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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 31, 1998
Registration Number 33-85930
---------------
TRANSAMERICAN 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 NORTH SAM HOUSTON PARKWAY EAST
SUITE 200
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)
(281) 986-8822
(Registrant's telephone number, including area code)
-------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares of common stock of the registrant outstanding on
September 17, 1998 was 9,000.
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TRANSAMERICAN ENERGY CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C> <C>
PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheet as of July 31, 1998 and January 31, 1998...........................2
Condensed Consolidated Statement of Operations for the three and six months ended
July 31, 1998 and 1997.............................................................................3
Condensed Consolidated Statement of Cash Flows for the six months ended
July 31, 1998 and 1997.............................................................................4
Notes to Condensed Consolidated Financial Statements....................................................5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................19
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................................26
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings......................................................................................27
Item 5. Other Information......................................................................................27
Item 6. Exhibits and Reports on Form 8-K.......................................................................28
Signature.......................................................................................................29
</TABLE>
1
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PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
JULY 31, JANUARY 31,
1998 1998
---------- -----------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 19,073 $ 86,513
Restricted cash held in disbursement accounts.................................. 3,000 158,563
Cash restricted for interest................................................... 36,680 32,823
Investments held in trust...................................................... 9,545 9,114
Accounts receivable............................................................ 18,028 17,926
Inventories ................................................................... 47,186 16,437
Other current assets........................................................... 15,459 12,065
---------- -----------
Total current assets ..................................................... 148,971 333,441
---------- -----------
Property and equipment ........................................................... 2,804,500 2,350,060
Less accumulated depreciation, depletion and amortization ........................ 770,794 741,952
---------- -----------
Net property and equipment -- based on the full cost method of
accounting for gas and oil properties of which $66,563 and $104,389
was excluded from amortization at July 31, 1998 and January 31, 1998,
respectively............................................................. 2,033,706 1,608,108
---------- -----------
Restricted cash held in disbursement accounts..................................... -- 60,166
Cash restricted for interest...................................................... 204 16,348
Investments held in trust......................................................... -- 8,592
Receivable from affiliates........................................................ 5,957 1,463
Other assets, net ................................................................ 73,714 103,321
---------- -----------
$2,262,552 $ 2,131,439
========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable............................................................... $ 128,755 $ 84,181
Payable to affiliate........................................................... 12,707 6,758
Accrued liabilities ........................................................... 55,791 52,326
Current maturities of long-term debt........................................... 8,451 16,891
---------- -----------
Total current liabilities ................................................ 205,704 160,156
---------- -----------
Due to affiliates................................................................. 5,993 6,827
Long-term debt, less current maturities........................................... 1,834,269 1,761,689
Revolving credit agreement........................................................ 7,209 7,917
Production payments, less current portion......................................... 49,582 4,121
Deferred income taxes ............................................................ 35,399 39,497
Other liabilities ................................................................ 23,698 25,668
Minority interest in net income of TransTexas..................................... 33,743 35,162
Commitments and contingencies (Note 8) ........................................... -- --
Stockholder's equity:
Common stock, $0.01 par value, 100,000 shares authorized; 9,000 shares issued
and outstanding.............................................................. -- --
Additional paid-in capital..................................................... 203,760 200,996
Accumulated deficit............................................................ (136,805) (110,594)
---------- -----------
Total stockholder's equity................................................ 66,955 90,402
---------- -----------
$2,262,552 $ 2,131,439
========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------------------------- -------------------------
1998 1997 1998 1997
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Revenues:
Gas, condensate and natural gas liquids............... $ 20,538 $ 39,199 $ 39,868 $ 111,848
Transportation........................................ -- 2,764 -- 12,055
Product sales......................................... 8,375 -- 8,375 --
Gain on the sale of assets............................ 47,693 532,929 60,020 532,929
Other................................................. 4,478 517 8,295 617
---------- ----------- ---------- -----------
Total revenues..................................... 81,084 575,409 116,558 657,449
---------- ----------- ---------- -----------
Costs and expenses:
Operating............................................. 14,995 12,450 24,359 47,887
Depreciation, depletion and amortization.............. 15,661 22,129 30,181 57,397
General and administrative ........................... 12,127 11,915 23,980 29,767
Taxes other than income taxes......................... 3,792 3,417 5,770 9,535
Impairment loss ...................................... 21,843 -- 21,843 --
---------- ----------- ---------- -----------
Total costs and expenses............................ 68,418 49,911 106,133 144,586
---------- ----------- ---------- -----------
Operating income ................................... 12,666 525,498 10,425 512,863
---------- ----------- ---------- -----------
Other income (expense):
Interest income....................................... 2,148 7,293 6,403 9,114
Interest expense, net................................. (21,742) (41,278) (48,179) (69,932)
Other, net............................................ -- 696 -- 735
---------- ----------- ---------- -----------
Total other income (expense)........................ (19,594) (33,289) (41,776) (60,083)
---------- ----------- ---------- -----------
Income (loss) before income taxes, minority
interest, extraordinary item and cumulative
effect of a change in accounting principle....... (6,928) 492,209 (31,351) 452,780
Income tax expense (benefit) ........................... 181 180,311 (3,483) 172,483
---------- ----------- ---------- -----------
Income (loss) before minority interest,
extraordinary item and cumulative effect
of a change in accounting principle.............. (7,109) 311,898 (27,868) 280,297
Minority interest in net loss of TransTexas............. 150 -- 1,419 --
Extraordinary item - early extinguishment of debt
(net of income tax benefit)........................... (1,142) (156,539) (2,436) (156,539)
Cumulative effect of a change in accounting principle... -- -- 2,674 --
---------- ----------- ---------- -----------
Net income (loss) before preferred stock dividend... $ (8,101) $ 155,359 $ (26,211) $ 123,758
========== =========== ========== ===========
Series A preferred stock dividend....................... $ -- -- $ -- $ 19
========== =========== ========== ===========
Net income (loss) available for common stockholders..... $ (8,101) $ 155,359 $ (26,211) $ 123,739
========== =========== ========== ===========
Basic and diluted net income (loss) per common share:
Income (loss) before extraordinary item and
cumulative effect of a change in accounting
principle ...................................... $ (773) $ 34,655 $ (2,939) $ 31,142
Extraordinary item.................................. (127) (17,393) (270) (17,393)
Cumulative effect of a change in accounting
principle....................................... -- -- 297 --
---------- ----------- ---------- -----------
$ (900) $ 17,262 $ (2,912) $ 13,749
========== =========== ========== ===========
Weighted average number of shares outstanding for
basic and diluted net income (loss) per share....... 9,000 9,000 9,000 9,000
========== =========== ========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JULY 31,
---------------------------
1998 1997
----------- ----------
<S> <C> <C>
Operating activities:
Net income (loss)............................................................ $ (26,211) $ 123,758
Adjustments to reconcile net income (loss) to net cash
used by operating activities:
Extraordinary item....................................................... 2,436 156,539
Cumulative effect of a change in accounting principle.................... (2,674) --
Depreciation, depletion and amortization................................. 30,181 57,397
Impairment loss.......................................................... 21,843 --
Amortization of discount on long-term debt............................... 17,603 17,863
Amortization of discount on subordinated notes........................... -- 4,941
Amortization of debt issue costs......................................... 3,196 2,175
Gain on the sale of assets............................................... (60,020) (532,929)
Deferred income taxes.................................................... (3,483) 172,483
Minority interest in net loss of TransTexas.............................. (1,419) --
Repayment of volumetric production payments.............................. -- (45,134)
Amortization of deferred revenue......................................... -- (9,420)
Changes in assets and liabilities:
Accounts receivable................................................. (102) 47,032
Inventories ....................................................... (15,475) (2,621)
Other current assets................................................ (3,394) 5,050
Accounts payable.................................................... (4,297) 11,885
Accrued liabilities................................................. 8,840 (51,106)
Transactions with affiliates, net................................... 592 (955)
Other assets........................................................ 182 259
Other liabilities................................................... (6,064) 1,867
----------- ----------
Net cash used by operating activities............................ (38,266) (40,916)
----------- ----------
Investing activities:
Capital expenditures......................................................... (416,430) (293,412)
Proceeds from the sale of assets............................................. 104,920 1,030,032
Increase in investments held in trust........................................ (279) --
Decrease in investments held in trust........................................ 8,439 --
Withdrawals from cash restricted for interest................................ -- 46,000
Advances to affiliate........................................................ -- (13,304)
Payment of advances by affiliate............................................. -- 56,354
Purchase of TARC warrants.................................................... -- (33,010)
TransTexas purchase of treasury stock........................................ -- (49,599)
----------- ----------
Net cash provided (used) by investing activities................. (303,350) 743,061
----------- ----------
Financing activities:
Issuance of long-term debt................................................... 42,125 1,403,706
Retirement of long-term debt................................................. (7,792) (1,365,214)
Principal payments on long-term debt......................................... (33,037) (5,428)
Increase in restricted cash held in disbursement accounts.................... -- (217,813)
Withdrawals from disbursement accounts....................................... 228,016 66,003
Issuance of production payments.............................................. 52,214 20,977
Principal payments on production payments.................................... (4,985) (23,909)
Revolving credit agreement, net.............................................. (708) (20,019)
Dividend payment on preferred stock.......................................... -- (19)
Advances from affiliates..................................................... -- 15,026
Repayment of advances to affiliates.......................................... -- (66,000)
Increase in cash restricted for TransTexas share repurchases................. -- (399,284)
Withdrawals from cash restricted for TransTexas share repurchases............ -- 49,599
Dividend to TransAmerican.................................................... -- (23,000)
Debt issue costs............................................................. (1,309) (46,746)
Redemption of Series A preferred stock....................................... -- (106)
Other........................................................................ (348) (438)
----------- ----------
Net cash provided (used) by financing activities................. 274,176 (612,665)
----------- ----------
Increase (decrease) in cash and cash equivalents................. (67,440) 89,480
Beginning cash and cash equivalents.............................................. 86,513 24,179
----------- ----------
Ending cash and cash equivalents................................................. $ 19,073 $ 113,659
=========== ==========
</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
TransAmerican Energy Corporation (the "Company" or "TEC") was formed on
July 12, 1994 to hold certain shares of common stock of TransTexas Gas
Corporation ("TransTexas") and all of the outstanding capital stock of
TransAmerican Refining Corporation ("TARC"). TEC is a wholly owned subsidiary of
TransAmerican Natural Gas Corporation ("TransAmerican"). Capitalized terms used
herein and not otherwise defined are as defined in the respective Annual Reports
on Form 10-K of TransTexas, TARC and the Company for the fiscal year ended
January 31, 1998. 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 the interim
periods. All significant intercompany transactions have been eliminated in
consolidation. Interim results of operations are not necessarily indicative of
the results that may be expected for the entire year. The financial information
presented herein should be read in conjunction with the financial statements and
notes included in the Company's annual report on Form 10-K for the year ended
January 31, 1998.
CONSOLIDATION
As of July 31, 1998, the TEC Notes Indenture (defined below) contained
restrictions that could substantially limit the Company's ability to use the
assets of one subsidiary to satisfy the liabilities of the other. 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 quarter ended July 31,
1998.
Below is selected financial information for each consolidated entity
(in millions of dollars):
<TABLE>
<CAPTION>
July 31, 1998
--------------------------------------------------------------------------------
Consolidation
TransTexas TARC TEC Entries Consolidated
---------- -------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data
Working capital (deficit) $ (43.9) $ (16.5) $ 3.7 $ -- $ (56.7)
Total assets 826.4 1,431.7 1,783.6 (1,779.1) 2,262.6
Long-term debt 605.7 1,050.6 1,487.8 (1,302.6) 1,841.5
Equity 17.0 264.5 286.8 (501.3) 67.0
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended July 31, 1998
-----------------------------------------------------------------------------
Consolidation
TransTexas TARC TEC Entries Consolidated
---------- ------- ------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Operations Data
Revenues $104.9 $ 11.7 $ -- $ -- $ 116.6
Operating income (loss) 29.5 (18.9) (0.2) -- 10.4
Net loss (7.6) (22.0) (1.3) 4.7 (26.2)
Cash Flow Data
Operating activities (20.5) (32.0) 1.6 12.6 (38.3)
Investing activities (23.5) (267.2) (120.9) 108.3 (303.3)
Financing activities 21.6 289.5 84.0 (120.9) 274.2
</TABLE>
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
RECENTLY ISSUED PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. The Company
will adopt SFAS 133 effective February 1, 2000. The Company is uncertain as to
the future impact on its financial statements of the adoption of SFAS 133;
however, there would have been no impact if SFAS 133 had been adopted on
July 31, 1998.
2. ACCOUNTING CHANGES
Effective May 1, 1998, the Company changed its method of accounting for
turnaround costs. Turnaround costs consist of required periodic maintenance on
major processing units including the shutdown and restart of the units.
Previously, the Company estimated the costs of a scheduled turnaround and
ratably accrued these costs over the period until the next scheduled turnaround.
