or transfers
options or other rights to acquire such shares) and, as a result of such
transfer, Deconsolidation of TransTexas occurs, TransTexas would not
thereafter receive any benefit pursuant to the Tax Allocation Agreement for
net operating losses of TransTexas used by other members of the TransAmerican
Consolidated Group prior to the Deconsolidation of TransTexas.
Each member of a consolidated group filing a consolidated federal income
tax return is severally liable to the Internal Revenue Service (the "IRS") for
the consolidated federal income tax liability of the consolidated group. There
can be no assurance that TransAmerican will have the ability to satisfy the
above tax obligation at the time due and, therefore, TransTexas, TARC or the
Company may be required to pay the tax.
Under the Tax Allocation Agreement, TransTexas will be required to pay any
Texas franchise tax (which is estimated not to exceed $10.6 million) which may
be attributable to any gain recognized by TransAmerican on the Transfer and
will be entitled to any benefits of the additional basis resulting from the
recognition of such gain.
7. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
The following information reflects the Company's noncash investing and
financing activities (in thousands of dollars):
<TABLE>
<CAPTION>
Six Months Ended
July 31,
----------------------------
1996 1995
------------ -----------
<S> <C> <C>
Accounts payable for property and equipment $ (18,527) $ 3,491
========== ===========
Contribution of TransTexas stock to TARC $ -- $ 37,176
========== ===========
Interest accretion on TARC Notes capitalized
in property and equipment $ 23,487 $ 9,840
========== ===========
Product financing arrangements $ (24,283) $ 27,671
========== ===========
Forgiveness of advances from TransAmerican $ -- $ 71,170
========== ===========
</TABLE>
8. LITIGATION SETTLEMENTS
TERRY/PENROD. TransAmerican and a group of TransAmerican's former bank lenders
(the "Bank Group") were parties to a consolidated suit filed December 6, 1991,
in the United States District Court for the Southern District of Texas, Houston
Division, relating to the interpretation of two third-party drilling agreements.
Plaintiffs Ensco Offshore Company, f/k/a Penrod Drilling Corporation, Terry
Oilfield Supply Co., Inc. and Terry Resources, Inc. ("Terry") sued TransAmerican
for approximately $50 million in actual damages and punitive damages of not less
than five times actual damages. On
21
<PAGE> 23
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
April 5, 1996, the court entered a final judgment against TransAmerican,
TransTexas and several of their affiliates, in the amount of approximately $43
million, plus interest. On April 18, 1996, the court entered a separate
judgment against the same parties for Terry's attorneys' fees of $2 million.
In May 1996, TransTexas paid Terry approximately $19 million and caused
escrowed funds held for the benefit of the Bank Group of approximately $22
million to be paid to Terry. Upon payment of the settlement amount, Terry
released the judgments, released all liens and reassigned to TransTexas a
production payment in certain properties. Terry dismissed an unrelated
administrative proceeding upon payment of the settlement amount described
above.
FRITO-LAY. On June 24, 1993, Frito-Lay, Inc. ("Frito-Lay") filed suit against
TransAmerican and TARC in the Supreme Court of the State of New York, County of
New York, alleging that TransAmerican and TARC failed to make indemnification
payments to Frito-Lay in the amounts and at the times required under the tax
benefit transfer sale-leaseback agreements executed by TransAmerican and
Frito-Lay in November and December 1981 relating to equipment located at TARC's
refinery. TARC assumed the obligations of TransAmerican under these
sale-leaseback agreements when the refinery was transferred to TARC in 1987.
Frito-Lay sought actual damages of not less than $7 million. In the Transfer,
TransTexas assumed certain liabilities for this matter subject to certain
indemnifications. On December 13, 1995, this suit was settled and dismissed
with prejudice. The liabilities will be allocated among TransTexas, TARC and
TransAmerican, in accordance with the Tax Allocation Agreement and other
relevant documents.
GINTHER/WARREN. Wilbur L. Ginther and Howard C. Warren conveyed a portion of
a lease to Henry J.N. Taub. Taub "farmed out" certain interests to
TransAmerican, and TransAmerican paid royalties to Taub. The Texas Supreme
Court upheld a judgment in favor of Messrs. Ginther and Warren against Taub's
interest in the lease. The lower court judgment had awarded a portion of the
lease to Messrs. Ginther and Warren because Taub's attorney had defrauded
Messrs. Ginther and Warren with respect to their interest in the lease. On
November 26, 1986, the estates of Messrs. Ginther and Warren filed an adversary
proceeding in the United States Bankruptcy Court for the Southern District of
Texas, Houston Division (the "Bankruptcy Court") against TransAmerican seeking
damages and claiming that TransAmerican had constructive notice of their
disputes but continued to pay royalties and proceeds of production to Taub.
TransAmerican filed an interpleader action in the Bankruptcy Court and
deposited the disputed funds accruing from and after November 1984 into the
registry of the court. On September 30, 1993, the Bankruptcy Court entered a
judgment against TransAmerican in the amount of $6.3 million plus post judgment
interest. On September 15, 1995, the U.S. District Court for the Southern
District of Texas entered an order reversing an award of interest to Taub and
affirming the final judgment in all other respects. TransTexas appealed the
judgment to the Fifth Circuit Court of Appeals. On July 2, 1996, TransTexas
and the estates of Messrs. Ginther and Warren entered into a settlement
pursuant to which such estates received $3.5 million and a promissory note for
$2.8 million. The promissory note is payable in 36 equal monthly installments
commencing August 1, 1996, and bears no interest unless an installment payment
is not made. In addition, TransTexas transferred to such estates an additional
overriding royalty interest in a portion of the lease and agreed to drill
additional wells on the lease. In conjunction with the settlement, the estates
of Messrs. Ginther and Warren agreed to farm out to TransTexas an additional
working interest in the lease.
WEST. On July 17, 1996, Milton H. West, III d/b/a West Energy Company ("West")
filed suit in the 333rd Judicial District Court of Harris County, Texas, against
TransTexas for $30 million, asserting TransTexas obtained its right to the
settlement proceeds received by it in the Tennessee lawsuit from ICA Energy,
Inc. ("ICA"). West alleges that it had a prior contract with ICA pursuant to
which West is entitled to a percentage of such proceeds. This lawsuit has now
been non-suited, and West is seeking damages from ICA only.
9. CREDIT AGREEMENTS
TransTexas and BNY Financial Corporation entered into an Amended and
Restated Accounts Receivable Management and Security Agreement, as of October
31, 1995, for a $40 million line of credit. The line of credit is
collateralized by accounts receivable and inventory of TransTexas and is
guaranteed by John R. Stanley. The amounts which may be advanced to TransTexas
under this line of credit are based on a percentage of TransTexas' natural gas
receivables from unaffiliated third parties. The amount outstanding under the
line of credit as of July 31, 1996 was $7.9 million. Based upon foreseeable
accounts receivable levels, TransTexas estimates the maximum amount available
at any one time under this facility will be approximately $26 million.
Under the terms of this agreement, TransTexas' net loss (including any
extraordinary losses) may not exceed $5 million for each fiscal quarter ending
after January 31, 1996 ($10 million for each six-month period). This line of
credit
22
<PAGE> 24
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
is also subject to certain other covenants which relate to, among other things,
the maintenance of certain financial ratios.
In May 1996, TransTexas entered into a Note Purchase Agreement pursuant to
which TransTexas issued notes in the aggregate principal amount of $15.75
million, for aggregate proceeds of $15 million. The notes, which bore interest
at 13 1/3% per annum, were paid in full in July 1996. The notes were
guaranteed on a senior secured basis by TransAmerican.
10. TRANSACTIONS WITH AFFILIATES
During 1995, TransAmerican acquired an office building which it renovated
and subsequently sold to TransTexas in February 1996. TransAmerican advanced
$4 million of the proceeds from this sale to TARC for working capital, a
portion of which has been repaid. TARC leases office space from TransTexas
on terms and conditions permitted by the TARC Indenture.
TransAmerican and its affiliates, including TransTexas, have provided TARC
with substantially all of its corporate services requirements, including
insurance, legal, accounting and treasury functions pursuant to a services
agreement (the "Services Agreement"). During each of the three months ended
July 31, 1996 and 1995, TransAmerican and TransTexas charged TARC approximately
$0.1 million to cover its costs of providing these services, which management
believes to be reasonable based on the limited services provided. TARC expects
its general and administrative expenses to increase significantly when the
refinery commences more complex operations. In addition, third party charges
incurred by TransAmerican and its affiliates have been charged directly or
allocated to TARC on usage or other methods that management believes are
reasonable. All significant transactions with affiliates to the extent unpaid
are recorded in the "Due to Affiliates" account.
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; such administrative costs and fees charged to TARC are $1.2
million per year. Total labor costs paid to Southeast Contractors for the six
months ended July 31, 1996 and 1995 were $4.4 million and $5.9 million,
respectively, of which approximately $0.9 million and $0.6 million were
payable at July 31, 1996 and January 31, 1996, respectively.
In December 1994, TransTexas entered into an interruptible gas sales
agreement with TransAmerican, revenues from which totaled approximately $1.3
million and $7.8 million, respectively, for the three months ended July 31,
1996 and 1995 and $11.7 million and $10.4 million, respectively, for the six
months ended July 31, 1996 and 1995. TransTexas' receivable from TransAmerican
for natural gas sales totaled approximately $11.7 million at July 31, 1996.
Pursuant to this agreement, interest accrues on all unpaid balances at a rate
of prime plus 2% per annum.
