<PAGE> 1
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended April 30, 1998
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 June
15, 1998 was 9,000.
================================================================================
<PAGE> 2
TRANSAMERICAN ENERGY CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements:
<S> <C>
Condensed Consolidated Balance Sheet as of April 30, 1998 and January 31, 1998..........................2
Condensed Consolidated Statement of Operations for the three months ended
April 30, 1998 and 1997.............................................................................3
Condensed Consolidated Statement of Cash Flows for the three months ended
April 30, 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...................21
Item 3. Quantitative and Qualitative Disclosures About Market Risk..............................................30
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................................31
Item 6. Exhibits and Reports on Form 8-K........................................................................31
Signature........................................................................................................32
</TABLE>
1
<PAGE> 3
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
APRIL 30, JANUARY 31,
1998 1998
----------- -----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................... $ 70,255 $ 86,513
Restricted cash held in disbursement accounts ............................... 102,634 158,563
Cash restricted for interest ................................................ 36,680 32,823
Investments held in trust ................................................... 9,426 9,114
Accounts receivable ......................................................... 36,431 17,926
Inventories ................................................................. 18,632 16,437
Other current assets ........................................................ 7,031 12,065
----------- -----------
Total current assets .................................................. 281,089 333,441
----------- -----------
Property and equipment ......................................................... 2,598,385 2,350,060
Less accumulated depreciation, depletion and amortization ...................... 754,217 741,952
----------- -----------
Net property and equipment -- based on the full cost method of
accounting for gas and oil properties of which $87,802 and $104,389
was excluded from amortization at April 30, 1998 and January 31, 1998,
respectively ......................................................... 1,844,168 1,608,108
----------- -----------
Restricted cash held in disbursement accounts .................................. -- 60,166
Cash restricted for interest ................................................... 19,175 16,348
Investments held in trust ...................................................... -- 8,592
Receivable from affiliates ..................................................... 1,487 1,463
Other assets, net .............................................................. 100,536 103,321
----------- -----------
$ 2,246,455 $ 2,131,439
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable ............................................................ $ 102,340 $ 84,181
Payable to affiliate ........................................................ 5,421 6,758
Accrued liabilities ......................................................... 76,315 52,326
Current maturities of long-term debt ........................................ 17,101 16,891
----------- -----------
Total current liabilities ............................................. 201,177 160,156
----------- -----------
Due to affiliates .............................................................. 7,317 6,827
Long-term debt, less current maturities ........................................ 1,821,033 1,761,689
Revolving credit agreement ..................................................... 7,935 7,917
Production payments, less current portion ...................................... 40,179 4,121
Deferred income taxes .......................................................... 35,833 39,497
Other liabilities .............................................................. 26,706 25,668
Minority interest in net income of TransTexas .................................. 33,893 35,162
Commitments and contingencies (Note 6) ......................................... -- --
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 ......................................................... (131,378) (110,594)
----------- -----------
Total stockholder's equity ............................................. 72,382 90,402
----------- -----------
$ 2,246,455 $ 2,131,439
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE> 4
TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
APRIL 30,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Revenues:
Gas, condensate and natural gas liquids ............................... $ 19,330 $ 72,649
Transportation ........................................................ -- 9,291
Gain on the sale of assets ............................................ 12,327 --
Other ................................................................. 3,817 100
-------- --------
Total revenues ...................................................... 35,474 82,040
-------- --------
Costs and expenses:
Operating ............................................................. 9,364 35,437
Depreciation, depletion and amortization .............................. 14,520 35,268
General and administrative ............................................ 11,853 17,852
Taxes other than income taxes ......................................... 1,978 6,118
-------- --------
Total costs and expenses ............................................ 37,715 94,675
-------- --------
Operating loss ...................................................... (2,241) (12,635)
-------- --------
Other income (expense):
Interest income ....................................................... 4,255 1,821
Interest expense, net ................................................. (26,437) (28,654)
Other, net ............................................................ -- 39
-------- --------
Total other income (expense) ........................................ (22,182) (26,794)
-------- --------
Loss before income taxes ............................................ (24,423) (39,429)
Income taxes (benefit) ................................................... (3,664) (7,828)
-------- --------
Loss before minority interest and extraordinary item ................ (20,759) (31,601)
Minority interest in net loss of TransTexas .............................. 1,269 --
Extraordinary item:
Early extinguishment of debt ......................................... (1,294) --
-------- --------
Net loss .......................................................... $(20,784) $(31,601)
======== ========
Basic and diluted net loss per share:
Loss before extraordinary item ........................................ $ (2,165) $ (3,511)
Extraordinary item .................................................... (144) --
-------- --------
$ (2,309) $ (3,511)
======== ========
Weighted average number of shares outstanding for basic and
diluted net loss per share............................................. 9,000 9,000
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 5
TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
APRIL 30,
-----------------------
1998 1997
--------- ----------
<S> <C> <C>
Operating activities:
Net loss .............................................................. $ (20,784) $ (31,601)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation, depletion and amortization .............................. 14,520 35,268
Extraordinary item.................................................... 1,294 --
Amortization of discount on long-term debt ............................ 10,316 3,294
Amortization of debt issue costs ...................................... 1,123 993
Gain on the sale of assets ............................................ (12,327) --
Deferred income taxes ................................................. (3,664) 4,175
Minority interest in net loss of TransTexas ........................... (1,269) --
Amortization of deferred revenue ...................................... -- (8,378)
Changes in assets and liabilities:
Accounts receivable ................................................. (5,187) 48,333
Inventories ......................................................... (2,195) (2,683)
Other current assets ................................................ 5,034 11,441
Accounts payable .................................................... (1,814) 19,958
Accrued liabilities ................................................. 23,808 16,172
Transactions with affiliates, net ................................... (470) (16,368)
Other assets ........................................................ (255) 388
Other liabilities ................................................... 622 (824)
--------- ---------
Net cash provided by operating activities ...................... 8,752 80,168
--------- ---------
Investing activities:
Capital expenditures .................................................. (231,822) (122,845)
Prepaid capital expenditure ........................................... 1,537 --
Proceeds from the sale of assets ...................................... 22,112 --
Increase in investments held in trust ................................. (160) --
Decrease in investments held in trust ................................. 8,439 --
--------- ---------
Net cash used by investing activities .......................... (199,894) (122,845)
--------- ---------
Financing activities:
Issuance of long-term debt ............................................ 40,625 8,300
Retirement of long-term debt .......................................... (7,792) --
Principal payments on long-term debt .................................. (2,466) (1,432)
Increase in restricted cash ........................................... (6,684) (34,920)
Withdrawals from disbursement accounts................................. 116,095 20,883
Issuance of notes payable ............................................. -- 36,000
Issuance of production payments ....................................... 39,100 20,977
Principal payments on production payments ............................. (2,705) (9,471)
Revolving credit agreement, net ....................................... 18 (17,882)
Dividend payment on preferred stock ................................... -- (19)
Advances from TransAmerican and affiliates to TARC .................... -- 12,003
Debt issue costs ...................................................... (1,166) (2,725)
Other ................................................................. (141) (219)
--------- ---------
Net cash provided by financing activities ..................... 174,884 31,495
--------- ---------
Decrease in cash and cash equivalents ......................... (16,258) (11,182)
Beginning cash and cash equivalents ...................................... 86,513 24,179
--------- ---------
Ending cash and cash equivalents ......................................... $ 70,255 $ 12,997
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 6
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 April 30, 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 three
months ended April 30, 1998.