To provide for better matching of turnaround costs with revenues and to be more
consistent with industry standards, the Company changed its method of accounting
for turnaround costs to one that results in the amortization of incurred costs
on a straight-line basis over the period of time estimated to lapse until the
next scheduled turnaround. The cumulative effect of this accounting change
through January 31, 1998 was a decrease in net loss for the six months ended
July 31, 1998 of $2.7 million or $297 per common share. Excluding the cumulative
effect, the change decreased net loss for the three and six months ended July
31, 1998 by $0.2 million or $21 per common share and $0.4 million or $42 per
common share, respectively.
Pro forma amounts assuming the change in accounting principle is
applied retroactively are as follows (in thousands of dollars except per share
amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
------------------------- ------------------------
1998 1997 1998 1997
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Income (loss) before extraordinary items ............. $(6,959) $312,089 $(26,449) $280,679
Basic and diluted net income (loss) per share
before extraordinary items:
As reported ........................................ (773) 34,655 (2,939) 31,142
Pro forma .......................................... (773) 34,676 (2,939) 31,184
Net income (loss) .................................... (8,101) 155,550 (28,885) 124,121
Basic and diluted net income (loss) per share:
As reported ........................................ (900) 17,262 (2,912) 13,749
Pro forma .......................................... (900) 17,283 (3,209) 13,791
</TABLE>
TARC's inventories consist primarily of feedstocks and refined products
and are stated at the lower of cost or market. Effective May 1, 1998, TARC
changed its method of inventory pricing for feedstocks and refined products from
the average cost method to the first-in-first-out method. Historically, sales of
refined products have been limited and sporadic due to intermittent operations
of the refinery during periods of construction and expansion. Upon completion of
the Capital Improvement Program, the refinery will be capable of producing
multiple refined products from a variety of feedstocks. TARC believes the change
from the average cost to the first-in-first-out method will enable TARC to more
efficiently value its inventory and match revenues and costs. Furthermore, TARC
believes the first-in-first-out method is more widely used than the average cost
method in the refining industry and desires to present more comparative
information. There was no cumulative effect of this accounting change for any
period presented.
3. LIQUIDITY
TEC's only source of funds for its holding company operations and debt
service will be from working capital, interest payments on the Intercompany
Loans to TransTexas and TARC, dividends from its subsidiaries, payments made by
TARC on behalf of TEC pursuant to the Services Agreement (as defined) and, in
limited circumstances as permitted by the TEC Notes Indenture, sales of stock
TEC holds in its subsidiaries.
6
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
During the two years following the TEC Notes Offering, TEC anticipates
that its annual cash needs for holding company operations will be approximately
$2.0 million, which TEC expects to be paid on its behalf by TARC pursuant to the
Services Agreement, and TEC's annual cash interest expense will be approximately
$54.6 million. In addition, TEC and its subsidiaries will pay $2.5 million in
the aggregate per year to TransAmerican for advisory services and other benefits
provided by TransAmerican. TransTexas will be required to pay TEC approximately
$48.9 million in interest annually on the TransTexas Intercompany Loan. TEC
expects to use this interest income together with working capital, if any, to
satisfy its cash needs, including its cash interest payments. If TEC incurs
unforeseen expenses, there is no assurance that its capital resources will be
sufficient to fund those expenses in addition to anticipated holding company
expenses and debt service.
The TEC Notes Indenture prohibits TEC from selling stock of TransTexas
and TARC during the two years following consummation of the TEC Notes Offering
unless the proceeds from such sales would be used to make an offer to purchase
the TEC Notes. Consequently, during the two years following the consummation of
the TEC Notes Offering, unless holders of the TEC Notes rejected all or a
portion of any such offer to purchase, sales of such stock would not be a source
of funds to supplement TEC's other resources in order to pay unforeseen
expenses.
TransTexas makes substantial capital expenditures for the exploration
and development of natural gas reserves. TransTexas historically has financed
its capital expenditures, debt service and working capital requirements with
cash flow from operations, public and private offerings of debt and equity
securities, the sale of production payments, asset sales, an accounts receivable
revolving credit facility and other financings. Cash flow from operations is
sensitive to the level of capital expenditures and the prices TransTexas
receives for its natural gas.
During the six months ended July 31, 1998, TransTexas' total capital
expenditures were $128 million, including $12 million for lease acquisitions,
$107 million for drilling and development, and $9 million for gas gathering,
other equipment and seismic acquisitions. Subject to cash availability, capital
expenditures for fiscal 1999 are estimated to be approximately $177 million,
which is in excess of projected cash flow from operations. A reduction in
planned capital spending could result in less than anticipated cash flow from
operations in fiscal 1999 and later years, which could have a material adverse
effect on TransTexas. To finance its capital expenditure and working capital
requirements, TransTexas will be required to supplement its anticipated cash
flow from operations with a combination of asset sales and financings which may
include borrowings or production payments. TransTexas' debt covenants may limit
its ability to obtain additional financing or to sell properties, and there is
no assurance that adequate funds can be obtained on a timely basis from such
sources.
TARC has historically incurred losses and negative cash flow from
operations as a result of limited refinery operations that did not cover the
fixed costs of maintaining the refinery, increased working capital requirements
(including debt service) and losses on refined product sales and processing
arrangements. As described in Note 5, TARC must raise additional funds in order
to complete the Capital Improvement Program. There is no assurance that TARC can
raise additional funds, complete the Capital Improvement Program, fund its
future working capital requirements or achieve positive cash flow from
operations. As a result, there is substantial doubt about TARC's ability to
continue as a going concern. Additionally, the Company has pledged its ownership
interest in TransTexas as collateral on the Company's Senior Discount Notes, the
repayment of which is substantially dependent on TARC's ability to provide cash
flow from operations or otherwise provide funds for debt repayment. In the event
TARC does not provide adequate funds to the Company, the Company may not be able
to recover its investment in TARC and could lose its ownership interest in
TransTexas. Therefore, there is substantial doubt about the Company's ability to
continue as a going concern. The condensed consolidated financial statements do
not include any adjustments that might result from the outcome of these
uncertainties.
4. GAIN ON THE SALE OF ASSETS
On April 30, 1998, TransTexas sold its oilfield stimulation, cementing
and coiled tubing equipment and related facilities to an unaffiliated third
party for a sales price of $30 million, subject to post-closing adjustments. For
the six months ended July 31, 1998, TransTexas recorded a $10.7 million pre-tax
gain as a result of this sale. During the three months ended July 31, 1998,
TransTexas recorded post-closing adjustments of $0.4 million thereby increasing
the pre-tax gain.
On June 26, 1998, TransTexas sold its drilling rigs and related
facilities to an unaffiliated third party for a sales price of $75 million.
TransTexas recorded a pre-tax gain of $51.9 million as a result of this sale.
On August 17, 1998, TransTexas sold its remaining drilling services
assets to an unaffiliated third party for a sales price of $20.5 million.
Additional adjustments to the Lobo Sale purchase price resulted in a
pre-tax loss on the sale of assets of $4.6 million and $2.6 million during the
three and six months ended July 31, 1998, respectively.
7
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
5. CAPITAL IMPROVEMENT PROGRAM
TARC's refinery is located in the Gulf Coast region along the Mississippi
River, approximately 20 miles from New Orleans, Louisiana. TARC's business
strategy is to modify, expand and reactivate its refinery and to maximize its
refining margins by converting low-cost, heavy, sour crude oils into light
petroleum products including primarily gasoline and heating oil.
In February 1995, TARC began a construction and expansion program (the
"1995 Program") designed to reactivate the refinery and increase its
complexity. From February 1995 through May 1997, TARC spent approximately $251
million on the 1995 Program, procured a majority of the equipment required and
completed substantially all of the process design engineering and a substantial
portion of the remaining engineering necessary for its completion.
In June 1997, in connection with the TEC Notes Offering, the TARC
Intercompany Loan and the TARC Notes Tender Offer, TARC adopted a revised
capital improvement program designed to increase the capacity and complexity of
the refinery ("Capital Improvement Program"). The most significant projects
include: (i) converting the visbreaker unit into a delayed coking unit to
process vacuum tower bottoms into lighter petroleum products, (ii) modernizing
and upgrading a fluid catalytic cracking unit to increase gasoline production
capacity and allow the direct processing of low-cost atmospheric residual
feedstocks, and (iii) upgrading and expanding hydrotreating, alkylation and
sulfur recovery units to increase sour crude processing capacity. In addition,
TARC is in the process of expanding, modifying and adding other processing
units, tankage and offsite facilities as part of the Capital Improvement
Program. The Capital Improvement Program includes expenditures necessary to
ensure that the refinery is in compliance with certain existing air and water
discharge regulations and that gasoline produced will comply with federal
standards. TARC is acting as general contractor, but has engaged a number of
specialty consultants and engineering and construction firms to assist it in
completing the individual projects that comprise the Capital Improvement
Program. Each of these firms was selected because of its specialized expertise
in a particular process or unit integral to the Capital Improvement Program.
The Capital Improvement Program is being executed in two phases. Phase I
of the Capital Improvement Program includes the completion and start-up of
several units, including the Delayed Coking Unit, one of the refinery's major
conversion units. Phase II of the Capital Improvement Program includes the
completion and start-up of the Fluid Catalytic Cracking Unit utilizing MSCC(SM)
technology and the installation of additional equipment expected to further
improve operating margins by allowing for a significant increase in the
refinery's capacity to produce gasoline. In June 1997, TARC estimated that
Phase I would be completed at a cost of $223 million, would be tested and
operational by September 30, 1998 and would result in the refinery having the
capacity to process up to 200,000 Bpd of sour crude oil. In June 1997, TARC
estimated that Phase II would be completed at a cost of $204 million and would
be tested and operational by July 31, 1999.
TARC's current estimates indicate that actual expenditures may exceed
the original budget by $221 million to $245 million (of which $131 million to
$134 million is allocated to Phase I), depending upon the extent to which an
unallocated contingency amount of $24 million is used. TARC spent approximately
$468.3 million on the Capital Improvement Program during the period between June
1997 and July 31, 1998. As of July 31, 1998, TARC had commitments to spend
another $58.5 million on the Capital Improvement Program. TARC intends to fund
the remaining Capital Improvement Program costs with proceeds from the issuance
of additional debt and equity securities and other sources of capital, including
cash flow from Phase I operations. TARC is engaged in negotiations with an
investor group which, if consummated, would result in additional construction
capital of approximately $100 million and a change of control of the refinery.
Consummation of any such transaction will be contingent upon obtaining the
consent of the holders of the TEC Notes and TARC's Senior Subordinated Notes.
There can be no assurance that additional financing to fund completion of the
Capital Improvement Program will be obtained or, if such financing is obtained,
what the terms thereof will be. Under certain circumstances involving a change
of control, neither TEC nor TARC may be able to recover all of its investment
in the refinery.
TARC achieved Mechanical Completion of the Delayed Coking Unit, the HDS
Unit and the related portion of the Sulfur Recovery System in June 1998. If
adequate financing is obtained on a timely basis, TARC believes that the
remainder of Phase I (other than the No. 2 Reformer) will reach Mechanical
Completion in November 1998. TARC intends to defer additional expenditures on
the No. 2 Reformer until the fourth quarter of fiscal 1999. TARC believes that
both Phase I and Phase II will be completed in advance of the respective
completion dates required by the TEC Notes Indenture. The foregoing estimates,
as well as other estimates and projections herein, are subject to substantial
revision upon the occurrence of future events, such as unavailability of
financing, engineering problems, work stoppages and further cost overruns, over
which TARC may not have any control, and there can be no assurance that any such
projections or estimates will prove accurate.
TARC believes, based on current estimates of refining margins and costs of
the expansion and modification of the refinery, that future undiscounted cash
flows will be sufficient to recover the cost of the refinery over its estimated
useful life. Management believes there have been no events or changes in
circumstances that would require the recognition of an impairment loss. However,
due to the inherent uncertainties in estimating future refining margins, and in
constructing and operating a large scale refinery, there can be no assurance
that TARC will ultimately recover the cost of the refinery. Management believes
that the book value of the refinery is in excess of its current estimated fair
market value.
6. DISBURSEMENT ACCOUNTS
Pursuant to a disbursement agreement dated June 13, 1997, as amended
December 30, 1997 (the "Disbursement Agreement") among TARC, TEC, Firstar Bank
of Minnesota, N.A., as trustee (the "TEC Indenture Trustee"), Firstar Bank of
Minnesota, N.A., as disbursement agent (the "Disbursement Agent"), and Baker &
O'Brien, Inc., as construction supervisor (the "Construction Supervisor"), $208
million of the net proceeds from the sale of the TEC Notes was placed into
accounts (collectively, the "TARC Disbursement Account") to be held and
invested by the Disbursement Agent until disbursed. In addition, proceeds to
TEC and TARC of approximately $201 million from the TransTexas share repurchase
program were deposited in the TARC Disbursement Account. On December 30, 1997,
TARC deposited $119 million of the net proceeds from the issuance of its Series
A Senior Subordinated Notes into the TARC Disbursement Account for use in the
Capital Improvement Program. All funds in the TARC Disbursement Account are
pledged as security for the repayment of the TEC Notes. TEC disbursements for
TARC expenditures are treated as capital contributions.