TransTexas sells natural gas to TARC under an interruptible long-term
sales contract. Revenues from TARC under this contract totaled approximately
$0.8 million and $1.2 million for the three months ended July 31, 1996 and
1995, respectively and $1.5 million and $1.3 million, respectively, for the six
months ended July 31, 1996 and 1995. TransTexas' receivable from TARC for
natural gas sales totaled approximately $1.4 million at July 31, 1996.
As of January 1996, TransTexas and TransTexas Exploration Corporation, a
wholly-owned subsidiary of TransTexas ("TTEX"), entered into a Drilling Program,
as defined in the TransTexas Indenture. Pursuant to the Program, TTEX received
a portion of revenues, in the form of a production payment, from certain of
TransTexas' wells. The production payment was transferred in consideration of
a note payable in the amount of $23.6 million issued by TTEX. In July 1996,
TTEX transferred this production payment to TransTexas in the form of a
dividend, and TransTexas forgave the $13.2 million remaining balance of the
note payable.
23
<PAGE> 25
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(Unaudited)
In July 1996, TTEX loaned $9.5 million to TransAmerican pursuant to the
terms of a $25 million promissory note due July 31, 1998 that bears interest,
payable quarterly, at 15% per annum. TTEX has made further advances pursuant
to the note, subject to the same terms. The amount outstanding under this
promissory note totaled approximately $24 million at September 10, 1996.
TransTexas believes that the advances by TTEX to TransAmerican reduce the risk
of tax deconsolidation (and potential tax liability of TransTexas) that could
be caused by the sale of TransTexas shares by TransAmerican or its affiliates.
Pursuant to the terms of the Transfer Agreement, TransAmerican has
indemnified TransTexas for substantially all of TransTexas' liability in
connection with the settlement of the Terry/Penrod litigation (See Note 8). In
order to facilitate the settlement, TransTexas has advanced to TransAmerican
$16.4 million of the settlement in exchange for a note receivable. In
connection with the litigation settlement, TransTexas received from Terry, the
reversionary interest in certain producing properties. TransTexas and
TransAmerican had intended that such interests would revert to TransAmerican
under the Transfer Agreement. TransTexas retained such interests in partial
satisfaction of TransAmerican's indemnity obligations. TransTexas' receivable
from TransAmerican related to this settlement totaled approximately $7 million
at July 31, 1996.
In September 1996, TransTexas intends to purchase from TDOC for
approximately $20 million certain oil and gas leasehold interests located in
the Lodgepole area of North Dakota. TransTexas believes that the combination of
its interests in the Lodgepole area with the interests of TDOC will produce a
more marketable property package.
In July 1996, TARC executed a promissory note to TransAmerican for up to
$25 million. The note bears an interest rate of 15% per annum payable
quarterly, beginning October 31, 1996 with principal due July 31, 1998. As of
July 31, 1996, TARC had drawn $2.5 million against the note. Also in July 1996,
TransAmerican advanced $4.3 million to TARC. This advance has now been included
as borrowings under the note. At August 31, 1996, TARC had $19.9 million
outstanding under the note.
TransTexas also provides accounting and legal services to the Company and
drilling and workover, administrative and procurement, accounting, legal, lease
operating, and gas marketing services to TransAmerican pursuant to the Services
Agreement. TransTexas provides general commercial legal services and certain
accounting services (including payroll, tax, and treasury services) to TARC
and the Company for a fee of $26,000 per month. At TransAmerican's request,
TransTexas, at its election, may provide drilling and workover services. The
receivable from TransAmerican for drilling, workover and administrative
services totaled approximately $12 million at July 31, 1996.
TransTexas made certain of its advances, described above, in anticipation
of production from wells drilled by TransAmerican providing a source of
repayment of such advances. In such regard, TransTexas anticipates obtaining a
$11.5 million dollar-denominated production payment, bearing interest at 17% per
annum, burdening certain oil and gas interests owned by TransAmerican. At July
31, 1996, $12 million of remaining related-party receivables has been recorded
as a contra-stockholder equity account due to uncertainties regarding the terms
and payment schedule for such receivables.
24
<PAGE> 26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
TransTexas conducts its operations through two industry segments:
exploration and production ("E&P"), and gas transportation ("Transportation").
The E&P segment explores for, develops, produces and markets natural gas,
condensate and natural gas liquids. The Transportation segment engages in
intrastate natural gas transportation and marketing. TARC's single business
segment is refining and storage operations ("Refining"). As described in Note
1 to the condensed consolidated financial statements, transactions between
TransTexas and TARC are significantly restricted. The following discussion
should be read in conjunction with the condensed consolidated financial
statements and notes thereto of the Company included elsewhere in this report.
E&P AND TRANSPORTATION
RESULTS OF OPERATIONS
TransTexas' results of operations are dependent upon natural gas
production volumes and unit prices from sales of natural gas, condensate, and
NGLs. The profitability of TransTexas also depends on the volume of natural
gas it gathers and transports, its ability to minimize finding and lifting
costs and maintaining its reserve base while maximizing production.
TransTexas' operating data for the three and six months ended July 31,
1996 and 1995, is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
-------------------- --------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales volumes:
Gas (Bcf) (1) 38.1 35.3 74.3 71.0
NGLs (MMgal) 41.1 51.7 89.3 104.0
Condensate (MBbls) 116 109 280 284
Average prices:
Gas (dry) (per Mcf) (2) $ 1.95 $ 1.47 $ 1.99 $ 1.39
NGLs (per gallon) .31 .25 .31 .25
Condensate (per Bbl) 19.62 20.63 19.86 18.44
Number of gross wells drilled 13 13 58 31
Percentage of wells completed 38% 69% 74% 77%
</TABLE>
- -------------------------------
(1) Sales volumes for the three and six months ended July 31, 1996 include 8.1
Bcf and 14.0 Bcf, respectively, delivered pursuant to a volumetric
production payment.
(2) Average price for the three and six months ended July 31, 1996 includes
amounts delivered under volumetric production payments. The average gas
price for TransTexas' undedicated production for these periods was $2.18
per Mcf and $2.17 per Mcf, respectively. Gas prices do not include the
effect of hedging agreements.
A summary of TransTexas' operating expenses is set forth below (in millions
of dollars):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
--------------------- --------------------
1996 1995 1996 1995
------- ------- ------- --------
<S> <C> <C> <C> <C>
Operating costs and expenses:
Lease $ 6.3 $ 5.4 $ 13.0 $ 9.4
Pipeline 8.1 6.1 16.3 11.4
Natural gas liquids 10.7 9.7 23.2 19.9
------- ------- ------- --------
25.1 21.2 52.5 40.7
Taxes other than income taxes (1) 7.2 3.8 12.4 7.7
------- ------- ------- --------
Total $ 32.3 $ 25.0 $ 64.9 $ 48.4
======= ======= ======= ========
</TABLE>
25
<PAGE> 27
- -------------------------------
(1) Taxes other than income taxes include severance, property, and other
taxes.
TransTexas' average depletion rates have been as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- --------------------
1996 1995 1996 1995
------- -------- -------- --------
<S> <C> <C> <C> <C>
Depletion rates (per Mcfe) $ .94 $ .78 $ .92 $ .77
</TABLE>
TransTexas' Consolidated EBITDA, as defined in the TransTexas Indenture,
which consists of TransTexas' earnings before consolidated fixed charges
(including capitalized interest and the interest component of rent expense
totaling approximately $4.1 million and $0.1 million for the quarters ended
July 31, 1996 and 1995, respectively, and $8.0 million and $1.1 million,
respectively, for the six months ended July 31, 1996 and 1995), income taxes,
depreciation, depletion, and amortization are set forth below (in millions of
dollars):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- --------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Consolidated EBITDA $ 143.1 $ 40.1 $ 204.0 $ 85.4
</TABLE>
THREE MONTHS ENDED JULY 31, 1996, COMPARED WITH THE THREE MONTHS ENDED JULY 31,
1995
Gas, condensate and NGLs revenues for the three months ended July 31, 1996
increased by $9.5 million from the comparable period of the prior year, due
primarily to increases in gas, condensate and NGL sales prices and gas sales
volumes, offset in part by decreases in NGL sales volumes. The average monthly
prices received per Mcf of gas, excluding amounts dedicated to volumetric
production payments, ranged from $2.04 to $2.37 in the three months ended July
31, 1996, compared to a range of $1.35 to $1.51 in the same period in the prior
year. The increase in gas sales volumes is due primarily to increased production
from TransTexas' new development areas, offset in part by the normal decline in
natural gas production from TransTexas' producing properties in the Lobo Trend
along with the sales of certain of TransTexas' producing properties. The
producing properties sold by TransTexas accounted for approximately 3.9 Bcfe of
TransTexas' net production for the quarter ended July 31, 1996. As of July 31,
1996, TransTexas had a total of 861 producing wells compared to 947 at July
31, 1995. NGL sales volumes decreased as a result of decreases in the
volumes of natural gas processed. Transportation revenues remained at
essentially the same levels as the prior year quarter as decreases in
TransTexas' volumes transported were offset by volumes attributable to
volumetric production payments and the sale of certain of TransTexas' producing
properties. TransTexas currently transports a portion of its production from
the Bob West and Bob West North development areas through a third-party
pipeline.
