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 September 30, 1998
Commission File Number 1-11154
------------------------------
ULTRAMAR DIAMOND SHAMROCK CORPORATION
(Exact name of registrant as specified in its charter)
Incorporated under the laws of the State of Delaware
I.R.S. Employer Identification No. 13-3663331
6000 N Loop 1604 W
San Antonio, Texas 78249-1112
Telephone number: (210) 592-2000
----------------------------------
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 ____
As of October 30, 1998, 87,603,682 shares of Common Stock, $0.01 par value, were
outstanding, and the aggregate market value of such shares as of October 30,
1998 was $2,360,043,000.
ULTRAMAR DIAMOND SHAMROCK CORPORATION
FORM 10-Q
SEPTEMBER 30, 1998
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
PAGE
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997......................................... 3
Consolidated Statements of Operations for the Three and
Nine Months Ended September 30, 1998 and 1997............. 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997......................... 5
Consolidated Statements of Comprehensive Income (Loss)
for the Three and Nine Months Ended September 30, 1998
and 1997.................................................. 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................ 27
Item 5. Other Information............................................ 28
Item 6. Exhibits and Reports on Form 8-K............................. 28
SIGNATURE.............................................................. 28
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1998 1997
---- ----
(Unaudited)
Assets (in millions)
Current assets:
Cash and cash equivalents..................................................... $ 105.4 $ 92.0
Accounts and notes receivable, net............................................ 630.1 673.9
Inventories................................................................... 627.4 741.0
Prepaid expenses and other current assets..................................... 28.6 53.1
Deferred income taxes......................................................... 44.9 50.8
-------- --------
Total current assets....................................................... $1,436.4 $1,610.8
-------- --------
Property, plant and equipment.................................................... 4,380.7 4,654.3
Less accumulated depreciation and amortization................................... (1,135.3) (1,093.3)
-------- --------
Property, plant and equipment, net............................................ 3,245.4 3,561.0
Other assets, net................................................................ 529.9 422.9
-------- --------
Total assets................................................................. $5,211.7 $5,594.7
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable and current portion of long-term debt........................... $ 5.9 $ 6.5
Accounts payable.............................................................. 359.6 661.7
Accrued liabilities........................................................... 344.8 331.9
Taxes other than income taxes................................................. 260.5 237.2
Income taxes payable.......................................................... 22.2 13.4
-------- --------
Total current liabilities.................................................. 993.0 1,250.7
-------- --------
Long-term debt, less current portion............................................. 1,870.3 1,866.4
Other long-term liabilities...................................................... 450.5 403.5
Deferred income taxes............................................................ 188.1 187.5
Commitments and contingencies
Company obligated preferred stock of subsidiary.................................. 200.0 200.0
Stockholders' equity:
5% Cumulative Convertible Preferred Stock, par value $0.01 per share:
25,000,000 shares authorized, no shares and 1,724,400 shares issued and
outstanding as of September 30, 1998 and December 31, 1997.................. - 0.0
Common Stock, par value $0.01 per share:
250,000,000 shares authorized, 87,847,000 and
86,663,000 shares issued and outstanding as of
September 30, 1998 and December 31, 1997................................... 0.9 0.9
Additional paid-in capital.................................................... 1,511.2 1,534.9
Treasury stock................................................................ (64.3) (30.1)
Retained earnings............................................................. 174.4 259.1
Accumulated other comprehensive loss.......................................... (112.4) (78.2)
-------- --------
Total stockholders' equity.................................................. 1,509.8 1,686.6
-------- --------
Total liabilities and stockholders' equity.................................. $5,211.7 $5,594.7
======== ========
See accompanying notes to consolidated financial statements.
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions, except share and per share data)
Sales and other revenues (including excise taxes)......... $ 2,740.9 $ 2,613.2 $ 8,571.5 $ 7,577.8
--------- --------- --------- ---------
Operating costs and expenses:
Cost of products sold.................................. 1,504.1 1,617.2 4,851.8 4,752.7
Operating expenses..................................... 275.2 201.7 851.1 604.1
Selling, general and administrative expenses........... 80.9 75.0 253.9 216.7
Taxes other than income taxes.......................... 742.3 547.2 2,178.6 1,577.0
Depreciation and amortization.......................... 57.3 46.2 180.8 135.9
Restructuring charges.................................. - - 131.6 -
--------- --------- --------- --------
Total operating costs and expenses.................. 2,659.8 2,487.3 8,447.8 7,286.4
--------- --------- --------- ---------
Operating income.......................................... 81.1 125.9 123.7 291.4
Interest income......................................... 2.3 2.3 6.6 10.2
Interest expense........................................ (35.2) (30.3) (107.3) (92.4)
Gain on sale of property, plant and equipment........... - - 7.0 11.0
--------- --------- --------- ---------
Income before income taxes and dividends of
subsidiary.............................................. 48.2 97.9 30.0 220.2
Provision for income taxes.............................. (19.9) (38.6) (32.7) (87.0)
Dividends on preferred stock of subsidiary.............. (2.5) (2.7) (7.7) (2.7)
--------- --------- --------- ---------
Net income (loss)......................................... $ 25.8 $ 56.6 $ (10.4) $ 130.5
========= ========= ========= =========
Net income (loss) per share:
Basic.................................................. $ 0.29 $ 0.73 $ (0.13) $ 1.69
Diluted................................................ $ 0.29 $ 0.71 $ (0.13) $ 1.64
Weighted average number of shares (in thousands):
Basic.................................................. 89,526 75,724 89,018 75,188
Diluted................................................ 89,760 80,164 89,018 79,386
Dividends per share:
Common Shares.......................................... $ 0.275 $ 0.275 $ 0.825 $ 0.825
5% Cumulative Convertible Preferred Shares............. $ - $ 0.625 $ 0.625 $ 1.875
See accompanying notes to consolidated financial statements.
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
(in millions)
Cash Flows from Operating Activities:
Net (loss) income.................................................. $ (10.4) $ 130.5
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Depreciation and amortization................................... $ 180.8 $ 135.9
Provision for losses on receivables............................. 9.2 10.5
Restructuring charges - write-down of property, plant
and equipment and goodwill.................................... 82.1 -
Equity income from Diamond-Koch joint venture................... (1.2) -
Gain on sale of property, plant and equipment................... (3.4) (14.5)
Deferred income tax provision................................... 16.1 80.7
Other, net...................................................... 2.4 (14.2)
Changes in operating assets and liabilities:
Decrease (increase) in accounts and notes receivable.......... 18.8 (0.8)
Decrease in inventories....................................... 98.5 103.3
Decrease in prepaid expenses and other current assets......... 23.3 5.9
Decrease (increase) in other assets........................... 5.6 (19.4)
Decrease in accounts payable and other current liabilities.... (240.0) (259.2)
Increase (decrease) in other long-term liabilities............ 7.4 (56.4)
Other, net.................................................... - (19.3)
------- -------
Net cash provided by operating activities................... 189.2 83.0
------- -------
Cash Flows from Investing Activities:
Capital expenditures.............................................. (93.1) (149.8)
Acquisition of Total, net of cash acquired........................ - (402.4)
Acquisition of marketing operations............................... - (20.3)
Deferred maintenance turnaround costs............................. (29.3) (15.5)
Expenditures for investments...................................... - (10.1)
Proceeds from sales of property, plant and equipment.............. 77.4 77.0
------- -------
Net cash used in investing activities........................... (45.0) (521.1)
------- -------
Cash Flows from Financing Activities:
Net change in commercial paper and short-term borrowings.......... 39.6 194.6
Proceeds from long-term debt...................................... - 15.3
Repayment of long-term debt....................................... (36.3) -
Issuance of Company obligated preferred stock of subsidiary....... - 200.0
Purchase of common stock.......................................... (64.3) -
Payment of cash dividends......................................... (74.2) (64.9)
Other, net........................................................ 6.7 6.7
------- -------
Net cash (used in) provided by financing activities............. (128.5) 351.7
Effect of exchange rate changes on cash............................ (2.3) 1.3
------- -------
Net Increase (Decrease) in Cash and Cash Equivalents............ 13.4 (85.1)
Cash and Cash Equivalents at Beginning of Period................... 92.0 197.9
------- -------
Cash and Cash Equivalents at End of Period......................... $ 105.4 $ 112.8
======= =======
See accompanying notes to consolidated financial statements.
