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 Quarter Ended September 30, 1998 Commission File No. 1-5591
PENNZOIL COMPANY
(Exact name of registrant as specified in its charter)
Delaware 74-1597290
(State or other jurisdiction of (I.R.S. Employer
incorporation of organization) Identification No.)
Pennzoil Place, P.O. Box 2967
Houston, Texas 77252-2967
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 546-4000
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 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 .
Number of shares outstanding of each class of stock, as of
latest practicable date, October 31, 1998:
Preferred stock, par value $1.00 per share, 1,500,000
shares.
Common stock, par value $0.83-1/3 per share, 47,810,419
shares.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
PENNZOIL COMPANY
CONDENSED CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Expressed in thousands except per share amounts)
REVENUES
Net sales $ 124,668 $ 205,619 $ 427,619 $ 633,000
Investment and other income, net 240,644 20,778 277,919 32,354
----------- ----------- ----------- -----------
Total revenues 365,312 226,397 705,538 665,354
COSTS AND EXPENSES
Operating expenses 59,004 52,138 163,752 156,782
Selling, general and administrative 31,208 11,273 47,334 23,931
Depreciation, depletion and amortization 49,718 60,211 159,702 167,598
Exploration expense 85,494 18,791 117,389 41,110
Taxes, other than income 7,726 9,370 23,585 28,230
Interest charges, net 40,094 39,839 119,523 118,653
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAX 92,068 34,775 74,253 129,050
Income tax provision 33,249 10,898 21,084 42,562
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS
BEFORE EXTRAORDINARY ITEM 58,819 23,877 53,169 86,488
Income from discontinued Pennzoil Products
Group operations, net of tax (See note 2) 9,442 13,947 33,579 32,763
----------- ----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY ITEM 68,261 37,824 86,748 119,251
Extraordinary items, net of tax (See note 4) (205,549) (2,575) (205,549) (2,575)
----------- ----------- ----------- -----------
NET INCOME (LOSS) (137,288) 35,249 (118,801) 116,676
Preferred stock dividends 2,434 - 3,191 -
----------- ----------- ----------- -----------
NET INCOME (LOSS) AVAILABLE TO
COMMON SHAREHOLDERS $ (139,722) $ 35,249 $ (121,992) $ 116,676
=========== =========== =========== ===========
NET INCOME (LOSS) $ (137,288) $ 35,249 $ (118,801) $ 116,676
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX 42,810 (1,695) 38,292 (5,388)
----------- ----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ (94,478) $ 33,554 $ (80,509) $ 111,288
=========== =========== =========== ===========
BASIC EARNINGS (LOSS) PER SHARE
Continuing operations $ 1.17 $ 0.50 $ 1.05 $ 1.83
Discontinued operations 0.20 0.30 0.70 0.70
Extraordinary item (4.30) (0.05) (4.31) (0.05)
----------- ----------- ----------- -----------
TOTAL BASIC EARNINGS (LOSS) PER SHARE $ (2.93) $ 0.75 $ (2.56) $ 2.48
=========== =========== =========== ===========
DILUTED EARNINGS (LOSS) PER SHARE
Continuing operations $ 1.17 $ 0.49 $ 1.03 $ 1.80
Discontinued operations 0.20 0.29 0.70 0.69
Extraordinary item (4.28) (0.05) (4.26) (0.05)
----------- ----------- ----------- -----------
TOTAL DILUTED EARNINGS (LOSS) PER SHARE $ (2.91) $ 0.73 $ (2.53) $ 2.44
=========== =========== =========== ===========
DIVIDENDS PER COMMON SHARE $ 0.25 $ 0.25 $ 0.75 $ 0.75
=========== =========== =========== ===========
AVERAGE SHARES OUTSTANDING
Basic 47,761 47,208 47,682 47,002
=========== =========== =========== ===========
Diluted 47,957 48,365 48,225 47,760
=========== =========== =========== ===========
END OF PERIOD SHARES OUTSTANDING 47,790 47,382 47,790 47,382
=========== =========== =========== ===========
<FN>
<F1>
See Notes to Condensed Consolidated Financial Statements.
</FN>
3
PART I. FINANCIAL INFORMATION - continued
PENNZOIL COMPANY
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, December 31,
1998 1997
------------- -------------
(Unaudited)
(Expressed in thousands)
ASSETS
Current assets
Cash and cash equivalents $ 12,251 $ 9,462
Receivables 118,511 150,979
Crude oil and natural gas inventories 7,194 6,638
Deferred income tax 19,794 19,479
Other current assets 23,811 68,796
------------- -------------
Total current assets 181,561 255,354
Property, plant and equipment, net 1,732,253 1,708,420
Marketable securities and other investments 609,545 900,421
Net assets of discontinued Pennzoil Products Group operations (See Note 2) 1,073,593 1,076,942
Other assets 35,008 42,069
------------- -------------
TOTAL ASSETS $ 3,631,960 $ 3,983,206
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt $ 822 $ -
Accounts payable and accrued liabilities 128,294 224,847
Interest accrued 44,069 30,016
Other current liabilities 27,919 44,206
------------- -------------
Total current liabilities 201,104 299,069
Long-term debt, less current maturities
Exchangeable debentures 738,641 889,027
Other long-term debt 1,181,492 1,258,722
------------- -------------
Total long-term debt, less current maturities 1,920,133 2,147,749
Deferred income tax 224,108 287,498
Other liabilities 108,073 110,351
------------- -------------
TOTAL LIABILITIES 2,453,418 2,844,667
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY 1,178,542 1,138,539
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,631,960 $ 3,983,206
============= =============
<FN>
<F1>
See Notes to Condensed Consolidated Financial Statements.