Below is selected financial information for each consolidated entity
(in millions of dollars):
5
<PAGE> 7
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
<TABLE>
<CAPTION>
April 30, 1998
--------------------------------------------------------------------------------
Consolidation
TransTexas TARC TEC Entries Consolidated
---------- -------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data
Working capital (deficit) $ (10.9) $ 38.3 $ 50.7 $ 1.8 $ 79.9
Total assets 874.2 1,322.1 1,758.7 (1,708.5) 2,246.5
Long-term debt 635.7 1,015.1 1,456.4 (1,278.2) 1,829.0
Equity 17.8 216.7 279.8 (441.9) 72.4
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended April 30, 1998
--------------------------------------------------------------------------------
Consolidation
TransTexas TARC TEC Entries Consolidated
---------- -------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Operations Data
Revenues $ 33.5 $ 2.0 $ -- $ -- $ 35.5
Operating income (loss) 8.5 (10.6) (0.1) -- (2.2)
Net loss (6.8) (16.9) (0.1) 3.0 (20.8)
Cash Flow Data
Operating activities (0.9) 2.9 1.4 5.4 8.8
Investing activities (39.2) (155.3) (73.8) 68.4 (199.9)
Financing activities 51.3 162.6 34.8 (73.8) 174.9
</TABLE>
RECENTLY ISSUED PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"), which
establishes standards for reporting information about operating segments. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. Adoption of this statement is not
expected to have a material effect on TEC's financial statements.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which
establishes standards for reporting and display of comprehensive income and its
components in financial statements. This statement was adopted by TEC effective
February 1, 1998. Adoption of this statement did not have a material effect on
the Company's financial statements.
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, "Reporting on the Costs of Start Up Activities,"
("SOP 98-5"), which provides guidance on the financial reporting of start-up
costs and organization costs. This statement of position was adopted by the
Company effective February 1, 1998. Implementation of the statement requires
start-up activities, such as those related to the Capital Improvement Program,
to be expensed as incurred. The adoption of this statement did not have a
material impact on the Company's financial statements for the three months
ended April 30, 1998.
2. 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,
interest on funds in the TARC Disbursement Account, 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.
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
6
<PAGE> 8
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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 income
generated from its working capital and, to the extent necessary, its working
capital 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.
Cash flow from operations is sensitive to the prices TransTexas
receives for its natural gas. TransTexas makes substantial capital expenditures
for the acquisition, exploration, development and production of gas and oil
properties. TransTexas historically has financed its capital expenditures, debt
service and working capital requirements from cash from operations, public and
private offerings of debt and equity securities, the sale of production
payments, asset sales, an accounts receivable revolving credit facility and
other financings.
For the three months ended April 30, 1998, TransTexas' total capital
expenditures were $61 million, including $7 million for lease acquisitions,
$49 million for drilling and development and $5 million for gas gathering and
pipeline system and other equipment and seismic acquisitions. Subject to cash
availability, capital expenditures for fiscal year 1999 are estimated to be
approximately $188 million, which amount is in excess of projected cash flow
from operations for fiscal year 1999. A reduction in planned capital spending
could result in less than anticipated cash flow from operations in fiscal year
1999 and future years which could have a material adverse effect on TransTexas.
To finance these capital expenditure requirements and reduce its working
capital deficit, TransTexas will be required to supplement its anticipated cash
flow from operations with a combination of asset sales, including assets of its
drilling services division, and financings which may include borrowings or
production payments. TransTexas' debt covenants may limit its ability to obtain
additional financings or to sell properties, and there is no assurance that
adequate funds can be obtained on a timely basis from such sources.
TARC has previously 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. There is no assurance that TARC can 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 consolidated financial statements do not include any adjustments that might
result from the outcome of these uncertainties.
3. GAIN ON THE SALE OF ASSETS
On April 30, 1998, TransTexas sold its oilfield stimulation, cementing
and coiled tubing equipment and related facilities to an unaffiliated third
party for a sales price of $30 million, subject to post-closing adjustments.
TransTexas recorded a $10.3 million pre-tax gain as a result of this sale.
On May 26, 1998, TransTexas entered into an asset purchase agreement
with an unaffiliated third party for the sale of its drilling rigs and related
facilities for a sales price of $75 million to be paid in cash at closing. The
closing, which is subject to several conditions, is expected to occur by the
end of July 1998.
TransTexas has also entered into a letter of intent to sell its
remaining drilling services assets. There can be no assurance that a definitive
agreement will be entered into.
Additional adjustments to the Lobo Sale purchase price resulted in a
pre-tax gain on the sale of assets of $2.0 million during the three months
ended April 30, 1998.
4. 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
7
<PAGE> 9
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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
state-of-the-art 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 will exceed the budget by as much as
$45 million (of which $36 million is allocated to Phase I). Although there can
be no assurance, TARC believes that cash available in the TARC Disbursement
Account is sufficient to fund the projected remaining costs of Phase I and that
cash available in the TARC Disbursement Account, other cash on hand and
anticipated cash flow from operations of certain Phase I units will be
sufficient to fund the projected remaining costs of Phase II. TARC believes that
both Phase I and Phase II will be completed in advance of the Phase I completion
date required by the TEC Notes Indenture. TARC anticipates Mechanical Completion
of the Delayed Coking Unit, the HDS Unit and the related portion of the Sulfur
Recovery System in June 1998. Upon Mechanical Completion of these units, TARC
will be able to purchase feedstocks using funds in the TARC Disbursement Account
reserved for such purpose. TARC believes that the remainder of Phase I (other
than the No. 2 Reformer) will reach Mechanical Completion during the second
quarter of fiscal 1999. TARC intends to defer additional expenditures on the No.
2 Reformer until the fourth quarter of fiscal 1999. TARC spent approximately
$359.6 million on the Capital Improvement Program during the period between June
1997 and April 30, 1998. As of April 30, 1998, TARC had commitments to spend
another $10.4 million. 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 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
8
<PAGE> 10
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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.
5. 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 April 30, 1998, $374 million had been disbursed to TARC out of
the TARC Disbursement Account for use in the Capital Improvement Program and
$18 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.
6. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
ARABIAN OFFSHORE PARTNERS. On June 27, 1997, Arabian Offshore Partners
filed a lawsuit against TransTexas in the 14th Judicial District Court, Dallas
County, Texas, seeking $20 million in damages in connection with TransTexas'
refusal to proceed with the acquisition of two jack-up drilling rigs.
TransTexas' motion for summary judgment was granted on January 13, 1998. The
plaintiffs have appealed.
FINKELSTEIN. On April 22, 1991, H. S. Finkelstein filed a suit against
TransAmerican and various affiliates in the 49th Judicial District Court,
Zapata County, Texas, alleging an improper calculation of overriding royalties
allegedly owed to the plaintiff and seeking damages and attorneys' fees in
excess of $33.7 million. On November 18, 1993, the plaintiff added TransTexas
as an additional defendant. The parties arbitrated this matter in January 1997.
In May 1998, the arbitration panel awarded $13 million to plaintiff. TransTexas
is evaluating its prospects for appeal.
HEIN MINERALS. On April 3, 1998, Henry and Luz A. Hein Minerals, L.C.
("Hein") filed suit in the 49th Judicial District Court, Zapata County, Texas,
against TransAmerican, TransTexas, TransTexas Transmission Corporation ("TTC")
and Conoco, Inc. Plaintiff alleges that a 1990 mineral lease from plaintiffs to
TransAmerican, comprising approximately 2,000 acres, was breached by failure to
release certain acreage from the lease. Plaintiff alleges trespass,
9
<PAGE> 11
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
tortious interference, conversion, fraud, breach of fiduciary duty, breach of
contract, conversion and slander of title, and claim damages including $10 per
day per acre that was not released. TransTexas intends to vigorously defend
against these claims.
ZURICH. On May 5, 1998, The Home Insurance Company and Zurich
Insurance Company filed suit against TransTexas in the United States District
Court, Southern District of New York, to enforce a $10 million arbitration
award relating to workers' compensation policies. TransTexas filed a motion to
dismiss on June 4, 1998, and intends to vigorously defend this claim.