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
(in millions)
Net income (loss)........................................ $ 25.8 $ 56.6 $(10.4) $130.5
Other comprehensive loss, net of tax -
Foreign currency translation adjustment.............. (21.1) - (34.2) (2.6)
------ ------ ------ ------
Comprehensive income (loss).............................. $ 4.7 $ 56.6 $ 44.6) $127.9
====== ====== ====== ======
See accompanying notes to consolidated financial statements.
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(Unaudited)
NOTE 1: Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
by Ultramar Diamond Shamrock Corporation (the Company), in accordance with
generally accepted accounting principles for interim financial reporting and
with Securities and Exchange Commission rules and regulations for Form 10-Q. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Certain previously reported amounts have been reclassified to conform to the
1998 presentation. These unaudited consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and notes
thereto included in the Company's annual report on Form 10-K for the year ended
December 31, 1997.
Operating results for the three and nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. The results of operations may be affected by seasonal
factors, such as the demand for petroleum products and working capital
requirements in the Northeast System, which vary significantly during the year;
or industry factors that may be specific to a particular period, such as
movements in and the general level of crude oil prices, the demand for and
prices of refined products, industry supply capacity and maintenance
turnarounds.
NOTE 2: Adoption of Accounting Pronouncements
Effective March 31, 1998, the Company adopted the Financial Accounting Standards
Board's Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income," which established standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. The Company added
separate statements of comprehensive income (loss) and certain amounts from
prior periods have been reclassified to conform with the new requirements of
SFAS No. 130.
NOTE 3: Inventories
Inventories consisted of the following:
September 30, December 31,
1998 1997
---- ----
(in millions)
Crude oil and other feedstocks........... $253.3 $342.7
Refined and other finished products
and convenience store items............ 317.3 340.5
Materials and supplies................... 56.8 57.8
------ ------
Total inventories...................... $627.4 $741.0
====== ======
During the quarter ended September 30, 1998, the Company recorded a $16.1
million ($9.7 million net of income tax benefit) non-cash reduction in the
carrying value of crude oil and refined product inventories to reduce such
inventories to market resulting in a $42.2 million ($24.8 million net of income
tax benefit) inventory reduction for the nine months ended September 30, 1998.
NOTE 4: Computation of Net Income (Loss) Per Share
Basic net income (loss) per share is calculated as net income (loss) less
preferred stock dividends divided by the average number of Common Shares
outstanding. Diluted net income (loss) per share assumes, when dilutive,
issuance of the net incremental shares from stock options and restricted stock,
and conversion of the 5% Cumulative Convertible Preferred Shares. The following
table reconciles the net income (loss) amounts and share numbers used in the
computation of net income (loss) per share (in millions, except per share data
and number of shares, which are in thousands).
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1998 1997 1998 1997
---- ---- ---- ----
Basic:
Average number of Common Shares outstanding........... 89,526 75,724 89,018 75,188
====== ====== ====== ======
Net income (loss)..................................... $25.8 $56.6 $(10.4) $130.5
Dividends on 5% Cumulative Convertible Preferred
Shares............................................. - 1.1 1.1 3.3
------ ------ ------ ------
Net income (loss) applicable to Common Shares......... $25.8 $ 55.5 $(11.5) $127.2
====== ====== ====== ======
Basic net income (loss) per share....................... $0.29 $ 0.73 $(0.13) $1.69
====== ====== ====== =====
Diluted:
Average number of Common Shares outstanding........... 89,526 75,724 89,018 75,188
Net effect of dilutive stock options and restricted
stock based on the treasury stock method using the
average market price for the periods presented........ 234 1,121 - 879
Assumed conversion of 5% Cumulative Convertible
Preferred Shares (prior to conversion in March 1998). - 3,319 - 3,319
------ ------ ------ ------
Total........................................... 89,760 80,164 89,018 79,386
====== ====== ====== ======
Net income (loss)....................................... $25.8 $ 56.6 $(11.5) (1) $130.5
====== ====== ====== ======
Diluted net income (loss) per share..................... $0.29 $ 0.71 $(0.13) $ 1.64
====== ====== ====== ======
(1) Includes dividends on 5% Cumulative Convertible Preferred Shares.
NOTE 5: Redemption of 5% Cumulative Convertible Preferred Shares
The Company's 5% Cumulative Convertible Preferred Shares (the Preferred Stock)
included a redemption feature effective through June 2000, such that if the
Company's Common Stock traded above $33.77 per share for any 20 days within a 30
day period, the Company could elect to redeem the Preferred Stock by issuance of
Common Stock of the Company. On February 27, 1998, the trading threshold was
reached and on March 18, 1998 the Company redeemed all 1,724,400 outstanding
shares of Preferred Stock. The Preferred Shares were redeemed for Common Stock
at a conversion rate of 1.9246 shares of Common Stock for each share of
Preferred Stock, resulting in a total of 3,318,698 shares of the Company's
Common Stock being issued. The Common Shares were issued from treasury to the
extent available and the balance were newly issued shares.
NOTE 6: Commitments and Contingencies
The Company's operations are subject to environmental laws and regulations
adopted by various governmental authorities. Site restoration and environmental
remediation and clean-up obligations are accrued either when known or when
considered probable and reasonably estimable. Total future environmental costs
cannot be reasonably estimated due to unknown factors such as the magnitude of
possible contamination, the timing and extent of remediation, the determination
of the Company's liability in proportion to other parties and the extent to
which environmental laws and regulations may change in the future. Although
environmental costs may have a significant impact on results of operations for
any single year, the Company believes that such costs will not have a material
adverse effect on the Company's financial position.
There are various legal proceedings and claims pending against the Company that
arise in the ordinary course of business. It is management's opinion, based upon
advice of legal counsel, that these matters, individually or in the aggregate,
will not have a material adverse effect on the Company's financial position or
results of operations.
NOTE 7: Gain on Sale of Assets
In March 1998, the Company recognized a pre-tax gain of $7.0 million ($4.1
million net of income taxes) resulting from the sale of a 25% interest in the
McKee to El Paso pipeline and El Paso terminal to Phillips Petroleum Company.
NOTE 8: Joint Venture with Petro-Canada
In June 1998, the Company and Petro-Canada terminated discussions relating to
the formation of a refining and marketing joint venture involving the Company's
Canadian and northern United States operations. The Competition Bureau of Canada
advised management of both companies that the joint venture raised serious
concerns under the competition laws of Canada. In light of these concerns and
the potentially lengthy review process, the project was terminated. Included in
selling, general and administrative expenses for the nine months ended September
30, 1998 is $11.2 million ($6.6 million net of income tax benefit) of costs
associated with the joint venture project including $2.5 million to write-off
costs for a coker development project that will not be pursued.
NOTE 9: Diamond-Koch LLC
On September 1, 1998, the Company and Koch Hydrocarbon Company, a division of
Koch Industries, Inc. and Koch Pipeline Company, L.P., an affiliate of Koch
Industries, Inc. (Koch), finalized the formation of Diamond-Koch LLC
(Diamond-Koch), a 50-50 joint venture related to each entity's Mont Belvieu
petrochemical assets. Koch contributed its interest in its Mont Belvieu natural
gas liquids fractionator facility and certain of its pipeline and supply
systems. The Company contributed its interests in its propane/propylene
splitters and related distribution pipeline and terminal and its interest in its
Mont Belvieu hydrocarbon storage facilities. Effective with the formation on
September 1, 1998, the Company transferred the net book value of the various
assets contributed of $111.2 million to its investment in Diamond-Koch, which is
included in other assets in the September 30, 1998 balance sheet.