</FN>
4
PART I. FINANCIAL INFORMATION - continued
PENNZOIL COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30
---------------------------------
1998 1997
----------- -----------
(Expressed in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (118,801) $ 116,676
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation, depletion and amortization 159,702 167,598
Dry holes and impairments 80,160 19,441
Deferred income tax (91,147) 17,168
Extraordinary loss associated with refinancing
of exchangeable debentures 321,170 -
Gain on sale of securities associated with
refinancing of exchangeable debentures (230,083) -
Other non-cash items 12,798 16,126
Income from discontinued Pennzoil Products
Group operations, net of tax (33,579) (32,763)
Changes in operating assets and liabilities 27,721 58,018
----------- -----------
Net cash provided by operating activities 127,941 362,264
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (330,586) (288,575)
Purchases of marketable securities and other investments (479,662) (431,394)
Proceeds from sales of marketable securities and other
investments 599,209 437,031
Proceeds from sales of assets 62,010 5,466
Other investing activities (44,178) (20,738)
----------- -----------
Net cash used in investing activities (193,207) (298,210)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from/(repayments of) notes payable (49,508) 60,328
Debt and capital lease obligation repayments (848,565) (1,169,024)
Proceeds from issuance of debt 820,000 1,165,000
Net proceeds from issuance of preferred stock 147,000 -
Dividends paid (38,962) (35,272)
Other financing activities 1,162 31,159
----------- -----------
Net cash provided by financing activities 31,127 52,191
----------- -----------
CASH PROVIDED BY (USED IN) DISCONTINUED PENNZOIL
PRODUCTS GROUP OPERATIONS 36,928 (113,610)
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,789 2,635
CASH AND CASH EQUIVALENTS, beginning of period 9,462 18,586
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 12,251 $ 21,221
=========== ===========
<FN>
<F1>
See Notes to Condensed Consolidated Financial Statements.
</FN>
5
PART I. FINANCIAL INFORMATION - continued
PENNZOIL COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) General -
The condensed consolidated financial statements included
herein have been prepared by Pennzoil Company ("Pennzoil") without
audit and should be read in conjunction with the financial
statements and the notes thereto included in Pennzoil's latest
annual report. The foregoing financial statements include only
normal recurring accruals and all adjustments which Pennzoil
considers necessary for a fair presentation. Certain prior period
items have been reclassified in the condensed consolidated
financial statements in order to conform with the current year
presentation.
(2) Discontinued Operations -
On April 14, 1998, Pennzoil, Pennzoil's subsidiary Pennzoil
Products Company ("PPC") and Downstream Merger Company, a wholly
owned subsidiary of PPC ("Merger Sub"), entered into an Agreement
and Plan of Merger (the "Merger Agreement") with Quaker State
Corporation ("Quaker State"). The Merger Agreement and related
agreements provide for the separation of Pennzoil's motor oil,
refined products and fast lube operations (which generally include
PPC and Jiffy Lube International, Inc. ("Jiffy Lube") and their
respective subsidiaries and is collectively referred to as
"Pennzoil Products Group") from its exploration and production
operations and for the combination of the motor oil, refined
products and fast lube operations with Quaker State.
The transactions contemplated by the Merger Agreement are (1)
a pro rata distribution (or spin-off), on a share-for-share basis,
of all of the issued and outstanding Common Stock of PPC (which,
among other things, will at such time hold the motor oil and
refined products operations of PPC and the fast lube operations of
Jiffy Lube) to the holders of Common Stock of Pennzoil and (2) a
merger of Merger Sub with and into Quaker State, in which holders
of Capital Stock of Quaker State will receive, in exchange for each
share held, 0.8204 shares of Common Stock of PPC. Immediately
following the transactions contemplated by the Merger Agreement,
approximately 38.5% of PPC will be owned by former Quaker State
stockholders and approximately 61.5% of PPC will be owned by
shareholders of Pennzoil.
Quaker State's stockholders approved the merger on September
18, 1998 and the required waiting period under the Hart-Scott-
Rodino Antitrust Improvements Act of 1976 has expired. The spin-off
and merger are expected to occur during the fourth quarter of 1998
following the anticipated receipt of a favorable tax ruling from
the Internal Revenue Service.
The historical operating results of Pennzoil Products Group
are shown net of tax as discontinued operations in the Condensed
Consolidated Statement of Income and Comprehensive Income. The net
assets of discontinued operations in the Condensed Consolidated
Balance Sheet include those assets and liabilities attributable to
the Pennzoil Products Group's businesses. In addition, Pennzoil's
historical financial position and results of operations have been
adjusted to reflect discontinued operations for all periods
presented.