The Disbursement Agent makes disbursements for the Capital Improvement
Program out of the TARC Disbursement Account in accordance with requests made
by TARC and approved by the Construction Supervisor. The Construction
Supervisor is required to review each such disbursement request by TARC.
Disbursements from the TARC Disbursement Account are generally restricted to
reimbursement for expenses incurred in connection with the Capital Improvement
Program. Disbursements for general and administrative expenses ($1.5 million
monthly) and, upon Mechanical Completion of certain units, for feedstock
purchases (up to a maximum aggregate of $50 million) are also permitted.
Interest income from the TARC Disbursement Account may be used for the Capital
Improvement Program or disbursed to fund administrative and other costs of TARC
and TEC. As of July 31, 1998, $469 million had been disbursed to TARC out of
the TARC Disbursement Account for use in the Capital Improvement Program and for
feedstock purchases and $22.5 million for general and administrative expenses.
In addition, special disbursements have been made in the amounts of $7 million
to pay accounts payable and $19 million for payments of interest on, and the
redemption, repurchase and defeasance of the TARC Notes.
7. INVENTORIES
The major components of inventories are as follows (in thousands of
dollars):
July 31, January 31,
1998 1998
------- ----------
Refinery feedstocks and blendstocks.... $21,926 $ --
Intermediate and refined products...... 10,107 --
Tubular goods and other................ 15,153 16,437
------- ----------
$47,186 $ 16,437
======= ==========
As noted in Note 2, TARC's inventories are valued using the
first-in-first-out method. TransTexas' inventories are valued using the average
cost method.
8. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
ARABIAN OFFSHORE PARTNERS. On June 27, 1997, Arabian Offshore Partners
filed a lawsuit against TransTexas in the 14th Judicial District Court, Dallas
County, Texas, seeking $20 million in damages in connection with TransTexas'
refusal to proceed with the acquisition of two jack-up drilling rigs.
TransTexas' motion for summary judgment was granted on January 13, 1998. The
plaintiffs have appealed.
FINKELSTEIN. On April 22, 1991, H. S. Finkelstein filed a suit against
TransAmerican and various affiliates in the 49th Judicial District Court, Zapata
County, Texas, alleging an improper calculation of overriding royalties
allegedly owed to the plaintiff and seeking damages and attorneys' fees in
excess of $33.7 million. On November 18, 1993, the plaintiff added TransTexas as
an additional defendant. The parties arbitrated this matter in January 1997. In
May 1998, the arbitration panel awarded $13 million to plaintiff, and plaintiff
subsequently obtained a judgment against TransTexas for the awarded amount.
Pursuant to a settlement agreement, TransTexas will pay the amount awarded over
a 24-month period. If payments are not made, plaintiff will have the right to
enforce its judgment.
HEIN MINERALS. On April 3, 1998, Henry and Luz A. Hein Minerals, L.C.
("Hein") filed suit in the 49th Judicial District Court, Zapata County, Texas,
against TransAmerican, TransTexas, TransTexas Transmission Corporation ("TTC")
and Conoco, Inc. Plaintiff alleges that a 1990 mineral lease from plaintiffs to
TransAmerican, comprising approximately 2,000 acres, was breached by failure to
release certain acreage from the lease. Plaintiff alleges trespass, tortious
interference, conversion, fraud, breach of fiduciary duty, breach of contract,
conversion and slander of title, and claim damages including $10 per day per
acre that was not released. In May 1998, TransTexas filed a motion to transfer
venue. TransTexas intends to vigorously defend against these claims.
ZURICH. On May 5, 1998, The Home Insurance Company and Zurich Insurance
Company filed suit against TransTexas in the United States District Court,
Southern District of New York, to enforce a $10 million arbitration award
relating to workers' compensation policies. TransTexas filed a motion to dismiss
on June 4, 1998, and intends to vigorously defend this claim.
EEOC. On September 30, 1997, the U.S. Equal Employment Opportunity
Commission ("EEOC") issued a Determination (the "Determination") as a result of
the Commissioner's Charge that had been filed in August 1995 against TARC and
Southeast Louisiana Contractors of Norco, Inc. ("Southeast Contractors")
pursuant to Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C.
Section 2000e et seq. ("Title VII"). In the Determination, the EEOC stated that
it found reasonable cause to believe that each of TARC and Southeast
Contractors had discriminated based on race and gender in its hiring and
promotion practices. Each violation of Title VII (for each individual allegedly
aggrieved), if proven, potentially could subject TARC and Southeast Contractors
to liability for (i) monetary damages for backpay and front pay in an
undetermined amount, and for compensatory damages and punitive damages in an
amount not to exceed $300,000 per plaintiff, (ii) injunctive relief, (iii)
attorney's fees, and (iv) interest. During the period covered by the
Commissioner's Charge and the Determination, TARC and Southeast Contractors
estimate that they received a combined total of approximately 23,000 to 30,000
employment applications and hired (or rehired) a combined total of
approximately 3,400 to 4,100 workers, although the total number of individuals
who ultimately are
8
<PAGE> 10
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
covered in any conciliation proposal or any subsequent lawsuit may be higher.
TARC and Southeast Contractors deny engaging in any unlawful employment
practices. TARC and Southeast Contractors intend vigorously to defend against
the allegations contained in the Commissioner's Charge and the findings set
forth in the Determination in any proceedings in state or federal court. If TARC
or Southeast Contractors is found liable for violations of Title VII based on
the matters asserted in the Determination, TARC can make no assurance that such
liability would not have a material adverse effect on its financial position,
results of operations or cash flows.
RINEHEART. On October 8, 1996, Carlton Gene Rineheart, et al., and as
representative of a class of persons similarly situated, filed suit against 84
individuals and corporations, including TARC, in the U.S. District Court, Middle
District of Louisiana alleging negligent and improper storage, handling,
treatment, and disposal of hazardous materials from 1976 to the present at two
sites in Iberville Parish, Louisiana. The suit claims damages for physical,
mental, and property damage in the communities of Bayou Sorrel, Bayou Pigeon and
Indian Village. TARC intends to vigorously defend this claim.
SHELL OIL. On September 27, 1996, Shell Oil filed a third party suit
against TARC in the U.S. District Court, Eastern District of Louisiana for
contribution and/or indemnity relating to alleged environmental contamination of
Bayou Trapagnier and surrounding lands near Norco, Louisiana. In March 1997,
TARC obtained a voluntary dismissal from Shell. Shell proceeded to trial on the
main case and settled with the plaintiffs during trial by purchasing their land
for $5 million. On June 27, 1997, Shell amended its third party action to bring
TARC back into the case. However, TARC has not yet been served in the case. If
TARC is served, it will defend the case vigorously.
GENERAL. TransTexas and TARC are also named defendants in other ordinary
course, routine litigation incidental to their businesses. Although the outcome
of these lawsuits cannot be predicted with certainty, the Company does not
expect these matters to have a material adverse effect on its financial
position, results of operations or cash flows. The litigation matters discussed
above amount to significant potential liability which, if adjudicated in a
manner adverse to TARC or TransTexas in one reporting period could have a
material adverse effect on the Company's results of operations or cash flows for
that period. At July 31, 1998, 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 $20 million.
ENVIRONMENTAL MATTERS
TransTexas' operations and properties are subject to extensive federal,
state, and local laws and regulations relating to the generation, storage,
handling, emission, transportation, and discharge of materials into the
environment. Permits are required for various of TransTexas' operations, and
these permits are subject to revocation, modification, and renewal by issuing
authorities. TransTexas also is subject to federal, state, and local laws and
regulations that impose liability for the cleanup or remediation of property
that has been contaminated by the discharge or release of hazardous materials or
wastes into the environment. Governmental authorities have the power to enforce
compliance with their regulations, and violations are subject to fines or
injunctions, or both. Certain aspects of TransTexas' operations may not be in
compliance with applicable environmental laws and regulations, and such
noncompliance may give rise to compliance costs and administrative penalties. It
is not anticipated that TransTexas will be required in the near future to expend
amounts that are material to the financial condition or operations of TransTexas
by reason of environmental laws and regulations, but because such laws and
regulations are frequently changed and, as a result, may impose increasingly
strict requirements, TransTexas is unable to predict the ultimate cost of
complying with such laws and regulations.
COMPLIANCE MATTERS. TARC is subject to federal, state and local laws,
regulations and ordinances ("Pollution Control Laws"), which regulate activities
such as discharges to air and water, as well as handling and disposal practices
for solid and hazardous wastes. TARC believes that it is now, and has included
in the Capital Improvement Program sufficient capital additions to remain, in
substantial compliance with applicable Pollution Control Laws. However,
Pollution Control Laws that may be enacted in the future, as well as
increasingly strict enforcement of existing Pollution
9
<PAGE> 11
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
Control Laws, may require TARC to make additional capital expenditures in order
to comply with such laws and regulations. To ensure continuing compliance, TARC
has made environmental compliance and permitting issues an integral part of its
refinery's start-up plans and has budgeted for such capital expenditures in the
Capital Improvement Program. However, there is no assurance that TARC will
remain in compliance with environmental regulations.
TARC uses (and in the past has used) certain materials, and generates
(and in the past has generated) certain substances or wastes, that are or may be
deemed hazardous substances or wastes. In the past, the refinery has been the
subject of certain environmental enforcement actions, and has incurred certain
fines, as a result of certain of TARC's operations. TARC also was previously
subject to enforcement proceedings relating to its prior production of leaded
gasoline and air emissions. TARC believes that, with minor exceptions, all of
these past matters were resolved prior to or in connection with the resolution
of the bankruptcy proceedings of its predecessor in interest, TransAmerican, or
are no longer applicable to TARC's operations. As a result, TARC believes that
such matters will not have a material adverse effect on TARC's future financial
position, results of operations or cash flow.
In September 1997, TARC purchased a tank storage facility located
adjacent to the refinery for a cash purchase price of $40 million (which does
not include a $3.1 million liability recorded for environmental remediation, as
discussed below). Environmental investigations conducted by the previous owner
of the facilities have indicated soil and groundwater contamination in several
areas on the property. As a result, the former owner submitted to the Louisiana
Department of Environmental Quality (the "LDEQ") plans for the remediation of
any significant indicated contamination in such areas. TARC has analyzed these
investigations and has carried out further Phase II Environmental Assessments to
verify their results. TARC intends to incorporate any required remediation into
its ongoing work at the refinery. In connection with the purchase of the
facilities, TARC agreed to indemnify the seller for all cleanup costs and
certain other damages resulting from contamination of the property, and created
a $5 million escrow account to fund required remediation costs and
indemnification claims by the seller. As a result of TARC's Phase II
Environmental Assessment, TARC believes that the amount in escrow should be
sufficient to fund the remediation costs associated with identified
contamination; however, because the LDEQ has not yet approved certain of the
remediation plans, there can be no assurance that the funds set aside in the
escrow account will be sufficient to pay all required remediation costs. As of
July 31, 1998, TARC has recognized a liability of $3.1 million for this
contingency.
REQUIREMENTS UNDER THE FEDERAL CLEAN AIR ACT. The National Emission
Standards for Hazardous Air Pollutants for Benzene Waste Operations (the
"Benzene Waste NESHAPS"), promulgated in January 1993 pursuant to the Clean Air
Act, regulate benzene emissions from numerous industries, including petroleum
refineries. The Benzene Waste NESHAPS require all existing, new, modified, or
reconstructed sources to reduce benzene emissions to a level that will provide
an ample margin of safety to protect public health. TARC will be required to
comply with the Benzene Waste NESHAPS as its refinery operations start up. TARC
believes that compliance with the Benzene Waste NESHAPS will not have a material
adverse effect on TARC's financial position, results of operations or cash flow.
Until the refinery is in full operation, however, there can be no assurance that
the regulations will not have such an effect.
In addition, the EPA promulgated National Emission Standards for
Hazardous Air Pollutants for Hazardous Organics (the "Hazardous Organic
NESHAPS") regulations for petroleum refineries under the Clean Air Act in 1995,
and subsequently has amended such regulations. These regulations set Maximum
Achievable Control Technology ("MACT") standards for petroleum refineries. The
LDEQ has incorporated MACT standards into TARC's air permits under federal and
state air pollution prevention laws. TARC believes that compliance with the
Hazardous Organics NESHAPS will not have a material adverse effect on TARC's
financial position, results of operations or cash flow. Until the refinery is in
full operation, however, there can be no assurance that the regulations will not
have such an effect.
The EPA has promulgated federal regulations pursuant to the Clean Air
Act to control fuels and fuel additives (the "Gasoline Standards") that could
have a material adverse effect on TARC. Under these regulations, only
10
<PAGE> 12
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
reformulated gasoline can be sold in certain domestic geographic areas in which
the EPA has mandated or approved its use. Reformulated gasoline must contain a
minimum amount of oxygen, have a lower vapor pressure, and have reduced sulfur,
olefins, benzene and aromatics compared to the average 1990 gasoline. The EPA
recently promulgated final National Ambient Air Quality Standards ("NAAQS") that
revise the standards for particulate matter and ozone. The number and extent of
the areas subject to reformulated gasoline standards may increase in the future
after the NAAQS are implemented. Conventional gasoline may be used in all other
domestic markets; however, a refiner's post-1994 average conventional gasoline
must not be more polluting than it was in 1990. With limited exceptions, to
determine its compliance as of January 1, 1995, a refiner must compare its
post-1994 and 1990 average values of controlled fuel parameters and emissions.