During the month ended September 30, 1998, the Company recognized equity income
of $1.2 million from the joint venture. Also in September 1998, the Company
received $27.0 million from Diamond-Koch for reimbursement of the cost to
construct the third propane/propylene splitter which was completed in August
1998 and transferred to Diamond-Koch in September 1998. NOTE 10: Restructuring
Charges
In light of increased competitive conditions, in June 1998, the Company approved
a restructuring plan designed to reduce its cost structure to reflect current
values and improve operating efficiencies in its retail marketing, refining and
pipeline operations and support services. As a result, the Company recorded a
one-time charge to earnings of $131.6 million ($97.6 million net of income tax
benefit) to cover the cost of eliminating 466 positions, the closure or sale of
316 convenience stores and the sale of certain non-strategic terminals and
pipelines.
The components of the $131.6 million charge are as follows (in millions):
Write-down of property, plant and
equipment and goodwill (non-cash)............... $ 82.1
Severance and related costs....................... 15.5
Lease buy-out costs............................... 14.1
Fuel system removal costs......................... 16.7
Other costs....................................... 3.2
-------
$ 131.6
The restructuring plan is expected to be completed by the year 2000.
NOTE 11: Common Stock Buyback Program
On July 28, 1998, the Board of Directors approved a $100.0 million stock buyback
program to purchase shares of Common Stock in the open market. As of September
30, 1998, the Company has purchased 2,440,200 shares of its Common Stock for a
total cost of $64.3 million. The Company expects to complete the buyback program
during the fourth quarter of 1998.
NOTE 12: Allocation of Total Purchase Price
On September 25, 1997, the Company completed its acquisition of Total Petroleum
(North America) Ltd. (Total) for a total purchase price of $851.8 million and
allocated the purchase price based on an estimate of the fair values of the
individual assets and liabilities at that time. Subsequently in 1998, it has
been determined that in the original purchase price allocation environmental
receivables were overstated, pension and other assets were understated and
environmental liabilities were understated. As a result, the purchase price has
been reallocated effective September 25, 1998 as follows:
Final Initial
Allocation Allocation
---------- ----------
(in millions)
Working capital...................................... $ 29.8 $ 36.1
Property, plant and equipment........................ 839.6 842.6
Excess of cost over fair value of net assets of
purchased business................................. 123.5 76.5
Liabilities assumed and other, net................... (141.1) (103.4)
------ ------
Total purchase price................................. $851.8 $851.8
====== ======
NOTE 13: Subsequent Events
On October 6, 1998, the Board of Directors declared a quarterly dividend of
$0.275 per Common Share payable on December 7, 1998 to holders of record on
November 20, 1998.
On October 8, 1998, the Company and Phillips Petroleum Company (Phillips) signed
a letter of intent to combine all of the operations of the Company and all of
the North American refining, marketing and transportation operations of Phillips
into a newly formed Delaware LLC named Diamond 66 LLC (Diamond 66). The Company
will own 55% of the voting and beneficial interest and control the board of
directors of Diamond 66 and Phillips will own the remaining 45%. The Company
expects to complete the transaction in the first quarter of 1999, subject to
various approvals and the execution of definitive agreements. Under the terms of
the letter of intent, Phillips is to receive from Diamond 66 a payment of $500.0
million at closing and an additional payment of $300.0 million one year
thereafter.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company
- -----------
Ultramar Diamond Shamrock Corporation (the Company) is a leading independent
refiner and marketer of petroleum products and convenience store merchandise in
the Southwest and central regions of the United States (the US System, formerly
referred to as the Southwest), and the Northeast United States and eastern
Canada (the Northeast System). The Company owns and operates seven refineries
located in Texas, California, Michigan, Oklahoma, Colorado and Quebec and
markets its products through Company-operated convenience stores and branded and
unbranded wholesale outlets. In the Northeast System, the Company sells home
heating oil on a retail basis.
On September 1, 1998, the Company contributed its petrochemical operations
located at Mont Belvieu, Texas to Diamond-Koch LLC (Diamond-Koch), a newly
formed 50-50 joint venture, with Koch Industries, Inc. and affiliates (Koch).
Koch contributed its petrochemical operations located at Mont Belvieu, Texas to
the joint venture. The Company is accounting for its 50% investment in
Diamond-Koch using the equity accounting method.
On September 25, 1997, the Company completed its acquisition of Total Petroleum
(North America) Ltd. (Total). The purchase price included the issuance of shares
of Company Common Stock and the assumption of Total's outstanding debt. The
acquisition has been accounted for using the purchase method and, accordingly,
operating results of Total have been included in the consolidated financial
statements since the date of acquisition. Total was an independent refiner and
marketer, operating three refineries in Michigan, Oklahoma and Colorado, and
marketing its products in the central region of the United States through
company-owned convenience stores and branded and unbranded wholesale outlets.
In the Northeast System, demand for petroleum products varies significantly
during the year. Distillate demand during the first and fourth quarters can
range from 30% to 40% above the average demand during the second and third
quarters. The substantial increase in demand for home heating oil during the
winter months results in the Company's Northeast System having significantly
higher accounts receivable and inventory levels during the first and fourth
quarters of each year. The Company's US System is less affected by seasonal
fluctuations in demand than its operations in the Northeast System. The working
capital requirements of the US System, though substantial, show little
fluctuation throughout the year.
The Company's operating results are affected by Company-specific factors,
primarily its refinery utilization rates and refinery maintenance turnarounds;
seasonal factors, such as the demand for petroleum products and working capital
requirements; and industry factors, such as movements in and the level of crude
oil prices, the demand for and prices of refined products and industry supply
capacity. The effect of crude oil price changes on the Company's operating
results is determined, in part, by the rate at which refined product prices
adjust to reflect such changes. As a result, the Company's earnings have been
volatile in the past and may be volatile in the future.
Results of Operations
- ---------------------
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
Financial and operating data by geographic area for the three months ended
September 30, 1998 and 1997 are as follows:
Financial Data:
- ---------------
Three Months Ended September 30,
-------------------------------------------------------------------------------
1998 1997
------------------------------------- -----------------------------------
U S Northeast Total U S Northeast Total
--- --------- ----- --- --------- -----
(in millions)
Sales and other revenues........ $2,157.7 $583.2 $2,740.9 $1,873.0 $740.2 $2,613.2
Cost of products sold (1)....... 1,200.6 303.5 1,504.1 1,191.6 425.6 1,617.2
Operating expenses.............. 248.9 26.3 275.2 173.9 27.8 201.7
Selling, general and
administrative expenses..... 42.9 38.0 80.9 32.4 42.6 75.0
Taxes other than income taxes... 558.0 184.3 742.3 338.6 208.6 547.2
Depreciation and amortization... 48.4 8.9 57.3 37.7 8.5 46.2
-------- ------ -------- -------- ------ --------
Operating income.............. $ 58.9 $ 22.2 81.1 $ 98.8 $ 27.1 125.9
======== ====== ======== ======
Interest income................. 2.3 2.3
Interest expense................ (35.2) (30.3)
-------- --------
Income before income taxes.... 48.2 97.9
Provision for income taxes...... (19.9) (38.6)
Dividend on subsidiary stock.... (2.5) (2.7)
-------- --------
Net income.................... $ 25.8 $ 56.6
======== ========
(1) For the quarter ended September 30, 1998, the Company recorded a $16.1 million
non-cash reduction in the carrying value of crude oil and refined product
inventories due to the continuing drop in crude oil and refined product prices.