6
PART I. FINANCIAL INFORMATION - continued
In connection with the spin-off, certain intercompany
indebtedness, including affiliated payables and notes payable, is
to be repaid by Pennzoil Products Group to Pennzoil immediately
prior to the transaction. The maximum payment is the total of $500
million plus outstanding cash of Pennzoil Products Group, less
existing third party debt and capital lease obligations of Pennzoil
Products Group. This anticipated payment has not been reflected in
the discontinued operations of Pennzoil Products Group.
After-tax earnings from discontinued operations for the
quarter and nine months ended September 30, 1998 were $9.4 million
and $33.6 million, respectively. This compares to $13.9 million
and $32.8 million, respectively, for the same periods in 1997. Taxes
on earnings from discontinued operations for the quarter and nine
months ended September 30, 1998 were $6.9 million and $24.5 million,
respectively. This compares to $10.3 million and $24.4 million,
respectively, for the same periods in 1997. Revenue included in
discontinued operations for the quarter and nine months ended
September 30, 1998 was $474.9 million and $1,417.3 million,
respectively. This compares to $515.7 million and $1,545.0
million, respectively, for the same periods in 1997.
The components of net assets of discontinued Pennzoil Products
Group operations at September 30, 1998 and December 31, 1997 are
summarized as follows:
September 30, December 31,
1998 1997
------------- -------------
(Expressed in thousands)
Current Assets $ 403,944 $ 399,360
Property, plant and equipment, net 800,394 790,177
Goodwill 159,902 158,489
Other assets 218,253 211,597
Current liabilities (245,078) (246,926)
Long-term debt and capital lease obligations (113,854) (116,936)
Other liabilities (149,968) (118,819)
------------- -------------
$ 1,073,593 $ 1,076,942
============= =============
(3) New Accounting Standards -
In June 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No.
131, "Disclosure about Segments of an Enterprise and Related
Information," which establishes standards for reporting information
about operating segments in annual financial statements and
requires that selected information be reported about the operating
segments in interim financial reports issued to the shareholders.
It also establishes standards for related disclosure about products
and services, geographic areas, and major customers. Pennzoil
plans to adopt SFAS No. 131 in its annual financial statement
disclosures for the fiscal year ending December 31, 1998.
7
PART I. FINANCIAL INFORMATION - continued
In March 1998, the American Institute of Certified Public
Accountants ("AICPA") issued Statement of Position ("SOP") No. 98-
1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." This SOP is effective for fiscal years
beginning after December 15, 1998 and earlier adoption is
permitted. The adoption of SOP No. 98-1 is not expected to have a
material impact on Pennzoil's results of operations.
In April 1998, the AICPA issued SOP No. 98-5, "Reporting on
the Costs of Start-Up Activities." This SOP is effective for
financial statements for fiscal years beginning after December 15,
1998 and earlier adoption is permitted. Pennzoil is currently
evaluating the impact of SOP No. 98-5.
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This SFAS
establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the balance sheet as either an
asset or liability measured at its fair value. This standard also
requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are
met. Accounting for qualifying hedges allows a derivative's gains
and losses to offset related results on the hedged item in the
income statement, and requires a company to formally document,
designate, and assess the effectiveness of transactions that
receive hedge accounting. SFAS No. 133 is effective for fiscal
years beginning after June 15, 1999 and early adoption is
permitted. The effect of adopting SFAS No. 133 has not been
determined, but is not expected to have a material impact on
Pennzoil's results of operations (Reference is made to Note 5 of
Notes to Condensed Consolidated Financial Statements).
(4) Debt -
On July 1, 1998, Pennzoil commenced an offer to issue new
exchangeable senior debentures ("New Debentures") in exchange for a
portion of its 6.50% Exchangeable Senior Debentures (the "6.50%
Debentures") and 4.75% Exchangeable Senior Debentures (the "4.75%
Debentures"). The exchange offer expired on July 31, 1998 and on
August 3, 1998, Pennzoil issued $443.8 million principal amount of
new 4.90% Debentures in exchange for $211.6 million principal
amount of 6.50% Debentures and $317.4 million principal amount of
new 4.95% Debentures in exchange for $211.6 million principal
amount of 4.75% Debentures. Pennzoil realized a pretax
extraordinary loss on early extinguishment of debt of $318.4
million, which is the difference between the carrying amount of the
exchanged debentures of $420.7 million (net of related unamortized
debt issue costs of $2.5 million) and the estimated market value
(net of discount) of the New Debentures being issued of $739.1
million. After an income tax benefit of $114.6 million, the
extraordinary loss totaled $203.8 million.
Holders of the remaining $464.2 million of the 6.50% and 4.75%
Debentures exercised their exchange rights to obtain either shares
of Chevron Corporation ("Chevron") common stock or the cash value
thereof. Pennzoil delivered Chevron common stock with a historical
cost of $308.0 million for substantially all of the exchange
requests resulting in a realized pretax gain of $156.2 million
included in investment and other income, net on the Condensed
Consolidated Statement of Income and Comprehensive Income, and an
extraordinary loss of $1.7 million on the write-off of the
remaining unamortized debt issue cost net of an income tax benefit
of $0.9 million.
