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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 31, 1998
Commission File Number 1-12204
TRANSTEXAS GAS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 76-0401023
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1300 NORTH SAM HOUSTON PARKWAY EAST
SUITE 310
HOUSTON, TEXAS 77032
(Address of principal executive offices) (Zip Code)
(281) 987-8600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares of common stock of the registrant outstanding on
September 14, 1998 was 57,515,566.
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TRANSTEXAS GAS CORPORATION
TABLE OF CONTENTS
PAGE
PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements:
Report of Independent Accountants............................................................ 2
Condensed Consolidated Balance Sheet as of July 31, 1998 and January 31, 1998................ 3
Condensed Consolidated Statement of Operations for the three and six months ended
July 31, 1998 and 1997................................................................... 4
Condensed Consolidated Statement of Cash Flows for the six months ended
July 31, 1998 and 1997................................................................... 5
Notes to Condensed Consolidated Financial Statements......................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 19
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 20
Item 4. Submission of Matters to a Vote of Security Holders............................................. 20
Item 6. Exhibits and Reports on Form 8-K................................................................ 20
Signature.................................................................................................. 21
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors
of TransTexas Gas Corporation
We have reviewed the accompanying condensed consolidated balance sheet of
TransTexas Gas Corporation as of July 31, 1998 and the related condensed
consolidated statements of operations for the three and six months ended July
31, 1998 and 1997 and the cash flows for the six months ended July 31, 1998 and
1997. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
for them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of January 31, 1998, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for the year then ended (not presented herein); and in our report
dated April 30, 1998, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of January 31, 1998, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
PricewaterhouseCoopers LLP
Houston, Texas
September 14, 1998
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TRANSTEXAS GAS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
JULY 31, JANUARY 31,
1998 1998
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 16,090 $ 38,502
Accounts receivable...................................................... 15,989 17,056
Inventories.............................................................. 15,153 16,437
Other current assets..................................................... 5,659 10,719
------------ ------------
Total current assets................................................ 52,891 82,714
------------ ------------
Property and equipment...................................................... 1,480,684 1,418,293
Less accumulated depreciation, depletion and amortization................... 741,072 716,695
------------ ------------
Net property and equipment -- based on the full cost method of
accounting for gas and oil properties of which $66,563 and $104,389
was excluded from amortization at July 31, 1998 and January 31, 1998,
respectively........................................................... 739,612 701,598
------------ ------------
Due from affiliates......................................................... 5,983 1,488
Other assets, net........................................................... 27,901 30,835
------------ ------------
$ 826,387 $ 816,635
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt..................................... $ 614 $ 10,181
Accounts payable......................................................... 49,994 52,075
Accrued interest payable to affiliate.................................... 6,790 6,762
Accrued liabilities...................................................... 39,393 35,818
------------ ------------
Total current liabilities........................................... 96,791 104,836
------------ ------------
Long-term debt, less current maturities..................................... 2,986 9,199
Production payments, less current portion................................... 49,582 4,121
Notes payable to affiliate.................................................. 479,733 486,991
Subordinated notes.......................................................... 115,815 115,815
Revolving credit agreement.................................................. 7,209 7,917
Deferred income taxes....................................................... 35,399 39,497
Payable to affiliates....................................................... 3,002 3,002
Other liabilities........................................................... 18,842 20,620
Commitments and contingencies (Note 3)...................................... -- --
Stockholders' equity:
Common stock, $0.01 par value, authorized 100,000,000
shares, issued and outstanding 57,515,566 shares........................ 740 740
Additional paid-in capital............................................... 26,834 26,834
Retained earnings........................................................ 251,859 259,468
------------ ------------
279,433 287,042
Treasury stock, at cost, 16,484,434 shares............................... (262,405) (262,405)
------------ ------------
Total stockholders' equity....................................... 17,028 24,637
------------ ------------
$ 826,387 $ 816,635
============ ============
See accompanying notes to condensed consolidated financial statements.