Operating Data:
- ---------------
Three Months Ended
September 30,
1998 1997
---- ----
US System (formerly the Southwest)
Mid-Continent Refineries (1)
Throughput (bpd) 367,000 245,000
Margin (dollars per barrel) (2), (4) $4.39 $5.19
Wilmington Refinery
Throughput (bpd) 116,200 122,500
Margin (dollars per barrel) (4) $4.44 $5.93
Retail Marketing
Fuel volume (bpd) 168,000 112,800
Fuel margin (cents per gallon) (2) 15.7 13.3
Merchandise sales ($1,000/day) $3,259 $2,565
Merchandise margin (%) 30.5% 29.6%
Northeast System
Quebec Refinery
Throughput (bpd) 150,300 148,300
Margin (dollars per barrel) (4) $2.87 $2.49
Retail Marketing
Fuel volume (bpd) 59,100 58,300
Overall margins (cents per gallon) (3) 21.4 26.0
(1) The Mid-Continent Refineries include the McKee and Three Rivers Refineries
and, since their acquisition on September 25, 1997, the Alma, Ardmore and Denver
Refineries.
(2) Effective January 1, 1998, the Company modified its policy for pricing
refined products transferred from its McKee and Three Rivers Refineries to its
Mid-Continent marketing operations to more closely reflect spot market prices
for such refined products. Accordingly, the 1997 amounts have been restated to
reflect the pricing policy change as if it had occurred on January 1, 1997. The
refining margin and retail marketing fuel margin originally reported for the
quarter ended September 30, 1997 were $5.50 per barrel and 11.8 cents per
gallon, respectively.
(3) Retail marketing overall margin reported for the Northeast System represents
a blend of gross margin for Company and dealer operated retail outlets and
convenience stores, home heating oil sales and the cardlock operations.
(4) Refinery margins for 1998 exclude the impact of the non-cash charge for the
reduction in the carrying value of crude oil and refined product inventories due
to the drop in crude oil and refined product prices. Had the non-cash charge for
the reduction of inventories been included in the refinery margin computation,
the 1998 refinery margins would have been $4.30 per barrel for the Mid-Continent
Refineries, $3.56 per barrel for the Wilmington Refinery, and $2.61 per barrel
for the Quebec Refinery.
General
Net income for the quarter ended September 30, 1998 totaled $25.8 million as
compared to net income of $56.6 million for the quarter ended September 30,
1997. The third quarter of 1998 included a $16.1 million ($9.7 million net of
income tax benefit) non-cash reduction in the carrying value of inventories due
to the drop in crude oil and refined product prices. Excluding this unusual
item, net income would have been $35.5 million for the quarter ended September
30, 1998 as compared to $56.6 million for the quarter ended September 30, 1997.
On a per share basis, the Company recognized net income per diluted share of
$0.29 for the quarter ended September 30, 1998 as compared to net income per
diluted share of $0.71 in 1997.
In the US System, the Company had operating income of $58.9 million for the
third quarter of 1998 as compared to operating income of $98.8 million for the
third quarter of 1997. The decrease in operating income from 1997 to 1998 is due
in part to the non-cash reduction in the carrying value of inventories discussed
above. In addition, the Mid-Continent Refineries' margin and the Wilmington
Refinery margin declined $0.80 per barrel and $1.49 per barrel, respectively,
mainly as a result of declining crude oil prices which have continued to squeeze
profit margins. The refinery margin decreases were partially offset by increased
throughput from the Mid-Continent Refineries, increased retail marketing fuel
volume and margins, and increased merchandise sales and margins.
In the Northeast System, operating income was $22.2 million for the third
quarter of 1998 as compared to $27.1 million in the third quarter of 1997. The
decrease in operating income from 1997 to 1998 is due primarily to lower retail
margins.
US System
Sales and other revenues in the US System in the third quarter of 1998 totaled
$2.2 billion and were 15.2% higher than for the third quarter of 1997 primarily
due to the increased sales generated from the Total operations acquired in
September 1997. Sales and other revenues for the Total operations for the three
months ended September 30, 1998 were $506.8 million. Sales and other revenues
continue to be adversely impacted by lower sales prices of products in 1998 as
compared to 1997 as a result of the overall market decline in crude oil prices
and high industry inventories.
The increase in throughput for the Mid-Continent Refineries from 245,000 barrels
per day for the third quarter of 1997 to 367,000 barrels per day in the third
quarter of 1998 is due mainly to the increased volume associated with the
acquisition of the Alma, Ardmore, and Denver Refineries from Total. Throughput
for the Ardmore Refinery, however, decreased from approximately 80,000 barrels
per day during the second quarter of 1998 to approximately 38,000 barrels per
day during the third quarter of 1998 as a result of a power failure and fire in
the main fractionation column in the plant's fluid catalytic cracking unit
(FCCU) which occurred in mid-July 1998. The repair of the Ardmore Refinery FCCU
was completed on September 18, 1998, at which time the refinery throughput
increased to full capacity.
The refining margin for the Mid-Continent Refineries of $4.39 per barrel in the
third quarter of 1998 decreased by 15.4% as compared to the third quarter of
1997 mainly because the decrease in product selling prices was greater than the
decrease in crude oil costs coupled with the lower margins generated at the
Ardmore Refinery as a result of the power failure and fire.
Throughput at the Wilmington Refinery decreased 5.1% from 122,500 barrels per
day in the third quarter of 1997 to 116,200 barrels per day in the third quarter
of 1998 due to an unscheduled nine-day shutdown of the FCCU in August 1998
caused by an expander blade failure. The refining margin decreased 25.1% from
$5.93 per barrel in 1997 to $4.44 per barrel in 1998 as a result of high
industry inventories and a decrease in product selling prices greater than the
decrease in crude oil costs.
Retail marketing fuel volume in the US System increased by 48.9% to 168,000
barrels per day as a result of the addition of approximately 500 high volume
Total convenience stores, which were acquired in September 1997, and the
addition of several new convenience stores in Colorado and Arizona in the last
quarter of 1997. The increase in retail fuel margins from 13.3 cents per gallon
for the third quarter of 1997 to 15.7 cents per gallon for the third quarter of
1998 is due mainly to the termination early in the third quarter of the frequent
fueler and stamp programs which increased margins by 1.2 cents per gallon.
Merchandise sales at the Company's convenience stores increased from $2.6
million per day during the third quarter of 1997 to $3.3 million per day during
the third quarter of 1998 due to the increased sales generated from the Total
stores. The merchandise margin increased slightly to 30.5% for the third quarter
of 1998 as compared to 29.6% for the third quarter of 1997, primarily as a
result of increased rebate activity from soft drink and tobacco vendors.
The petrochemicals and natural gas liquids business contributed to operating
income, however at lower levels in 1998 as compared to 1997 due to the negative
impact on prices of propylene and other petrochemicals caused by continued weak
economic conditions in Asia and the Far East.
Selling, general and administrative expenses of $42.9 million in the third
quarter of 1998 were $10.5 million higher than in the third quarter of 1997,
reflecting primarily higher selling costs incurred to support the increased
sales resulting from the Total operations.
Northeast System
Sales and other revenues in the Northeast System in the third quarter of 1998
totaled $583.2 million and were $157.0 million, or 21.2%, lower than in the
corresponding quarter of 1997 as a result of reduced 1998 selling prices of
refined products in comparison to 1997 as a result of high industry inventories
and lower crude oil prices.
Throughput at the Quebec Refinery increased slightly to 150,300 barrels per day
for the third quarter of 1998 compared to 148,300 barrels per day for the third
quarter of 1997 as a result of improved performance during August 1998 resulting
from the modification of the crude heat burners. Also, during August 1997,
throughput was slightly reduced following a compressor breakdown and lack of
light crude oil for processing. Refining margins increased by 15.3% to $2.87 per
barrel in the third quarter of 1998 as compared to $2.49 per barrel in the third
quarter of 1997 due mainly to lower crude oil costs achieved through favorable
long-term supply agreements.