8
PART I. FINANCIAL INFORMATION - continued
Completion of the exchange offers allowed Pennzoil to release
and sell on the open market approximately 1.5 million shares of
Chevron common stock that previously had been allocated for the
exchange rights of the 6.50% Debentures and 4.75% Debentures.
Pennzoil realized pretax income of $73.9 million through the sale
of these shares.
Each 4.90% Debenture and each 4.95% Debenture is exchangeable
into 9.3283 shares of Chevron common stock; each matures on August
15, 2008 and is not callable until August 15, 2000. The New
Debentures are exchangeable at the option of the holders at any
time prior to maturity, unless previously redeemed, for shares of
Chevron common stock. In lieu of delivering Chevron common stock,
Pennzoil may, at its option, pay to any holder an amount in cash
equal to the market value of the Chevron common stock to satisfy
the exchange request. Changes in the fair value of the New
Debentures, which fluctuates with changes in the market value of
Chevron common stock, will be recorded in income.
(5) Use of Derivatives -
Pennzoil has a price risk management program that utilizes
derivative financial instruments, principally crude oil and natural
gas swaps, to reduce the price risks associated with fluctuations
in crude oil and natural gas prices. These financial instruments
are designated as hedges and accounted for on the accrual basis
with gains and losses being recognized based on the type of
contract and exposure being hedged. Realized gains or losses on
crude oil and natural gas swaps designated as hedges of anticipated
transactions related to anticipated production are treated as
deferred credits or charges and are included in other current
liabilities or other current assets on the balance sheet. Net
gains and losses on crude oil and natural gas swaps designated as
hedges of anticipated transactions, including accrued gains or
losses upon maturity or termination of the contract, are deferred
and recognized in income when the associated hedged commodities are
produced.
In order for crude oil and natural gas swaps to qualify as a
hedge of an anticipated transaction, the derivative contract must
identify the expected date of the transaction, the commodity
involved, and the expected quantity to be purchased or sold. In
the event that a hedged transaction does not occur, future gains
and losses, including termination gains or losses, are included in
the income statement when incurred. In the statement of cash
flows, cash receipts or payments related to financial instruments
are classified consistent with the cash flows from the transaction
being hedged. Effective January 1, 2000, the accounting for
derivative financial instruments will be amended as required
pursuant to SFAS No. 133 (Reference is made to Note 3 of Notes to
Condensed Consolidated Financial Statements). Under this new
standard, crude oil and natural gas swaps used to hedge future
crude oil and natural gas production will be marked to fair value
with unrealized changes in the fair value of the crude oil and
natural gas swaps recorded as comprehensive income. At the time of
maturity or termination of the contract, any deferred gain or loss
is recognized in earnings.
Pennzoil has not materially hedged crude oil or natural gas
prices in 1998. Pennzoil will continually review and may alter its
hedged positions as conditions change.
9
PART I. FINANCIAL INFORMATION - continued
(6) Earnings Per Share -
Earnings per share of common stock outstanding were computed as
follows:
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Expressed in thousands except per share amounts)
Income from continuing operations $ 58,819 $ 23,877 $ 53,169 $ 86,488
Less: Preferred stock dividend 2,434 - 3,191 -
Income from continuing operations available
to common shareholders $ 56,385 $ 23,877 $ 49,978 $ 86,488
Basic weighted average shares 47,761 47,208 47,682 47,002
Effect of dilutive securities <F1>:
Options 51 1,037 396 638
Awards 145 120 147 120
Diluted weighted average shares 47,957 48,365 48,225 47,760
Per share income from continuing operations
available to common shareholders
Basic $ 1.17 $ 0.50 $ 1.05 $ 1.83
Diluted $ 1.17 $ 0.49 $ 1.03 $ 1.80
<FN>
<F1> A weighted average number of options to purchase 2,851,247 and
169,280 shares of common stock were outstanding for the three
months ended September 30, 1998 and 1997, respectively, but
were not included in the computation of diluted earnings per
share because the options' exercise prices were greater than
the average market price of the common shares. A weighted
average number of options to purchase 1,524,082 and 863,948
shares of common stock were outstanding for the nine months
ended September 30, 1998 and 1997, respectively, but were not
included in the computation of diluted earnings per share
because the options' exercise prices were greater than the
average market price of the common shares.
</FN>
(7) Comprehensive Income -
In June 1997, the FASB issued SFAS No. 130, "Reporting
Comprehensive Income," which requires that an enterprise classify
items of other comprehensive income by their nature in a financial
statement and display the accumulated balance of other
comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of the balance
sheet. Pennzoil adopted SFAS No. 130 in the first quarter of 1998.
Components of comprehensive income consist of foreign currency
translation adjustments, unrealized holding gains and losses on
available-for-sale securities and minimum pension liability. Other
comprehensive income for the quarter and nine months ended
September 30, 1998 is primarily related to unrealized holding gains
on Chevron common stock of $43.9 million.