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.
ss. 2000e et seq. ("Title VII"). In the Determination, the EEOC stated that it
found reasonable cause to believe that each of TARC and Southeast Contractors
had discriminated based on race and gender in its hiring and promotion
practices. Each violation of Title VII (for each individual allegedly
aggrieved), if proven, potentially could subject TARC and Southeast Contractors
to liability for (i) monetary damages for backpay and front pay in an
undetermined amount, and for compensatory damages and punitive damages in an
amount not to exceed $300,000 per plaintiff, (ii) injunctive relief, (iii)
attorney's fees, and (iv) interest. During the period covered by the
Commissioner's Charge and the Determination, TARC and Southeast Contractors
estimate that they received a combined total of approximately 23,000 to 30,000
employment applications and hired (or rehired) a combined total of
approximately 3,400 to 4,100 workers, although the total number of individuals
who ultimately are covered in any conciliation proposal or any subsequent
lawsuit may be higher. TARC and Southeast Contractors deny engaging in any
unlawful employment practices. TARC and Southeast Contractors intend vigorously
to defend against the allegations contained in the Commissioner's Charge and
the findings set forth in the Determination in any proceedings in state or
federal court. If TARC or Southeast Contractors is found liable for violations
of Title VII based on the matters asserted in the Determination, TARC can make
no assurance that such liability would not have a material adverse effect on
its financial position, results of operations or cash flows.
RINEHEART. On October 8, 1996, Carlton Gene Rineheart, et al., and as
representative of a class of persons similarly situated, filed suit against 84
individuals and corporations, including TARC, in the U.S. District Court,
Middle District of Louisiana alleging negligent and improper storage, handling,
treatment, and disposal of hazardous materials from 1976 to the present at two
sites in Iberville Parish, Louisiana. The suit claims damages for physical,
mental, and property damage in the communities of Bayou Sorrel, Bayou Pigeon
and Indian Village. TARC intends to vigorously defend this claim.
SHELL OIL. On September 27, 1996, Shell Oil filed a third party suit
against TARC in the U.S. District Court, Eastern District of Louisiana for
contribution and/or indemnity relating to alleged environmental contamination
of Bayou Trapagnier and surrounding lands near Norco, Louisiana. In March 1997,
TARC obtained a voluntary dismissal from Shell. Shell proceeded to trial on the
main case and settled with the plaintiffs during trial by purchasing their land
for $5 million. On June 27, 1997, Shell amended its third party action to bring
TARC back into the case. However, TARC has not yet been served in the case. If
TARC is served, it will defend the case vigorously.
GENERAL. 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 April 30, 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.
10
<PAGE> 12
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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
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
April 30, 1998, TARC has recognized a liability of $3.1 million for this
contingency.
11
<PAGE> 13
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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
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
12
<PAGE> 14
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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.
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
13
<PAGE> 15
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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 April 30, 1998, TARC had commitments for refinery
construction and maintenance of approximately $10.4 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. As of April 30, 1998, TARC was storing
approximately 0.7 million barrels of feedstock and intermediate or refined
products pursuant to this processing agreement. Included in the 0.7 million
barrels of product stored at the refinery as of April 30, 1998, are
approximately 0.6 million barrels of feedstock owned by a third party related to
a purchase commitment entered into in April 1997. For the three months ended
April 30, 1998, TARC incurred no income or loss related to this purchase
commitment compared to a $5.1 million loss for the three months ended April 30,
1997. During June 1998, TARC completed processing these barrels pursuant to the
processing agreement described above. TARC expects to incur additional losses on
this purchase commitment in the second quarter of fiscal 1999.
PRODUCTION PAYMENTS
In April 1997, TransTexas sold to an unaffiliated third party a term
overriding royalty in the form of a dollar-denominated production payment in
certain of TransTexas' producing properties for net proceeds of $20 million.
The production payment calls for the repayment of the primary sum plus an
amount equivalent to a 16% annual interest rate on the unpaid portion of such
primary sum. As of April 30, 1998, the remaining outstanding balance was $2.1
million.
In February 1998, TransTexas entered into a production payment
drilling program agreement with an unaffiliated third party for the
reimbursement of certain drilling costs with respect to wells drilled by
TransTexas. Pursuant to the agreement, upon the approval of the third party of
a recently drilled or currently drilling well for inclusion in the program, the
third party will commit to the reimbursement of all or a portion of the cost of
such well, up to an aggregate maximum for all such wells of $75 million. The
program wells are subject to a dollar-denominated production payment equal to
the primary sum of such reimbursed costs, plus an amount equivalent to a 15%
annual interest rate on the unpaid portion of such primary sum. As of April 30,
1998, the outstanding balance on the production payment was $39.1 million.
POTENTIAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence
14
<PAGE> 16
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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 upon independent legal advice, TransTexas has determined that it
will not report any significant federal income tax liability as a result of the
Lobo Sale. There are, however, significant uncertainties regarding TransTexas'
tax position and no assurance can be given that its position will be sustained
if challenged by the IRS. TransTexas is part of an affiliated group for tax
purposes (the "TNGC Consolidated Group"), which includes TNGC Holdings
Corporation, the sole stockholder of TransAmerican ("TNGC"), TransAmerican, TEC
and TARC. No letter ruling has been or will be obtained from the IRS regarding
the Lobo Sale by any member of the TNGC Consolidated Group. If the IRS were to
successfully challenge TransTexas' position, each member of the TNGC
Consolidated Group would be severally liable under the consolidated tax return
regulations for the resulting taxes, in the estimated amount of up to $250
million (assuming the use of existing tax attributes of the TNGC Consolidated
Group), possible penalties equal to 20% of the amount of the tax, and interest
at the statutory rate (currently 8%) on the tax and penalties (if any). The Tax
Allocation Agreement has been amended so that TransAmerican will become
obligated to fund the entire tax deficiency (if any) resulting from the Lobo
Sale. There can be no assurance that TransAmerican would be able to fund any
such payment at the time due and the other members of the TNGC Consolidated
Group, thus, may be required to pay the tax. TransTexas has reserved
approximately $75 million with respect to the potential tax liability for
financial reporting purposes to reflect a portion of the federal tax liability
that TransAmerican might not be able to pay. If TransTexas were required to pay
this tax deficiency, it is likely that it would be required to sell significant
assets or raise additional debt or equity capital to fund the payment.
TNGC, TransAmerican and its existing subsidiaries, including TARC, TEC
and TransTexas, are parties to a tax allocation agreement, as amended (the "Tax
Allocation Agreement"), the general terms of which require TransAmerican and
all of its subsidiaries to file federal income tax returns as members of a
consolidated group to the extent permitted by law. Filing on a consolidated
basis allows income and tax of one member to be offset by losses and credits of
another and allows deferral of certain intercompany gains; however, each member
is severally liable for the consolidated federal income tax liability of the
consolidated group.
The Tax Allocation Agreement requires each of TransAmerican's
subsidiaries to pay to TransAmerican each year its allocable share of the
federal income tax liabilities of the consolidated group ("Allocable Share").
The Tax Allocation Agreement provides for a reallocation of the group's
consolidated federal income tax liabilities among the members if the IRS or the
courts ultimately re-determine the group's regular tax or alternative minimum
tax liability. In the event of an IRS audit or examination, the Tax Allocation
Agreement generally gives TransAmerican the authority to compromise or settle
disputes and to control litigation, subject to the approval of TARC, TEC or
TransTexas, as the case may be, where such compromise or settlement affects the
determination of the separate tax liability of that company.
Under the Tax Allocation Agreement, each subsidiary's Allocable Share
for each tax year will generally equal the amount of federal income tax it
would have owed had it filed a separate federal income tax return for each year
except
15
<PAGE> 17
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
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 occurred during
the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the
IRS successfully challenged TransTexas' position on the Lobo Sale. Each member
of a consolidated group filing a consolidated federal income tax return is
severally liable to the IRS for the consolidated federal income tax liability
of the consolidated group. There can be no assurance that each TNGC
Consolidated Group member will have the ability to satisfy any tax obligation
attributable to these transactions at the time due and, therefore, other
members of the group, including TEC, TransTexas or TARC, may be required to pay
the tax.
TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of April 30, 1998, TransTexas had
paid $5.4 million of these franchise taxes and estimates that it will pay
approximately $6.0 million during fiscal 1999.