Retail marketing fuel volumes remained level as compared with the third quarter
of 1997 at approximately 59,100 barrels per day. Retail margins, however,
dropped to 21.4 cents per gallon in 1998 as compared to 26.0 cents per gallon in
1997 due to continued aggressive pricing by competitors in the lower-margin
motorist market. In addition, government hearings in Quebec to bring retail fuel
margins to a minimum level for the benefit of independent marketers have
negatively impacted retail fuel margins in recent months.
Selling, general and administrative expenses of $38.0 million were $4.6 million
lower than in the third quarter of 1997 due to continuing efforts to control
costs.
Corporate
Interest expense of $35.2 million in the third quarter of 1998 was $4.9 million
higher than in the corresponding quarter of 1997 due to higher average
borrowings in 1998 as compared to 1997 resulting from the debt incurred to
finance the Total acquisition in September 1997.
The consolidated income tax provision for the third quarter of 1998 was based
upon the Company's estimated effective income tax rate for the year ending
December 31, 1998 of 41.3%, exclusive of the impact of the non-deductible
goodwill included in the second quarter restructuring charge. The consolidated
income tax provision for the third quarter of 1997 was based upon the Company's
estimated effective income tax rate for the year ended December 31, 1997 of
39.5%. The consolidated effective income tax rates exceed the U.S. Federal
statutory income tax rate primarily due to state income taxes, non-deductible
goodwill and the effects of foreign operations.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
Financial and operating data by geographic area for the nine months ended
September 30, 1998 and 1997 are as follows:
Financial Data:
- ---------------
Nine Months Ended September 30,
-----------------------------------------------------------------------------
1998 1997
----------------------------------- ----------------------------------
U S Northeast Total U S Northeast Total
--- --------- ----- --- --------- -----
(in millions)
Sales and other revenues........ $6,732.9 $1,838.6 $8,571.5 $5,321.4 $2,256.4 $7,577.8
Cost of products sold (1)....... 3,861.8 990.0 4,851.8 3,418.1 1,334.6 4,752.7
Operating expenses.............. 765.4 85.7 851.1 515.0 89.1 604.1
Selling, general and
administrative expenses (2). 127.4 126.5 253.9 93.0 123.7 216.7
Taxes other than income taxes... 1,632.6 546.0 2,178.6 980.3 596.7 1,577.0
Depreciation and amortization... 153.8 27.0 180.8 112.2 23.7 135.9
Restructuring charges (3)....... 131.6 - 131.6 - -
-------- -------- -------- -------- -------- --------
Operating income.............. $ 60.3 $ 63.4 123.7 $ 202.8 $ 88.6 291.4
======== ======== ======== ========
Interest income................. 6.6 10.2
Interest expense................ (107.3) (92.4)
Gain on sale of assets (4)...... 7.0 11.0
-------- --------
Income before income taxes.... 30.0 220.2
Provision for income taxes...... (32.7) (87.0)
Dividend on subsidiary stock.... (7.7) (2.7)
-------- --------
Net (loss) income............. $ (10.4) $ 130.5
======== ========
(1) During the nine months ended September 30, 1998, the Company recorded a
$42.2 million non-cash reduction in the carrying value of crude oil and refined
product inventories due to the significant drop in crude oil and refined product
prices in 1998.
(2) During the second quarter of 1998, the Company incurred $11.2 million in
costs associated with the aborted Petro-Canada joint venture including $2.5
million to write-off costs for a coker development project that will not be
pursued.
(3) On June 9, 1998, the Company recorded a one-time charge of $131.6 million to
restructure its retail marketing, refining and pipeline operations and support
services. The restructuring charges include a property, plant and equipment and
goodwill write-down totaling $82.1 million, severance and relocation costs of
$15.5 million, and lease buyout, fuel system removal and other costs totaling
$34.0 million.
(4) In March 1998, the Company recognized a $7.0 million gain on the sale of a
25% interest in its McKee to El Paso pipeline and El Paso terminal to Phillips
Petroleum Company. In March 1997, the Company recognized an $11.0 million gain
on the sale of an office building in San Antonio, Texas.
Operating Data:
- ---------------
Nine Months Ended
September 30,
-------------
1998 1997
---- ----
US System (formerly the Southwest)
Mid-Continent Refineries (1)
Throughput (bpd) 393,400 234,800
Margin (dollars per barrel) (2), (4) $4.32 $4.87
Wilmington Refinery
Throughput (bpd) 120,500 116,800
Margin (dollars per barrel) (4) $4.87 $4.76
Retail Marketing
Fuel volume (bpd) 170,300 110,600
Fuel margin (cents per gallon) (2) 13.9 13.1
Merchandise sales ($1,000/day) $3,149 $2,397
Merchandise margin (%) 30.6% 29.9%
Northeast System
Quebec Refinery
Throughput (bpd) 152,300 134,400
Margin (dollars per barrel) (4) $2.55 $2.33
Retail Marketing
Fuel volume (bpd) 63,100 63,000
Overall margins (cents per gallon) (3) 24.9 27.7
(1) The Mid-Continent Refineries include the McKee and Three Rivers Refineries
and, since their acquisition on September 25, 1997, the Alma, Ardmore and Denver
Refineries.
(2) Effective January 1, 1998, the Company modified its policy for pricing
refined products transferred from its McKee and Three Rivers Refineries to its
Mid-Continent marketing operations to more closely reflect spot market prices
for such refined products. Accordingly, the 1997 amounts have been restated to
reflect the pricing policy change as if it had occurred on January 1, 1997. The
refining margin and retail marketing fuel margin originally reported for the
nine months ended September 30, 1997, were $5.19 per barrel and 11.4 cents per
gallon, respectively.
(3) Retail marketing overall margin reported for the Northeast System represents
a blend of gross margin for Company and dealer operated retail outlets and
convenience stores, home heating oil sales and the cardlock operations.
(4) Refinery margins for 1998 exclude the impact of the non-cash charge for the
reduction in the carrying value of crude oil and refined product inventories due
to the drop in crude oil and refined product prices. Had the non-cash charge for
the reduction of inventories been included in the refinery margin computation,
the 1998 refinery margins would have been $4.22 per barrel for the Mid-Continent
Refineries, $4.35 per barrel for the Wilmington Refinery, and $2.21 per barrel
for the Quebec Refinery.
General
Net loss for the nine months ended September 30, 1998 totaled $10.4 million as
compared to net income of $130.5 million for the nine months ended September 30,
1997. The first nine months of 1998 included a one-time charge of $131.6 million
($97.6 million net of income tax benefit) related to the restructuring of the
retail marketing, refining and pipeline operations and support services; a $42.2
million ($24.8 million net of income tax benefit) non-cash charge to reduce
inventories due to the continuing drop in crude oil and refined product prices;
$11.2 million of costs ($6.6 million net of income tax benefit) associated with
the aborted joint venture with Petro-Canada; and a $7.0 million ($4.1 million
net of income taxes) gain on the sale of a 25% interest in the McKee to El Paso
pipeline and El Paso terminal. In the first nine months of 1997, the Company
recognized an $11.0 million ($6.6 million net of income taxes) gain on the sale
of an office building. Excluding these unusual items, net income would have been
$114.5 million for the nine months ended September 30, 1998 as compared to
$123.9 million for the nine months ended September 30, 1997.
As a result of these unusual items, for the nine months ended September 30,
1998, the Company recognized a net loss of $0.13 per basic share as compared to
net income of $1.69 per basic share in 1997. The net loss per diluted share for
the nine months ended September 30, 1998 was also $0.13 as compared to net
income of $1.64 per diluted share in 1997.