The Gasoline Standards recognize that many gasoline refiners may not be able to
develop an individual 1990 baseline for a number of reasons, including, for
example, lack of adequate data or the absence or limited scope of operations in
1990. Under such circumstances, the refiner must use a statutory baseline
reflecting the 1990 industry average. The EPA has authority, upon a showing of
extenuating circumstances by a refiner, to grant an individual adjusted baseline
or other appropriate regulatory relief to that refiner.
TARC filed a petition with the EPA requesting an individual baseline
adjustment or other appropriate regulatory relief based on extenuating
circumstances. The extenuating circumstances upon which TARC relied in its
petition include the fact that the refinery was not in operation in 1990 (and
thus there is no 1990 average for purposes of the necessary comparison) and the
fact that the start-up of the refinery is to occur on a phased-in basis. The EPA
has denied TARC's request for an individual baseline adjustment and other
regulatory relief. TARC will continue to pursue regulatory relief with the EPA.
However, there can be no assurance that regulatory relief will be granted. There
can be no assurance that any action taken by the EPA will not have a material
adverse effect on TARC's future financial position, results of operations or
cash flow.
Title V of the Clean Air Act requires states to implement an Operating
Permit Program that codifies all federally enforceable limitations that are
applicable to a particular source. The EPA has approved Louisiana's Title V
Operating Permit Program. The Title V Operating Permit is necessary for TARC to
produce at projected levels upon completion of the Capital Improvement Program.
TARC has submitted its Title V Operating Permit Application covering the
refinery and the adjacent tank storage facility. TARC believes that its
application will be approved. However, there can be no assurance that it will be
approved as submitted or that additional expenditures required pursuant to Title
V Operating Permit obligations will not have a material adverse effect on TARC's
financial position, results of operations or cash flow.
CLEANUP MATTERS. TARC also is subject to federal, state and local laws,
regulations and ordinances that impose liability for the costs of clean up
related to, and certain damages resulting from, past spills, disposals or other
releases of hazardous substances ("Hazardous Substance Cleanup Laws"). Over the
past several years, TARC has been, and to a limited extent continues to be,
engaged in environmental cleanup or remedial work relating to or arising out of
operations or activities at the refinery. In addition, TARC has been engaged in
upgrading its solid waste facilities, including the closure of several waste
management units. Similar to numerous other industrial sites in the state, the
refinery has been listed by the LDEQ on the Federal Comprehensive Environmental
Response, Compensation and Liability Information System, as a result of TARC's
prior waste management activities (as discussed below).
In 1991, the EPA performed a facility assessment at the refinery
pursuant to the Federal Resource Conservation and Recovery Act ("RCRA"). The EPA
performed a follow up assessment in March 1996, but has not yet issued a report
of its investigations. In July 1996, the EPA and the LDEQ agreed that the LDEQ
would serve as the lead agency with respect to the investigation and remediation
of areas of concern identified in the investigations. TARC, under a voluntary
initiative approved by the LDEQ, submitted a work plan to the LDEQ to determine
which areas may require further investigation and remediation. TARC submitted
further information in January 1998 which was requested by the LDEQ. Based on
the workplan submitted and additional requests by the LDEQ, TARC believes that
any further action will not have a material adverse effect on its financial
position, results of operations or cash flow.
11
<PAGE> 13
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
TARC has been identified as a potentially responsible party ("PRP")
under the Comprehensive Environmental Response, Compensation, and Liability Act
of 1980, as amended ("CERCLA" or "Superfund"), for the cleanup of contamination
from hazardous substances at three Superfund sites (i.e. sites on the National
Priorities List ("NPL")) to which it has been alleged that TARC, or its
predecessors, sent hazardous substances in the past. CERCLA requires cleanup of
sites from which there has been a "release" or threatened release of "hazardous
substances" (as such terms are defined under CERCLA). CERCLA requires the EPA to
include sites needing long-term study and cleanup on the NPL based on their
potential effect on public health or the environment. CERCLA authorizes the EPA
to take any necessary response actions at NPL sites and, in certain
circumstances, to order PRPs liable for the release to take such actions. PRPs
are broadly defined under CERCLA to include past and present owners and
operators of a site, as well as generators and transporters of wastes to a site
from which hazardous substances are released.
The EPA may seek reimbursement of expenditures of federal funds from
PRPs under Superfund. Courts have interpreted CERCLA to impose strict, joint and
several liability upon all persons liable for the entire amount of necessary
cleanup costs. As a practical matter, at sites where there are multiple PRPs for
a cleanup, the costs of cleanup typically are allocated according to a
volumetric or other standard among the parties. CERCLA also provides that
responsible parties generally may recover a portion of the costs of cleaning up
a site from other responsible parties. Thus, if one party is required to clean
up an entire site, that party can seek contribution or recovery of such costs
from other responsible parties. A number of states have laws similar to
Superfund, pursuant to which cleanup obligations, or the costs thereof, also may
be imposed.
At one Superfund site, TARC has submitted information to the EPA
indicating that it should have no liability for this matter, and negotiations
with the EPA in this regard are continuing. With respect to the remaining two
sites, TARC's liability for each such matter has not been determined, and TARC
anticipates that it may incur costs related to the cleanup (and possibly
including additional costs arising in connection with any recovery or other
actions brought pursuant or relating to such matters) at each such site. After a
review of the data available to TARC regarding the basis of TARC's alleged
liability at each site, and based on various factors, which depend on the
circumstances of the particular Superfund site (including, for example, the
relationship of TARC to each such site, the volume of wastes TARC is alleged to
have contributed to each such site in comparison to other PRPs without giving
effect to the ability of any other PRPs to contribute to or pay for any
liabilities incurred, and the range of likely cleanup costs at each such site),
TARC believes that its ultimate environmental liabilities will not be
significant; however, it is not possible to determine the ultimate environmental
liabilities, if any, that may arise from the matters discussed above.
PURCHASE COMMITMENTS
TARC has various purchase commitments for materials, supplies and
services incidental to the ordinary course of business and for the Capital
Improvement Program. As of July 31, 1998, TARC had commitments for refinery
construction and maintenance of approximately $58.5 million. TARC is acting as
general contractor and can generally cancel or postpone capital projects.
PROCESSING AGREEMENTS
In April 1996, TARC entered into a processing agreement with a third
party to process feedstocks. Under the terms of the agreement, the processing
fee earned from the third party is based on the margin earned by the third
party, if any, after deducting all of its related costs such as feedstock
acquisition, hedging, transportation, processing and inspections plus a
commission for each barrel processed. During the three months ended July 31,
1998 and 1997, TARC processed approximately 0.8 million barrels and 0.4 million
barrels, respectively, pursuant to processing agreements. Income from this
processing agreement was $1.8 million and $3.1 million for the three months
ended July 31, 1998 and 1997, respectively.
12
<PAGE> 14
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
PRODUCTION PAYMENTS
In April 1997, TransTexas sold to an unaffiliated third party a term
overriding royalty in the form of a dollar-denominated production payment in
certain of TransTexas' producing properties for net proceeds of $20 million. The
production payment calls for the repayment of the primary sum plus an amount
equivalent to a 16% annual interest rate on the unpaid portion of such primary
sum. As of July 31, 1998, the production payment had been paid in full.
In February 1998, TransTexas entered into a production payment drilling
program agreement with an unaffiliated third party for the reimbursement of
certain drilling costs with respect to wells drilled by TransTexas. Pursuant to
the agreement, upon the approval of the third party of a recently drilled or
currently drilling well for inclusion in the program, the third party will
commit to the reimbursement of all or a portion of the cost of such well, up to
an aggregate maximum for all such wells of $75 million. The program wells are
subject to a dollar-denominated production payment equal to the primary sum of
such reimbursed costs, plus an amount equivalent to a 15% annual interest rate
on the unpaid portion of such primary sum. As of July 31, 1998, the outstanding
balance of the production payment was $51.4 million.
POTENTIAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and a contingent
liability for interest of $102 million owed by TransAmerican. TransAmerican has
taken the federal tax position that the entire amount of this debt cancellation
is excluded from its income under the cancellation of indebtedness provisions
(the "COD Exclusion") of the Internal Revenue Code of 1986, as amended, and has
reduced its tax attributes (including its net operating loss and credit
carryforwards) as a consequence of the COD Exclusion. No federal tax opinion was
rendered with respect to this transaction, however, and TransAmerican has not
obtained a ruling from the Internal Revenue Service (the "IRS") regarding this
transaction. TransTexas believes that there is substantial legal authority to
support the position that the COD Exclusion applies to the cancellation of
TransAmerican's indebtedness. However, due to factual and legal uncertainties,
there can be no assurance that the IRS will not challenge this position, or that
such challenge would not be upheld. Under the Tax Allocation Agreement (defined
below), TransTexas has agreed to pay an amount equal to any federal tax
liability (which would be approximately $25.4 million) attributable to the
inapplicability of the COD Exclusion. Any such tax would be offset in future
years by alternative minimum tax credits and retained loss and credit
carryforwards to the extent recoverable from TransAmerican. As a member of the
TNGC Consolidated Group (defined below), each of TransTexas, TEC and TARC will
be severally liable for any tax liability resulting from the above-described
transactions. The IRS has commenced an audit of the consolidated federal income
tax returns of the TNGC Consolidated Group for its taxable years ended July 31,
1995 and 1994. At this time, it is not possible to predict the scope of the IRS'
review or whether any tax deficiencies will be proposed by the IRS as a result
of its review.
Based in part upon independent legal advice, TransTexas has taken the
position that it will not incur any significant federal income tax liability as
a result of the Lobo Sale. There are, however, significant uncertainties
regarding TransTexas' tax position and no assurance can be given that its
position will be sustained if challenged by the IRS. TransTexas is part of an
affiliated group for tax purposes (the "TNGC Consolidated Group"), which
includes TNGC Holdings Corporation, the sole stockholder of TransAmerican
("TNGC"), TransAmerican, TEC and TARC. No letter ruling has been or will be
obtained from the IRS regarding the Lobo Sale by any member of the TNGC
Consolidated Group. If the IRS were to successfully challenge TransTexas'
position, each member of the TNGC Consolidated Group would be severally liable
under the consolidated tax return regulations for the resulting taxes, in the
estimated amount of up to $250 million (assuming the use of existing tax
attributes of the TNGC Consolidated Group), possible penalties equal to 20% of
the amount of the tax, and interest at the statutory rate (currently 8%) on the
tax and penalties (if any). The Tax Allocation Agreement provides that
TransAmerican will be obligated to fund the entire tax deficiency (if any)
13
<PAGE> 15
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
resulting from the Lobo Sale. There can be no assurance that TransAmerican would
be able to fund any such payment at the time due and the other members of the
TNGC Consolidated Group may be required to pay the tax. TransTexas has
reserved approximately $75 million with respect to the potential tax liability
for financial reporting purposes to reflect a portion of the federal tax
liability that TransAmerican might not be able to pay. If TransTexas were
required to pay this tax deficiency, it is likely that it would be required to
sell significant assets or raise additional debt or equity capital to fund the
payment.
TNGC, TransAmerican and its existing subsidiaries, including TARC, TEC
and TransTexas, are parties to a tax allocation agreement, as amended (the "Tax
Allocation Agreement"), the general terms of which require TransAmerican and all
of its subsidiaries to file federal income tax returns as members of a
consolidated group to the extent permitted by law. Filing on a consolidated
basis allows income and tax of one member to be offset by losses and credits of
another and allows deferral of certain intercompany gains; however, each member
is severally liable for the consolidated federal income tax liability of the
consolidated group.
The Tax Allocation Agreement requires each of TransAmerican's
subsidiaries to pay to TransAmerican each year its allocable share of the
federal income tax liabilities of the consolidated group ("Allocable Share").
The Tax Allocation Agreement provides for a reallocation of the group's
consolidated federal income tax liabilities among the members if the IRS or the
courts ultimately redetermine the group's regular tax or alternative minimum tax
liability. In the event of an IRS audit or examination, the Tax Allocation
Agreement generally gives TransAmerican the authority to compromise or settle
disputes and to control litigation, subject to the approval of TARC, TEC or
TransTexas, as the case may be, where such compromise or settlement affects the
determination of the separate tax liability of that company.
Under the Tax Allocation Agreement, each subsidiary's Allocable Share
for each tax year will generally equal the amount of federal income tax it would
have owed had it filed a separate federal income tax return for each year except
that each subsidiary will be able to utilize net operating losses and credits of
TransAmerican and the other members of the consolidated group effectively to
defer payment of tax liabilities that it would have otherwise owed had it filed
a separate federal income tax return. Each subsidiary will essentially pay the
deferred taxes at the time TransAmerican (or the member whose losses or credits
are utilized by such subsidiary) begins generating taxable income or tax. This
will have the effect of deferring a portion of such subsidiary's tax liability
to future years. The parties to the Tax Allocation Agreement amended such
agreement in connection with the Lobo Sale to include additional affiliates as
parties, and further amended the Tax Allocation Agreement in June 1997 to
allocate to TransAmerican, as among the parties, any tax liability associated
with the Lobo Sale.
Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation were to occur
during the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the IRS
successfully challenged TransTexas' position on the Lobo Sale. Each member of a
consolidated group filing a consolidated federal income tax return is severally
liable to the IRS for the consolidated federal income tax liability of the
consolidated group. There can be no assurance that each TNGC Consolidated Group
member will have the ability to satisfy any tax obligation attributable to these
transactions at the time due and, therefore, other members of the group,
including TEC, TransTexas or TARC, may be required to pay the tax.
14
<PAGE> 16
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of July 31, 1998, TransTexas had
paid $8.4 million of these franchise taxes and estimates that it will pay
approximately $3.0 million during the remainder of fiscal year 1999.
POTENTIAL EFFECTS OF A CHANGE OF CONTROL
The TransTexas Subordinated Notes Indenture provides that, upon the
occurrence of a Change of Control, each holder of the TransTexas Subordinated
Notes will have the right to require TransTexas to repurchase such holder's
TransTexas Subordinated Notes at 101% of the principal amount thereof plus
accrued and unpaid interest. Pursuant to the terms of the TransTexas
Intercompany Loan, upon the occurrence of a Change of Control, TEC would have
the right to require TransTexas to repay the principal of the TransTexas
Intercompany Loan in an amount equal to a pro rata share of the amount TEC is
required to pay under the TEC Notes Indenture. Such pro rata share would be
calculated using the ratio of the outstanding principal amount of the TransTexas
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan. Pursuant to the terms of the
TARC Intercompany Loan, upon the occurrence of a Change of Control, TEC would
have the right to require TARC to repay the principal of the TARC Intercompany
Loan in an amount equal to a pro rata share of the amount TEC is required to pay
under the TEC Indenture. Such pro rata share would be calculated using the ratio
of the accreted value of the outstanding principal amount of the TARC
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the TransTexas
Subordinated Notes Indenture in the case of certain changes or other events in
respect of the ownership of TransTexas, including any circumstances pursuant to
which any person or group other than John R. Stanley (or his heirs, his estate,
or any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the TransTexas Subordinated Notes is
downgraded or withdrawn. A Change of Control would be deemed to occur under the
TransTexas Intercompany Loan in the case of certain changes or other events in
respect of the ownership or control of TEC or TransTexas, including any
circumstance pursuant to which (i) any person or group, other than John R.
Stanley (or his heirs, his estate, or any trust in which he or his immediate
family members have, directly or indirectly, a beneficial interest in excess of
50%) and his subsidiaries or the TEC Indenture Trustee is or becomes the
beneficial owner of more than 50% of the total voting power of TEC's then
outstanding voting stock, or (ii) TEC or any of its subsidiaries own some of
TransTexas' capital stock, but less than 50% of the total voting stock or
economic value of TransTexas, unless the TEC Notes have an investment grade
rating for the period of 120 days thereafter. A Change of Control would be
deemed to occur under the TEC Notes Indenture or the TARC Intercompany Loan in
the case of certain changes or other events in respect of the ownership or
control of TEC, TARC or TransTexas including any circumstance pursuant to which
(i) any person or group, other than John R. Stanley (or his heirs, his estate or
any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TEC's then outstanding voting stock, or (ii) TEC or any of
its subsidiaries own some of TARC's or TransTexas' capital stock, respectively,
but less than 50% of the total voting stock or economic value of TARC or
TransTexas', unless (in the case of either (i) or (ii) above) the TEC Notes have
an investment grade rating for the period of 120 days thereafter. The term
"person," as used in the definition of Change of Control, means a natural
person, company, government or political subdivision, agency or instrumentality
of a government and also includes a "group," which is defined as two or more
persons acting as a partnership, limited partnership or other group.
In 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 Subordinated Notes Indenture, the TEC Notes Indenture or
the TransTexas Intercompany Loan may result in a "change of control" of
TransTexas under the terms of the BNY Facility. Such an occurrence could create
an obligation for TransTexas to repay any amounts due under the BNY Facility. At
July 31, 1998, TransTexas had approximately $7.2
15
<PAGE> 17
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
million of indebtedness subject to such right of repayment. In the event of a
Change of Control under the TransTexas Subordinated Notes Indenture, the TEC
Notes Indenture or the Intercompany Loans, or a "change of control" under the
terms of the BNY Facility, there can be no assurance that TransTexas or TARC
will have sufficient funds to satisfy any such payment obligations. A change of
control or other event that results in Deconsolidation of TransTexas and
TransAmerican for federal income tax purposes could result in acceleration of a
substantial amount of federal income taxes.
LOBO SALE
Pursuant to the Lobo Sale, TransTexas is required to indemnify the
buyer for certain liabilities related to the assets owned by TTC. Although
TransTexas does not anticipate that it will incur any material indemnity
liability, no assurance can be given that TransTexas will have sufficient funds
to satisfy any such indemnity obligation or that any payment thereof will not
have a material adverse effect on its ability to fund its debt service, capital
expenditure and working capital requirements.
DELIVERY COMMITMENTS
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 475 MMcf per day to specified delivery points.
TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.4 million and $2.4
million during the three and six months ended July 31, 1998, respectively. Under
a proposed settlement agreement, delivery commitments of approximately 350 MMcf
per day will be released in exchange for TransTexas' interest in a pipeline,
elimination of amounts due TransTexas pursuant to the Lobo Sale Agreement and a
cash payment by TransTexas of $2.7 million. TransTexas reduced the gain on sale
of assets by $3.4 million as a result of this proposed settlement.
REGISTRATION RIGHTS AGREEMENT
TARC had an obligation under its Registration Rights Agreement with the
holders of its Senior Subordinated Notes to have its registration statement on
Form S-4 relating to the Exchange Offer for the Senior Subordinated Notes
declared effective by the Securities and Exchange Commission by July 28, 1998.
As a result of its failure to meet its obligation under the Registration Rights
Agreement, TARC will incur $10,000 per week in additional interest from July 28,
1998 until such date as the registration statement is declared effective.
16
<PAGE> 18
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
9. 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,
---------------------------
1998 1997
----------- ----------
<S> <C> <C>
Accounts payable for property and equipment ................... $ 84,925 $ 36,825
Product financing arrangements ................................ 15,274 --
Accrued interest on long-term debt capitalized
in property and equipment ................................... 57,689 30,426
Exchange of Subordinated Notes ................................ -- 115,815
</TABLE>
10. CREDIT AGREEMENT
TransTexas and BNY Financial Corporation ("BNY") are parties to a
Second Amended and Restated Accounts Receivable Management and Security
Agreement (the "BNY Facility"), dated as of October 14, 1997. As of July 31,
1998, outstanding advances under the BNY Facility totaled approximately $7.2
million. Interest accrues on advances at the rate of (i) the higher of (a) the
prime rate of The Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1%
plus (ii) 1/2 of 1%. Obligations under the BNY Facility are secured by liens on
TransTexas' receivables and inventory. The BNY Facility contains certain
financial covenants including a limitation on net losses.
11. TRANSACTIONS WITH AFFILIATES
On June 13, 1997, a services agreement was entered into among
TransAmerican, TEC, TARC and TransTexas. Under the services agreement,
TransTexas provides accounting, legal, administrative and other services to
TARC, TEC and TransAmerican and its affiliates. TransAmerican will provide
advisory services to TransTexas, TARC and TEC. TARC will pay to TransTexas
approximately $300,000 per month for services rendered and for allocated
expenses paid by TransTexas on behalf of TARC. TransAmerican will pay to
TransTexas approximately $20,000 per month for such services. TEC and its
subsidiaries will pay $2.5 million in the aggregate per year to TransAmerican
for advisory services and benefits provided by TransAmerican. As of July 31,
1998, the payable to TransAmerican for such services was $2.5 million.
17
<PAGE> 19
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
Southeast Contractors, a subsidiary of TransAmerican, provides
construction personnel to TARC in connection with the Capital Improvement
Program. These construction workers are temporary employees, and the number and
composition of the workforce will vary throughout the Capital Improvement
Program. Southeast Contractors charges TARC for the direct costs it incurs
(which consist solely of employee payroll and benefits) plus administrative
costs and fees of up to $2.0 million per year. Total labor costs charged by
Southeast Contractors for the three and six months ended July 31, 1998 and 1997
were $44.5 million, $82.0 million, $7.5 million and $9.7 million, respectively,
of which $9.6 million and $2.0 million were payable at July 31, 1998 and January
31, 1998, respectively.
12. IMPAIRMENT LOSS
As of July 31, 1998, TransTexas' net capitalized costs of gas and oil
properties exceeded the cost center ceiling. Under the full cost method of
accounting for exploration and development costs, the net capitalized costs of
gas and oil properties are limited to the lower of unamortized cost or the cost
center ceiling. For the three months ended July 31, 1998, TransTexas adjusted
its net capitalized costs resulting in a non-cash pre-tax loss of approximately
$16.3 million.
TransTexas has also evaluated the carrying value of a pipeline system
which is currently underutilized. Based on existing production levels,
TransTexas believes the pipeline will remain significantly underutilized.
Accordingly, TransTexas recorded a non-cash pre-tax loss of approximately $5.5
million related to the pipeline.
18
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The condensed consolidated financial statements of TEC reflect the
results of operations of TEC's wholly and majority owned subsidiaries, TARC and
TransTexas. As of July 31, 1998, TransTexas' operations consisted of exploration
and production of natural gas, condensate and natural gas liquids ("E&P").
TARC's business is refining and storage operations ("Refining"). As described in
Note 1 of Notes to 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.
TRANSTEXAS
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 its ability to minimize
finding and lifting costs and maintaining its reserve base while maximizing
production. On May 29, 1997, TransTexas consummated a stock purchase agreement
with an unaffiliated buyer (the "Lobo Sale Agreement"), with an effective date
of March 1, 1997, to effect the sale (the "Lobo Sale") of the stock of
TransTexas Transmission Corporation ("TTC"), its subsidiary that owned
substantially all of TransTexas' Lobo Trend producing properties and related
pipeline transmission system, for an adjusted sales price of approximately $1.1
billion. Accordingly, TransTexas' reported results for the three and six months
ended July 31, 1998 reflect the effects of reduced sales volumes as a result of
the Lobo Sale.
TransTexas' operating data for the three and six months ended July 31,
1998 and 1997, is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales volumes:
Gas (Bcf)(1) 8.7 17.8 16.5 53.2
NGLs (MMgal) 1.3 14.3 3.3 61.7
Condensate (MBbls) 147 151 219 426
Average prices:
Gas (dry) (per Mcf)(2) $ 2.23 $ 2.06 $ 2.21 $ 1.80
NGLs (per gallon) .18 .26 .23 .29
Condensate (per Bbl) 12.24 18.33 12.65 19.46
Number of gross wells drilled 15 26 28 55
Percentage of wells completed 80% 54% 75% 58%
</TABLE>
----------------------
(1) Sales volumes for the six months ended July 31, 1997 include 7.3
Bcf delivered prior to the third quarter pursuant to volumetric
production payments.
(2) Average prices for the three and six months ended July 31, 1997
include amounts delivered under volumetric production payments.
The average gas price for TransTexas' undedicated production for
these periods were $2.06 per Mcf and $1.91 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):
19
<PAGE> 21
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
July 31, July 31,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating costs and expenses:
Lease $ 3.5 $ 4.3 $ 6.7 $ 12.2
Pipeline and gathering 1.1 3.2 3.7 11.4
Natural gas liquids -- 3.6 -- 14.5
Drilling services 1.5 0.6 2.2 0.7
-------- -------- -------- --------
6.1 11.7 12.6 38.8
Taxes other than income taxes (1) 2.5 2.5 3.5 7.7
-------- -------- -------- --------
$ 8.6 $ 14.2 $ 16.1 $ 46.5
======== ======== ======== ========
</TABLE>
-----------------------------
(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,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Depletion rates (per Mcfe) $ 1.36 $ 1.02 $ 1.34 $ 1.04
======== ======== ======== ========
</TABLE>
THREE MONTHS ENDED JULY 31, 1998, COMPARED WITH THE THREE MONTHS ENDED
JULY 31, 1997
Gas, condensate and NGL revenues for the three months ended July 31,
1998 decreased $18.8 million from the prior period, due primarily to decreases
in gas, condensate and NGLs sales volumes attributable to the divestiture of
producing properties as a result of the Lobo Sale. The average monthly prices
received per Mcf of gas ranged from $2.17 to $2.31 in the three months ended
July 31, 1998, compared to a range of $2.02 to $2.17, excluding amounts
dedicated to volumetric production payments, in the prior period. As of July 31,
1998, TransTexas had a total of 126 producing wells compared to 99 producing
wells at July 31, 1997. Transportation revenues decreased $2.8 million over the
prior period due primarily to the divestiture of the pipeline system as a result
of the Lobo Sale. Drilling services revenues increased by $1.2 million for the
three months ended July 31, 1998, due primarily to an increase in services
provided to third parties. For the three months ended July 31, 1998, TransTexas
recognized a pre-tax gain of $52.3 million on the sale of certain drilling
services division assets offset by a pre-tax loss of $4.6 million related to
additional adjustments to the Lobo Sale purchase price.