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TRANSTEXAS GAS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
------------------------------ ------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenues:
Gas, condensate and natural gas liquids ..... $ 20,538 $ 39,288 $ 39,868 $ 112,170
Transportation .............................. -- 2,764 -- 12,055
Gain on the sale of assets .................. 47,693 532,929 60,020 532,929
Other ....................................... 3,208 439 5,018 617
------------ ------------ ------------ ------------
Total revenues ............................ 71,439 575,420 104,906 657,771
------------ ------------ ------------ ------------
Costs and expenses:
Operating ................................... 6,061 11,683 12,573 38,825
Depreciation, depletion and amortization .... 13,870 20,415 25,716 53,972
General and administrative .................. 6,132 9,383 11,777 24,523
Taxes other than income taxes ............... 2,474 2,514 3,450 7,728
Impairment loss ............................. 21,843 -- 21,843 --
------------ ------------ ------------ ------------
Total costs and expenses .................. 50,380 43,995 75,359 125,048
------------ ------------ ------------ ------------
Operating income .......................... 21,059 531,425 29,547 532,723
------------ ------------ ------------ ------------
Other income (expense):
Interest income ............................. 453 5,593 1,027 7,287
Interest expense, net ....................... (20,995) (21,845) (40,524) (47,203)
------------ ------------ ------------ ------------
Total other income (expense) .............. (20,542) (16,252) (39,497) (39,916)
------------ ------------ ------------ ------------
Income (loss) before income taxes ......... 517 515,173 (9,950) 492,807
Income taxes (benefit) ......................... 181 180,311 (3,483) 172,483
------------ ------------ ------------ ------------
Net income before extraordinary item ...... 336 334,862 (6,467) 320,324
Extraordinary item - early extinguishment
of debt (net of income tax benefit) ....... (1,142) (72,117) (1,142) (72,117)
------------ ------------ ------------ ------------
Net income (loss).......................... $ (806) $ 262,745 $ (7,609) $ 248,207
============ ============ ============ ============
Basic and diluted net income (loss) per share:
Income (loss) before extraordinary item ... $ 0.01 $ 4.60 $ (0.11) $ 4.36
Extraordinary item ........................ (0.02) (0.99) (0.02) (0.98)
------------ ------------ ------------ ------------
Basic and diluted net income (loss)
per share ............................. $ (0.01) $ 3.61 $ (0.13) $ 3.38
============ ============ ============ ============
Weighted average number of shares outstanding
for basic and diluted net income (loss)
per share .................................... 57,515,566 72,832,632 57,515,566 73,406,642
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
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TRANSTEXAS GAS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
SIX MONTHS ENDED
JULY 31,
----------------------------
1998 1997
---------- ----------
Operating activities:
Net income (loss) ................................................... $ (7,609) $ 248,207
Adjustments to reconcile net income to net cash used by operating
activities:
Extraordinary item ................................................ 1,142 72,117
Depreciation, depletion and amortization .......................... 25,716 53,972
Impairment loss ................................................... 21,843 --
Amortization of debt issue costs .................................. 2,880 1,348
Accretion on subordinated notes ................................... -- 4,941
Gain on the sale of assets ........................................ (60,020) (532,929)
Deferred income taxes ............................................. (3,481) 172,483
Repayment of volumetric production payments ....................... -- (45,134)
Amortization of deferred revenue .................................. -- (9,420)
Changes in assets and liabilities:
Accounts receivable ............................................ 1,067 47,383
Receivable from affiliates ..................................... -- (914)
Inventories .................................................... 1,284 (2,621)
Other current assets ........................................... 5,060 5,627
Accounts payable ............................................... (4,161) 16,640
Accrued interest payable to affiliate .......................... 28 --
Accrued liabilities ............................................ 6,093 (44,603)
Accounts receivable from affiliates ............................ (4,497) (1,898)
Other assets ................................................... 197 54
Other liabilities .............................................. (6,064) 1,867
----------- -----------
Net cash used by operating activities ...................... (20,522) (12,880)
----------- -----------
Investing activities:
Capital expenditures ................................................ (128,393) (235,996)
Proceeds from the sale of assets .................................... 104,920 1,030,032
Advances to affiliates .............................................. -- (13,304)
Payment of advances by affiliate .................................... -- 56,354
Withdrawals from cash restricted for interest ....................... -- 46,000
Increase in cash restricted for share repurchases ................... -- (399,284)
Withdrawals from cash restricted for share repurchases .............. -- 49,599
----------- -----------
Net cash provided (used) by investing activities ........... (23,473) 533,401
----------- -----------
Financing activities:
Issuance of production payments ..................................... 52,214 20,977
Principal payments on production payments ........................... (4,985) (23,909)
Issuance of note payable to TEC ..................................... 11,948 450,000
Principal payment on note payable to TEC ............................ (19,206) --
Issuance of long-term debt .......................................... 15,500 14,946
Principal payments on long-term debt ................................ (33,037) (5,428)
Revolving credit agreement, net ..................................... (708) (20,019)
Debt issue costs .................................................... (143) (771)
Retirement of senior secured notes .................................. -- (892,000)
Purchases of treasury stock ......................................... -- (49,599)
----------- -----------
Net cash provided (used) by financing activities ........... 21,583 (505,803)
----------- -----------
Increase (decrease) in cash and cash equivalents ........... (22,412) 14,718
Beginning cash and cash equivalents .................................... 38,502 23,561
----------- -----------
Ending cash and cash equivalents ....................................... $ 16,090 $ 38,279
=========== ===========
Noncash operating and investing activities:
Accounts payable for property and equipment ......................... $ 29,194 $ 27,709
Exchange of Subordinated Notes ...................................... -- 115,815
Deferred financing costs from affiliates ............................ -- 2,228
See accompanying notes to condensed consolidated financial statements.