POTENTIAL EFFECTS OF A CHANGE OF CONTROL
The Subordinated Notes Indenture provides that, upon the occurrence of
a Change of Control, each holder of the Subordinated Notes will have the right
to require TransTexas to repurchase such holder's Subordinated Notes at 101% of
the principal amount thereof plus accrued and unpaid interest. Pursuant to the
terms of the TransTexas Intercompany Loan, upon the occurrence of a Change of
Control, TEC would have the right to require TransTexas to repay the principal
of the TransTexas Intercompany Loan in an amount equal to a pro rata share of
the amount TEC is required to pay under the TEC Notes Indenture. Such pro rata
share would be calculated using the ratio of the outstanding principal amount
of the TransTexas Intercompany Loan to the sum of (i) the outstanding principal
amount of the TransTexas Intercompany Loan plus (ii) the accreted value of the
outstanding principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the Subordinated
Notes Indenture in the case of certain changes or other events in respect of
the ownership of TransTexas, including any circumstances pursuant to which any
person or group other than John R. Stanley (or his heirs, his estate, or any
trust in which he or his immediate family members have, directly or indirectly,
a beneficial interest in excess of 50%) and his subsidiaries or the TEC
Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the Subordinated Notes is downgraded or
withdrawn. A Change of Control would be deemed to occur under the TransTexas
Intercompany Loan in the case of certain changes or other events in respect of
the ownership or control of TEC, TransTexas or TARC, including
16
<PAGE> 18
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
any circumstance pursuant to which (i) any person or group, other than John R.
Stanley (or his heirs, his estate, or any trust in which he or his immediate
family members have, directly or indirectly, a beneficial interest in excess of
50%) and his subsidiaries or the TEC Indenture Trustee is or becomes the
beneficial owner of more than 50% of the total voting power of TEC's then
outstanding voting stock, or (ii) TEC or any of its subsidiaries own some of
TransTexas' or TARC's capital stock, respectively, but less than 50% of the
total voting stock or economic value of TransTexas or TARC, respectively,
unless the TEC Notes have an investment grade rating for the period of 120 days
thereafter. The term "person," as used in the definition of Change of Control,
means a natural person, company, government or political subdivision, agency or
instrumentality of a government and also includes a "group," which is defined
as two or more persons acting as a partnership, limited partnership or other
group.
In addition, certain changes or other events in respect of the
ownership or control of TransTexas that do not constitute a Change of Control
under the Subordinated Notes Indenture or the TEC Notes Indenture may result in
a "change of control" of TransTexas under the terms of the BNY Facility and
certain equipment financing. Such an occurrence could create an obligation for
TransTexas to repay such other indebtedness. At April 30, 1998, TransTexas had
approximately $36.2 million of indebtedness subject to such right of repayment
or repurchase. In the event of a Change of Control under the Subordinated Notes
Indenture or the TEC Notes Indenture or a "change of control" under the terms
of other outstanding indebtedness, there can be no assurance that TransTexas
will have sufficient funds to satisfy any such payment obligations. A change of
control or other event that results in deconsolidation of TransTexas and
TransAmerican for federal income tax purposes could result in acceleration of a
substantial amount of federal income taxes.
LOBO SALE
Pursuant to the Lobo Sale, TransTexas is required to indemnify the
buyer for certain liabilities related to the assets owned by TTC. Although
TransTexas does not anticipate that it will incur any material indemnity
liability, no assurance can be given that TransTexas will have sufficient funds
to satisfy any such indemnity obligation or that any payment thereof will not
have a material adverse effect on its ability to fund its debt service, capital
expenditure and working capital requirements.
DELIVERY COMMITMENTS
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 425 MMcf per day to specified delivery
points. TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.0 million during the
three months ended April 30, 1998.
7. OTHER CURRENT ASSETS
The major components of other current assets are as follows (in
thousands of dollars):
<TABLE>
<CAPTION>
April 30, January 31,
1998 1998
--------- -----------
<S> <C> <C>
Prepayments:
Trade $ 1,607 $ 7,120
Insurance 4,083 4,120
Other 1,341 825
------- -------
$ 7,031 $12,065
======= =======
</TABLE>
17
<PAGE> 19
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
8. ACCRUED LIABILITIES
The major components of accrued liabilities are as follows (in thousands of
dollars):
<TABLE>
<CAPTION>
April 30, January 31,
1998 1998
--------- -----------
<S> <C> <C>
Royalties $ 6,272 $ 7,171
Taxes other than income taxes 6,701 3,146
Interest 40,475 13,189
Payroll 6,804 6,528
Litigation settlements and other 453 1,387
Insurance 9,079 9,682
Maintenance turnarounds 2,864 2,673
Other 3,667 8,550
-------- -----------
$ 76,315 $ 52,326
======== ===========
</TABLE>
9. LONG-TERM DEBT
On January 14, 1998, TARC called for redemption on February 17, 1998
approximately $7 million in aggregate principal amount of TARC Notes pursuant
to the terms of the indenture governing the TARC Notes. On January 16, 1998,
TARC deposited pursuant to an irrevocable trust agreement approximately $9.8
million for defeasance of the remaining TARC Notes outstanding after the
redemption. The deposited funds are sufficient to pay the principal of the
remaining TARC Notes and interest thereon from the date of deposit to and
including the final redemption date of February 15, 1999, as well as a call
premium of 6%. As of April 30, 1998, TARC Mortgage Notes and TARC Discount
Notes with an aggregate carrying value of approximately $7.8 million remained
outstanding.
On March 16, 1998, TARC issued in a private offering 25,000 Units
consisting of $25 million in aggregate principal amount of its 16% Series C
Senior Subordinated Notes due 2003 (the "Series C Notes") and 25,000 warrants
(the "March 1998 Warrants") to purchase 333,606 shares of TARC common stock.
Interest on the Series C Notes is payable semi-annually on June 30 and December
30, commencing June 30, 1998. Net proceeds to TARC, after deducting fees and
expenses of approximately $1.2 million, were approximately $26.2 million. Net
proceeds of approximately $2.8 million from the sale of the Units were
allocated to the March 1998 Warrants. TARC deposited $6.0 million into an
interest reserve account for interest payments on the Series C Notes through
June 30, 1999. The remaining $20.2 million of net proceeds has been or will be
used for general corporate purposes.
10. OTHER LIABILITIES
The major components of other liabilities are as follows (in thousands
of dollars):
<TABLE>
<CAPTION>
April 30, January 31,
1998 1998
----------- -----------
<S> <C> <C>
Litigation settlements and accruals $ 14,508 $ 15,008
Environmental accrual 3,100 3,100
Insurance 740 740
Other 8,358 6,820
----------- -----------
$ 26,706 $ 25,668
=========== ===========
</TABLE>
18
<PAGE> 20
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
11. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
The following information reflects the Company's noncash investing and
financing activities (in thousands of dollars):
<TABLE>
<CAPTION>
Three Months Ended
April 30,
---------------------------
1998 1997
--------- ----------
<S> <C> <C>
Accounts payable for property and equipment $ 76,853 $ 51,339
Long-term debt accretion capitalized
in property and equipment 25,764 14,826
</TABLE>
12. LITIGATION SETTLEMENTS
ALAMEDA. On May 22, 1993, Alameda Corporation ("Alameda") sued
TransAmerican in the 234th Judicial District Court, Harris County, Texas,
claiming that TransAmerican failed to account to Alameda for a share of the
proceeds TransAmerican received in a 1990 settlement of litigation with El Paso
Natural Gas Company ("El Paso"), and that TransAmerican has been unjustly
enriched by its failure to share such proceeds with Alameda. On September 20,
1995, the jury rendered a verdict in favor of TransAmerican. Alameda appealed
to the Fourteenth Court of Appeals, which affirmed the trial court judgment in
favor of TransAmerican. Alameda's motion for rehearing was denied and Alameda
appealed to the Texas Supreme Court. The Texas Supreme Court refused to hear
Alameda's appeal. Alameda filed a motion for rehearing which was denied by the
Texas Supreme Court on May 21, 1998. The judgment in favor of TransAmerican is
final.