Lease operating expenses for the quarter ended July 31, 1998 decreased
by $0.8 million from the prior period due primarily to the Lobo Sale and the
resulting decrease in the number of producing wells. Pipeline and gathering
expenses decreased $2.1 million from the prior period due primarily to the
divestiture of the pipeline system. NGL costs decreased by $3.6 million from the
prior period primarily due to the Lobo Sale and the resulting decrease in the
volumes of natural gas processed. Drilling service expenses for the three months
ended July 31, 1998 increased $0.9 million primarily due to increased costs
related to providing services to the new operator of the Lobo Trend properties.
Depreciation, depletion and amortization expense for the three months ended July
31, 1998 decreased $6.5 million due to the Lobo Sale and the resulting decrease
in TransTexas' undedicated natural gas production, partially offset by a $0.34
per Mcfe increase in the depletion rate. General and administrative expenses
decreased by $3.3 million primarily as a result of a decrease in litigation
expense. Taxes other than income taxes decreased marginally over the prior
period due primarily to decreases in severance taxes associated with the Lobo
Sale and resulting decrease in the number of producing wells offset by increases
in ad valorem and excise taxes. The impairment loss of $21.8 million for the
quarter ended July 31, 1998 relates to a write-down of $16.3 million of
TransTexas' net capitalized costs of gas and oil properties to the cost center
ceiling and a $5.5 million write-down of an underutilized pipeline system that
is contemplated to be exchanged as part of a proposed settlement agreement of
certain natural gas delivery commitments.
Interest income for the three months ended July 31, 1998 decreased by
$5.1 million as compared to the prior period due to lower cash balances
available for investment. TransTexas does not expect to earn significant
interest income during the remainder of fiscal year 1999. Interest expense
decreased by $0.9 million primarily as a result of the retirement of the Senior
Secured Notes in June 1997, and an increase in the amount of interest
capitalized in connection with the acquisition of undeveloped leasehold acreage
and interest associated with the TransTexas Intercompany Loan.
SIX MONTHS ENDED JULY 31, 1998, COMPARED WITH THE SIX MONTHS ENDED JULY
31, 1997
Gas, condensate and NGL revenues for the six months ended July 31, 1998
decreased by $72.3 million from the prior period, due primarily to decreases in
gas, condensate and NGLs sales volumes attributable to the divestiture of
producing properties as a result of the Lobo Sale. The average monthly prices
received per Mcf of gas, ranged from $2.36 to $2.09 in the six months ended July
31, 1998, compared to a range of $2.29 to $1.49, excluding amounts dedicated to
volumetric production payments in the same period in the prior year. As of July
31, 1998, TransTexas had a total of 126 producing wells compared to 99 producing
wells at July 31, 1997. Transportation revenues decreased $12.1 million over the
prior period due primarily to the divestiture of the pipeline system as a result
of the Lobo Sale. Drilling services revenues increased by $4.4 million for the
six months ended July 31, 1998 due to an increase in services provided to third
parties. TransTexas recognized a pre-tax gain of $62.6 million the sale of
certain drilling services division assets and a pre-tax loss of $2.6 million due
to post-closing adjustments to the Lobo Sale purchase price.
Lease operating expenses for the six months ended July 31, 1998
decreased by $5.5 million from the prior period due primarily to the Lobo Sale
and the resulting decrease in the number of producing wells. Pipeline and
gathering expenses decreased by $7.7 million from the prior period due primarily
to the divestiture of the pipeline system. NGL costs decreased by $14.5 million
from the prior period due to the Lobo Sale and the resulting decrease in the
volumes of natural gas processed. Drilling service expenses for the six months
ended July 31, 1998 increased $1.5 million primarily due to increased costs
related to providing services to the new operator of the Lobo Trend properties.
Depreciation, depletion and amortization expense for the six months ended July
31, 1998 decreased $28.3 million due to the Lobo Sale and the resulting decrease
in TransTexas' undedicated natural gas production, partially offset by a $0.30
per Mcfe increase in the depletion rate. General and administrative expenses
decreased by $12.7 million primarily as a result of a decrease in litigation
expense. Taxes other than income taxes decreased by $4.2 million over the prior
period due primarily to decreases in ad valorem, severance and excise taxes
associated with the Lobo Sale and the resulting decrease in the number of
producing wells. The impairment loss of $21.8 million for the quarter ended July
31, 1998 relates to a write-down of $16.3 million of TransTexas' net capitalized
costs of gas and oil properties to the cost center ceiling and a $5.5 million
write-down of an underutilized pipeline system that is contemplated to be
exchanged as part of a proposed settlement agreement of certain natural gas
delivery commitments.
Interest income for the six months ended July 31, 1998 decreased by
$6.3 million as compared to the prior period due to lower cash balances
available for investment. TransTexas does not expect to earn significant
interest income during the remainder of fiscal year 1999. Interest expense
decreased by $6.7 million primarily as a result of the retirement of the Senior
Secured Notes in June 1997.
TARC
RESULTS OF OPERATIONS
TARC's refinery was inoperative from January 1983 through February
1994. During this period, TARC's revenues were derived primarily from tank
rentals and its expenses consisted of maintenance and repairs, tank rentals,
general and administrative expenses and property taxes. The No. 2 Vacuum Unit
was operated intermittently between March 1994 and January 1997. The No. 2
Vacuum Unit recommenced operations in May 1998 and the No. 2 Crude Unit
commenced operations in June 1998. TARC does not consider its historical results
to be indicative of future results.
TARC's results of operations are dependent on the operating status of
certain units within its refinery, which determines the types of feedstocks
processed and refined product yields. The results are also affected by the unit
costs of purchased feedstocks and the unit prices of refined products, which can
vary significantly. The Capital Improvement Program is designed to significantly
change TARC's throughput capacity, the feedstocks processed, and refined product
yields.
TARC believes, based on current estimates of refining margins and costs
of the expansion and modification of the refinery, that future undiscounted cash
flows will be sufficient to recover the cost of the refinery over its estimated
useful life. Management believes there have been no events or changes in
circumstances that would require the recognition of an impairment loss. However,
due to the inherent uncertainties in estimating future refining margins, and in
constructing and operating a large-scale refinery, there can be no assurance
that TARC will ultimately recover
20
<PAGE> 22
the cost of the refinery. Management believes that the book value of the
refinery is in excess of its current estimated fair market value.
THREE MONTHS ENDED JULY 31, 1998, COMPARED WITH THE THREE MONTHS ENDED JULY
31, 1997
TARC's revenues for the three months ended July 31, 1998 resulted
primarily from sales of vacuum gas oil ("VGO"), naphtha and distillate produced
by the No. 2 Vacuum Unit and the No. 2 Crude Unit. The average price of the
approximately 481,000 barrels of VGO and naphtha sold was $14.14, and the
average price of the 104,000 barrels of distillate sold was $15.16. Other
revenues consisted primarily of rental income from TARC's tank storage facility
acquired in September 1997.
Cost of products sold of $7.8 million for the three months ended July
31, 1998 related to the refining of approximately 585,000 barrels of feedstocks
purchased at an average price of $13.11 per barrel.
During 1998 and 1997, TARC entered into processing arrangements
whereby TARC did not take title to feedstocks or refined products but received a
fee based on margins, if any, realized by the counterparty to the arrangement.
TARC retained all market and production risks related to barrels processed.
These arrangements, which are recorded net in the statement of operations,
resulted in income of $1.8 million and $3.1 million for the three months ended
July 31, 1998 and 1997, respectively.
Operations and maintenance expense for the three months ended July 31,
1998 decreased to $3.1 million from $4.2 million for the same period in 1997,
primarily due to increased capitalization of costs related to the Capital
Improvement Program and an allocation of overhead to inventory.
TARC incurred no income or loss on purchase commitments for the three
months ended July 31, 1998 compared to a $0.3 million gain on purchase
commitments for the same period in 1997.
Depreciation and amortization expense for the three months ended July
31, 1998 increased to $1.8 million from $1.7 million for the same period in
1997, primarily due to depreciation related to the tank storage facility
acquired in September 1997.
General and administrative expenses for the three months ended July
31, 1998 increased to $5.9 million from $2.3 million for the same period in
1997. The increase was primarily due to increased salaries and training for
personnel added in anticipation of the commencement of refinery operations,
services agreement fees and increased professional fees.
Taxes other than income taxes for the three months ended July 31, 1998
increased to $1.3 million from $0.9 million for the same period in 1997,
primarily due to increased franchise taxes.
Interest income for the three months July 31, 1998 increased to $1.5
million from $0.9 million for the same period in 1997, primarily due to the
investment of proceeds from the TARC Intercompany Loan and Senior Subordinated
Notes. Net interest expense, for the three months ended July 31, 1998 decreased
to $1.1 million from $3.5 million for the same period in 1997, due primarily to
increased interest capitalization. During the three months ended July 31, 1998,
TARC capitalized approximately $41.6 million of interest related to Capital
Improvement Program additions compared to $22.8 million for the three months
ended July 31, 1997.
The loss on the early retirement of debt of $84.4 million for the
three months ended July 31, 1997 was a result of the completion of the TARC
Notes Tender Offer.
SIX MONTHS ENDED JULY 31, 1998, COMPARED WITH THE SIX MONTHS ENDED JULY 31,
1997
TARC's revenues for the six months ended July 31, 1998 resulted
primarily from sales of VGO, naphtha and distillate produced by the No. 2 Vacuum
Unit and the No. 2 Crude Unit. The average price of the approximately 481,000
barrels of VGO and naphtha sold was $14.14, and the average price of the 104,000
barrels of distillate sold was $15.16. Other revenues consisted primarily of
rental income from TARC's tank storage facility acquired in September 1997.
Cost of products sold of $7.8 million for the six months ended July
31, 1998 related to the refining of approximately 585,000 barrels of feedstocks
purchased at an average price of $13.11 per barrel.
During 1998 and 1997, TARC entered into processing arrangements
whereby TARC did not take title to feedstocks or refined products but received a
fee based on margins, if any, realized by the counterparty to the arrangement.
TARC retained all market and production risks related to barrels processed.
These arrangements, which are recorded net in the statement of operations,
resulted in income of $1.8 million and $3.2 million for the six months ended
July 31, 1998 and 1997, respectively.
Operations and maintenance expense for the six months ended July 31,
1998 decreased to $5.8 million from $7.9 million for the same period in 1997,
primarily due to the increased capitalization of costs related to the Capital
Improvement Program and an allocation of overhead to inventory.
Loss on purchase commitments of $4.8 million for the six months ended
July 31, 1997 related to a commitment to purchase 0.6 million barrels of
feedstock. These barrels have been sold to a third party and TARC has processed
the barrels pursuant to a processing agreement with the third party.
Depreciation and amortization expense for the six months ended July
31, 1998 increased to $4.5 million from $3.4 million for the same period in
1997, primarily due to depreciation related to the tank storage facility
acquired in September 1997.
General and administrative expenses increased to $12.0 million for the
six months ended July 31, 1998 from $5.0 million for the same period in 1997.
The increase was primarily due to increased salaries and training for personnel
added in anticipation of the commencement of refinery operations, services
agreement fees and increased professional fees.
Taxes other than income taxes for the six months ended July 31, 1998
increased to $2.3 million from $1.8 million for the same period in 1997,
primarily due to increased franchise taxes.
Interest income for the six months ended July 31, 1998 increased to
$3.8 million from $1.0 million for the same period in 1997, primarily due to the
investment of proceeds from the TARC Intercompany Loan and Senior Subordinated
Notes. Net interest expense for the six months ended July 31, 1998 increased to
$8.0 million from $6.8 million for the same period in 1997, due primarily to
interest on the TARC Intercompany Loan and Senior Subordinated Notes partially
offset by increased interest capitalization. During the six months ended July
31, 1998, TARC capitalized approximately $75.3 million of interest related to
Capital Improvement Program additions compared to $41.6 million for the six
months ended July 31, 1997.
The loss on the early extinguishment of debt of $1.3 million for the
six months ended July 31, 1998 is a result of the redemption of $7.0 million of
TARC Notes in February 1998. The loss on the early retirement of debt of $84.4
million for the six months ended July 31, 1997 was a result of the completion of
the TARC Notes Tender Offer.
The cumulative effect of a change in accounting principle of $2.7
million for the six months ended July 31, 1998 relates to TARC's selection of
the deferred method of accounting for turnaround costs as described in Note 2 of
Notes to Condensed Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
TransTexas makes substantial capital expenditures for the exploration
and development of natural gas reserves. TransTexas historically has financed
its capital expenditures, debt service and working capital requirements with
cash flow from operations, public and private offerings of debt and equity
securities, the sale of production payments, asset sales, an accounts receivable
revolving credit facility and other financings. Cash flow from operations is
sensitive to the prices TransTexas receives for its natural gas.