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
In the opinion of management, all adjustments, consisting of normal
recurring accruals, have been made that are necessary to fairly state the
financial position of TransTexas Gas Corporation ("TransTexas" or the "Company")
as of July 31, 1998 and the results of its operations and cash flows for the
interim periods ended July 31, 1998 and 1997. The results of operations for
interim periods should not be regarded as necessarily indicative of results that
may be expected for the entire year. The financial information presented herein
should be read in conjunction with the consolidated financial statements and
notes included in TransTexas' annual report on Form 10-K for the year ended
January 31, 1998. Unless otherwise noted, the term "TransTexas" refers to
TransTexas Gas Corporation and its subsidiaries. TransTexas is a subsidiary of
TransAmerican Energy Corporation ("TEC"), which is a wholly owned subsidiary of
TransAmerican Natural Gas Corporation ("TransAmerican"). TransAmerican Refining
Corporation ("TARC") is a wholly owned subsidiary of TEC.
LIQUIDITY
Cash flow from operations is sensitive to the level of capital
expenditures and the prices TransTexas receives for its natural gas. TransTexas
makes substantial capital expenditures for the exploration and development of
natural gas reserves. TransTexas historically has financed its capital
expenditures, debt service and working capital requirements with cash flow from
operations, public and private offerings of debt and equity securities, the sale
of production payments, asset sales, an accounts receivable revolving credit
facility and other financings.
During the six months ended July 31, 1998, total capital expenditures were
$128 million, including $12 million for lease acquisitions, $107 million for
drilling and development, and $9 million for gas gathering, other equipment and
seismic acquisitions. Subject to cash availability, capital expenditures for
fiscal 1999 are estimated to be approximately $177 million, which is in excess
of projected cash flow from operations. A reduction in planned capital spending
could result in less than anticipated cash flow from operations in fiscal 1999
and later years, which could have a material adverse effect on TransTexas. To
finance its capital expenditure and working capital requirements, TransTexas
will be required to supplement its anticipated cash flow from operations with a
combination of asset sales and financings which may include borrowings or
production payments. TransTexas' debt covenants may limit its ability to obtain
additional financing or to sell properties, and there is no assurance that
adequate funds can be obtained on a timely basis from such sources.
2. GAIN ON THE SALE OF ASSETS
On April 30, 1998, TransTexas sold its oilfield stimulation, cementing and
coiled tubing equipment and related facilities to an unaffiliated third party
for a sales price of $30 million, subject to post-closing adjustments. For the
six months ended July 31, 1998, TransTexas recorded a $10.7 million pre-tax gain
as a result of this sale. During the three months ended July 31, 1998,
TransTexas recorded post-closing adjustments of $0.4 million thereby increasing
the pre-tax gain.
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
On June 26, 1998, TransTexas sold its drilling rigs and related facilities
to an unaffiliated third party for a sales price of $75 million. TransTexas
recorded a pre-tax gain of $51.9 million as a result of this sale.
On August 17, 1998, TransTexas sold its remaining drilling services assets
to an unaffiliated third party for a sales price of $20.5 million.
Additional adjustments to the Lobo Sale purchase price resulted in a
pre-tax loss on the sale of assets of $4.6 million and $2.6 million during the
three and six months ended July 31, 1998, respectively.
3. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
ARABIAN OFFSHORE PARTNERS. On June 27, 1997, Arabian Offshore Partners
filed a lawsuit against TransTexas in the 14th Judicial District Court, Dallas
County, Texas, seeking $20 million in damages in connection with TransTexas'
refusal to proceed with the acquisition of two jack-up drilling rigs.
TransTexas' motion for summary judgment was granted on January 13, 1998. The
plaintiffs have appealed.
FINKELSTEIN. On April 22, 1991, H. S. Finkelstein filed a suit against
TransAmerican and various affiliates in the 49th Judicial District Court, Zapata
County, Texas, alleging an improper calculation of overriding royalties
allegedly owed to the plaintiff and seeking damages and attorneys' fees in
excess of $33.7 million. On November 18, 1993, the plaintiff added TransTexas as
an additional defendant. The parties arbitrated this matter in January 1997. In
May 1998, the arbitration panel awarded $13 million to plaintiff, and plaintiff
subsequently obtained a judgment against TransTexas for the awarded amount.