FINKELSTEIN. On April 15, 1990, H.S. Finkelstein filed suit against
TransAmerican in the 49th Judicial District Court, Zapata County, Texas,
alleging that TransAmerican failed to pay royalties and improperly marketed oil
and gas produced from certain leases. On September 27, 1994, the plaintiff
added TransTexas as an additional defendant. On January 6, 1995, a judgment
against TransAmerican and TransTexas was entered for approximately $18 million
in damages, interest and attorneys' fees. TransTexas and TransAmerican appealed
the judgment to the Fourth Court of Appeals, San Antonio, Texas, which affirmed
the judgment on April 3, 1996. TransTexas and TransAmerican filed a motion for
rehearing. On August 14, 1996, the Fourth Court of Appeals reversed the trial
court judgment and rendered judgment in favor of TransAmerican and TransTexas.
On August 29, 1996, Finkelstein filed a motion for stay and a motion for
rehearing with the court. On October 9, 1996, the court denied Finkelstein's
motion for rehearing. In November 1996, Finkelstein filed an application for
writ to proceed to with the Supreme Court of Texas. The Texas Supreme Court
denied Finkelstein's application in March 1998. Finkelstein's motion for
rehearing was also denied, and the Appellate Court judgment in favor of
TransAmerican is now final.
13. CREDIT AGREEMENTS
TransTexas and BNY Financial Corporation ("BNY") are parties to a
Second Amended and Restated Accounts Receivable Management and Security
Agreement (the "BNY Facility"), dated as of October 14, 1997. As of April 30,
1998, outstanding advances under the BNY Facility totaled approximately $7.9
million. Interest accrues on advances at the rate of (i) the higher of (a) the
prime rate of The Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1%
plus (ii) 1/2 of 1%. Obligations under the BNY Facility are secured by liens on
TransTexas' receivables and inventory. The BNY Facility contains certain
financial covenants including a limitation on net losses.
19
<PAGE> 21
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
14. TRANSACTIONS WITH AFFILIATES
On June 13, 1997, a services agreement was entered into among
TransAmerican, TEC, TARC and TransTexas. Under the services agreement,
TransTexas provides accounting, legal, administrative and other services to
TARC, TEC and TransAmerican and its affiliates. TransAmerican will provide
advisory services to TransTexas, TARC and TEC. TARC will pay to TransTexas
approximately $300,000 per month for services rendered and for allocated
expenses paid by TransTexas on behalf of TARC. TransAmerican will pay to
TransTexas approximately $20,000 per month for such services. TEC and its
subsidiaries will pay $2.5 million in the aggregate per year to TransAmerican
for advisory services and benefits provided by TransAmerican. As of April 30,
1998, the receivable from TransAmerican for such services was $0.2 million.
During the year ended January 31, 1998, TEC made advances to TransTexas
and TARC pursuant to promissory notes which mature on June 14, 2002. The notes
bear interest in an amount equal to a fixed semi-annual interest payment of $2.8
million, prorated based upon the average outstanding balance of all notes (other
than the note evidencing the TransTexas Intercompany Loan) between TransTexas
and TEC and the average outstanding balance of all notes (other than the note
evidencing the TARC Intercompany Loan) between TARC and TEC. Interest payments
are due and payable semi-annually on June 15 and December 15. During the three
months ended April 30, 1998, TEC advanced $3.3 million to TransTexas under these
notes and TARC repaid $1.6 million of the advances to TEC. On April 30, 1998,
the aggregate outstanding balance of these notes was $53.7 million.
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 months ended April 30, 1998 and 1997 were
$37.5 million and $2.2 million, respectively, of which $5.1 million and $2.0
million were payable at April 30, 1998 and January 31, 1998, respectively.
During the three months ended April 30, 1998, TEC contributed $4.5
million to TARC for general corporate purposes and $67.6 million for use in the
Capital Improvement Program pursuant to the Disbursement Agreement.
In April 1998, TARC distributed all of its shares of TransTexas common
stock to TEC at TARC's historical basis of $1.8 million.
20
<PAGE> 22
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 April 30, 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, the Company's reported results for the three months ended
April 30, 1998 include the effect of reduced volumes attributable to the
producing properties sold as part of the Lobo Sale.
TransTexas' operating data for the three months ended April 30, 1998
and 1997, is as follows:
<TABLE>
<CAPTION>
Three Months Ended
April 30,
----------------------------
1998 1997
----------- ------------
<S> <C> <C>
Sales volumes:
Gas (Bcf) (1) 7.8 35.4
NGLs (MMgal) 2.0 47.4
Condensate (MBbls) 72 275
Average prices:
Gas (dry) (per Mcf) (2) $ 2.18 $ 1.67
NGLs (per gallon) .23 .30
Condensate (per Bbl) 13.51 20.08
Number of gross wells drilled 13 29
Percentage of wells completed 69% 72%
</TABLE>
----------------------
(1) Sales volumes for the three months ended April 30, 1997 include 7.2 Bcf
delivered prior to the third quarter pursuant to volumetric production
payments.
(2) Average prices for the three months ended April 30, 1997 include amounts
delivered under volumetric production payments. The average gas price for
TransTexas' undedicated production for this period was $1.80 per Mcf. Gas
prices do not include the effect of hedging agreements.
A summary of TransTexas' operating expenses is set forth below (in
millions of dollars):
<TABLE>
<CAPTION>
Three Months Ended
April 30,
-----------------------------
1998 1997
------ ------
<S> <C> <C>
Operating costs and expenses:
Lease $ 3.2 $ 7.9
Pipeline 2.6 8.2
Natural gas liquids -- 10.9
</TABLE>
21
<PAGE> 23
<TABLE>
<S> <C> <C>
Drilling services 0.7 0.1
------ ------
6.5 27.1
Taxes other than income taxes (1) 1.0 5.2
------ ------
Total $ 7.5 $ 32.3
====== ========
</TABLE>
-----------------------------
(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
April 30,
--------------------------
1998 1997
------ ------
<S> <C> <C>
Depletion rates (per Mcfe) $ 1.32 $ 1.05
====== =======
</TABLE>
THREE MONTHS ENDED APRIL 30, 1998, COMPARED WITH THE THREE MONTHS ENDED
APRIL 30, 1997
Gas, condensate and NGL revenues for the three months ended April 30,
1998 decreased $53.6 million from the prior period, due primarily to decreases
in gas, condensate and NGLs sales volumes attributable to the divestiture of
producing properties as a result of the Lobo Sale. The average monthly prices
received per Mcf of gas ranged from $2.10 to $2.35 in the three months ended
April 30, 1998, compared to a range of $1.49 to $2.29, excluding amounts
dedicated to volumetric production payments, in the prior period. As of April
30, 1998, TransTexas had a total of 118 producing wells compared to 872
producing wells at April 30, 1997. Transportation revenues decreased $9.3
million over the prior period due primarily to the divestiture of the pipeline
system as a result of the Lobo Sale. Drilling services revenues increased by
$0.9 million for the three months ended April 30, 1998, due primarily to an
increase in services provided to third parties. For the three months ended
April 30, 1998, TransTexas recognized a pre-tax gain of $10.3 million on the
sale of certain drilling services division assets and a pre-tax gain of $2.0
million due to post-closing adjustments to the Lobo Sale purchase price.
Lease operating expenses for the quarter ended April 30, 1998
decreased by $4.7 million from the prior period due primarily to the Lobo Sale
and the resulting decrease in the number of producing wells. Pipeline and
gathering expenses decreased $5.6 million from the prior period due primarily
to the divestiture of the pipeline system, offset partially by an increase of
$1.0 million attributable to contractual transportation charges. NGL costs
decreased by $10.9 million from the prior period primarily due to the Lobo Sale
and the resulting decrease in the volumes of natural gas processed. Drilling
service expenses for the three months ended April 30, 1998 increased $0.6
million primarily due to increased costs related to providing services to the
new operator of the Lobo Trend properties. Depreciation, depletion and
amortization expense for the three months ended April 30, 1998 decreased $21.7
million due to the Lobo Sale and the resulting decrease in TransTexas'
undedicated natural gas production, partially offset by a $0.27 increase in the
depletion rate. General and administrative expenses decreased by $9.5 million
primarily as a result of a decrease in litigation expense. Taxes other than
income taxes decreased by $4.2 million over the prior period due primarily to
decreases in ad valorem, severance and excise taxes associated with the Lobo
Sale and resulting decrease in the number of producing wells.