Lease operating expenses for the quarter ended July 31, 1996 increased by
$0.9 million over the comparable prior year period primarily due to the
initiation of a program to increase flow rates on certain of TransTexas' wells
through increases in workovers and the installation of leased wellhead
compressors. Pipeline operating expenses increased by $2.0 million due
primarily to increases in compressor fuel costs and chemicals used in the
operation of TransTexas' amine plants. NGLs cost increased by $1.0 million
from the first quarter in the prior year due to the increase in the cost of
natural gas processed. Depreciation, depletion and amortization expense for
the three months ended July 31, 1996 increased by $2.7 million due to a $0.16
increase in the depletion rate, offset by a decrease in TransTexas' undedicated
natural gas production. General and administrative expenses decreased by $1.3
million in the three months ended July 31, 1996, due primarily to a litigation
accrual of $7.0 million in the prior year quarter, offset in part by a
litigation accrual of $5.0 million in the current year quarter, increases in
wages and benefits and outside services. Taxes other than income taxes
increased by $3.3 million over the prior year quarter due primarily to an
increase in severance taxes, including an accrual of $1.5 million as a result
of a severance tax audit adjustment.
26
<PAGE> 28
Interest income for the three months ended July 31, 1996 decreased by
approximately $0.5 million over the comparable prior year period due to
increased cash balances in the prior year quarter resulting from the issuance
of the TransTexas Notes in June 1995. Interest expense increased by $6.6
million over the same period of the prior year primarily as a result of
interest accrued on the TransTexas Notes, offset in part by the capitalization
of approximately $3.8 million of interest in connection with the acquisition of
certain of TransTexas' gas and oil properties.
SIX MONTHS ENDED JULY 31, 1996, COMPARED WITH THE SIX MONTHS ENDED JULY 31,
1995
Gas, condensate and NGL revenues for the six months ended July 31, 1996
increased by $25.4 million from the comparable period of the prior year, due
primarily to increases in gas, condensate and NGL sales prices and gas sales
volumes, partly offset by decreases in NGL sales volumes. The average monthly
prices received per Mcf of gas, excluding amounts dedicated to volumetric
production payments, ranged from $2.02 to $2.45 in the six months ended July 31,
1996, compared to a range of $1.29 to $1.52 in the same period in the prior
year. The increase in gas sales volumes is due primarily to increased
production from TransTexas' new development areas, offset in part by the normal
decline in natural gas production from TransTexas' Lobo Trend wells and the sale
of a portion of TransTexas' producing properties in the Lobo Trend. NGLs sales
volumes decreased as a result of decreases in the volumes of natural gas
processed. Transportation revenues decreased by $0.7 million for the six months
ended July 31, 1996, due primarily to decreases in volumes transported.
Lease operating expenses in the six months ended July 31, 1996 increased by
$3.6 million from the prior year period due primarily to increases in repairs
and maintenance and workover expense attributable to the increase in the number
of producing wells prior to the sale of certain of TransTexas' producing
properties and the initiation in the first quarter of the current fiscal year of
a program to increase flow rates on certain of TransTexas' wells through
increased workovers and the installation of leased wellhead compressors.
Pipeline operating expenses increased by $4.9 million due primarily to
increases in compressor fuel costs and chemicals used in the operation of
TransTexas' amine plants. NGLs cost increased by $3.3 million from the
comparable period in the prior year due to increases in the cost of natural gas
used in NGL processing, offset by a decrease in volumes of natural gas
processed. Depreciation, depletion and amortization expense for the six months
ended July 31, 1996 increased by $1.9 million due to a $0.15 increase in the
depletion rate offset by the decrease in TransTexas' undedicated natural gas
production. General and administrative expenses increased by $0.5 million in
the six months ended July 31, 1996, due primarily to increases in wages and
benefits. Taxes other than income taxes increased by $4.6 million over the
comparable prior year period due primarily to an increase in severance taxes,
including an accrual of $1.5 million as a result of a severance tax audit
adjustment.
Interest income for the six months ended July 31, 1996 increased by
approximately $0.1 million over the comparable period of the prior year due to
increased average cash balances. Interest expense increased by $13.5 million
primarily as a result of interest accrued on the Notes and the amortization of
debt issue costs, offset in part by the capitalization of approximately $7.5
million of interest in connection with the acquisition of TransTexas'
unevaluated gas and oil properties.
Cash flow from operating activities for the six months ended July 31, 1996
increased by approximately $121.3 million from the prior-year period due
primarily to cash received in the settlement of take-or-pay litigation and
proceeds from the sale of volumetric production payments.
Cash used in investing activities decreased by $134.8 million due to
decreases in lease acquisitions, along with proceeds from the sale of certain
of TransTexas' producing properties, offset in part by advances to affiliates.
Cash flow from financing activities decreased by approximately $307.5
million due primarily to the issuance of the TransTexas Notes in June 1995.
LIQUIDITY AND CAPITAL RESOURCES
A primary source of funds to meet TransTexas' capital and debt service
requirements is net cash flow provided by operating activities, which is
dependent on the prices TransTexas receives for the volumes of natural gas
TransTexas produces. TransTexas has entered into hedge agreements to reduce a
portion of its exposure to natural gas prices. See Note 2 of Notes to Condensed
Consolidated Financial Statements included elsewhere herein.
27
<PAGE> 29
TransTexas makes substantial capital expenditures for the exploration,
development and production of its natural gas reserves. TransTexas has
financed these expenditures primarily with cash from operations, public
offerings of debt and equity securities, the sale of production payments and
other financings. For the six months ended July 31, 1996, total capital
expenditures were $122 million, including $10 million for lease acquisitions,
$96 million for drilling and development and $16 million for TransTexas' gas
gathering and pipeline system and other equipment. Pursuant to the TransTexas
Indenture, if TransTexas' Working Capital, as defined in the TransTexas
Indenture, is less than $20 million at the end of any fiscal quarter,
TransTexas' Capital Expenditures, as defined, for the next succeeding fiscal
quarter may not exceed 90% of TransTexas's Consolidated EBITDA for such prior
fiscal quarter minus TransTexas' Consolidated Fixed Charges for such prior
fiscal quarter (the "Capital Expenditure Limit"). TransTexas' Working Capital
at April 30, 1996 was less than $20 million. As a result, TransTexas' Capital
Expenditures for the quarter ended July 31, 1996 could not exceed the Capital
Expenditure Limit of $31.3 million. TransTexas' Capital Expenditures for the
quarter ended July 31, 1996 totaled $30.1 million. TransTexas believes that
this restriction did not have a material effect on developmental drilling for
the quarter. TransTexas' Working Capital at July 31, 1996 was $27.2 million.
TransTexas anticipates total capital expenditures of approximately $245
million and $210 million in fiscal 1997 and fiscal 1998, respectively, subject
to TransTexas Indenture requirements and available cash flow, of which
approximately $200 million and $175 million, respectively, will be used for
drilling and development, and $25 million and $20 million, respectively, for
TransTexas' gas gathering and pipeline system (including pipeline expansion into
the La Grulla development area), and other equipment and seismic acquisition.
TransTexas anticipates expenditures of approximately $20 million in both fiscal
years for lease acquisitions. If revenues decrease, certain contingent
obligations of TransTexas become fixed or TransTexas' level of capital
expenditures is limited by the TransTexas Indenture, TransTexas may not have
sufficient funds for, or may be restricted in maintaining the level of, capital
expenditures necessary to replace its reserves or to maintain production at
current levels and, as a result, production may decrease over time. Although
cash from operating activities for the six months ended July 31, 1996 has
increased due to sales of volumetric production payments and litigation
settlements, net cash provided by operating activities declined over the three
and one-half years ended January 31, 1996. No assurance can be given that
TransTexas' cash flow from operating activities and other sources of cash will
be sufficient to meet planned capital expenditures, contingent liabilities and
debt service in the future. Since July 31, 1995, TransTexas has utilized asset
sales and various financings, in addition to cash flow from operating
activities, to meet its working capital requirements. TransTexas anticipates
that it will utilize additional financing or sales of assets, as allowed by the
TransTexas Indenture, to fund planned levels of operations and to meet its
obligations, including its obligations under the TransTexas Indenture, through
January 1997.
In January 1996, TransTexas entered into a reimbursement agreement with an
unaffiliated third party pursuant to which the third party caused a $20 million
letter of credit to be issued to collateralize a supersedeas bond on behalf of
TransTexas in a legal proceeding. Prior to this transaction, the supersedeas
bond had been collateralized by other letters of credit. These letters of
credit were collateralized by $20 million in cash, which was released to
TransTexas. If there is a draw under the letter of credit, TransTexas is
required to reimburse the third party within 60 days.
In January and February 1996, TransTexas completed both a financing and a
sale-leaseback transaction, each in the amount of $3 million, related to its
operating equipment. Both the financing, which has an interest rate of 9% per
annum, and the sale-leaseback transaction, which has a monthly lease payment
of approximately $56,400, have a 36-month term. In February 1996,
TransTexas completed an additional financing collateralized by its operating
equipment in the amount of $10 million at an interest rate of 12% per annum and
a 36-month term.
In January 1996, TransTexas sold to an unaffiliated third party a term
overriding royalty interest in the form of a production payment carved out of
its interests in certain of its producing properties. For net proceeds of
approximately $33 million, TransTexas conveyed to the third party a term
overriding royalty equivalent to a base volume of approximately 29 Bcf of
natural gas, subject to certain increases in the base volume and in the
percentage interest dedicated if certain minimum performance and delivery
requirements are not met. In February 1996, in consideration for additional net
proceeds of approximately $16 million, TransTexas supplemented the production
payment to subject a percentage of its interests in certain additional
producing properties to the production payment and to include additional
volumes of approximately 14 Bcf of natural gas within the base volume subject
to the production payment.
In March 1996, TransTexas sold its 41.67% interest in the 76-mile, 24-inch
MidCon Texas pipeline, which runs from TransTexas' Thompsonville compressor
station to Agua Dulce, for $7.5 million. TransTexas believes that its existing
transportation capacity in this area is adequate for TransTexas' production and
does not anticipate any material constraints on the transportation of its
natural gas as a result of this sale.