In the US System, the Company had operating income of $60.3 million for the
first nine months of 1998 as compared to operating income of $202.8 million for
the same period of 1997. In the Northeast System, operating income was $63.4
million for the first nine months of 1998 as compared to $88.6 million in 1997.
The decrease in operating income from 1997 to 1998 for both the US System and
the Northeast System is due primarily to the unusual items discussed above.
US System
Sales and other revenues in the US System for the nine months ended September
30, 1998 totaled $6.7 billion and were 26.5% higher than for the nine months
ended September 30, 1997 primarily due to the increased sales generated from the
Total operations acquired in September 1997. Sales and other revenues for the
Total operations for the nine months ended September 30, 1998 were $1.8 billion.
Sales and other revenues were adversely impacted by lower sales prices of
products in 1998 as compared to 1997 as a result of the overall market decline
in crude oil prices and high industry inventories.
The increase in throughput for the Mid-Continent Refineries from 234,800 barrels
per day in the first nine months of 1997 to 393,400 barrels per day in the first
nine months of 1998 is due mainly to the increased volume associated with the
acquisition of the Total refineries. Throughput for the Ardmore Refinery,
however, decreased from approximately 80,000 barrels per day for the first six
months of 1998 to approximately 67,000 barrels per day for the nine months ended
September 30, 1998 as a result of a power failure and fire in the main
fractionation column in the plant's FCCU which occurred in mid-July 1998. The
repair of the Ardmore Refinery FCCU was completed on September 18, 1998, at
which time the refinery throughput increased to full capacity.
The refining margin for the Mid-Continent Refineries of $4.32 per barrel in the
first nine months of 1998 decreased by 11.3% as compared to $4.87 per barrel in
the first nine months of 1997 due to a 21-day scheduled maintenance turnaround
at the Three Rivers Refinery, lower throughput at the Ardmore Refinery in order
to de-bottleneck the crude unit and as a result of the fire in mid-July 1998,
and an unplanned repair of the FCCU at the McKee Refinery. In addition, product
selling prices were negatively impacted by high industry inventories and
decreased by more than the decrease in crude oil costs. Throughput at the
Wilmington Refinery increased 3.2% for the nine months ended September 30, 1998
to 120,500 barrels per day because of purchases of high sulfur distillate to
produce finished diesel during 1998 which did not occur during the first nine
months of 1997, coupled with a scheduled maintenance turnaround on the gas oil
hydrotreater in February 1997. In addition, the increase in the refining margin
by 2.3% was a result of improved spreads between crude oil/feedstocks and
refined products.
Retail marketing fuel volume in the US System increased by 54.0% to 170,300
barrels per day, as a result of the addition of approximately 500 high volume
Total convenience stores, which were acquired in September 1997, and the
addition of several new convenience stores in Colorado and Arizona in the last
quarter of 1997. Retail fuel margins rose slightly for the nine months ended
September 30, 1998 from 13.1 cents per gallon in 1997 to 13.9 cents per gallon
in 1998 due mainly to the termination early in the third quarter of the frequent
fueler and stamp programs which increased margins in the third quarter by 1.2
cents per gallon.
Merchandise sales at the Company's convenience stores increased from $2.4
million per day during the first nine months of 1997 to $3.1 million per day
during the first nine months of 1998 due to the increased sales generated from
the Total stores. The merchandise margin for the nine months ended September 30,
1998 was up slightly at 30.6% as compared to 29.9% for the nine months ended
September 30, 1997.
For the first nine months of 1998, the petrochemicals and natural gas liquids
businesses contributed to operating income, however at lower levels due to the
declining prices of propylene and other petrochemicals which continue to be
impacted by very weak economic conditions in Asia and the Far East.
Selling, general and administrative expenses of $127.4 million for the nine
months ended September 30, 1998 were $34.4 million higher than for the nine
months ended September 30, 1997, primarily due to higher selling costs incurred
to support the increased sales resulting from the Total operations, $1.6 million
of costs incurred related to the aborted Petro-Canada joint venture and
approximately $3.5 million of non-recurring costs associated with Total's Denver
office which was closed in May 1998.
Northeast System
Sales and other revenues in the Northeast System in the first nine months of
1998 totaled $1.8 billion and were $417.8 million, or 18.5%, lower than in the
corresponding nine months of 1997, as a result of lower sales in the retail and
wholesale segments following the relatively mild winter in Eastern Canada and
the Northeast United States. The lower sales were also directly affected by the
reduced 1998 selling prices of refined products in comparison to 1997 as a
result of high industry inventories and lower crude oil prices.
Throughput at the Quebec Refinery increased 13.3% to 152,300 barrels per day in
the first nine months of 1998 compared to 134,400 barrels per day in the first
nine months of 1997. The low throughput in 1997 was caused by a planned
maintenance turnaround on the FCCU in May and June 1997. Refining margins
increased by 9.4% to $2.55 per barrel in the first nine months of 1998 as
compared to $2.33 per barrel in the first nine months of 1997 due mainly to the
scheduled refinery maintenance turnaround which occurred in the second quarter
of 1997 combined with lower crude oil costs achieved through favorable long-term
supply agreements.
Retail marketing fuel volumes remained level in 1998 as compared with the first
nine months of 1997 at approximately 63,100 barrels per day. Retail margins,
however, dropped to 24.9 cents per gallon in 1998 as compared to 27.7 cents per
gallon in 1997 due to the decreased demand for high-margin home heating oil
resulting from a mild winter in 1998 which was offset partially by increased
demand in the lower-margin motorist and cardlock markets.
Selling, general and administrative expenses of $126.5 million were $2.8 million
higher than in the first nine months of 1997, principally due to $9.6 million of
costs incurred related to the formation of the aborted Petro-Canada joint
venture which was offset by reductions resulting from continuing efforts to
control costs.
Corporate
Interest expense of $107.3 million in the first nine months of 1998 was $14.9
million higher than in the corresponding nine months of 1997 due to higher
average borrowings in 1998 as compared to 1997 resulting from the debt incurred
to finance the acquisition of Total in September 1997.
The consolidated income tax provision, exclusive of the restructuring charges,
for the nine months ended September 30, 1998 was based upon the Company's
estimated effective income tax rate for the year ending December 31, 1998 of
41.3%. The income tax benefit of the second quarter restructuring charges was
computed separately at 25.9%, resulting in a 109% effective income tax rate for
the nine months ended September 30, 1998. The income tax rate on the
restructuring charges is below the U.S. Federal statutory income tax rate due to
the non-deductible writedown of goodwill.
The consolidated income tax provision for the nine months ended September 30,
1997 was based upon the Company's estimated effective income tax rate for the
year ended December 31, 1997 of 39.5%. The consolidated effective income tax
rate exceeds the U.S. Federal statutory income tax rate primarily due to state
income taxes and the effects of foreign operations.
Outlook
- -------
The Company's earnings depend largely on refining and retail marketing margins.
The petroleum refining and marketing industry has been and continues to be
volatile and highly competitive. The cost of crude oil purchased by the Company
as well as the price of refined products sold by the Company have fluctuated
widely in the past. As a result of the historic volatility of refining and
marketing margins and the fact that they are affected by numerous diverse
factors, it is impossible to predict future margin levels.
The second and third quarters of 1998 were characterized by low crude oil prices
which were consistently cheaper in the forward months, prompting refiners to run
their facilities at near-full utilization rates. However, seasonal strength in
product demand could not keep pace with production, and industry margins
weakened, particularly in the third quarter of 1998. The Company's composite
crack spread, which is the weighted average of each of the crack spreads in the
areas in which it operates, fell from $5.45 per barrel during the second quarter
of 1998 to $3.76 per barrel during the third quarter of 1998.