Interest income for the three months ended April 30, 1998 decreased by
$1.1 million as compared to the prior period due to lower cash balances
available for investment. TransTexas does not expect to earn significant
interest income during fiscal year 1999. Interest expense decreased by $5.8
million primarily as a result of the retirement of the Senior Secured Notes in
June 1997.
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,
22
<PAGE> 24
general and administrative expenses and property taxes. The No. 2 Vacuum Unit
was operated intermittently between March 1994 and January 1997. TARC did not
operate the No. 2 Vacuum Unit during the three months ended April 30, 1998.
TARC's results of operations are dependent on the operating status of
certain units within its refinery, which determines the types of feedstocks
processed and refined product yields. The results are also affected by the unit
costs of purchased feedstocks and the unit prices of refined products, which
can vary significantly. The Capital Improvement Program is designed to
significantly change TARC's throughput capacity, the feedstocks processed, and
refined product yields.
TARC believes, based on current estimates of refining margins and
costs of the expansion and modification of the refinery, that future
undiscounted cash flows will be sufficient to recover the cost of the refinery
over its estimated useful life. Management believes there have been no events
or changes in circumstances that would require the recognition of an impairment
loss. However, due to the inherent uncertainties in estimating future refining
margins, and in constructing and operating a large-scale refinery, there can be
no assurance that TARC will ultimately recover the cost of the refinery.
Management believes that the book value of the refinery is in excess of its
current estimated fair market value.
THREE MONTHS ENDED APRIL 30, 1998, COMPARED WITH THE THREE MONTHS ENDED
APRIL 30, 1997
TARC's revenues for the three months ended April 30, 1998 consisted
primarily of rental income from TARC's tank storage facility acquired in
September 1997.
Operations and maintenance expense for the three months ended April
30, 1998 decreased to $2.9 million from $3.6 million for the same period in
1997, primarily due to lower tank rental expense.
Depreciation and amortization expense for the three months ended April
30, 1998 increased to $2.7 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 April
30, 1998 increased to $6.1 million from $2.7 million for the same period in
1997. The increase was primarily due to increased salary expense resulting from
additional personnel added in anticipation of starting up refinery operations,
fees related to the services agreement entered into among TransAmerican, TEC,
TARC and TransTexas and increased professional fees.
Taxes other than income taxes for the three months ended April 30,
1998 increased to $1.0 million from $0.9 million for the same period in 1997,
primarily due to increased franchise tax expense.
TARC incurred no income or loss on purchase commitments for the three
months ended April 30, 1998 compared to a $5.1 million loss on purchase
commitments for the same period in 1997.
Interest income for the three months April 30, 1998 increased to $2.3
million from $0.1 million for the same period in 1997, primarily due to the
investment of proceeds from the TARC Intercompany Loan and Senior Subordinated
Notes. Interest expense, net for the three months ended April 30, 1998
increased to $7.0 million from $3.3 million for the same period in 1997, due
primarily to interest on the TARC Intercompany Loan and Senior Subordinated
Notes. During the three months ended April 30, 1998, TARC capitalized
approximately $33.7 million of interest related to property and equipment
additions at TARC's refinery compared to $18.8 million for the three months
ended April 30, 1997.
The equity in loss of TransTexas for the three months ended April 30,
1998 and 1997 of $(0.2) million and $(2.1) million, respectively, reflects
TARC's equity interest in TransTexas. In April 1998, TARC distributed all of
its shares of TransTexas common stock to TEC.
23
<PAGE> 25
The loss on the early extinguishment of debt of $1.3 million for the
three months ended April 30, 1998 is a result of the redemption of $7.0 million
of TARC Notes in February 1998.
LIQUIDITY AND CAPITAL RESOURCES
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,
interest on funds in the TARC Disbursement Account, 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 income
generated from its working capital and, to the extent necessary, its working
capital 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.
Cash flow from operations is sensitive to the prices TransTexas
receives for its natural gas. TransTexas makes substantial capital expenditures
for the acquisition, exploration, development and production of gas and oil
properties. TransTexas historically has financed its capital expenditures, debt
service and working capital requirements from cash flow from operations, public
and private offerings of debt and equity securities, the sale of production
payments, asset sales, an accounts receivable revolving credit facility and
other financings.
For the three months ended April 30, 1998, TransTexas' total capital
expenditures were $61 million, including $7 million for lease acquisitions, $49
million for drilling and development and $5 million for gas gathering and
pipeline system and other equipment and seismic acquisitions. Subject to cash
availability, capital expenditures for fiscal year 1999 are estimated to be
approximately $188 million, which amount is in excess of projected cash flow
from operations for fiscal year 1999. A reduction in planned capital spending
could result in less than anticipated cash flow from operations in fiscal year
1999 and future years which could have a material adverse effect on TransTexas.
To finance these capital expenditure requirements and reduce its working capital
deficit, TransTexas will be required to supplement its anticipated cash flow
from operations with a combination of asset sales, including assets of its
drilling services division, and financings which may include borrowings or
production payments. TransTexas' debt covenants may limit its ability to obtain
additional financings or to sell properties, and there is no assurance that
adequate funds can be obtained on a timely basis from such sources.
In March 1998, TransTexas executed an amended and restated note in the
principal amount of approximately $14.9 million consolidating equipment
financing debt previously incurred. Concurrently, TransTexas incurred an
additional $14 million in equipment financing debt, evidenced by a promissory
note. Both notes are secured by a lien on the equipment financed. The notes
bear interest at a rate of 13.87%, payable in monthly installments with a final
installment due on April 1, 2001.
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.
24
<PAGE> 26
Pursuant to the agreement, upon the approval of the third party of a recently
drilled or currently drilling well for inclusion in the program, the third
party will commit to the reimbursement of all or a portion of the cost of such
well, up to an aggregate maximum for all such wells of $75 million. The program
wells are subject to a dollar-denominated production payment equal to the
primary sum of such reimbursed costs, plus an amount equivalent to a 15% annual
interest rate on the unpaid portion of such primary sum. As of April 30, 1998,
the outstanding balance on the production payment was $39.1 million.
TransTexas and BNY Financial Corporation are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of April 30, 1998,
outstanding advances under the BNY Facility totaled approximately $7.9 million.
Interest accrues on advances at the rate of (i) the higher of (a) the prime
rate of The Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1% plus
(ii) 1/2 of 1%. Obligations under the BNY Facility are secured by liens on
TransTexas' receivables and inventory.
Subsequent to the Lobo Sale, TransTexas' exploration and production
activities are no longer concentrated in the Laredo, Texas area nor are they
comparable to those historically conducted. Therefore, the utilization of a
centrally located drilling services operation in Laredo is no longer as
efficient or cost effective. In April 1998, TransTexas sold its oilfield
stimulation, cementing and coiled tubing equipment and related facilities for a
sales price of $30 million, subject to post-closing adjustments. In May 1998,
TransTexas entered into an agreement to sell its drilling rigs and related
assets for a sales price of $75 million. This sale is expected to close in July
1998, subject to certain conditions. TransTexas has also entered into a letter
of intent to sell its remaining drilling services assets. There can be no
assurance that a definitive agreement will be entered into. TransTexas expects
that its future general and administrative expenses and operating expenses will
be reduced as a result of these sales.
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. Although TARC and a lender have engaged in
discussions concerning the terms of a revolving credit facility, there can be
no assurance TARC will be able to obtain such a facility.