28
<PAGE> 30
In May 1996, TransTexas sold to two unaffiliated third parties a
volumetric production payment for net proceeds of approximately $43 million.
TransTexas conveyed to the third parties a term overriding royalty equivalent
to a base volume of approximately 37 Bcf of natural gas, subject to certain
increases in the base volume and in the percentage interest dedicated if
certain minimum performance and delivery requirements are not met. Concurrently
with the closing of that transaction, TransTexas and one of the unaffiliated
third parties terminated, prior to the expiration of its stated term, a
dollar-denominated term overriding royalty interest previously sold by
TransTexas to that unaffiliated third party for a payment by TransTexas of
approximately $25 million. As a result of such termination, the remaining base
volume from the previously sold overriding royalty interest was conveyed to
TransTexas.
In May 1996, TransTexas entered into a Note Purchase Agreement pursuant to
which TransTexas issued notes in the aggregate principal amount of $15.75
million for aggregate proceeds of $15 million. The notes, which bore interest
at 13 1/3% per annum, were paid in full in July 1996. The notes were
guaranteed on a senior secured basis by TransAmerican.
In June 1996, TransTexas entered into an agreement with one of its swap
counter parties as a result of which TransTexas, subject to compliance with
certain collateral coverage tests, will not be required to make cash margin
deposits with respect to the swaps covered by such agreement. See Note 2 to
the accompanying Condensed Consolidated Financial Statements.
In September 1996, TransTexas sold to an unaffiliated third party a term
royalty in the form of a dollar-denominated production payment in certain of
TransTexas' properties for proceeds of $13.5 million. The production payment
calls for the repayment of the primary sum plus an amount equivalent to a 16.0%
annual interest rate on the unpaid portion of such primary sum.
In September 1996, TransTexas entered into an agreement with an
unaffiliated third party for the reimbursement of certain drilling costs with
respect to wells drilled by TransTexas. Pursuant to the agreement, upon the
approval of the third party of a recently drilled or currently drilling well
for inclusion in the program, the third party will commit to the reimbursement
of all or a portion of the cost of such well, up to an aggregate maximum for
all such wells of $16.5 million. The program wells will be subject to a
dollar-denominated production payment equal to the principal amount of such
reimbursed costs, plus an amount equivalent to a 17.5% annual interest rate on
the unpaid portion of such principal amount.
Pursuant to the terms of the Transfer Agreement, TransAmerican has
indemnified TransTexas for substantially all of TransTexas' liability in
connection with the settlement of the Terry/Penrod litigation (see Note 8 to
the accompanying Condensed Consolidated Financial Statements). In order to
facilitate the settlement, TransTexas advanced to TransAmerican $16.4 million
of the settlement in exchange for a note receivable. In connection with the
litigation settlement, TransTexas received from Terry the reversionary
interest in certain producing properties. TransTexas and TransAmerican had
intended that such interests would revert to TransAmerican under the Transfer
Agreement. TransTexas retained such interests in partial satisfaction of
TransAmerican's indemnity obligations.
During 1995, TransAmerican acquired an office building which it renovated
and subsequently sold to TransTexas in February 1996. TransAmerican advanced
$4 million of the proceeds from this sale to TARC for working capital, a
portion of which has been repaid. TARC leases office space from TransTexas
on terms and conditions permitted by the TARC Indenture.
TransAmerican and its affiliates, including TransTexas, have provided TARC
with substantially all of its corporate services requirements, including
insurance, legal, accounting and treasury functions pursuant to a services
agreement (the "Services Agreement"). During each of the three months ended
July 31, 1996 and 1995, TransAmerican and TransTexas charged TARC approximately
$0.1 million to cover its costs of providing these services, which management
believes to be reasonable based on the limited services provided. TARC expects
its general and administrative expenses to increase significantly when the
refinery commences more complex operations. In addition, third party charges
incurred by TransAmerican and its affiliates have been charged directly or
allocated to TARC on usage or other methods that management believes are
reasonable. All significant transactions with affiliates to the extent unpaid
are recorded in the "Due to Affiliates" account.
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; such administrative costs and fees charged to TARC are $1.2
million per year. Total labor costs paid to Southeast Contractors for the six
months ended July 31, 1996 and 1995 were $4.4 million and $5.9 million,
respectively, of which approximately $0.9 million and $0.6 million were
payable at July 31, 1996 and January 31, 1996, respectively.
In December 1994, TransTexas entered into an interruptible gas sales
agreement with TransAmerican, revenues from which totaled approximately $1.3
million and $7.8 million, respectively, for the three months ended July 31,
1996 and 1995 and $11.7 million and $10.4 million, respectively, for the six
months ended July 31, 1996 and 1995. TransTexas' receivable from TransAmerican
for natural gas sales totaled approximately $11.7 million at July 31, 1996.
Pursuant to this agreement, interest accrues on all unpaid balances at a rate
of prime plus 2% per annum.
TransTexas sells natural gas to TARC under an interruptible long-term
sales contract. Revenues from TARC under this contract totaled approximately
$0.8 million and $1.2 million for the three months ended July 31, 1996 and
1995, respectively and $1.5 million and $1.3 million, respectively, for the six
months ended July 31, 1996 and 1995. TransTexas' receivable from TARC for
natural gas sales totaled approximately $1.4 million at July 31, 1996.
As of January 1996, TransTexas and TTEX entered into a Drilling Program,
as defined in the TransTexas Indenture. Pursuant to the Program, TTEX received
a portion of revenues, in the form of a production payment, from certain of
TransTexas' wells. The production payment was transferred in consideration of
a note payable in the amount of $23.6 million issued by TTEX. In July 1996,
TTEX transferred this production payment to TransTexas in the form of a
dividend, and TransTexas forgave the $13.2 million remaining balance of the
note payable.
In July 1996, TTEX loaned $9.5 million to TransAmerican pursuant to the
terms of a $25 million promissory note due July 31, 1998 that bears interest,
payable quarterly, at 15% per annum. TTEX has made further advances pursuant
to the note, subject to the same terms. The amount outstanding under this
promissory note totaled approximately $24 million at September 10, 1996.
TransTexas believes that the advances by TTEX to TransAmerican reduce the risk
of tax deconsolidation (and potential tax liability of TransTexas) that could
be caused by the sale of TransTexas shares by TransAmerican or its affiliates.
Pursuant to the terms of the Transfer Agreement, TransAmerican has
indemnified TransTexas for substantially all of TransTexas' liability in
connection with the settlement of the Terry/Penrod litigation (See Note 8). In
order to facilitate the settlement, TransTexas has advanced to TransAmerican
$16.4 million of the settlement in exchange for a note receivable. In
connection with the litigation settlement, TransTexas received from Terry, the
reversionary interest in certain producing properties. TransTexas and
TransAmerican had intended that such interests would revert to TransAmerican
under the Transfer Agreement. TransTexas retained such interests in partial
satisfaction of TransAmerican's indemnity obligations. TransTexas' receivable
from TransAmerican related to this settlement totaled approximately $7 million
at July 31, 1996.
In September 1996, TransTexas intends to purchase from TDOC for
approximately $20 million certain oil and gas leasehold interests located in
the Lodgepole area of North Dakota. TransTexas believes that the combination of
its interests in the Lodgepole area with the interests of TDOC will produce a
more marketable property package.
In July 1996, TARC executed a promissory note to TransAmerican for up to
$25 million. The note bears an interest rate of 15% per annum payable
quarterly, beginning October 31, 1996 with principal due July 31, 1998. As of
July 31, 1996, TARC had drawn $2.5 million against the note. Also in July 1996,
TransAmerican advanced $4.3 million to TARC. This advance has now been included
as borrowings under the note. At August 31, 1996, TARC had $19.9 million
outstanding under the note.
TransTexas also provides accounting and legal services to the Company and
drilling and workover, administrative and procurement, accounting, legal, lease
operating, and gas marketing services to TransAmerican pursuant to the Services
Agreement. TransTexas provides general commercial legal services and certain
accounting services (including payroll, tax, and treasury services) to TARC
and the Company for a fee of $26,000 per month. At TransAmerican's request,
TransTexas, at its election, may provide drilling and workover services. The
receivable from TransAmerican for drilling, workover and administrative
services totaled approximately $12 million at July 31, 1996.
TransTexas made certain of its advances, described above, in anticipation
of production from wells drilled by TransAmerican providing a source of
repayment of such advances. In such regard, TransTexas anticipates obtaining a
$11.5 million dollar-denominated production payment, bearing interest at 17% per
annum, burdening certain oil and gas interests owned by TransAmerican. At July
31, 1996, $12 million of remaining related-party receivables has been recorded
as a contra-stockholder equity account due to uncertainties regarding the terms
and payment schedule for such receivables.
On July 2, 1996, TransTexas consummated the sale, effective as of May 1,
1996, of producing properties in Zapata County, Texas for consideration of
approximately $62 million. On June 17, and August 13, 1996, TransTexas
consummated the sales, effective as of February 1, 1996, of certain other
producing properties in Webb County, Texas for consideration of approximately
$9.95 million and $21.5 million, respectively. The purchase price for each of
the properties discussed above was or is subject to adjustment for gas sales
between the effective date and the closing date. TransTexas retained or will
retain the proceeds of all such gas sales.