Pursuant to a settlement agreement, TransTexas will pay the amount awarded over
a 24-month period. If payments are not made, plaintiff will have the right to
enforce its judgment.
HEIN MINERALS. On April 3, 1998, Henry and Luz A. Hein Minerals, L.C.
("Hein") filed suit in the 49th Judicial District Court, Zapata County, Texas,
against TransAmerican, TransTexas, TransTexas Transmission Corporation ("TTC")
and Conoco, Inc. Plaintiff alleges that a 1990 mineral lease from plaintiffs to
TransAmerican, comprising approximately 2,000 acres, was breached by failure to
release certain acreage from the lease. Plaintiff alleges trespass, tortious
interference, conversion, fraud, breach of fiduciary duty, breach of contract,
conversion and slander of title, and claim damages including $10 per day per
acre that was not released. In May 1998, TransTexas filed a motion to transfer
venue. TransTexas intends to vigorously defend against these claims.
ZURICH. On May 5, 1998, The Home Insurance Company and Zurich Insurance
Company filed suit against TransTexas in the United States District Court,
Southern District of New York, to enforce an arbitration award of approximately
$7.25 million relating to workers' compensation policies. TransTexas filed a
motion to dismiss on June 4, 1998, and intends to vigorously defend this claim.
GENERAL. The resolution in any reporting period of one or more of the
foregoing matters in a manner adverse to TransTexas could have a material
adverse effect on TransTexas' results of operations and cash flows for that
period. TransTexas is also a named defendant in other ordinary course, routine
litigation incidental to its business. Although the outcome of these other
lawsuits cannot be predicted with certainty, TransTexas does not expect these
matters to have a material adverse effect on its financial position. As of
July 31, 1998, management's estimate of the range of loss related to all of the
aforementioned claims, in addition to the estimates accrued by TransTexas, is
$0 to $20 million. Litigation expense, including legal fees, totaled
approximately $0.9 million and $4.3 million for the three months ended
July 31, 1998 and 1997, respectively, and approximately $1.0 million and
$9.4 million for the six months ended July 31, 1998 and 1997, respectively.
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
ENVIRONMENTAL MATTERS
TransTexas' operations and properties are subject to extensive federal,
state, and local laws and regulations relating to the generation, storage,
handling, emission, transportation, and discharge of materials into the
environment. Permits are required for various of TransTexas' operations, and
these permits are subject to revocation, modification, and renewal by issuing
authorities. TransTexas also is subject to federal, state, and local laws and
regulations that impose liability for the cleanup or remediation of property
that has been contaminated by the discharge or release of hazardous materials or
wastes into the environment. Governmental authorities have the power to enforce
compliance with their regulations, and violations are subject to fines or
injunctions, or both. Certain aspects of TransTexas' operations may not be in
compliance with applicable environmental laws and regulations, and such
noncompliance may give rise to compliance costs and administrative penalties. It
is not anticipated that TransTexas will be required in the near future to expend
amounts that are material to the financial condition or operations of TransTexas
by reason of environmental laws and regulations, but because such laws and
regulations are frequently changed and, as a result, may impose increasingly
strict requirements, TransTexas is unable to predict the ultimate cost of
complying with such laws and regulations.
PRODUCTION PAYMENTS
In April 1997, TransTexas sold to an unaffiliated third party a term
overriding royalty in the form of a dollar-denominated production payment in
certain of TransTexas' producing properties for net proceeds of $20 million. The
production payment called for the repayment of the primary sum plus an amount
equivalent to a 16% annual interest rate on the unpaid portion of such primary
sum. As of July 31, 1998, the production payment had been paid in full.
In February 1998, TransTexas entered into a production payment drilling
program agreement with an unaffiliated third party for the reimbursement of
certain drilling costs with respect to wells drilled by TransTexas. Pursuant to
the agreement, upon the approval of the third party of a recently drilled or
currently drilling well for inclusion in the program, the third party will
commit to the reimbursement of all or a portion of the cost of such well, up to
an aggregate maximum for all such wells of $75 million. The program wells are
subject to a dollar-denominated production payment equal to the primary sum of
such reimbursed costs, plus an amount equivalent to a 15% annual interest rate
on the unpaid portion of such primary sum. As of July 31, 1998, the outstanding
balance of the production payment was $51.4 million.
POTENTIAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and a contingent
liability for interest of $102 million owed by TransAmerican. TransAmerican has
taken the federal tax position that the entire amount of this debt cancellation
is excluded from its income under the cancellation of indebtedness provisions
(the "COD Exclusion") of the Internal Revenue Code of 1986, as amended, and has
reduced its tax attributes (including its net operating loss and credit
carryforwards) as a consequence of the COD Exclusion. No federal tax opinion was
rendered with respect to this transaction, however, and TransAmerican has not
obtained a ruling from the Internal Revenue Service (the "IRS") regarding this
transaction. TransTexas believes that there is substantial legal authority to
support the position that the COD Exclusion applies to the cancellation of
TransAmerican's indebtedness. However, due to factual and legal uncertainties,
there can be no assurance that the IRS will not challenge this position, or that
such challenge would not be upheld. Under the Tax Allocation Agreement (defined
below), TransTexas has agreed to pay an amount equal to any federal tax
liability (which would be approximately $25.4 million) attributable to the
inapplicability of the COD Exclusion. Any such tax would be offset in future
years by alternative minimum tax credits and retained loss and credit
carryforwards to the extent recoverable from TransAmerican. As a member of the
TNGC Consolidated Group (defined below), each of TransTexas, TEC and TARC will
be severally liable for any tax liability resulting from the above-described
transactions. The IRS has commenced an audit of the consolidated federal income
tax returns of the TNGC Consolidated Group for its taxable years ended July 31,
1995 and 1994. At this time, it is not possible to predict the scope of the IRS'
review or whether any tax deficiencies will be proposed by the IRS as a result
of its review.
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
Based in part upon independent legal advice, TransTexas has taken the
position that it will not incur any significant federal income tax liability as
a result of the Lobo Sale. There are, however, significant uncertainties
regarding TransTexas' tax position and no assurance can be given that its
position will be sustained if challenged by the IRS. TransTexas is part of an
affiliated group for tax purposes (the "TNGC Consolidated Group"), which
includes TNGC Holdings Corporation, the sole stockholder of TransAmerican
("TNGC"), TransAmerican, TEC and TARC. No letter ruling has been or will be
obtained from the IRS regarding the Lobo Sale by any member of the TNGC
Consolidated Group. If the IRS were to successfully challenge TransTexas'
position, each member of the TNGC Consolidated Group would be severally liable
under the consolidated tax return regulations for the resulting taxes, in the
estimated amount of up to $250 million (assuming the use of existing tax
attributes of the TNGC Consolidated Group), possible penalties equal to 20% of
the amount of the tax, and interest at the statutory rate (currently 8%) on the
tax and penalties (if any). The Tax Allocation Agreement provides that
TransAmerican will be obligated to fund the entire tax deficiency (if any)
resulting from the Lobo Sale. There can be no assurance that TransAmerican would
be able to fund any such payment at the time due and the other members of the
TNGC Consolidated Group may be required to pay the tax. TransTexas has
reserved approximately $75 million with respect to the potential tax liability
for financial reporting purposes to reflect a portion of the federal tax
liability that TransAmerican might not be able to pay. If TransTexas were
required to pay this tax deficiency, it is likely that it would be required to
sell significant assets or raise additional debt or equity capital to fund the
payment.
TNGC, TransAmerican and its existing subsidiaries, including TARC, TEC and
TransTexas, are parties to a tax allocation agreement, as amended (the "Tax
Allocation Agreement"), the general terms of which require TransAmerican and all
of its subsidiaries to file federal income tax returns as members of a
consolidated group to the extent permitted by law. Filing on a consolidated
basis allows income and tax of one member to be offset by losses and credits of
another and allows deferral of certain intercompany gains; however, each member
is severally liable for the consolidated federal income tax liability of the
consolidated group.
The Tax Allocation Agreement requires each of TransAmerican's subsidiaries
to pay to TransAmerican each year its allocable share of the federal income tax
liabilities of the consolidated group ("Allocable Share"). The Tax Allocation
Agreement provides for a reallocation of the group's consolidated federal income
tax liabilities among the members if the IRS or the courts ultimately
redetermine the group's regular tax or alternative minimum tax liability. In the
event of an IRS audit or examination, the Tax Allocation Agreement generally
gives TransAmerican the authority to compromise or settle disputes and to
control litigation, subject to the approval of TARC, TEC or TransTexas, as the
case may be, where such compromise or settlement affects the determination of
the separate tax liability of that company.
Under the Tax Allocation Agreement, each subsidiary's Allocable Share for
each tax year will generally equal the amount of federal income tax it would
have owed had it filed a separate federal income tax return for each year except
that each subsidiary will be able to utilize net operating losses and credits of
TransAmerican and the other members of the consolidated group effectively to
defer payment of tax liabilities that it would have otherwise owed had it filed
a separate federal income tax return. Each subsidiary will essentially pay the
deferred taxes at the time TransAmerican (or the member whose losses or credits
are utilized by such subsidiary) begins generating taxable income or tax. This
will have the effect of deferring a portion of such subsidiary's tax liability
to future years. The parties to the Tax Allocation Agreement amended such
agreement in connection with the Lobo Sale to include additional affiliates as
parties, and further amended the Tax Allocation Agreement in June 1997 to
allocate to TransAmerican, as among the parties, any tax liability associated
with the Lobo Sale.
Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
the TNGC Consolidated Group that own TransTexas' common stock could incur a
substantial amount of federal income tax liability. If such Deconsolidation were
to occur during the fiscal year ending January 31, 1999, the aggregate amount of
this tax liability is estimated to be approximately $100 million, assuming no
reduction for tax attributes of the TNGC Consolidated Group. However, such tax
liability generally would be substantially reduced or eliminated in the event
that the IRS successfully challenged TransTexas' position on the Lobo Sale. Each
member of a consolidated group filing a consolidated federal income tax return
is severally liable to the IRS for the consolidated federal income tax liability
of the consolidated group. There can be no assurance that each TNGC Consolidated
Group member will have the ability to satisfy any tax obligation attributable to
these transactions at the time due and, therefore, other members of the group,
including TEC, TransTexas or TARC, may be required to pay the tax.
TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of July 31, 1998, TransTexas had
paid $8.4 million of these franchise taxes and estimates that it will pay
approximately $3.0 million during the remainder of fiscal year 1999.
POTENTIAL EFFECTS OF A CHANGE OF CONTROL
The Subordinated Notes Indenture provides that, upon the occurrence of a
Change of Control, each holder of the Subordinated Notes will have the right to
require TransTexas to repurchase such holder's Subordinated Notes at 101% of the
principal amount thereof plus accrued and unpaid interest. Pursuant to the terms
of the TransTexas Intercompany Loan, upon the occurrence of a Change of Control,
TEC would have the right to require TransTexas to repay the principal of the
TransTexas Intercompany Loan in an amount equal to a pro rata share of the
amount TEC is required to pay under the TEC Notes Indenture. Such pro rata share
would be calculated using the ratio of the outstanding principal amount of the
TransTexas Intercompany Loan to the sum of (i) the outstanding principal amount
of the TransTexas Intercompany Loan plus (ii) the accreted value of the
outstanding principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the Subordinated Notes
Indenture in the case of certain changes or other events in respect of the
ownership of TransTexas, including any circumstances pursuant to which any
person or group other than John R. Stanley (or his heirs, his estate, or any
trust in which he or his immediate family members have, directly or indirectly,
a beneficial interest in excess of 50%) and his subsidiaries or the TEC
Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and, during the
90 days thereafter, the rating of the Subordinated Notes is downgraded or
withdrawn. A Change of Control would be deemed to occur under the TransTexas
Intercompany Loan in the case of certain changes or other events in respect of
the ownership or control of TEC or TransTexas, including any circumstance
pursuant to which (i) any person or group, other than John R. Stanley (or his
heirs, his estate, or any trust in which he or his immediate family members
have, directly or indirectly, a beneficial interest in excess of 50%) and his
subsidiaries or the TEC Indenture Trustee is or becomes the beneficial owner of
more than 50% of the total voting power of TEC's then outstanding voting stock,
or (ii) TEC or any of its subsidiaries own some of TransTexas' capital stock,
but less than 50% of the total voting stock or economic value of TransTexas,
unless the TEC Notes have an investment grade rating for the period of 120 days
thereafter. The term "person," as used in the definition of Change of Control,
means a natural person, company, government or political subdivision, agency or
instrumentality of a government and also includes a "group," which is defined as
two or more persons acting as a partnership, limited partnership or other group.
In addition, certain changes or other events in respect of the ownership or
control of TransTexas that do not constitute a Change of Control under the
Subordinated Notes Indenture or the TransTexas Intercompany Loan may result in a
"change of control" of TransTexas under the terms of the BNY Facility. Such an
occurrence could create an obligation for TransTexas to repay any amounts due
under the BNY Facility. At July 31, 1998, TransTexas had approximately $7.2
million of indebtedness subject to such right of repayment. In the event of a
Change of Control under the Subordinated Notes Indenture or the TransTexas
Intercompany Loan, or a "change of control" under the terms of the BNY
10
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
Facility, there can be no assurance that TransTexas will have sufficient funds
to satisfy any such payment obligations. A change of control or other event that
results in Deconsolidation of TransTexas and TransAmerican for federal income
tax purposes could result in acceleration of a substantial amount of federal
income taxes.