TARC expects to commence the staged start-up of the No. 2 Vacuum Unit,
the No. 2 Crude Unit and the Delayed Coking Unit in June and July 1998. Upon
Mechanical Completion of the Delayed Coking Unit and related facilities
(expected in mid- to late June), TARC will have access to funds in the
Disbursement Account reserved for feedstock purchases. Because efficient
start-up will require feedstocks prior to Mechanical Completion of the Delayed
Coking Unit, TARC has purchased approximately 1.35 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.
TARC estimates that capital expenditures for the Capital Improvement
Program will be $256 million during the fiscal year ending January 31, 1999.
TARC currently estimates that Capital Improvement Program costs may increase by
as much as $45 million over the $427 million originally estimated. Although
there can be no assurance, TARC believes that it will have cash sufficient to
fund the remaining construction. See Note 4 of Notes to Condensed Financial
Statements. If engineering problems, further cost overruns or delays occur and
other financing sources are not available, TARC may not be able to complete
both phases 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. There is no
assurance that TARC can complete the Capital Improvement Program, fund its
future working capital requirements or achieve positive cash flow from
operations. As a result, there is substantial doubt about TARC's ability to
continue as a going concern. The condensed financial statements do not include
any adjustments that might result from the outcome of these uncertainties.
As of April 30, 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 amended
(the "Disbursement Agreement") among TARC, TEC, Firstar Bank of Minnesota,
N.A., as trustee (the "TEC
25
<PAGE> 27
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 5 of Notes to Condensed
Financial Statements. Of these funds, $427 million was designated for the
Capital Improvement Program, approximately $25.5 million was designated for
general and administrative expenses, $7 million was designated for outstanding
accounts payable, $50 million was designated for working capital upon
completion of the Delayed Coking Unit and certain supporting units and $19
million was designated for the payment of interest on, or the redemption,
purchase, defeasance or other retirement of, the outstanding TARC Notes. There
is no assurance that the funds deposited in the TARC Disbursement Account will
be adequate for their designated purposes. As of April 30, 1998, $374 million
had been disbursed to TARC out of the TARC Disbursement Account for use in the
Capital Improvement Program, $7 million for accounts payable, $18 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.
On January 14, 1998, TARC called for redemption on February 17, 1998
approximately $7 million in aggregate principal amount of TARC Notes pursuant
to the terms of the indenture governing the TARC Notes. On January 16, 1998,
TARC deposited pursuant to an irrevocable trust agreement approximately $9.8
million for defeasance of the remaining TARC Notes outstanding after the
redemption. The deposited funds are sufficient to pay the principal of the
remaining TARC Notes and interest thereon from the date of deposit to and
including the final redemption date of February 15, 1999, as well as a call
premium of 6%. As of April 30, 1998, TARC Mortgage Notes and TARC Discount
Notes with an aggregate carrying value of approximately $7.8 million remained
outstanding.
On March 16, 1998, TARC issued in a private offering 25,000 Units
consisting of $25 million in aggregate principal amount of its 16% Series C
Senior Subordinated Notes due 2003 (the "Series C Notes") and 25,000 warrants
(the "March 1998 Warrants") to purchase 333,606 shares of TARC common stock.
Net proceeds to TARC, after deducting fees and expenses of approximately $1.2
million, were approximately $26.2 million. Net proceeds of approximately $2.8
million from the sale of the Units were allocated to the March 1998 Warrants.
TARC deposited $6.0 million into an interest reserve account for interest
payments on the Series C Notes through June 30, 1999. The remaining $20.2
million of net proceeds has been or will be used for general corporate
purposes.
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. As of April 30, 1998, TARC was storing
approximately 0.7 million barrels of feedstock and intermediate or refined
products pursuant to this processing agreement. Included in the 0.7 million
barrels of product stored at the refinery as of April 30, 1998, are
approximately 0.6 million barrels of feedstock owned by a third party related
to a purchase commitment entered into in April 1997. For the three months ended
April 30, 1998, TARC incurred no income or loss related to this purchase
commitment compared to a $5.1 million loss for the three months ended April 30,
1997. During June 1998, TARC completed processing these barrels pursuant to the
processing agreement described above. TARC expects to incur additional losses
on this purchase commitment in the second quarter of fiscal 1999.
During the year ended January 31, 1998, TEC made advances to
TransTexas and TARC pursuant to promissory notes which mature on June 14, 2002.
The notes bear interest in an amount equal to a fixed semi-annual interest
payment of $2.8 million, prorated based upon the average outstanding balance of
all notes (other than the note evidencing the TransTexas Intercompany Loan)
between TransTexas and TEC and the average outstanding balance of all notes
(other than the note evidencing the TARC Intercompany Loan) between TARC and
TEC. Interest payments are due and payable each June 15 and December 15. During
the three months ended April 30, 1998, TEC advanced $3.3 million to TransTexas
under these notes and TARC repaid $1.6 million of the advances to TEC. On April
30, 1998, the aggregate outstanding balance of these notes was $53.7 million.
During the three months ended April 30, 1998, TEC contributed $4.5
million to TARC for general corporate purposes and $67.6 million for use in the
Capital Improvement Program pursuant to the Disbursement Agreement.
26
<PAGE> 28
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 6 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 425 MMcf per day to specified delivery
points. TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.0 million during the
three months ended April 30, 1998.
POTENTIAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence of the COD Exclusion.
No federal tax opinion was rendered with respect to this transaction, however,
and TransAmerican has not obtained a ruling from the Internal Revenue Service
(the "IRS") regarding this transaction. TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness. However, due to
factual and legal uncertainties, there can be no assurance that the IRS will
not challenge this position, or that such challenge would not be upheld. Under
an agreement between TransTexas, TransAmerican and certain of TransAmerican's
subsidiaries (the "Tax Allocation Agreement"), TransTexas has agreed to pay an
amount equal to any federal tax liability (which would be approximately $25.4
million) attributable to the inapplicability of the COD Exclusion. Any such tax
would be offset in future years by alternative minimum tax credits and retained
loss and credit carryforwards to the extent recoverable from TransAmerican. As
a member of the TNGC Consolidated Group (defined below), each of TransTexas,
TEC and TARC will be severally liable for any tax liability resulting from the
above-described transactions. The IRS has commenced an audit of the
consolidated federal income tax returns of the TNGC Consolidated Group for its
taxable years ended July 31, 1995 and 1994. At this time, it is not possible to
predict the scope of the IRS' review or whether any tax deficiencies will be
proposed by the IRS as a result of its review.
Based upon independent legal advice, TransTexas has determined that it
will not report any significant federal income tax liability as a result of the
Lobo Sale. There are, however, significant uncertainties regarding TransTexas'
tax position and no assurance can be given that its position will be sustained
if challenged by the IRS. TransTexas is part of an affiliated group for tax
purposes (the "TNGC Consolidated Group"), which includes TNGC Holdings
Corporation, the sole stockholder of TransAmerican. No letter ruling has been
or will be obtained from the IRS regarding the Lobo Sale by any member of the
TNGC Consolidated Group. If the IRS were to successfully challenge TransTexas'
position, each member of the TNGC Consolidated Group would be severally liable
under the consolidated tax return regulations for the resulting taxes, in the
estimated amount of up to $250 million (assuming the use of existing
27
<PAGE> 29
tax attributes of the TNGC Consolidated Group), possible penalties equal to 20%
of the amount of the tax, and interest at the statutory rate (currently 8%) on
the tax and penalties (if any). The Tax Allocation Agreement has been amended
so that TransAmerican will become obligated to fund the entire tax deficiency
(if any) resulting from the Lobo Sale. There can be no assurance that
TransAmerican would be able to fund any such payment at the time due and the
other members of the TNGC Consolidated Group, thus, may be required to pay the
tax. TransTexas has reserved approximately $75 million with respect to the
potential tax liability for financial reporting purposes to reflect a portion
of the federal tax liability that TransAmerican might not be able to pay. If
TransTexas were required to pay this tax deficiency, it is likely that it would
be required to sell significant assets or raise additional debt or equity
capital to fund the payment.