TransTexas has engaged an investment banking firm to assist in the
potential sale or sale-leaseback of all or a portion of TransTexas' pipeline
system. TransTexas has also engaged an investment banking firm to assist in
the sale of its interest in the Lodgepole area. On August 29, 1996, TransTexas
announced that it has engaged two investment banking firms to assist in the
sale of TransTexas' remaining Lobo Trend producing properties in Webb and
Zapata counties, Texas, and associated undeveloped acreage. If such a sale is
consummated, TransTexas intends to use the proceeds of this sale, along with
proceeds from any sales of its pipeline system and Lodgepole area properties,
for general corporate purposes and a possible repurchase of the TransTexas
Notes.
TransTexas currently has a $40 million credit facility with BNY Financial
Corporation (the "BNY Facility") pursuant to which it may borrow funds based on
the amount of its accounts receivable. At July 31, 1996, the outstanding
balance
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under the BNY Facility was $7.9 million. TransTexas does not anticipate that
it will be able to borrow more than $26 million under the BNY Facility during
fiscal 1997, based on the expected amount of its accounts receivable. The BNY
Facility requires TransTexas to maintain certain financial ratios and includes
certain covenants. Under the terms of the BNY Facility, TransTexas' net loss
(including any extraordinary losses) may not exceed $5 million for each fiscal
quarter ending after January 31, 1996 ($10 million for each six-month period).
Pursuant to the TransTexas Indenture, TransTexas maintains an account (the
"Interest Reserve Account") from which funds may only be disbursed in accordance
with the terms of a Cash Collateral and Disbursement Agreement (the
"Disbursement Agreement"). TransTexas has deposited into the Interest Reserve
Account funds sufficient to pay the aggregate amount of the next ensuing
interest payment due in respect of the TransTexas Notes. Funds in the Interest
Reserve Account may be invested, at the direction of TransTexas (except as
provided below), only in cash and Cash Equivalents as defined in the
Disbursement Agreement, and any interest income thereon will be added to the
balance of the Interest Reserve Account. TransTexas must maintain a balance
(the "Requisite Balance") in the Interest Reserve Account at least equal to the
amount necessary to satisfy TransTexas' obligation to pay interest in respect of
all then outstanding TransTexas Notes on the next Interest Payment Date (as
defined); provided, however, that if, pursuant to the Disbursement Agreement,
any funds in the Interest Reserve Account are applied to the payment of interest
on the TransTexas Notes, TransTexas shall not be obligated to maintain the
Requisite Balance during the period of 60 days immediately following the
Interest Payment Date in respect of which such payment was made.
TransTexas may instruct the disbursement agent under the Disbursement
Agreement to deposit with the Indenture Trustee, on any Interest Payment Date,
any or all of the funds in the Interest Reserve Account. The Disbursement
Agreement provides that if TransTexas fails to pay an installment of interest on
the TransTexas Notes on any Interest Payment Date, then all investments in the
Interest Reserve Account will be immediately liquidated and all funds in the
Interest Reserve Account will be deposited with the Indenture Trustee. If
TransTexas has not paid such installment of interest within five days after such
Interest Payment Date, or if TransTexas so instructs the Indenture Trustee, the
Indenture Trustee will apply such deposited funds to the payment of interest on
the TransTexas Notes. The Disbursement Agreement provides that funds may be
disbursed from the Interest Reserve Account and released to TransTexas only to
the extent that the balance thereof exceeds the Requisite Balance.
DECONSOLIDATION FOR FEDERAL INCOME TAX PURPOSES
Under certain circumstances, TransAmerican, TAEC, TDOC, the Company or
TARC may sell or otherwise dispose of shares of common stock of TransTexas.
If, as a result of any sale or other disposition of TransTexas' common stock,
the direct and indirect ownership of TransTexas by TransAmerican is less than
80% (measured by voting power and value), TransTexas will no longer be a member
of TransAmerican's consolidated group for federal tax purposes (the
"TransAmerican Consolidated Group") and, with certain exceptions, will no
longer be obligated under the terms and conditions of, or entitled to the
benefits of, the Tax Allocation Agreement ("Deconsolidation"). Further, if
the Company or TARC sells or otherwise transfers any stock of TARC, or issues
any options, warrants or other similar rights relating to such stock, outside
of the TransAmerican Consolidated Group, then a Deconsolidation of both TARC
and TransTexas from the TransAmerican Consolidated Group would occur. For the
taxable year during which Deconsolidation of TransTexas occurs, which would
also be the final year that TransTexas is a member of the TransAmerican
Consolidated Group, TransAmerican would recognize a previously deferred gain of
approximately $266.3 million associated with the Transfer and would be
required to pay federal income tax on this gain (the tax is estimated to be
between $29 million and $56 million if Deconsolidation occurs in fiscal 1997
and between $24 million and $45 million if Deconsolidation occurs in fiscal
1998). This analysis is based on TransTexas' position that the gain from the
Transfer, which occurred in 1993, was deferred under the consolidated return
regulations. The deferred gain generally is being included in TransAmerican's
taxable income in a manner that corresponds (as to timing and amount) with the
realization by TransTexas of (and, thus, will be offset by) the tax benefits
(i.e., additional depreciation, depletion and amortization on, or reduced gain
or increased loss from a sale of, the transferred assets) arising from the
additional basis. If, under the terms of the TARC Notes, it was reasonably
certain when the TARC Notes were issued that a sufficient amount of TransTexas'
stock would be disposed in the future to cause a Deconsolidation of TransTexas
from the TransAmerican Consolidated Group, it is possible that the
Deconsolidation of TransTexas would be treated as occurring as of the date the
TARC Notes were issued. However, TARC has advised the Company that it believes
that when the TARC Notes were issued it was not reasonably certain that a
Deconsolidation of TransTexas would occur in the future. Under the Tax
Allocation Agreement, TransTexas is required to pay TransAmerican each year an
amount equal to the lesser of (i) the reduction in taxes paid by TransTexas for
such year as a result of any increase in the tax basis of assets acquired by
TransTexas from TransAmerican that is attributable
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to the Transfer and (ii) the increase in taxes paid by TransAmerican for such
year and all prior years attributable to gain recognized by TransAmerican in
connection with the contribution of assets by TransAmerican to TransTexas (less
certain amounts paid by TransTexas for all prior years). TransTexas estimates
that if Deconsolidation occurs in fiscal 1997 or 1998, the amount reimbursed to
TransAmerican would be between $15 million and $26 million and between $4
million and $7 million, respectively. The remaining amount of the tax relating
to the gain would be paid over the lives of the assets transferred. However,
TransTexas could be liable for additional taxes pursuant to the Tax Allocation
Agreement and the several liability provisions of federal tax law.
Generally, under the Tax Allocation Agreement, if net operating losses of
TransTexas are used by other members of the TransAmerican Consolidated Group,
then TransTexas is entitled to the benefit (through reduced current tax
payable) of such losses in later years to the extent TransTexas has taxable
income, remains a member of the TransAmerican Consolidated Group, and the other
group members have the ability to pay such taxes. If TransAmerican, TAEC, the
Company, TARC or TDOC transfers shares of TransTexas (or transfers options or
other rights to acquire such shares) and, as a result of such transfer,
Deconsolidation of TransTexas occurs, TransTexas would not thereafter receive
any benefit pursuant to the Tax Allocation Agreement for net operating losses of
TransTexas used by other members of the TransAmerican Consolidated Group prior
to the Deconsolidation of TransTexas.
Each member of a consolidated group filing a consolidated federal income
tax return is severally liable to the IRS for the consolidated federal income
tax liability of the consolidated group. There can be no assurance that
TransAmerican will have the ability to satisfy the above tax obligation at the
time due and, therefore, TransTexas, TARC or the Company may be required to pay
the tax.
Under the Tax Allocation Agreement, TransTexas will be required to pay any
Texas franchise tax (which is estimated not to exceed $10.6 million) which may
be attributable to any gain recognized by TransAmerican on the Transfer and
will be entitled to any benefits of the additional basis resulting from the
recognition of such gain.
CONTINGENT LIABILITIES
TransTexas has significant contingent liabilities, including liabilities
with respect to litigation matters, indemnification obligations relating to
certain tax benefit transfer sale-leaseback transactions, and other obligations
assumed in the Transfer. These matters, individually and in the aggregate,
amount to significant potential liability which, if adjudicated in a manner
adverse to TransTexas in one reporting period, could have a material adverse
effect on TransTexas' cash flow or operations for that period. Although the
outcome of these lawsuits cannot be predicted with certainty, TransTexas does
not expect these matters to have a material adverse effect on its financial
position. TransTexas has delivered letters of credit and placed into escrow
cash, which letters of credit and cash total approximately $21.1 million, to be
applied to certain potential litigation claims.
POTENTIAL EFFECTS OF CHANGE OF CONTROL
Capitalized words in the following discussion have the meanings as defined
in the TransTexas Indenture.