The beginning of the fourth quarter of 1998 has seen some increases in crude oil
prices and an industry-wide reduction in refinery utilization leading to a
decline in inventories - all of which should add up to stronger margins.
Distillate inventories are still very high, but demand has started to increase
as winter approaches. Continued margin strength will depend on stable crude oil
prices and a shift in demand from gasoline to distillates as the fourth quarter
progresses.
All of the Company's facilities are operating well, including the Ardmore,
Oklahoma Refinery which returned to full capacity on September 18, 1998
following repairs and turnaround work related to the power failure and fire in
the main fractionation column of the FCCU on July 13, 1998. The Company plans to
turnaround the FCCU at the Wilmington Refinery late in the fourth quarter 1998.
See "Certain Forward Looking Statements."
Capital Expenditures
- --------------------
The refining and marketing of petroleum products is a capital intensive
business. Significant capital requirements include expenditures to upgrade or
enhance refinery operations to meet environmental regulations and maintain the
Company's competitive position, as well as to acquire, build and maintain
broad-based retail networks. The capital requirements of the Company's
operations consist primarily of (i) reliability, environmental and regulatory
expenditures, such as those required to maintain equipment reliability and
safety and to address environmental regulations (including reformulated fuel
specifications, stationary source emission standards and underground storage
tank regulations); and (ii) growth opportunity expenditures, such as those
planned to expand and upgrade its retail marketing business, to increase the
capacity of certain refinery processing units and pipelines and to construct
additional petrochemical processing units.
During the nine months ended September 30, 1998, capital expenditures totaled
$93.1 million, of which $43.2 million related to growth opportunity
expenditures, and $49.9 million related to reliability, environmental and
regulatory expenditures. Approximately $27.0 million and $14.7 million have been
incurred at the refineries and the retail level, respectively, for various
reliability, environmental and regulatory expenditures. During the nine months
ended September 30, 1998, the Company also incurred $29.3 million in maintenance
turnaround costs primarily at the Ardmore, Three Rivers and McKee Refineries.
Growth opportunity spending during the first nine months of 1998 included:
- $12.7 million for the construction of a third propane/propylene
splitter at the Company's Mont Belvieu facility which was completed in
August 1998 and transferred to Diamond-Koch in September 1998;
- $2.9 million for the McKee to El Paso pipeline expansion to increase
capacity to 60,000 barrels per day with the cost being shared with
Phillips Petroleum Company, a partner in the project and the pending
Diamond 66 LLC;
- $2.5 million to replace the Three Rivers Refinery FCCU's reactor and
regenerator with new state-of-the-art designs and to install new
exchangers, pumps and towers in the gas concentration and merox
treating units which have increased throughput capacity by
approximately 2,000 barrels per day; and,
- $3.1 million to modify the main column and gas concentration sections
of the Wilmington Refinery FCCU to expand throughput capacity by 5,000
barrels per day. This project is expected to be completed in December
1998 at a total estimated cost of $13.0 million.
The Company is continually investigating strategic acquisitions and other
business opportunities, some of which may be material, that will complement its
current business activities. The Company expects to fund its capital
expenditures over the next several years from cash provided by operations and,
to the extent necessary, from the proceeds of borrowings under its bank credit
facilities and its commercial paper and medium-term note programs discussed
below. In addition, depending upon its future needs and the cost and
availability of various financing alternatives, the Company may, from time to
time, seek additional debt or equity financing in the public or private markets.
Liquidity and Capital Resources
- -------------------------------
As of September 30, 1998, the Company had cash and cash equivalents of $105.4
million. The Company currently has two committed, unsecured bank facilities
which provide a maximum of $700.0 million U.S. and $200.0 million Cdn. of
available credit, and a $700.0 million commercial paper program supported by the
committed, unsecured U.S.
bank facility.
As of September 30, 1998, the Company had approximately $503.6 million remaining
borrowing capacity under its committed bank facilities and commercial paper
program. In addition to its committed bank facilities, on September 30, 1998,
the Company had approximately $509.3 million of borrowing capacity under
uncommitted, unsecured short-term lines of credit with various financial
institutions.
In addition to its bank credit facilities, the Company has $1.0 billion
available under universal shelf registrations previously filed with the
Securities and Exchange Commission. The net proceeds from any debt or equity
offering under the universal shelf registrations would add to the Company's
working capital and would be available for general corporate purposes.
The Company also has $73.1 million available pursuant to committed lease
facilities aggregating $355.0 million, under which the lessors will construct or
acquire and lease to the Company primarily convenience stores.
The bank facilities and other debt agreements require that the Company maintain
certain financial ratios and other restrictive covenants. The Company is in
compliance with such covenants and believes that such covenants will not have a
significant impact on the Company's liquidity or its ability to pay dividends.
The Company believes its current sources of funds will be sufficient to satisfy
its capital expenditure, working capital, debt service and dividend requirements
for at least the next twelve months.
In March 1998, the Company exercised its right to redeem the 1,724,400
outstanding shares of its 5% Cumulative Convertible Preferred Stock into Common
Stock at a conversion rate of 1.9246 shares of Common Stock for each share of
Preferred Stock. The redemption resulted in 3,318,698 shares of Common Stock
being issued, a portion of which came from treasury shares and the balance of
shares were newly issued. As a result of the redemption, the cash dividend
requirements for the Company will be lower by $0.7 million on an annualized
basis.
The continued consolidation in the refining and marketing industry has changed
the retail product pricing environment resulting in lower retail marketing
margins over the past several years. In order to stay competitive and increase
profitability, the Company initiated a restructuring program in June 1998 to
reorganize its retail support infrastructure (eliminating 341 positions), to
close or sell 316 under-performing convenience stores, and to sell certain
excess terminal and pipeline assets, including the elimination of an additional
125 positions. Accordingly, the Company recognized a one-time charge of $131.6
million in the quarter ended June 30, 1998 consisting of $82.1 million to
write-down property, plant and equipment and goodwill, $34.0 million for costs
associated with closing the 316 convenience stores, and of $15.5 million of
severance costs to eliminate 466 positions.
The restructuring initiatives are expected to increase annual earnings before
interest and income taxes by $99.6 million in 1999, $124.0 million in 2000, and
$128.9 million in 2001 due to lower operating costs. The increase in annual
earnings will more than offset the one-time cash outlays related to the
restructuring program estimated at $49.5 million over the next three years. In
addition, as part of the restructuring plan, the Company has decreased its
retail marketing capital expenditures budget by $32.6 million for the second
half of 1998. On July 28, 1998, the Board of Directors approved a $100.0 million
stock buyback program to purchase shares of Common Stock in the open market. The
purchase of Common Stock is being funded using available cash flow from
operations. The purchased stock will be used to fund future employee benefit
obligations of the Company. As of September 30, 1998, the Company had purchased
2,440,200 shares of its Common Stock for a total cost of $64.3 million. The
Company expects to complete the buyback program during the fourth quarter of
1998.
On October 6, 1998, the Board of Directors declared a quarterly dividend of
$0.275 per Common Share payable on December 7, 1998 to holders of record on
November 20, 1998.
Cash Flows for the Nine Months Ended September 30, 1998
During the nine months ended September 30, 1998, the Company's cash position
increased $13.4 million to $105.4 million. Net cash provided by operating
activities during the first nine months of 1998 was $189.2 million as compared
to $83.0 million in 1997. This increase is due primarily to additional
depreciation and amortization as a result of the Total acquisition and an
improved working capital position.
Net cash used in investing activities during the nine months ended September 30,
1998, totaled $45.0 million, including cash outflows of $93.1 million for
capital expenditures and $29.3 million for maintenance turnaround costs. Cash
inflows from investing activities included $27.8 million related to proceeds
from the sale of the McKee to El Paso pipeline and El Paso terminal to Phillips
Petroleum Company, $17.2 million of proceeds from the sale of 29 convenience
stores to Griffin L.L.C. and $27.0 million received from Diamond-Koch for
reimbursement of the cost to construct the third propane/propylene splitter at
Mont Belvieu.