Under certain circumstances, TransAmerican or TEC may sell or
otherwise dispose of shares of TransTexas common stock. If, as a result of any
sale or other disposition of TransTexas' common stock, the aggregate ownership
of TransTexas by members of the TNGC Consolidated Group (excluding TransTexas)
is less than 80% (measured by voting power and value), TransTexas will no
longer be a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation occurred during
the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the
IRS successfully challenged TransTexas' position on the Lobo Sale. Each member
of a consolidated group filing a consolidated federal income tax return is
severally liable to the IRS for the consolidated federal income tax liability
of the consolidated group. There can be no assurance that each TNGC
Consolidated Group member will have the ability to satisfy any tax obligation
attributable to these transactions at the time due and, therefore, other
members of the group, including TEC, TransTexas or TARC, may be required to pay
the tax.
Generally, under the Tax Allocation Agreement, if net operating losses
of TransTexas are used by other members of the TNGC Consolidated Group, then
TransTexas is entitled to the benefit (through reduced current taxes payable)
of such losses in later years to the extent TransTexas has taxable income,
remains a member of the TNGC Consolidated Group and the other group members
have the ability to pay such taxes. If TransAmerican or TEC transfers shares of
common stock of TransTexas (or transfers options or other rights to acquire
such shares) and, as a result of such transfer, Deconsolidation of TransTexas
occurs, TransTexas would not thereafter receive any benefit pursuant to the Tax
Allocation Agreement for net operating losses of TransTexas used by other
members of the TNGC Consolidated Group prior to the Deconsolidation of
TransTexas.
TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of April 30, 1998, TransTexas had
paid approximately $5.4 million of such tax and estimates that approximately $6
million will be paid in fiscal year 1999.
POTENTIAL EFFECTS OF CHANGE OF CONTROL
The Subordinated Notes Indenture provides that, upon the occurrence of
a Change of Control, each holder of the Subordinated Notes will have the right
to require TransTexas to repurchase such holder's Subordinated Notes at 101% of
the principal amount thereof plus accrued and unpaid interest. Pursuant to the
terms of the TransTexas Intercompany Loan, upon the occurrence of a Change of
Control, TEC would have the right to require TransTexas to repay the principal
of the TransTexas Intercompany Loan in an amount equal to a pro rata share of
the amount TEC is required to pay under the TEC Notes Indenture. Such pro rata
share would be calculated using the ratio of the outstanding principal amount
of the TransTexas Intercompany Loan to the sum of (i) the outstanding principal
amount of the TransTexas Intercompany Loan plus (ii) the accreted value of the
outstanding principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the Subordinated
Notes Indenture in the case of certain changes or other events in respect of
the ownership of TransTexas, including any circumstances pursuant to which any
person or group other than John R. Stanley (or his heirs, his estate, or any
trust in which he or his immediate family
28
<PAGE> 30
members have, directly or indirectly, a beneficial interest in excess of 50%)
and his subsidiaries or the TEC Indenture Trustee is or become the beneficial
owner of more than 50% of the total voting power of TransTexas' then
outstanding voting stock, and during the 90 days thereafter, the rating of the
Subordinated Notes is downgraded or withdrawn. A Change of Control would be
deemed to occur under the TransTexas Intercompany Loan in the case of certain
changes or other events in respect of the ownership or control of TEC,
TransTexas or TARC including any circumstance pursuant to which (i) any person
or group, other than John R. Stanley (or his heirs, his estate, or any trust in
which he or his immediate family members have, directly or indirectly, a
beneficial interest in excess of 50%) and his subsidiaries or the TEC Indenture
Trustee is or becomes the beneficial owner of more than 50% of the total voting
power of TEC's then outstanding voting stock, or (ii) TEC or any of its
subsidiaries own some of TransTexas' or TARC's capital stock, respectively, but
less than 50% of the total voting stock or economic value of TransTexas or
TARC, respectively, unless the TEC Notes have an investment grade rating for
the period of 120 days thereafter. The term "person," as used in the definition
of Change of Control, means a natural person, company, government or political
subdivision, agency or instrumentality of a government and also includes a
"group," which is defined as two or more persons acting as a partnership,
limited partnership or other group.
In addition, certain changes or other events in respect of the
ownership or control of TransTexas that do not constitute a Change of Control
under the TEC Notes Indenture or the Subordinated Notes Indenture may result in
a "change of control" of TransTexas under the terms of the BNY Facility and
certain equipment financing. Such an occurrence could create an obligation for
TransTexas to repay such other indebtedness. At April 30, 1998, TransTexas had
approximately $36.2 million of indebtedness subject to such right of repayment
or repurchase. In the event of a Change of Control under the Subordinated Notes
Indenture or the TEC Notes Indenture or a "change of control" under the terms
of other outstanding indebtedness, there can be no assurance that TransTexas
will have sufficient funds to satisfy any such payment obligations. A change of
control or other event that results in deconsolidation of TransTexas and
TransAmerican for federal income tax purposes could result in acceleration of a
substantial amount of federal income taxes.
IMPACT OF YEAR 2000
The year 2000 issue relates to computer programs or computer equipment
designed to use two digits rather than four digits to define the applicable
year. As a result, computer systems with time-sensitive software may not
accurately calculate, store or use a date subsequent to December 31, 1999. This
could result in system failures or miscalculations and disruptions of
operations, including among other things, a temporary inability to process
transactions or engage in other normal business activities.
In June 1997, management began a Company-wide program to prepare its
computer systems for year 2000 compliance. In January 1998, the Company began
implementation of new client/server based systems which are anticipated to be
completed by January 1999. The Company estimates the cost of upgrading its
computer systems to be approximately $4 million. There can be no assurance that
the Company will timely complete the implementation of the new systems.
FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
are included throughout this report. All statements other than statements of
historical facts included in this 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.
29
<PAGE> 31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
30
<PAGE> 32
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Notes 6 and 12 of Notes to Condensed Consolidated Financial
Statements for a discussion of the Company's legal proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
27.1 - Financial Data Schedule
99.1 - Financial statements of TransTexas dated April 30, 1998
(filed as part of TransTexas' Quarterly Report on Form
10-Q for the quarter ended April 30, 1998, and
incorporated herein by reference thereto).
99.2 - Financial statements of TARC dated April 30, 1998 (filed
as part of TARC's Quarterly Report on Form 10-Q for the
quarter ended April 30, 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
April 30, 1998.
31
<PAGE> 33
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
June 15, 1998
32
<PAGE> 34
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27.1 - Financial Data Schedule
99.1 - Financial statements of TransTexas dated April 30, 1998 (filed as
part of TransTexas' Quarterly Report on Form 10-Q for the quarter
ended April 30, 1998, and incorporated herein by reference thereto).
99.2 - Financial statements of TARC dated April 30, 1998 (filed as part of
TARC's Quarterly Report on Form 10-Q for the quarter ended April 30,
1998, and incorporated herein by reference thereto).
</TABLE>
33
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AT APRIL 30, 1998 AND THE
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE THREE MONTHS
ENDED APRIL 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> APR-30-1998
<CASH> 218,995
<SECURITIES> 0
<RECEIVABLES> 36,431
<ALLOWANCES> 0
<INVENTORY> 18,632
<CURRENT-ASSETS> 281,089
<PP&E> 2,598,385
<DEPRECIATION> 754,217
<TOTAL-ASSETS> 2,246,455
<CURRENT-LIABILITIES> 201,177
<BONDS> 1,828,968
0
0
<COMMON> 0
<OTHER-SE> 72,382
<TOTAL-LIABILITY-AND-EQUITY> 2,246,455
<SALES> 19,330
<TOTAL-REVENUES> 35,474
<CGS> 0
<TOTAL-COSTS> 37,715
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 26,437
<INCOME-PRETAX> (24,423)
<INCOME-TAX> (3,664)
<INCOME-CONTINUING> (19,490)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,294)
<CHANGES> 0
<NET-INCOME> (20,784)
<EPS-PRIMARY> (2,309)
<EPS-DILUTED> (2,309)
</TABLE>