10
PART I. FINANCIAL INFORMATION - continued
(8) Preferred Stock -
On June 2, 1998, Pennzoil issued 1,500,000 shares of cumulative
preferred stock at $100 per share. Dividends on the 6.49% Series A
Cumulative Preferred Stock, par value $1.00 per share, are
cumulative from the date of original issue and will be payable
quarterly, in cash, when declared by the Board of Directors of the
Company, commencing September 30, 1998. Preferred dividends are
required to be deducted from net income in determining net income
per common share. The Series A Cumulative Preferred Stock will be
redeemable at the option of Pennzoil at any time on or after June
2, 2008, in whole or in part, at a redemption price of $100 per
share, plus accrued and unpaid dividends to the redemption date.
(9) Statement of Cash Flow Information -
Significant noncash investing and financing activities are as
follows:
1. In August 1998, Pennzoil issued $761.2 million in new
exchangeable senior debentures in exchange for $432.2
million of its 6.50% and 4.75% exchangeable senior
debentures. Reference is made to Note 4 of Notes to
Condensed Consolidated Financial Statements.
2. In August 1998, Pennzoil exchanged Chevron common
stock with a historical cost of $308.0 million for
$464.2 million in 6.50% and 4.75% exchangeable senior
debentures. Reference is made to Note 4 of Notes to
Condensed Consolidated Financial Statements.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Results of Continuing Operations
Before extraordinary items totaling $205.5 million, income
from continuing operations available to common shareholders for the
quarter and nine months ended September 30, 1998 was $56.4 million,
or $1.17 per share, and $50.0 million, or $1.05 per share,
respectively. This compares with net income available to common
shareholders before extraordinary items of $23.9 million, or $0.50
per share, for the third quarter of 1997 and $86.5 million, or
$1.83 per share, for the nine months ended September 30, 1997.
The income increase for the quarter ended September 30, 1998
compared to the same period in 1997 was primarily due to a gain on
the disposition of Chevron common stock and the exchange of a
portion of Pennzoil's old debentures for Chevron stock (Reference
is made to Note 4 of Notes to Condensed Consolidated Financial
Statements) partially offset by higher exploration expense, lower
realized liquids prices, lower natural gas production volumes and
charges associated with the pending merger of Pennzoil Products
Group with Quaker State. The income decrease for the nine months
ended September 30, 1998 compared to the same period in 1997 was
primarily due to higher exploration expense, lower realized liquids
prices and lower natural gas production volumes.
Oil and Gas
Operating loss for the quarter and nine months ended September
30, 1998 was $77.9 million and $22.2 million, respectively. This
compares with operating income of $67.7 million and $244.0 million,
respectively, for the same periods in 1997. The decrease in
operating income for the quarter and nine months ended September
30, 1998, compared to the same periods in 1997, was primarily due to
higher exploration expense, lower realized liquids prices and lower
natural gas production volumes.
11
PART I. FINANCIAL INFORMATION - continued
Natural gas price realizations averaged $1.91 per thousand
cubic feet ("Mcf") and $2.04 per Mcf, respectively, for the quarter
and nine months ended September 30, 1998, compared to $2.09 per Mcf
and $2.25 per Mcf, respectively, for the same periods in 1997.
Liquids price realizations averaged $9.79 per barrel and $11.07 per
barrel for the quarter and nine months ended September 30, 1998,
compared to $15.55 per barrel and $16.77 per barrel, respectively,
for the same periods in 1997. Natural gas volumes produced for
sale were 434.2 million cubic feet ("MMcf") per day and 471.6 MMcf
per day, respectively, for the quarter and nine months ended
September 30, 1998, compared to 619.4 MMcf per day and 586.7 MMcf
per day, respectively, for the same periods in 1997. Liquids
production volumes were 53.7 thousand barrels ("Mbbls") per day and
54.2 Mbbls per day, respectively, for the quarter and nine months
ended September 30, 1998, compared to 59.9 Mbbls per day and 58.8
Mbbls per day, respectively, for the same periods in 1997. The
lower volumes are primarily attributable to production declines at
Pennzoil's West Cameron 580 field, the sale of Pennzoil's remaining
Canadian natural gas interests in December 1997 and hurricane
related production curtailment in and adjacent to the Gulf of
Mexico.
In the Gulf of Mexico, new wells at West Cameron 575 and West
Cameron 291 came on stream during the third quarter of 1998 and
additional wells at West Cameron 575 and Ship Shoal 154 will come
on stream in the fourth quarter of 1998. Pennzoil is also
continuing its in-fill drilling program in the Carthage field in
east Texas and its enhanced oil recovery project in SACROC in west
Texas. Pennzoil's onshore domestic drilling program for the fourth
quarter of 1998 includes six south Louisiana and south Texas
exploration wells. Pennzoil also spud an offshore exploration well
at High Island 19 and production tests are being performed on South
Marsh Island 23J-1 to establish commerciality.
Internationally, the Azerbaijan International Operating
Company ("AIOC") delivered its first oil shipment to the Black Sea
in March from the Azeri-Chirag-Gunashli ("ACG") joint development
area offshore Baku in the Caspian Sea. At the end of the third
quarter of 1998, daily oil production at ACG was 72,000 barrels.
This production should rise to an estimated 100,000 barrels per day
by year-end 1998. The ACG joint development area is estimated to
contain 4.9 billion barrels of crude oil. Pennzoil has a 4.8
percent carried interest in the field.