LOBO SALE
Pursuant to the Lobo Sale Agreement, TransTexas is required to indemnify
the buyer for certain liabilities related to the assets previously owned by TTC.
Although TransTexas does not anticipate that it will incur any material
indemnity liability, no assurance can be given that TransTexas will have
sufficient funds to satisfy any such indemnity obligation or that any payment
thereof would not have a material adverse effect on its ability to fund its debt
service, capital expenditure and working capital requirements.
DELIVERY COMMITMENTS
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 475 MMcf per day to specified delivery points.
TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.4 million and $2.4
million during the three and six months ended July 31, 1998, respectively. Under
a proposed settlement agreement, delivery commitments of approximately 350 MMcf
per day will be released in exchange for TransTexas' interest in a pipeline,
elimination of amounts due TransTexas pursuant to the Lobo Sale Agreement and a
cash payment by TransTexas of $2.7 million. TransTexas reduced the gain on sale
of assets by $3.4 million as a result of this proposed settlement.
4. OTHER CURRENT ASSETS
The major components of other current assets are as follows (in thousands
of dollars):
JULY 31, JANUARY 31,
1998 1998
------- -----------
Prepayments:
Trade ........................................................................... $ 2,259 $ 7,120
Insurance ....................................................................... 2,640 3,171
Other ........................................................................... 760 428
------- -------
$ 5,659 $10,719
======= =======
5. ACCRUED LIABILITIES
The major components of accrued liabilities are as follows (in thousands
of dollars):
JULY 31, JANUARY 31,
1998 1998
------- -----------
Royalties .......................................................................... $ 7,548 $ 7,171
Taxes other than income taxes ...................................................... 4,642 2,562
Interest ........................................................................... 2,633 2,544
Payroll ............................................................................ 3,042 5,185
Litigation settlements ............................................................. 4,387 1,387
Insurance .......................................................................... 9,206 9,041
Other .............................................................................. 7,935 7,928
------- -----------
$39,393 $ 35,818
======= ===========
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TRANSTEXAS GAS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
6. OTHER LIABILITIES
The major components of other liabilities are as follows (in thousands of
dollars):
JULY 31, JANUARY 31,
1998 1998
------- -------
Litigation accrual ..................................................................... $14,391 $15,008
Other .................................................................................. 4,451 5,612
------- -------
$18,842 $20,620
======= =======
7. CREDIT AGREEMENT
TransTexas and BNY Financial Corporation ("BNY") are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of July 31, 1998, outstanding
advances under the BNY Facility totaled approximately $7.2 million. Interest
accrues on advances at the rate of (i) the higher of (a) the prime rate of The
Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1% plus (ii) 1/2 of
1%. Obligations under the BNY Facility are secured by liens on TransTexas'
receivables and inventory. The BNY Facility contains certain financial covenants
including a limitation on net losses.
8. TRANSACTIONS WITH AFFILIATES
On June 13, 1997, a services agreement was entered into among
TransAmerican, TEC, TARC and TransTexas. Under the services agreement,
TransTexas provides accounting, legal, administrative and other services to
TARC, TEC and TransAmerican and its affiliates. TransAmerican will provide
advisory services to TransTexas, TARC and TEC. TARC will pay to TransTexas
approximately $300,000 per month for services rendered and for allocated
expenses paid by TransTexas on behalf of TARC. TransAmerican will pay to
TransTexas approximately $20,000 per month for such services. TEC and its
subsidiaries will pay $2.5 million in the aggregate per year to TransAmerican
for advisory services and benefits provided by TransAmerican. As of July 31,
1998, the receivable from TARC and TransAmerican for such services was $1.2
million.
TEC makes advances to TransTexas pursuant to a promissory note which
matures on June 14, 2002. The note bears interest in an amount equal to a fixed
semi-annual interest payment of $2.8 million, prorated based upon the average
outstanding balance of all notes (other than the note evidencing the TransTexas
Intercompany Loan) between TransTexas and TEC and the average outstanding
balance of all notes (other than the note evidencing the TARC Intercompany Loan)
between TARC and TEC. During the six months ended July 31, 1998, TransTexas
repaid $7.3 million to TEC under the note. Interest payments are due and payable
each June 15 and December 15. As of July 31, 1998, the outstanding balance of
the note was $29.7 million.
9. IMPAIRMENT LOSS
As of July 31, 1998, TransTexas' net capitalized costs of gas and oil
properties exceeded the cost center ceiling. Under the full cost method of
accounting for exploration and development costs, the net capitalized costs of
gas and oil properties are limited to the lower of unamortized cost or the cost
center ceiling. For the three months ended July 31, 1998, TransTexas adjusted
its net capitalized costs resulting in a non-cash pre-tax loss of approximately
$16.3 million.