The TransTexas Indenture provides that, upon the occurrence of a Change
of Control, each holder of the TransTexas Notes will have the right to require
TransTexas to repurchase such holder's TransTexas Notes at 101% of the
principal amount thereof plus accrued and unpaid interest. As used in the
TransTexas Indenture, "Change of Control" means (i) any sale, transfer, or
other conveyance, whether direct or indirect, of all or substantially all of
the assets of TransTexas, on a consolidated basis, to any "person" or "group"
(as such terms are used for purposes of Sections 13(d) and 14(d) of the
Exchange Act, whether or not applicable), other than to or among TransTexas'
Wholly Owned Subsidiaries or the trustee under the TransTexas Indenture,
whether in a single transaction or a series of related transactions, unless,
immediately after such transaction, John R. Stanley has, directly or
indirectly, in the aggregate, sole beneficial ownership of more than 50%, on a
fully diluted basis, of the total voting power entitled to vote in the election
of directors, managers, or trustees of the transferee, (ii) the liquidation or
dissolution of TransTexas, or (iii) any transaction, event or circumstance
pursuant to which any "person" or "group" (as such terms are used for purposes
of Sections 13(d) and 14(d) of the Exchange Act, whether or not applicable),
other than John R. Stanley and his Wholly Owned Subsidiaries or the trustee
under the TransTexas Indenture, is or becomes the "beneficial owner" (as that
term is used in Rules 13d-3 and 13d-5 under
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the Exchange Act, whether or not applicable, except that a person shall be
deemed to be the "beneficial owner" of all shares that any such person has the
right to acquire, whether such right is exercisable immediately or only after
the passage of time), directly or indirectly, of more than 50% of the total
voting power of TransTexas' then outstanding Voting Stock, unless, at the time
of the occurrence of an event specified in clauses (i), (ii) or (iii), the
TransTexas Notes, issued under the TransTexas Indenture have an Investment
Grade Rating provided, however, that if, at any time within 120 days after
such occurrence, the TransTexas Notes cease having an Investment Grade Rating,
such event would constitute a "Change of Control." The term "person," as used
in the definition of Change of Control, means a natural person, company,
government or political subdivision, agency or instrumentality of a government
and also includes a "group," which is defined as two or more persons acting as
a partnership, limited partnership or other group. In addition, certain
changes or other events in respect of the ownership or control of TransTexas
that do not constitute a Change of Control under the TransTexas Indenture may
result in a "change of control" of TransTexas under the terms of the BNY
Facility and certain equipment financing. Such an occurrence could create an
obligation for TransTexas to repay such other indebtedness. At July 31, 1996,
TransTexas had approximately $16.5 million of indebtedness (excluding the
TransTexas Notes) subject to such right of repayment or repurchase. In the
event of a Change of Control under the TransTexas Indenture or a "change of
control" under the terms of other outstanding indebtedness, there can be no
assurance that TransTexas will have sufficient funds to satisfy any such payment
obligations.
In February 1995, TARC issued the TARC Notes that were initially
collateralized by, among other things, 55 million shares of TransTexas' common
stock (the "Common Stock"). In March 1996, TARC sold 4.55 million shares of
Common Stock to provide additional financing for the Capital Improvement
Program. TARC will require substantial additional financing to complete the
Capital Improvement Program. TARC has advised TransTexas that if this financing
is not available in the near future, or if significant engineering problems,
personnel shortages, cost overruns or delays occur, TARC likely will not be able
to complete and test Phase I of the Capital Improvement Program by February 15,
1997. TARC has further advised TransTexas that, if required financing is
obtained on a timely basis, completion by February 15, 1997 will still prove
very difficult. Under the TARC Indenture, the failure of TARC to complete and
test Phase I of the Capital Improvement Program by February 15, 1997 would
constitute an Event of Default at such date. Such date, however, may be
extended, without an Event of Default, to May 15, 1997 or further extended to
August 15, 1997 if TARC's fixed charge coverage ratio is 1.25 to 1 for the
three month periods ended December 31, 1996 and March 31, 1997, respectively.
TARC is actively pursuing transactions that could allow it to meet the
requisite ratio. Any such Event of Default could result in the sale,
following the occurrence of such Event of Default, of some or all of the
remaining 50.45 million shares of Common Stock pledged to collateralize the TARC
Notes. A foreclosure on such shares would constitute a "change of control" of
TransTexas under the BNY Facility and certain equipment financing, which may
create an obligation for TransTexas to repay amounts outstanding thereunder. A
sale of such shares following a foreclosure could result in a Change of Control
under the TransTexas Indenture.
REFINING
GENERAL
TARC's refinery was inoperative from January 1983 through February 1994.
During this period, TARC's revenues were primarily from tank rentals and its
expenses were comprised of maintenance and repairs, tank rentals, general and
administrative expenses and property taxes. TARC commenced partial operations
at the refinery in March 1994 and has operated the vacuum unit intermittently
since then. TARC's decision to commence or suspend operations is based on the
availability of financing, current operating margins and the need to tie-in
units as they are completed. 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 its
refinery equipment, 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.
THREE MONTHS ENDED JULY 31, 1996, COMPARED WITH THE THREE MONTHS ENDED JULY 31,
1995
There were no total revenues for the three months ended July 31, 1996 due
to processing all of the refinery
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throughput for third parties pursuant to processing agreements. For the same
period in 1995, revenues were $68.4 million.
Costs of products sold for the three months ended July 31, 1996 consisted
of inventory writedowns. Costs of products sold declined to $0.9 million from
$74.1 million for the same period in 1995, primarily as a result of operating
under processing agreements with third parties whereby TARC had no ownership of
feedstocks.
Operations and maintenance expense for the three months ended July 31,
1996 decreased to $3.5 million from $4.9 million for the same period in 1995,
primarily due to decreases in salaries and tank rental charges.
Taxes other than income taxes for the three months ended July 31, 1996
increased $1.4 million to $2.5 million from $1.1 million for the same period in
1995, primarily due to increased property tax expense.
Interest income for the three months ended July 31, 1996 decreased $2.1
million as compared to the same period in 1995 primarily due to interest earned
in 1995 on the initial $173 million long-term debt proceeds held in the
Collateral Account. Interest expense for the three months ended July 31, 1996
decreased $6.9 million, primarily due to a larger portion of interest
capitalized in 1996 versus 1995. During the three months ended July 31, 1996,
TARC capitalized approximately $16.7 million of interest related to property
and equipment additions at TARC's refinery compared to $8.8 million for the
three months ended July 31, 1995.
The equity in earnings (loss) of TransTexas for the three months ended
July 31, 1996, reflects TARC's 14.1% equity interest in TransTexas. TARC's
interest in TransTexas decreased from 20.3% as a result of TARC's sale of 4.55
million shares of TransTexas stock in March 1996.
Other income for the three months ended July 31, 1995 was $5.4 million
which was primarily a result of trading gains on futures contracts.
SIX MONTHS ENDED JULY 31, 1996, COMPARED WITH THE SIX MONTHS ENDED JULY
31, 1995
Total revenues for the six months ended July 31, 1996 decreased $58.1
million to $10.9 million from $69.0 million for the same period in 1995,
primarily as a result of processing the majority of refinery throughput for
third parties under processing agreements.
Costs of products sold for the six months ended July 31, 1996 decreased to
$12.4 million from $75.2 million for the same period in 1995, primarily as a
result of TARC's processing agreements with third parties.
Operations and maintenance expense for the six months ended July 31, 1996
increased $2.0 million to $6.6 million from $4.6 million for the same period in
1995, primarily due to an increase in fuel costs and salaries.
Taxes other than income taxes for the six months ended July 31, 1996
increased $0.8 million to $2.9 million from $2.1 million for the same period in
1995 primarily due to increased property tax expense.
Interest income for the six months ended July 31, 1996 decreased $3.9
million as compared to the same period in 1995 primarily due to interest earned
in 1995 on the initial $173 million long-term debt proceeds held in the
Collateral Account. Interest expense for the six months ended July 31, 1996
decreased $10.4 million, primarily due to a larger portion of interest
capitalized in 1996 versus 1995. During the six months ended July 31, 1996,
TARC capitalized approximately $33.3 million of interest related to property
and equipment additions at TARC's refinery.
The equity in earnings (loss) of TransTexas for the six months ended July
31, 1996, reflects TARC's 20.3% equity interest in TransTexas until TARC's sale
of 4.55 million shares of TransTexas stock in March 1996 which decreased TARC's
interest in TransTexas to 14.1%.
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Other income for the six months ended July 31, 1995 was $2.4 million which
was primarily a result of trading gains on futures contracts.
LIQUIDITY AND CAPITAL RESOURCES
In connection with the issuance of the TARC Notes, $173 million of the
proceeds thereof were deposited into a cash collateral account, designated for
use in the Capital Improvement Program. The current budget for the Capital
Improvement Program calls for total expenditures of $434 million; however, TARC
estimates that expenditures of approximately $146 million to $151 million in
addition to the current budget will be required to complete the Capital
Improvement Program. 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, or delays in, financing, engineering
problems, work stoppages, personnel shortages and cost overruns over which TARC
may not have any control.
As of July 31, 1996, expenditures on the Capital Improvement Program funded
by or approved for reimbursement from the cash collateral account totaled
approximately $205 million. Approximately $0.4 million remained in the cash
collateral account as of July 31, 1996. TARC sold 4.55 million shares of
TransTexas common stock in March 1996, and deposited approximately $26.6 million
of the proceeds of such sale into the cash collateral account in accordance with
the requirements of the TARC Indenture. Giving effect to current estimates,
additional funding of $374 million to $379 million will be required to complete
the Capital Improvement Program, of which approximately $41 million is
anticipated to be funded by the Port Commission tax exempt bonds. As of July
31, 1996, TARC had commitments for refinery construction and maintenance of
approximately $56.2 million. Additional funds necessary to complete the Capital
Improvement Program may be provided from (i) the sale of additional shares of
TransTexas common stock held by TARC, (ii) the sale of common stock of TARC,
(iii) equity investments in TARC (including the sale of preferred stock of TARC
to the Company, funded by the sale of TransTexas common stock held by the
Company), (iv) capital contributions or loans by TransAmerican, or (v) other
sources of financing, the access to which could require the consent of the
holders of the TARC Notes. TARC has entered into preliminary discussions with
potential third party investors, including strategic equity investors, financial
investors and foreign producers of crude oil. There is no assurance that
sufficient funds will be available from these sources on a timely basis or upon
terms acceptable to TARC or TransAmerican. If this financing is not available
in the near future or if significant engineering problems, work stoppages,
personnel shortages or cost overruns occur, TARC likely will not be able to
complete and test Phase I of the Capital Improvement Program by February 15,
1997. If required financing is obtained on a timely basis, completion by
February 15, 1997 will still prove very difficult. TARC has identified and is
considering certain steps to optimize construction completion, including the
retention of field supervisors, direct hiring of field supervisors and field
labor by TARC's major contractors, adding additional shifts, and modularization
and outsourcing of certain construction items. Under the TARC Indenture, the
failure of TARC to complete and test Phase I by February 15, 1997 would
constitute an Event of Default at such date. Such date, however, may be
extended, without an Event of Default, to May 15, 1997 or further extended to
August 15, 1997 if TARC's fixed charge coverage ratio is 1.25 to 1 for the three
month periods ended December 31, 1996 and March 31, 1997, respectively. TARC is
actively pursuing transactions that could allow it to meet the requisite ratio.