During the six months ended July 31, 1998, TransTexas' total capital
expenditures were $128 million, including $12 million for lease acquisitions,
$107 million for drilling and development, and $9 million for gas gathering,
other equipment and seismic acquisitions. Subject to cash availability, capital
expenditures for fiscal year 1999 are estimated to be approximately $177
million, which is in excess of projected cash flow from operations. A reduction
in planned capital spending could result in less than anticipated cash flow from
operations in fiscal year 1999 and later years, which could have a material
adverse effect on TransTexas. To finance its capital expenditure and working
capital requirements, TransTexas will be required to supplement its anticipated
cash flow from operations with a combination of asset sales and financing which
may include borrowings or production payments. TransTexas' debt covenants may
limit its ability to obtain additional financing or to sell properties, and
there is no assurance that adequate funds can be obtained on a timely basis from
such sources.
In March 1998, TransTexas executed an amended and restated note in the
principal amount of approximately $14.9 million consolidating equipment
financing debt previously incurred. Concurrently, TransTexas incurred an
21
<PAGE> 23
additional $14 million in equipment financing debt, evidenced by a promissory
note. These notes were repaid in June 1998 with proceeds from the sale of
TransTexas drilling rigs.
In February 1998, TransTexas entered into a production payment drilling
program agreement with an unaffiliated third party for the reimbursement of
certain drilling costs with respect to wells drilled by TransTexas. Pursuant to
the agreement, upon the approval of the third party of a recently drilled or
currently drilling well for inclusion in the program, the third party will
commit to the reimbursement of all or a portion of the cost of such well, up to
an aggregate maximum for all such wells of $75 million. The program wells are
subject to a dollar-denominated production payment equal to the primary sum of
such reimbursed costs, plus an amount equivalent to a 15% annual interest rate
on the unpaid portion of such primary sum. As of July 31, 1998, the outstanding
balance on the production payment was $51.4 million.
TransTexas and BNY Financial Corporation are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of July 31, 1998, outstanding
advances under the BNY Facility totaled approximately $7.2 million. Interest
accrues on advances at the rate of (i) the higher of (a) the prime rate of The
Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1% plus (ii) 1/2 of
1%. Obligations under the BNY Facility are secured by liens on TransTexas'
receivables and inventory.
Subsequent to the Lobo Sale, TransTexas' exploration and production
activities were no longer concentrated in the Laredo, Texas area nor comparable
to those historically conducted. Therefore, the utilization of a centrally
located drilling services operation in Laredo was no longer as efficient or cost
effective. In April 1998, TransTexas sold its oilfield stimulation, cementing
and coiled tubing equipment and related facilities for a sales price of $30
million, subject to post-closing adjustments. In June 1998, TransTexas sold its
drilling rigs and related assets for a sales price of $75 million. In August
1998, TransTexas sold its remaining drilling services assets for a sales price
of $20.5 million. TransTexas expects that its future general and administrative
expenses and operating expenses will be reduced as a result of these sales.
TARC estimates that capital expenditures for the Capital Improvement
Program will be $431 million during the fiscal year ending January 31, 1999 and
$53 million during the fiscal year ending January 31, 2000. TARC currently
estimates that Capital Improvement Program costs may increase by $221 million to
$245 million over the $427 million originally estimated, depending upon the
extent to which an unallocated contingency amount of $24 million is used. See
Note 3 of Notes to Condensed Consolidated Financial Statements. If engineering
problems, further cost overruns or delays occur and other financing sources are
not available, TARC will not be able to complete either phase of the Capital
Improvement Program. TARC has historically incurred losses and negative cash
flow from operating activities as a result of limited refinery operations that
did not cover the fixed costs of maintaining the refinery, increased working
capital requirements (including debt service) and losses on refined product
sales and processing arrangements. As described in Note 3 of Notes to Condensed
Consolidated Financial Statements, TARC must raise additional funds in order to
complete the Capital Improvement Program. There is no assurance that TARC can
raise additional funds, complete the Capital Improvement Program, fund its
future working capital requirements or achieve positive cash flow from
operations. As a result, there is substantial doubt about TARC's ability to
continue as a going concern. The condensed consolidated financial statements do
not include any adjustments that might result from the outcome of these
uncertainties.
The TEC Notes Indenture permits TARC to obtain a revolving credit
facility but places certain limitations on TARC's ability to incur other
indebtedness. In order to operate the refinery at expected levels after the
completion of Phase I of the Capital Improvement Program, TARC will require
additional working capital. TARC has not obtained a working capital facility.
During the three months ended July 31, 1998, TARC purchased
approximately 3.7 million barrels of feedstocks financed by cash-backed letters
of credit and letters of credit supported by the credit of a third party. Under
the third-party arrangement, if TARC is unable to obtain feedstock disbursements
from the TARC Disbursement Account prior to a draw under the letters of credit,
the third party will take title to the feedstock and TARC will be required to
buy the feedstock from the third party at a price equal to the purchase price
plus interest at a rate of 15% per annum.
As of July 31, 1998, TARC and TEC had deposited an aggregate of $529
million into accounts (collectively, the "TARC Disbursement Account") from which
disbursements are made pursuant to a disbursement agreement, as
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<PAGE> 24
amended (the "Disbursement Agreement") among TARC, TEC, Firstar Bank of
Minnesota, N.A., as trustee (the "TEC Indenture Trustee") under the indenture
governing the TEC Notes (the "TEC Notes Indenture"), Firstar Bank of Minnesota,
N. A., as Disbursement Agent, and Baker & O'Brien, Inc., as Construction
Supervisor. See Note 6 of Notes to Condensed Consolidated Financial Statements.
Of these funds, $427 million was designated for the Capital Improvement Program,
approximately $25.5 million was designated for general and administrative
expenses, $7 million was designated for outstanding accounts payable, $50
million was designated for working capital upon completion of the Delayed Coking
Unit and certain supporting units and $19 million was designated for the payment
of interest on, or the redemption, purchase, defeasance or other retirement of,
the outstanding TARC Notes. As of July 31, 1998, $469 million had been disbursed
to TARC out of the TARC Disbursement Account for use in the Capital Improvement
Program and for feedstock purchases, $7 million for accounts payable, $22.5
million for general and administrative expenses and $19 million for the payment
of interest on, and the redemption, repurchase and defeasance of the TARC Notes.
In April 1996, TARC entered into a processing agreement with a third
party to process feedstocks. Under the terms of the agreement, the processing
fee earned from the third party is based on the margin earned by the third
party, if any, after deducting all of its related costs such as feedstock
acquisition, hedging, transportation, processing and inspections plus a
commission for each barrel processed. During the three months ended July 31,
1998 and 1997, TARC processed approximately 0.8 million barrels and 0.4 million
barrels, respectively, pursuant to processing agreements. Income from this
processing agreement was $1.8 million and $3.2 million for the six months ended
July 31, 1998 and 1997, respectively.
TARC had an obligation under its Registration Rights Agreement with the
holders of its Senior Subordinated Notes to have its registration statement on
Form S-4 relating to the Exchange Offer for the Senior Subordinated Notes
declared effective by the Securities and Exchange Commission by July 28, 1998.
As a result of its failure to meet its obligation under the Registration Rights
Agreement, TARC will incur $10,000 per week in additional interest from July 28,
1998 until such date as the registration statement is declared effective.
TEC's only source of funds for its holding company operations and debt
service will be from working capital, interest payments on the Intercompany
Loans to TransTexas and TARC, dividends from its subsidiaries, payments made by
TARC on behalf of TEC pursuant to the Services Agreement and, in limited
circumstances as permitted by the TEC Notes Indenture, sales of stock TEC holds
in its subsidiaries.
During the two years following the TEC Notes Offering, TEC anticipates
that its annual cash needs for holding company operations will be approximately
$2.0 million, which TEC expects to be paid on its behalf by TARC pursuant to the
Services Agreement, and TEC's annual cash interest expense will be approximately
$54.6 million. In addition, TEC and its subsidiaries will pay $2.5 million in
the aggregate per year to TransAmerican for advisory services and other benefits
provided by TransAmerican. TransTexas will be required to pay TEC approximately
$48.9 million in interest annually on the TransTexas Intercompany Loan. TEC
expects to use this interest income together with working capital, if any, to
satisfy its cash needs, including its cash interest payments. If TEC incurs
unforeseen expenses, there is no assurance that its capital resources will be
sufficient to fund those expenses in addition to anticipated holding company
expenses and debt service.
The TEC Notes Indenture prohibits TEC from selling stock of TransTexas
and TARC during the two years following consummation of the TEC Notes Offering
unless the proceeds from such sales would be used to make an offer to purchase
the TEC Notes. Consequently, during the two years following the consummation of
the TEC Notes Offering, unless holders of the TEC Notes rejected all or a
portion of any such offer to purchase, sales of such stock would not be a source
of funds to supplement TEC's other resources in order to pay unforeseen
expenses.
Environmental compliance and permitting issues are an integral part of
the capital expenditures anticipated in connection with the expansion and
modification of the refinery. TARC does not expect to incur any additional
significant expenses for environmental compliance during fiscal 1999 other than
those budgeted for the Capital Improvement Program. There is no assurance,
however, that costs incurred to comply with environmental laws will not have a
material adverse effect on TARC's future financial condition, results of
operations or cash flow.
CONTINGENT LIABILITIES
The Company has significant contingent liabilities, including
liabilities with respect to the litigation matters described in Note 8 of Notes
to Condensed Consolidated Financial Statements. These matters, individually and
in the aggregate, amount to significant potential liability which, if
adjudicated in a manner adverse to the Company in one reporting period, could
have a material adverse effect on the Company's cash flows or results of
operations for that period.
Pursuant to the Lobo Sale Agreement, TransTexas is required to
indemnify the buyer for certain liabilities related to the assets owned by TTC.
Although TransTexas does not anticipate that it will incur any material
indemnity liability, no assurance can be given that TransTexas will have
sufficient funds to satisfy any such indemnity obligation or that any payment
thereof will not have a material adverse effect on its ability to fund its debt
service, capital expenditure and working capital requirements.
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 475 MMcf per day to specified delivery points.
TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.4 million and $2.4
million during the three and six months ended July 31, 1998, respectively. Under
a proposed settlement agreement, delivery commitments of approximately 350 MMcf
per day will be released in exchange for TransTexas' interest in a pipeline,
elimination of amounts due TransTexas pursuant to the Lobo Sale Agreement and a
cash payment by TransTexas of $2.7 million. TransTexas reduced the gain on the
sale of assets by $3.4 million as a result of this proposed settlement.
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<PAGE> 25
POTENTIAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence of the COD Exclusion.
No federal tax opinion was rendered with respect to this transaction, however,
and TransAmerican has not obtained a ruling from the Internal Revenue Service
(the "IRS") regarding this transaction. TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness. However, due to
factual and legal uncertainties, there can be no assurance that the IRS will not
challenge this position, or that such challenge would not be upheld. Under an
agreement between TransTexas, TransAmerican and certain of TransAmerican's
subsidiaries (the "Tax Allocation Agreement"), TransTexas has agreed to pay an
amount equal to any federal tax liability (which would be approximately $25.4
million) attributable to the inapplicability of the COD Exclusion. Any such tax
would be offset in future years by alternative minimum tax credits and retained
loss and credit carryforwards to the extent recoverable from TransAmerican. As a
member of the TNGC Consolidated Group (defined below), each of TransTexas, TEC
and TARC will be severally liable for any tax liability resulting from the
above-described transactions. The IRS has commenced an audit of the consolidated
federal income tax returns of the TNGC Consolidated Group for its taxable years
ended July 31, 1995 and 1994. At this time, it is not possible to predict the
scope of the IRS' review or whether any tax deficiencies will be proposed by the
IRS as a result of its review.
Based in part upon independent legal advice, TransTexas has taken the
position that it will not incur any significant federal income tax liability as
a result of the Lobo Sale. There are, however, significant uncertainties
regarding TransTexas' tax position and no assurance can be given that its
position will be sustained if challenged by the IRS. TransTexas is part of an
affiliated group for tax purposes (the "TNGC Consolidated Group"), which
includes TNGC Holdings Corporation, the sole stockholder of TransAmerican. No
letter ruling has been or will be obtained from the IRS regarding the Lobo Sale
by any member of the TNGC Consolidated Group. If the IRS were to successfully
challenge TransTexas' position, each member of the TNGC Consolidated Group would
be severally liable under the consolidated tax return regulations for the
resulting taxes, in the estimated amount of up to $250 million (assuming the use
of existing tax attributes of the TNGC Consolidated Group), possible penalties
equal to 20% of the amount of the tax, and interest at the statutory rate
(currently 8%) on the tax and penalties (if any). The Tax Allocation Agreement
provides that TransAmerican will be obligated to fund the entire tax deficiency
(if any) resulting from the Lobo Sale. There can be no assurance that
TransAmerican would be able to fund any such payment at the time due and the
other members of the TNGC Consolidated Group may be required to pay the
tax. TransTexas has reserved approximately $75 million with respect to the
potential tax liability for financial reporting purposes to reflect a portion of
the federal tax liability that TransAmerican might not be able to pay. If
TransTexas were required to pay this tax deficiency, it is likely that it would
be required to sell significant assets or raise additional debt or equity
capital to fund the payment.
Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation were to occur
during the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the IRS
successfully challenged TransTexas' position on the Lobo Sale. Each member of a
consolidated group filing a consolidated federal income tax return is severally
liable to the IRS for the consolidated federal income tax liability of the
consolidated group. There can be no assurance that each TNGC Consolidated Group
member will have
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<PAGE> 26
the ability to satisfy any tax obligation attributable to these transactions at
the time due and, therefore, other members of the group, including TEC,
TransTexas or TARC, may be required to pay the tax.
Generally, under the Tax Allocation Agreement, if net operating losses
of TransTexas or TARC are used by other members of the TNGC Consolidated Group,
then TransTexas and TARC are entitled to the benefit (through reduced current
taxes payable) of such losses in later years to the extent TransTexas or TARC
has taxable income, remains a member of the TNGC Consolidated Group and the
other group members have the ability to pay such taxes. If TransAmerican or TEC
transfers shares of common stock of TransTexas (or transfers options or other
rights to acquire such shares) and, as a result of such transfer,
Deconsolidation of TransTexas occurs, TransTexas would not thereafter receive
any benefit pursuant to the Tax Allocation Agreement for net operating losses of
TransTexas used by other members of the TNGC Consolidated Group prior to the
Deconsolidation of TransTexas.
TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of July 31, 1998, TransTexas had
paid approximately $8.4 million of these franchise taxes and estimates that
approximately $3.0 million will be paid during the remainder of fiscal year
1999.
POTENTIAL EFFECTS OF CHANGE OF CONTROL
The TransTexas Subordinated Notes Indenture provides that, upon the
occurrence of a Change of Control, each holder of the TransTexas Subordinated
Notes will have the right to require TransTexas to repurchase such holder's
TransTexas Subordinated Notes at 101% of the principal amount thereof plus
accrued and unpaid interest. Pursuant to the terms of the TransTexas
Intercompany Loan, upon the occurrence of a Change of Control, TEC would have
the right to require TransTexas to repay the principal of the TransTexas
Intercompany Loan in an amount equal to a pro rata share of the amount TEC is
required to pay under the TEC Notes Indenture. Such pro rata share would be
calculated using the ratio of the outstanding principal amount of the TransTexas
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan. Pursuant to the terms of the
TARC Intercompany Loan, upon the occurrence of a Change of Control, TEC would
have the right to require TARC to repay the principal of the TARC Intercompany
Loan in an amount equal to a pro rata share of the amount TEC is required to pay
under the TEC Indenture. Such pro rata share would be calculated using the ratio
of the accreted value of the outstanding principal amount of the TARC
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the TransTexas
Subordinated Notes Indenture in the case of certain changes or other events in
respect of the ownership of TransTexas, including any circumstances pursuant to
which any person or group other than John R. Stanley (or his heirs, his estate,
or any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the TransTexas Subordinated Notes is
downgraded or withdrawn. A Change of Control would be deemed to occur under the
TransTexas Intercompany Loan in the case of certain changes or other events in
respect of the ownership or control of TEC or TransTexas, including any
circumstance pursuant to which (i) any person or group, other than John R.
Stanley (or his heirs, his estate, or any trust in which he or his immediate
family members have, directly or indirectly, a beneficial interest in excess of
50%) and his subsidiaries or the TEC Indenture Trustee is or becomes the
beneficial owner of more than 50% of the total voting power of TEC's then
outstanding voting stock, or (ii) TEC or any of its subsidiaries own some of
TransTexas' capital stock, but less than 50% of the total voting stock or
economic value of TransTexas, unless the TEC Notes have an investment grade
rating for the period of 120 days thereafter. A Change of Control would be
deemed to occur under the TEC Notes Indenture or the TARC Intercompany Loan in
the case of certain changes or other events in respect of the ownership or
control of TEC, TransTexas or TARC including any circumstance pursuant to which
(i) any person or group, other than John R. Stanley (or his heirs, his estate or
any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TEC's then outstanding voting stock, or (ii) TEC or any of
its subsidiaries own some of TARC's or TransTexas' capital stock, respectively,
but less than 50% of the total voting stock or economic value of TARC or
TransTexas, respectively, unless (in the case of either (i) or (ii) above) the
TEC Notes have an investment grade rating for the period of 120 days thereafter.
The term "person," as used in the definition of Change of Control, means a
natural person,
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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 Subordinated Notes Indenture, the TEC Notes Indenture or
the TransTexas Intercompany Loan may result in a "change of control" of
TransTexas under the terms of the BNY Facility. Such an occurrence could create
an obligation for TransTexas to repay any amounts due under the BNY Facility. At
July 31, 1998, TransTexas had approximately $7.2 million of indebtedness subject
to such right of repayment. In the event of a Change of Control under the
TransTexas Subordinated Notes Indenture, the TEC Notes Indenture or the
Intercompany Loans, or a "change of control" under the terms of the BNY
Facility, there can be no assurance that TransTexas or TARC will have sufficient
funds to satisfy any such payment obligations. A change of control or other
event that results in Deconsolidation of TransTexas and TransAmerican for
federal income tax purposes could result in acceleration of a substantial amount
of federal income taxes.
IMPACT OF YEAR 2000
The year 2000 issue relates to computer programs or computer equipment
designed to use two digits rather than four digits to define the applicable
year. As a result, computer systems with time-sensitive software may not
accurately calculate, store or use a date subsequent to December 31, 1999. This
could result in system failures or miscalculations and disruptions of
operations, including among other things, a temporary inability to process
transactions or engage in other normal business activities.
In June 1997, management began a Company-wide program to prepare its
computer systems for year 2000 compliance. In January 1998, the Company began
implementation of new client/server based systems which are anticipated to be
completed and tested by January 1999. The Company estimates the cost of
upgrading its computer systems to be approximately $4 million. In addition, the
Company is currently assessing its state of readiness for non-informational
technological systems and the readiness of significant third parties with whom
the Company conducts business. As of July 31, 1998, no contingency plans have
been developed to mitigate the Company's year 2000 issues.
FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
are included throughout this report. All statements other than statements of
historical facts included in this Quarterly Report on Form 10-Q regarding TEC's
financial position, business strategy, plans and objectives of management for
future operations, including but not limited to words such as "anticipates,"
"expects," "believes," "estimates," "intends," "projects" and "likely" indicate
forward-looking statements. TEC's management believes that its current views and
expectations are based on reasonable assumptions; however, there are significant
risks and uncertainties that could significantly affect expected results.
Factors that could cause actual results to differ materially from those in the
forward-looking statements include, without limitation, fluctuations in the
commodity prices for natural gas, crude oil, condensate and natural gas liquids,
the extent of TransTexas' success in discovering, developing and producing
reserves, engineering problems, work stoppages, cost overruns, personnel or
materials shortages, fluctuations in commodity prices for petroleum and refined
products, casualty losses, conditions in the equity and capital markets, the
ultimate resolution of litigation and competition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 8 of Notes to Condensed Consolidated Financial Statements for
a discussion of the Company's legal proceedings.
ITEM 5. OTHER INFORMATION
In a press release dated September 1, 1998, the Company announced that
TARC had revised its cost estimates for completion of the Capital
Improvement Program. The following table sets forth certain information
with respect to the Capital Improvement Program, including the original
budget as of June 13, 1997, expenditures as of July 31, 1998 and the
revised budget as of July 31, 1998.
<TABLE>
<CAPTION>
Original Expenditures to Revised
Budget (1) July 31, 1998 (2) Budget (3)
----------- ----------------- -----------
(dollars in (dollars in (dollars in
millions) millions) millions)
<S> <C> <C> <C>
PHASE I:
Crude Unit...................... $ 3.0 $ 7.4 $ 8.1
Delayed Coking Unit............. 27.0 77.0 82.0
Naphtha Pretreater.............. 12.0 17.7 25.0
No. 2 Reformer.................. 9.0 1.9 13.0
HDS Unit........................ 24.0 38.2 47.0
Sulfur Recovery System.......... 53.0 59.1 70.2
Offsite Facilities/Tankage...... 46.0 81.2 94.0
Other........................... 3.0 0.4 0.5
Engineering and Administrative.. 7.0 14.2 14.2
Contingencies(4)................ 39.0 -- 3.0
------- -------- --------
Total Phase I............ 223.0 297.1 357.0
------- -------- --------
PHASE II:
FCC Unit........................ 115.0 124.7 197.0
FCC Flue Gas Scrubber........... 14.0 10.3 15.0
Alkylation Unit................. 24.0 21.5 43.0
Offsite Facilities/Tankage...... 26.0 13.5 35.0
Other........................... 2.0 -- --
Engineering and Administrative.. 3.0 1.2 4.0
Contingencies(4)................ 20.0 -- 21.0
------- -------- --------
Total Phase II........... 204.0 171.2 315.0
------- -------- --------
Total Phase I and
Phase II............... $ 427.0 $ 468.3 $ 672.0
======= ======== ========
</TABLE>
- ----------
(1) Budget as of June 13, 1997 for estimated expenditures from June 13, 1997 to
completion.
(2) From June 13, 1997 through July 31, 1998.
(3) Revised budget as of July 31, 1998 for estimated expenditures from June 13,
1997 to completion.
(4) To the extent expenditures have exceeded or are expected to exceed the
approved capital budget for a unit or units, the contingencies portion of
the budget is allocated to specific units. As of July 31, 1998, the entire
contingencies portion of the original budget had been allocated to specific
units.
27
<PAGE> 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
18.1 - Letter dated September 17, 1998 from
PricewaterhouseCoopers LLP regarding changes in accounting
principles.
27.1 - Financial Data Schedule
99.1 - Financial statements of TransTexas dated July 31, 1998
(filed as part of TransTexas' Quarterly Report on Form
10-Q for the quarter ended July 31, 1998, and incorporated
herein by reference thereto).
99.2 - Financial statements of TARC dated July 31, 1998 (filed as
part of TARC's Quarterly Report on Form 10-Q for the
quarter ended July 31, 1998, and incorporated herein by
reference thereto).
(b) REPORTS ON FORM 8-K
There were no reports on Form 8-K filed during the quarter ended
July 31, 1998.
28
<PAGE> 30
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/ ED DONAHUE
--------------------------------------
Ed Donahue, Vice President and
Chief Financial Officer
September 17, 1998
29
<PAGE> 31
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
18.1 - Letter dated September 17, 1998 from PricewaterhouseCoopers LLP
regarding changes in accounting principles.
27.1 - Financial Data Schedule
99.1 - Financial statements of TransTexas dated July 31, 1998 (filed as part
of TransTexas' Quarterly Report on Form 10-Q for the quarter ended July
31, 1998, and incorporated herein by reference thereto).
99.2 - Financial statements of TARC dated July 31, 1998 (filed as part of
TARC's Quarterly Report on Form 10-Q for the quarter ended July 31,
1998, and incorporated herein by reference thereto).
</TABLE>
<PAGE> 1
EXHIBIT 18.1
TransAmerican Energy Corporation
1300 North Sam Houston Parkway Eas3t
Houston, Texas 77032
Gentlemen:
We are providing this letter to you for inclusion as an exhibit to your Form
10-Q filing pursuant to Item 601 of Regulation S-K.
We have read management's justification for TransAmerican Refining Corporation's
change in accounting method for inventory pricing from the average cost method
to the first-in-first-out method and the change in accounting method for
turnaround costs from the accrual method to the deferral method contained in
TransAmerican Energy Corporation's (the "Company") Form 10-Q for the quarter
ended July 31, 1998. Based on our reading of the data and discussions with
Company officials of the business judgment and business planning factors
relating to the changes, we believe management's justification to be reasonable.
Accordingly, we concur that the newly adopted accounting principles described
above are preferable in the Company's circumstances to the methods previously
applied.
We have not audited any financial statements of the Company as of any date or
for any period subsequent to January 31, 1998, nor have we audited the
application of the changes in accounting principles disclosed in the Company's
Form 10-Q for the quarter ended July 31, 1998; accordingly, our comments are
subject to revision on completion of an audit of the financial statements that
include the accounting changes.
PricewaterhouseCoopers LLP
Houston, Texas
September 17, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM TRANSAMERICAN
ENERGY CORPORATION'S UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AT JULY 31,
1998 AND THE UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE
SIX MONTHS ENDED JULY 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JUL-31-1998
<CASH> 68,298
<SECURITIES> 0
<RECEIVABLES> 18,028
<ALLOWANCES> 0
<INVENTORY> 47,186
<CURRENT-ASSETS> 148,971
<PP&E> 2,804,500
<DEPRECIATION> 770,794
<TOTAL-ASSETS> 2,262,552
<CURRENT-LIABILITIES> 205,704
<BONDS> 1,841,478
0
0
<COMMON> 0
<OTHER-SE> 66,955
<TOTAL-LIABILITY-AND-EQUITY> 2,262,552
<SALES> 48,243
<TOTAL-REVENUES> 116,558
<CGS> 7,819
<TOTAL-COSTS> 106,133
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 48,179
<INCOME-PRETAX> (31,351)
<INCOME-TAX> (3,483)
<INCOME-CONTINUING> (26,449)
<DISCONTINUED> 0
<EXTRAORDINARY> (2,436)
<CHANGES> 2,674
<NET-INCOME> (26,211)
<EPS-PRIMARY> (2,912)
<EPS-DILUTED> (2,912)
</TABLE>