Net cash used in financing activities during the nine months ended September 30,
1998, totaled $128.5 million, primarily due to the cash dividends declared and
paid totaling $74.2 million on outstanding Common Stock ($0.825 per share) and
5% Cumulative Convertible Preferred Stock ($0.625 per share) prior to redemption
in March 1998 and the purchase of 2,440,200 shares of the Company's Common Stock
for a total cost of $64.3 million.
Exchange Rates
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The value of the Canadian dollar relative to the U.S. dollar has weakened
substantially since the acquisition of the Canadian operations in 1992, and
reached an historic low against the U.S. dollar in the third quarter of 1998. As
the Company's Canadian operations are in a net asset position, the weaker
Canadian dollar has reduced, in U.S. dollars, the Company's net equity at
September 30, 1998, by $112.4 million. Although the Company expects the exchange
rate to fluctuate during the remainder of 1998, it cannot reasonably predict its
future movement.
With the exception of its crude oil costs, which are U.S. dollar denominated,
fluctuations in the Canadian dollar exchange rate will affect the U.S. dollar
amount of revenues and related costs and expenses reported by the Canadian
operations. The potential impact on refining margin of fluctuating exchange
rates together with U.S. dollar denominated crude oil costs is mitigated by the
Company's pricing policies in the Northeast System, which generally pass on any
change in the cost of crude oil. Marketing margins, on the other hand, have been
adversely affected by exchange rate fluctuations as competitive pressures have,
from time to time, limited the Company's ability to promptly pass on the
increased costs to the ultimate consumer. The Company has considered various
strategies to manage currency risk, and it hedges the Canadian currency risk
when such hedging is considered economically appropriate.
Update on Impact of Year 2000 Issues
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In 1997, the Company initiated an enterprise-wide effort to assess and mitigate
or eliminate the business risk associated with year 2000 issues, focusing on (1)
information technology (IT) computer hardware and software systems, (2) internal
process control equipment outside of the IT area used in the refining or retail
operations, and (3) interfaces and support services from vendors, suppliers and
customers.
The Company's U S IT systems are substantially year 2000 compliant as a result
of the 1995 implementation of a new IT system and the migration earlier this
year of Total's operations to the U S IT system at a cost of $4.3 million. The
Company's Northeast IT systems are not year 2000 compliant; however, the Company
has begun implementing a new stand-alone enterprise-wide IT system, which will
bring the Northeast into compliance by the second quarter of 1999. This new
enterprise-wide IT system will also be implemented in the U S operations during
the later part of 1999 because it offers superior technological enhancements and
operating efficiencies not available in the existing U S IT system. The cost of
the new enterprise-wide IT system for the Northeast and U S systems is expected
to be $48.0 million, with most of the costs being capitalized.
The Company has identified most, if not all, of the exposure items associated
with internal process control equipment used at the refineries and throughout
the retail operations, and has implemented a plan to bring such equipment into
compliance with year 2000. The Company has also hired an outside consultant to
assist in addressing its year 2000 issues. Additionally, the Company has
corresponded with its numerous suppliers, vendors and customers and developed a
plan to mitigate potential exposure areas. The estimated cost to be incurred for
the non-IT and third-party corrective action plans range from $28.2 million to
$44.0 million, with most of the costs being capitalized. The actual costs
incurred will depend on the alternative chosen for each corrective action.
Management anticipates that all corrective actions will be completed by December
31, 1999 to ensure minimal disruption to operations as the new millennium
begins.
The failure to correct a material year 2000 issue could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could adversely affect the Company's results of
operations, liquidity and financial condition. Due to the general uncertainty
inherent in the year 2000 issue, resulting in part from the uncertainty of the
year 2000 readiness of third-party suppliers and customers, the Company is
unable to determine at this time whether the consequences of year 2000 failures
will have a material impact on the Company's results of operations, liquidity or
financial condition. The Company's current and planned activities with respect
to the year 2000 issue are expected to significantly reduce the Company's level
of uncertainty about the magnitude of the risk posed by the year 2000 issue and,
in particular, about the year 2000 compliance and readiness of its material
customers and suppliers. The Company believes that, with the implementation of
new IT systems and completion of the planned activities as scheduled, the
possibility of significant interruptions of normal operations should be reduced.
See "Certain Forward Looking Statements."
Certain Forward Looking Statements
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This quarterly report on Form 10-Q contains certain "forward-looking" statements
as such term is defined in the U. S. Private Securities Litigation Reform Act of
1995 and information relating to the Company and its subsidiaries that are based
on the beliefs of management as well as assumptions made by and information
currently available to management. When used in this report, the words
"anticipate," "believe," "estimate," "expect," and "intend" and words or phrases
of similar import, as they relate to the Company or its subsidiaries or
management, identify forward-looking statements. Such statements reflect the
current views of management with respect to future events and are subject to
certain risks, uncertainties and assumptions relating to the operations and
results of operations, including as a result of competitive factors and pricing
pressures, shifts in market demand and general economic conditions and other
factors.
Should one or more of these risks or uncertainties materialize, or should any
underlying assumptions prove incorrect, actual results or outcomes may vary
materially from those described herein as anticipated, believed, estimated,
expected or intended. The Company disclaims any obligation to update
forward-looking statements contained in this document.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Alleged Environmental Violations at Three Rivers and McKee
Refineries. On September 15, 1998, the Company was notified by the
U.S. Department of Justice (DOJ), on behalf of the Environmental
Protection Agency (EPA), of alleged violations of the Clean Air Act
(CAA) and Resource Conservation Recovery Act at the McKee and the
Three Rivers Refineries and for alleged violations of the Clean
Water Act (CWA) at the Three Rivers Refinery. These alleged
violations were categorized as failure to implement and maintain
proper records and reports with respect to the facilities' leak
detection and repair programs under the CAA; failure to operate the
facilities in a manner consistent with good air pollution control
prevention for minimizing emissions; failure to comply with
effluent limitations and reporting requirements under a CWA permit
as well as to properly operate and maintain the Three Rivers
Refinery in accordance with the CWA permit conditions; and
discharging pollutants into the waters of the United States without
a permit. The DOJ has proposed a penalty of $2.5 million for such
alleged violations. The Company has requested additional
information form the DOJ concerning the alleged violations.
In the Matter of Total Petroleum, Inc. (Combined Notice of
Violation No. EPA-5-97-MI-33 and Finding of Violation No.
EPA-5-97-MI-34 filed August 5, 1997). The EPA has expanded the
scope of the alleged violations to a multimedia enforcement action
and amended the related Administrative Findings of Violations,
Notice of Violations, and Table of Violations to reflect the
expanded scope. The alleged violations now include, in addition to
the previously alleged Clean Air Act violations, violations in
monitoring, quantifying, and reporting benzene NESHAPs, excessive
SO2 and CO emissions, improper inspection procedures on regulated
tankage, and violations relating to the labeling, storage, and
disposal of hazardous waste. The Company continues to discuss the
above issues with the EPA.
ITEM 5. OTHER INFORMATION
Discretionary Voting Authority Relating to Certain Matters. The
Company will use its discretionary voting authority granted in the
proxies relating to the Company's 1999 annual meeting of
shareholders (the "1999 Meeting") with respect to any shareholder
proposal (which matter has not been included in the Company's proxy
statement relating to the 1999 Meeting) raised at the 1999 Meeting
of which the Company has not been notified on or before February
14, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
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None.
SIGNATURE
Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
ULTRAMAR DIAMOND SHAMROCK CORPORATION
(Registrant)
By: /s/ H. PETE SMITH
H. PETE SMITH
EXECUTIVE VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
November 13, 1998