As of July 1996, TARC had expended the $173 million placed in the
collateral account from the issuance of the TARC Notes as well as the majority
of the proceeds from the March 1996 sale of TransTexas common stock. In May
1996, in anticipation of the limited availability of collateral account funds,
TARC began scaling back expenditures on the Capital Improvement Program so that
remaining funds were expended only on those critical path items necessary to
complete and test refinery units by the dates specified in the TARC Indenture.
In July 1996, TARC executed a promissory note to TransAmerican for up to $25
million. As of July 31, 1996, TARC had drawn $2.5 million against the note.
Also in July 1996, TransAmerican advanced $4.3 million to TARC. This advance has
now been included as borrowings under the note. At August 31, 1996, TARC had
$19.9 million outstanding under the note. The note bears interest at 15% per
annum, with quarterly interest payments beginning in October 1996 and with the
principal due in July 1998. These and additional borrowings will be utilized by
TARC to fund the critical path items mentioned above, as well as working capital
needs, pending additional financing from other sources. There can be no
assurance that such borrowings will provide sufficient interim funds to keep the
Capital Improvement Program on schedule even if additional financing is
eventually obtained.
TARC and the Port Commission have reached an agreement in principle which
would allow for the issuance of approximately $75 million in Port Commission
tax exempt bonds, the proceeds of which may be used to construct tank storage
facilities, docks and air and waste water treatment facilities. A portion of
these facilities was included in the
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Capital Improvement Program at an estimated cost of $41 million. The issuance
of the tax exempt bonds could provide an alternate source of financing for the
construction of such facilities. The Port Commission would own the facilities
built with the proceeds of the bonds, and TARC would operate the facilities
pursuant to a long-term (30-year) lease. There can be no assurance that the
issuance of the tax-exempt bonds, which may require the consent of the holders
of the TARC Notes, will occur.
In March 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
As of February 1, 1996, TARC adopted the requirements of SFAS No. 121. TARC
currently believes, based on estimates of refining margins and current
estimates for costs of the Capital Improvement Program, defined below, 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 constructing
and operating a large scale refinery and the uncertainty regarding TARC's
ability to complete the Capital Improvement Program (see Note 1), there can
be no assurance that TARC will ultimately recover the cost of the refinery.
TARC has incurred losses and negative cash flow from operations as a result
of limited refining operations that did not cover the fixed costs of maintaining
the refinery, increased working capital requirements and losses on refined
product sales and processing agreements due to financing costs and low margins.
Based on recent refining margins, recent projected levels of operations and debt
service requirements, such negative cash flows are likely to continue unless
TARC is successful in its pursuit of fixed fee crude processing transactions. In
order to operate the refinery and service its debt, TARC must raise additional
debt or equity capital in addition to the funds required to complete the Capital
Improvement Program. TransAmerican, the Company or TARC may sell securities to
raise funds for additional working capital. There is no assurance that
necessary additional funding for the refinery expansion and working capital can
be obtained or that profitable operations will be ultimately achieved. As a
result, there is substantial doubt about TARC's ability to continue as a going
concern. If TARC (i) does not complete the Capital Improvement Program timely,
(ii) incurs significant cost overruns, (iii) does not ultimately achieve
profitable operations, or (iv) ceases to continue operations, TARC's investment
in the refinery may not be recovered. The consolidated financial statements do
not include any adjustments for such uncertainties.
Additionally, the Company has pledged its entire ownership interest of
the common stock of TransTexas as collateral for the TARC Notes. In the event
TARC does not continue as a going concern, it is likely that the Company will
lose its entire investment in TransTexas. Therefore, if the Company is unable
to recover its investment in TARC and it loses its investment in TransTexas,
there is substantial doubt in the Company's ability to continue as a going
concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of these uncertainties.
A change of control or other event that results in deconsolidation of TARC
from TransAmerican's consolidated group for federal income tax purposes could
result in the acceleration of payment of a substantial amount of federal income
taxes by TransAmerican. Each member of a consolidated group filing a
consolidated federal income tax return is severally liable for the consolidated
federal income tax liability of the consolidated group. There can be no
assurance that TransAmerican will have the ability to satisfy the above tax
obligation at the time due and, therefore, TARC or other members may be
required to pay the tax. A decision by the Company or TARC to sell TransTexas
shares could result in deconsolidation of TransTexas for tax purposes. Such
sales may be necessary to raise funds required to complete the Capital
Improvement Program. TransAmerican's tax liability which could result from
deconsolidation is estimated to be approximately $35 million at July 31, 1996.
TARC as a member of the consolidated group is severally liable for this
liability. To the extent TransAmerican is unable to fund the entire liability,
TARC may be required to pay a portion of this tax. TARC is unable to determine
its share, if any, of the liability which would result from deconsolidation
because (i) it is uncertain whether deconsolidation will occur and (ii) if
deconsolidation should occur, it is uncertain whether TARC would be required to
fund any portion of the tax liability under the joint and several provisions.
TARC enters into financing arrangements to maintain an available supply of
feedstocks. Typically, TARC enters into an agreement with a third party to
acquire a cargo of feedstock scheduled for delivery to TARC's refinery. TARC
pays through the third party all transportation costs, related taxes and duties
and letter of credit fees for the cargo, plus a negotiated commission. Prior
to arrival at the refinery, another third party purchases the cargo, and TARC
commits to purchase, at a later date, the cargo at an agreed price plus
commission and costs. TARC also places margin deposits with the third party to
permit the third party to hedge its price risk. TARC purchases these cargos in
quantities sufficient to maintain expected operations and is obligated to
purchase all of the cargos delivered pursuant to these arrangements. In the
event the refinery is not operating, these cargos may be sold on the spot
market. During the six months ended July 31, 1996, approximately 1.1 million
barrels of feedstocks with a cost of $23 million were sold by a third party on
the spot market prior to delivery to TARC without a material gain or loss to
TARC.
In March 1996, TARC entered into a processing agreement with a third party
for the processing of various feedstocks at the refinery. Under the terms of
the agreement, the processing fee earned by TARC is based on the margin earned
35
<PAGE> 37
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. This agreement provides for TARC to
process a total of approximately 1.1 million barrels of feedstock. For the
six months ended July 31, 1996, TARC incurred a loss of approximately $1.9
million related to this processing agreement primarily as a result of price
management decisions.
In April 1996, TARC entered into a similar processing agreement with
another third party to process feedstocks. As of July 31, 1996, TARC had
completed processing approximately 4.3 million barrels of feedstocks and is
storing approximately 1.1 million barrels of intermediate and refined products
under this agreement. Upon sale of these barrels, TARC and the third party
will complete a settlement of the agreement. As of July 31, 1996, TARC
recorded a loss of approximately $1.4 million related to this processing
agreement primarily as a result of price management decisions.
In July and September 1996, TARC entered into processing agreements with a
third party to process approximately 0.5 million barrels of feedstocks for a
fixed price per barrel. Under the terms of the agreement, TARC is responsible
for only certain quantity and quality yields.
Environmental compliance and permitting issues are an integral part of the
capital expenditures in the Capital Improvement Program. During the next three
fiscal years TARC does not expect to incur significant expenses for
environmental compliance in addition to the amounts included in 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 results of operations, cash flows or financial condition. TARC also has
contingent liabilities with respect to litigation matters as more fully
described in Note 2 of Notes to Condensed Consolidated Financial Statements.
On December 13, 1995, litigation with Frito-Lay, Inc. was settled. TARC
intends to pay $2.5 million to Frito-Lay, Inc. during fiscal year 1997 in
accordance with the Tax Allocation Agreement and other relevant documents. As
of July 31, 1996, TARC has paid approximately $2.1 million of this obligation.
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. Words such as "anticipates," "expects,"
"believes" and "likely" indicate forward-looking statements. The Company'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 TARC's success in raising additional capital to complete the Capital
Improvement Program as scheduled, engineering problems, work stoppages, cost
overruns, personnel shortages, fluctuations in the commodity prices for
petroleum and refined products, casualty losses, conditions in the capital
markets and competition. Additional factors affecting TransTexas include the
commodity prices for natural gas, crude oil, condensate and natural gas liquids,
the extent of TransTexas' success in discovering, developing and producing
reserves and the ultimate resolution of litigation.
36
<PAGE> 38
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Notes 2 and 8 to the condensed consolidated financial
statements for a discussion of the Company's legal proceedings.