On the nearby Karabakh prospect, Pennzoil took a $34.9 million
charge in the third quarter of 1998 after Caspian International
Petroleum Company ("CIPCO"), the joint operating company in which
Pennzoil has a 30 percent interest, determined that the first two
exploratory wells were not commercial. CIPCO is presently drilling
the final commitment well on the prospect and should be to total
depth by mid November 1998.
In Egypt, Pennzoil has five concessions covering 9.2 million
acres. Four of the concessions are in the Gulf of Suez: North July
(100 percent Pennzoil), West Feiran (50 percent Pennzoil),
Southwest Gebel el-Zeit (43.75 percent Pennzoil), and Southeast
Gulf of Suez (25 percent Pennzoil). The fifth block, West Beni
Suef (100 percent Pennzoil), is located in Egypt's western desert.
In July 1998, Pennzoil entered into agreements whereby Seagull
Energy can earn half of Pennzoil's interest in the Southwest Gebel
el-Zeit Block and the Southeast Gulf of Suez Block in exchange for
funding current and future exploration costs. During the third
quarter of 1998 Pennzoil drilled two wells in Southwest Gebel el-
Zeit Block and AGIP, the operator on the West Feiran Block, drilled
one well. None of the wells found commercial hydrocarbons and
Pennzoil recorded charges of $6.2 million in the third quarter of
1998. Pennzoil is also conducting a seismic program on the West
Beni Suef field that will continue for the rest of the year.
12
PART I. FINANCIAL INFORMATION - continued
On July 1, 1998, Pennzoil began operating the B2X-68/79 and
B2X-70/80 oil production blocks in Venezuela. The blocks each
encompass approximately 10,000 acres in eastern Lake Maracaibo.
Net production from the two blocks is currently 2,500 barrels per
day. Development drilling should commence in Lake Maracaibo late
in the fourth quarter of 1998.
In Australia, the Whicher Range No. 1 and Whicher Range No. 4
were deemed to be uneconomical following completion stimulation and
flow testing operations completed in the third quarter of 1998.
This resulted in a pretax charge of $12.4 million in the third
quarter of 1998.
Other
Other operating income for the quarter and nine months ended
September 30, 1998 was $236.8 million and $257.7 million,
respectively, compared with $14.9 million and $24.9 million for the
same periods in 1997. Pennzoil's other income increased primarily
due to gains on the disposition of Chevron stock and the exchange
of a portion of Pennzoil's old debentures for Chevron stock.
Reference is made to Note 4 of Notes to Condensed Consolidated
Financial Statements. Pennzoil beneficially owned approximately 7
million shares of common stock of Chevron on September 30, 1998.
Net interest expense for the quarter and nine months ended
September 30, 1998 increased $0.3 million and $0.9 million,
respectively, from the same periods in 1997 primarily due to higher
short-term borrowings.
Capital Resources and Liquidity
Preferred Stock. On June 2, 1998, Pennzoil issued 1,500,000
shares of cumulative preferred stock at $100 per share. Dividends
on the 6.49% Series A Cumulative Preferred Stock, par value $1.00
per share, are cumulative from the date of original issue and will
be payable quarterly, in cash, when declared by the Board of
Directors of the Company, commencing September 30, 1998. The
Series A Cumulative Preferred Stock will be redeemable at the
option of Pennzoil at any time on or after June 2, 2008, in whole
or in part, at a redemption price of $100 per share, plus accrued
and unpaid dividends to the redemption date.
Cash Flow. As of September 30, 1998, Pennzoil had cash and
cash equivalents of $12.3 million. During the nine months ended
September 30, 1998, cash and cash equivalents increased $2.8
million.
Debt Instruments and Repayments. During the nine months ended
September 30, 1998, Pennzoil refinanced its outstanding
exchangeable debentures for new exchangeable debentures which
resulted in a decrease of $149.6 million of outstanding
exchangeable debentures. Reference is made to Note 4 of the Notes
to Condensed Consolidated Financial Statements for additional
information on Pennzoil's exchangeable debentures.
Borrowings under Pennzoil's commercial paper, revolving credit
facility and other variable-rate credit arrangements totaled $298.0
million as of September 30, 1998, all of which has been classified
as long-term debt.
13
PART I. FINANCIAL INFORMATION - continued
Year 2000
Pennzoil completed a review of its key computer systems and
has identified a number of systems that were affected by the year
2000 compliance issue. Pennzoil is undertaking or has completed
conversions or upgrades of these non-compliant financial,
operating, human resources, payroll and seismic data systems.
These conversions and upgrades are targeted for completion during
the second quarter of 1999, after compliant upgrades are received
from the vendors, currently scheduled for the first quarter of
1999. Upgrades and standardization to network, infrastructure,
desktop and communications systems to make these assets compliant
are in progress. This effort is scheduled for completion in the
first quarter of 1999 following the release of compliant updates
from the vendors. International as well as domestic sites were
included in these assessments. The assessment of specialized
hardware and software unique to an international location should be
completed by December 1998. The only system replacements that have
been accelerated to remedy non-compliance are some of the Pennzoil
voicemail systems and security systems. No major IT projects
have been deferred due to year 2000 compliance issues. Contingency
planning will be started for the IT systems in the first quarter of
1999 and will include backup, standby and storage service solutions
to reduce the impact of critical service providers. The validation
phase that consists of testing mission-critical and significant
systems will be completed by June 1999.