ITEM 5. OTHER INFORMATION
CAPITAL IMPROVEMENT PROGRAM
The Capital Improvement Program ("CIP") is designed to increase the
capacity and complexity of the refinery. The most significant projects include:
(i) completion of a delayed coking unit to process vacuum tower bottoms into
lighter petroleum products, (ii) reactivation and revamping of a fluid catalytic
cracking unit to increase gasoline production capacity, (iii) upgrading and
expanding existing hydrotreating and desulfurization units to increase sour
crude processing capacity and (iv) reactivation of the MTBE unit. In addition,
TARC plans to expand, modify, and add other processing units, tankage, and
offsite facilities as part of the CIP. The CIP includes expenditures necessary
to ensure that the refinery is in compliance with certain existing air and water
discharge regulations. TARC has engaged a number of specialty consultants and
engineering and construction firms to assist TARC in completing the individual
projects that comprise the CIP. Each of these firms was selected because of its
specialized expertise in a particular process or unit integral to the CIP.
The following table sets forth, as of July 31, 1996, TARC's capital budget
for, and expenditures on the Capital Improvement Program (in millions of
dollars):
<TABLE>
<CAPTION>
CAPITAL
BUDGET EXPENDITURES
------------ ------------
<S> <C> <C>
PHASE I:
Delayed Coking Unit $ 38 $ 55
Naphtha Pretreater 7 4
No. 2 Reformer 6 1
VGO HDS Unit 25 5
FCC Unit 75 36
FCC Upgrades 11 7
Alkylation Unit 20 9
MTBE Unit 2 --
Sulfur Recovery Units/Amine System 26 22
Additional Tank Storage Capacity 21 10
Offsite Facilities 22 24
Other 8 3
Engineering and Administrative 8 14
Contingencies 40* 9
------- ---------
Total Phase I 309 199
------- ---------
PHASE II:
Light Naphtha Isomerization Unit 5 3
No 2 Fuel Oil HDS Unit 31 2
Sulfur Recovery Units/Amine System 17 --
Offsite Facilities 18 --
MTBE Unit Expansion 33** --
Other 2 --
Engineering and Administrative 3 --
Contingencies 16* 1
------- ---------
Total Phase II 125 6
------- ---------
Total Capital Improvement Program $ 434 $ 205
======= =========
</TABLE>
- ---------------------------------------
*To the extent that expenditures exceed the approved capital budget for a unit
or units, the contingencies portion of the budget will be allocated to specific
units. As of July 31, 1996, approximately $25 million of the contingencies
have been allocated for expenditures on the Delayed Coking Unit, Engineering
and Administrative and Offsite Facilities. The foregoing estimates, as well as
other estimates and projections herein, are subject to substantial revision
upon the
37
<PAGE> 39
occurrence of future events, such as unavailability of, or delays in
financing, engineering problems, work stoppages, personnel shortages and cost
overruns over which TARC may not have any control.
** TARC intends to reallocate these expenditures to other budgeted items in
accordance with the Disbursement Agreement.
TARC estimates that expenditures of between $146 million and $151 million
in addition to the current budget of $434 million will be required to complete
the Capital Improvement Program. As of July 31, 1996, expenditures on the
Capital Improvement Program funded by or approved for reimbursement from the
cash collateral account totaled approximately $205 million. Approximately $0.4
million remained in the cash collateral account as of July 31, 1996. Giving
effect to current estimates, additional funding of $374 million to $379 million
will be required to complete the Capital Improvement Program of which
approximately $41 million is anticipated to be funded by the Port Commission tax
exempt bonds. As of July 31, 1996, TARC had commitments for refinery
construction and maintenance of approximately $56.2 million. Additional funds
necessary to complete the Capital Improvement Program may be provided from (i)
the sale of additional shares of TransTexas common stock held by TARC, (ii) the
sale of common stock of TARC, (iii) equity investments in TARC (including the
sale of preferred stock of TARC to the Company, funded by the sale of TransTexas
common stock held by the Company), (iv) capital contributions or loans by
TransAmerican, or (v) other sources of financing, the access to which could
require the consent of the holders of the TARC Notes. TARC has entered into
preliminary discussions with potential third party investors, including
strategic equity investors, financial investors and foreign producers of crude
oil. There is no assurance that sufficient funds will be available from these
sources on a timely basis or upon terms acceptable to TARC or TransAmerican. If
this financing is not available when needed or if significant engineering
problems, work stoppages, personnel shortages or cost overruns occur, TARC
likely will not be able to complete and test Phase I of the Capital Improvement
Program by February 15, 1997. If required financing is obtained on a timely
basis, completion by February 15, 1997 will still prove very difficult. TARC
has identified and is considering certain steps to optimize construction
completion, including the retention of field supervisors, direct hiring of field
supervisors and field labor by TARC's major contractors, adding additional
shifts, and modularization and outsourcing of certain construction items. Under
the TARC Indenture, the failure of TARC to complete and test Phase I by February
15, 1997 would constitute an Event of Default at such date. Such date, however,
may be extended, without an Event of Default to May 15, 1997 or further extended
to August 15, 1997 if TARC's fixed charge coverage ratio is 1.25 to 1 for the
three month periods ended December 31, 1996 and March 31, 1997, respectively.
TARC is actively pursuing transactions that could allow it to meet the requisite
ratio.
As of July 1996, TARC had expended the $173 million placed in the
collateral account from the issuance of the TARC Notes as well as the majority
of the proceeds from the March 1996 sale of TransTexas common stock. In May
1996, in anticipation of the limited availability of collateral account funds,
TARC began scaling back expenditures on the Capital Improvement Program so that
remaining funds were expended only on those critical path items necessary to
complete and test refinery units by the dates specified in the TARC Indenture.
In July 1996, TARC executed a promissory note to TransAmerican for up to $25
million. As of July 31, 1996, TARC had drawn $2.5 million against the note.
Also in July 1996, TransAmerican advanced $4.3 million to TARC. This advance has
now been included as borrowings under the note. At August 31, 1996, TARC had
$19.9 million outstanding under the note. The note bears interest at 15% per
annum, with quarterly interest payments beginning in October 1996 and with the
principal due in July 1998. These and additional borrowings will be utilized by
TARC to fund the critical path items mentioned above, as well as working capital
needs, pending additional financing from other sources. There can be no
assurance that such borrowings will provide sufficient interim funds to keep the
Capital Improvement Program on schedule even if additional financing is
eventually obtained.
TARC and the Port Commission have reached an agreement in principle which
would allow for the issuance of approximately $75 million in Port Commission
tax exempt bonds, the proceeds of which may be used to construct tank storage
facilities, docks and air and waste water treatment facilities. A portion of
these facilities was included in the Capital Improvement Program at an
estimated cost of $41 million. The issuance of the tax exempt bonds could
provide an alternate source of financing for the construction of such
facilities. The Port Commission would own the facilities built with the
proceeds of the bonds, and TARC would operate the facilities pursuant to a
long-term (30-year) lease. There can be no assurance that the issuance of the
tax-exempt bonds, which may require the consent of the holders of the TARC
Notes, will occur.
TARC plans to complete the CIP in two phases as described below:
PHASE I
38
<PAGE> 40
Phase I will involve completion or reactivation of a delayed coking unit, a
naphtha pretreater, a catalytic reformer, a vacuum gas oil hydrodesulfurization
unit, a fluid catalytic cracking unit, an alkylation plant, an MTBE unit and
sulfur recovery facilities. TARC estimates additional expenditures of between
$270 million and $275 million will be required to complete Phase I. TARC
anticipates that following completion of Phase I, it will be processing
low-cost, sour crude oil in combination with sweet crude oil and atmospheric
tower bottoms. Products from this phase are expected to include all the
products produced prior to Phase I plus conventional gasoline and petroleum
coke. TARC must raise additional capital to complete Phase I.
PHASE II
In Phase II of the Capital Improvement Program, TARC will expand
hydrodesulfurization capacity, add a naphtha isomerization unit and add sulfur
recovery facilities. Current plans do not include expansion of the MTBE Unit.
TARC anticipates that, following completion of Phase II, it will process 200,000
BPD of heavy, sour crude oil. TARC estimates that additional expenditures of
$104 million will be required to complete Phase II.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
27.1 - Financial Data Schedule
(b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed during the three months
ended July 31, 1996.
39
<PAGE> 41
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
TRANSAMERICAN ENERGY CORPORATION
(Registrant)
By: /S/ JOHN R. STANLEY
------------------------------------
John R. Stanley, Chief Executive
Officer
September 20, 1996 /S/ JEFFREY H. SIEGEL
------------------------------------
Jeffrey H. Siegel,
Chief Financial Officer
(Principal Financial Officer and
Accounting Officer)
40
<PAGE> 42
INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- ------ -------
27.1 Financial Data Schedule
41
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED BALANCE SHEET AT JULY 31, 1996 AND THE UNAUDITED CONDENSED
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JULY 31, 1996 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-31-1997
<PERIOD-START> FEB-01-1996
<PERIOD-END> JUL-31-1996
<CASH> 88,641
<SECURITIES> 0
<RECEIVABLES> 42,998
<ALLOWANCES> 0
<INVENTORY> 29,025
<CURRENT-ASSETS> 197,242
<PP&E> 2,596,653
<DEPRECIATION> 1,371,969
<TOTAL-ASSETS> 1,482,229
<CURRENT-LIABILITIES> 159,728
<BONDS> 1,155,406
<COMMON> 0
96
0
<OTHER-SE> 21,234
<TOTAL-LIABILITY-AND-EQUITY> 1,482,229
<SALES> 184,329
<TOTAL-REVENUES> 192,091
<CGS> 73,390
<TOTAL-COSTS> 83,473
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 54,121
<INCOME-PRETAX> 113,108
<INCOME-TAX> 7,788
<INCOME-CONTINUING> 105,320
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 105,320
<EPS-PRIMARY> 11,702
<EPS-DILUTED> 0
</TABLE>