Pennzoil has completed a comprehensive inventory and is
currently assessing and renovating systems and devices with
embedded chips in the exploration, production, and non-production
facilities. The exploration and production facilities consist of
offshore platforms, onshore regions, gas plants, regional
pipelines and a natural gas retail distribution operation. These
facilities, which include the processing, storage and movement of
oil and natural gas, have the greatest inherent risk since embedded
chip systems control and monitor these processes. At this time,
several of Pennzoil's onshore exploration and production
facilities have non-compliant metering and control equipment.
These deficiencies are being addressed by upgrading or replacing the
non-compliant portion of mission-critical equipment. This effort
is targeted for completion by the end of June 1999. Non mission-
critical production equipment that may have non-compliant
components is being replaced with compliant components during
normal maintenance and repair outages that occur through 1999. If
for any reason, these systems do not receive maintenance prior to
the millenium or are still found to be non-compliant after the
millenium, they will be operated in a manual mode until further
renovation and testing is completed. In addition, all currently
compliant control systems that have potential for environmental,
safety, or business interruption impact will be tested during
scheduled maintenance. The majority of this type of production
equipment is used to monitor and control production only.
Nevertheless, operation of these systems would still be reduced or
discontinued if a component is found to be non-compliant in order
to prevent safety and environmental problems. Contingency planning
is also underway to provide alternatives in the event these systems
are partially or completely inoperable. Spare components are being
tested to ensure compliant systems remain compliant through the
maintenance process.
Pennzoil is contacting key suppliers, banks, customers and
other unaffiliated companies that have business relationships with
Pennzoil to assess their year 2000 compliance programs. Pennzoil
could be adversely affected by the failure of these unaffiliated
companies to adequately address the year 2000 issue. This
assessment includes activities such as face-to-face meetings,
reviews of year 2000 readiness and co-operative testing.
Contingency planning will be included in this assessment to
identify arrangements to mitigate the impact of disruptions from
outside sources. This process is targeted for completion by the
end of June 1999. In addition, Pennzoil has implemented internal
procedures to respond cooperatively to inquiries from regulatory
agencies and other businesses about its year 2000 program.
14
PART I. FINANCIAL INFORMATION - continued
As with most companies, Pennzoil anticipates more issues
arising from international business partners, especially in the
banking, utility, shipping and governmental segments. Pennzoil is
currently reviewing all banking relationships in international
locations. In addition, Pennzoil is actively involved in a joint
industry effort through the American Petroleum Institute to
collectively address the readiness of their common business
partners such as utilities and governmental agencies, and to share
approaches to solving the specific problems of each international
location.
If these steps are not completed successfully in a timely
manner, Pennzoil's operations and financial performance could be
adversely affected through disruptions in operations. Costs
associated with such disruptions currently cannot be estimated.
Both incremental historical and estimated future costs related
to the year 2000 issue are not expected to be material to the
financial results of Pennzoil for several reasons. Most of the
renovation is being accomplished with upgrades to existing software
that is under maintenance contracts. The implementation of the
major IT systems was not accelerated to remedy year 2000 problems.
Independent quality assurance services and tools are being used to
assure the reliability of the assessment and costs. These services
will be supplemented with Pennzoil resources. Costs for all year
2000 activities are estimated to be less than $8 million. This
estimate does not include Pennzoil's potential share of year 2000
costs that may be incurred by partnerships and joint ventures in
which the company participates but is not the operator.
Pennzoil has a June 30, 1999 target readiness date for all
major phases of its year 2000 preparations. Pennzoil's existing
emergency response plan will be re-evaluated in the fourth quarter
of 1999, using the latest information available for infrastructure
services such as utilities. Adjustments to this plan will be made
based on this information. Pennzoil expects to be fully ready for
the new millenium.
Readers are cautioned that forward-looking statements
contained in this year 2000 update should be read in conjunction
with the company's disclosures under the heading: "Forward-Looking
Statements - Safe Harbor Provisions".
Discontinued Operations
After-tax earnings from discontinued operations for the
quarter and nine months ended September 30, 1998 were $9.4 million
and $33.6 million, respectively. This compares to $13.9 million
and $32.8 million, respectively, for the same periods in 1997. Taxes
on earnings from discontinued operations for the quarter and nine
months ended September 30, 1998 were $6.9 million and $24.5 million,
respectively. This compares to $10.3 million and $24.4 million,
respectively, for the same periods in 1997. Revenue included in
discontinued operations for the quarter and nine months ended
September 30, 1998 was $474.9 million and $1,417.3 million,
respectively. This compares to $515.7 million and $1,545.0
million, respectively, for the same periods in 1997.
Forward-Looking Statements - Safe Harbor Provisions
This quarterly report on Form 10-Q of Pennzoil Company for the
quarter ended September 30, 1998 contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities Exchange Act
of 1934, as amended, which are intended to be covered by the safe
harbors created thereby. To the extent that such statements are
not recitations of historical fact, such statements constitute
forward-looking statements which, by definition, involve risks and
uncertainties. Where, in any forward-looking statements, Pennzoil
expresses an expectation or belief as to future results or events,
such expectation or belief is expressed in good faith and believed
to have a reasonable basis, but there can be no assurance that the
statement of expectation or belief will result or be achieved or
accomplished.
15
PART I. FINANCIAL INFORMATION - continued
The following are factors that could cause actual results or
events to differ materially from those anticipated, and include but
are not limited to: general economic, financial and business
conditions; commodity prices for natural gas and crude oil; the
effect of weather on natural gas demand and consumption;
competition for international drilling rights; the costs of
exploration and development of petroleum reserves; exploration
risks; political risks impacting exploration and development;
competition in the motor oil and marketing business; base oil
margins and supply and demand in the base oil business; the success
and cost of advertising and promotional efforts; mechanical failure
in refining operations; unanticipated environmental liabilities;
changes in and compliance with governmental regulations; changes in
tax laws; and the cost and effects of legal proceedings.
16
PART I. FINANCIAL INFORMATION - continued
(UNAUDITED)
The following tables show revenues and operating income by segment,
other components of income and operating data.
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(Dollar amounts expressed in thousands)
REVENUES
Oil and Gas $ 127,017 $ 210,703 $ 445,973 $ 641,718
Other 238,295 15,694 259,565 23,636
----------- ----------- ----------- -----------
Total revenues $ 365,312 $ 226,397 $ 705,538 $ 665,354
=========== =========== =========== ===========
OPERATING INCOME (LOSS)
Oil and Gas $ (77,900) $ 67,689 $ (22,224) $ 243,975
Other 236,831 14,944 257,704 24,971
----------- ----------- ----------- -----------
Total operating income 158,931 82,633 235,480 268,946
Corporate administrative expense 26,769 8,019 41,704 21,243
Interest charges, net 40,094 39,839 119,523 118,653
----------- ----------- ----------- -----------
Income before income tax 92,068 34,775 74,253 129,050
Income tax provision 33,249 10,898 21,084 42,562
----------- ----------- ----------- -----------
INCOME FROM CONTINUING OPERATIONS
BEFORE EXTRAORDINARY ITEM 58,819 23,877 53,169 86,488
DISCONTINUED OPERATIONS, NET OF TAX 9,442 13,947 33,579 32,763
----------- ----------- ----------- -----------
INCOME BEFORE EXTRAORDINARY ITEM 68,261 37,824 86,748 119,251
EXTRAORDINARY ITEM, NET OF TAX (205,549) (2,575) (205,549) (2,575)
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (137,288) $ 35,249 $ (118,801) $ 116,676
=========== =========== =========== ===========
RATIO OF EARNINGS TO COMBINED FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS 1.53 2.05
=========== ===========
17
PART I. FINANCIAL INFORMATION - continued
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------ ------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
OPERATING DATA
- --------------
CONTINUING OPERATIONS:
- ----------------------
OIL AND GAS
Net production
Crude oil, condensate and natural
gas liquids (barrels per day) 53,671 59,938 54,225 58,807
Natural gas produced for sale (Mcf per day) 434,200 619,364 471,599 586,709
Weighted average prices
Crude oil, condensate and natural
gas liquids (per barrel) $ 9.79 $ 15.55 $ 11.07 $ 16.77
Natural gas (per Mcf) $ 1.91 $ 2.09 $ 2.04 $ 2.25
DISCONTINUED OPERATIONS:
- ------------------------
MOTOR OIL & REFINED PRODUCTS
Sales (barrels per day)
Gasoline and naphtha 24,804 18,807 23,751 19,015
Distillates and gas oils 26,218 24,073 25,877 26,479
Lubricating oil and other specialty products 29,500 25,014 26,847 23,932
Residual fuel oils 1,691 1,284 3,046 1,962
Penreco specialty products <F1> 4,090 5,243 4,166 5,268
----------- ----------- ----------- -----------
Total sales (barrels per day) 86,303 74,421 83,687 76,656
=========== =========== =========== ===========
Raw materials processed
(barrels per day) <F2> 74,426 63,245 72,047 64,891
Refining capacity
(barrels per day) <F2> 80,300 76,000 80,300 76,000
FAST LUBE OPERATIONS
Domestic systemwide sales (in thousands) $ 209,961 $ 199,002 $ 610,402 $ 572,566
Same center sales (in thousands) $ 199,630 $ 197,682 $ 578,204 $ 569,163
Centers open (U.S.) 1,574 1,476 1,574 1,476
<FN>
<F1> Represents PPG's proportional share of Penreco sales for 1998 and 100% of PPG's
specialty sales in 1997.
<F2> Includes Pennzoil's 50% ownership in Excel Paralubes.
</FN>
18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits -
3 By-laws of Pennzoil Company, as amended through September
23, 1998.
12 Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends for the nine months ended
September 30, 1998 and 1997.
27 Financial Data Schedule
(b) Reports -
No reports on Form 8-K were filed during the quarter for which
this report was filed.
19
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.
PENNZOIL COMPANY
Registrant
S/N Michael J. Maratea
Michael J. Maratea
Vice President and Controller
November 12, 1998