TransTexas has also evaluated the carrying value of a pipeline system
which is currently underutilized. Based on existing production levels,
TransTexas believes the pipeline will remain significantly underutilized.
Accordingly, TransTexas recorded a non-cash pre-tax loss of approximately $5.5
million related to the pipeline.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto of TransTexas included
elsewhere in this report.
RESULTS OF OPERATIONS
GENERAL
TransTexas' results of operations are dependent upon natural gas
production volumes and unit prices from sales of natural gas, condensate and
NGLs. The profitability of TransTexas also depends on its ability to minimize
finding and lifting costs and maintain its reserve base while maximizing
production. On May 29, 1997, TransTexas consummated a stock purchase agreement
with an unaffiliated buyer (the "Lobo Sale Agreement"), with an effective date
of March 1, 1997, to effect the sale (the "Lobo Sale") of the stock of
TransTexas Transmission Corporation ("TTC"), its subsidiary that owned
substantially all of TransTexas' Lobo Trend producing properties and related
pipeline transmission system, for an adjusted sales price of approximately $1.1
billion. Accordingly, TransTexas' reported results for the three and six months
ended July 31, 1998 reflect the effects of reduced sales volumes as a result of
the Lobo Sale.
TransTexas' operating data for the three and six months ended July 31,
1998 and 1997, is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
Sales volumes:
Gas (Bcf) (1) ................... 8.7 17.8 16.5 53.2
NGLs (MMGal) .................... 1.3 14.3 3.3 61.7
Condensate (MBbls) .............. 147 151 219 426
Average prices:
Gas (dry) (per Mcf) (2) ........ $ 2.23 $ 2.06 $ 2.21 $ 1.80
NGLs (per gallon) ............... .18 .26 .23 .29
Condensate (per Bbl) ............ 12.24 18.33 12.65 19.46
Number of gross wells drilled ... 15 26 28 55
Percentage of wells completed ... 80% 54% 75% 58%
- -------------------
(1) Sales volumes for six months ended July 31, 1997 include 7.3 Bcf
delivered pursuant to volumetric production payments.
(2) Average prices for the three and six months ended July 31, 1997 include
amounts delivered under volumetric production payments. The average gas
price for TransTexas' undedicated production for these periods was $2.06
per Mcf and $1.91 per Mcf, respectively. Gas prices do not include the
effect of hedging agreements.
A summary of TransTexas' operating expenses is set forth below (in
millions of dollars):
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
------------------------- -------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Operating costs and expenses:
Lease........................................... $ 3.5 $ 4.3 $ 6.7 $ 12.2
Pipeline and gathering.......................... 1.1 3.2 3.7 11.4
Natural gas liquids............................. -- 3.6 -- 14.5
Drilling services............................... 1.5 0.6 2.2 0.7
----------- ---------- ---------- ---------
6.1 11.7 12.6 38.8
Taxes other than income taxes (1)............... 2.5 2.5 3.5 7.7
----------- ---------- ---------- ---------
$ 8.6 $ 14.2 $ 16.1 $ 46.5
=========== ========== ========== =========
- -----------------------------
(1) Taxes other than income taxes include severance, property, and other taxes.
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TransTexas' average depletion rates have been as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
----------------------- -----------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Depletion rates (per Mcfe) ................................ $ 1.36 $ 1.02 $ 1.34 $ 1.04
========= ========= ========= =========
THREE MONTHS ENDED JULY 31, 1998, COMPARED WITH THE THREE MONTHS ENDED
JULY 31, 1997
Gas, condensate and NGL revenues for the three months ended July 31, 1998
decreased $18.8 million from the prior period, due primarily to decreases in
gas, condensate and NGLs sales volumes attributable to the divestiture of
producing properties as a result of the Lobo Sale. The average monthly prices
received per Mcf of gas ranged from $2.17 to $2.31 in the three months ended
July 31, 1998, compared to a range of $2.02 to $2.17, excluding amounts
dedicated to volumetric production payments, in the prior period. As of July 31,
1998, TransTexas had a total of 126 producing wells compared to 99 producing
wells at July 31, 1997. Transportation revenues decreased $2.8 million over the
prior period due primarily to the divestiture of the pipeline system as a result
of the Lobo Sale. Drilling services revenues increased by $1.2 million for the
three months ended July 31, 1998, due primarily to an increase in services
provided to third parties. For the three months ended July 31, 1998, TransTexas
recognized a pre-tax gain of $52.3 million on the sale of certain drilling
services division assets offset by a pre-tax loss of $4.6 million related to
additional adjustments to the Lobo Sale purchase price.
Lease operating expenses for the quarter ended July 31, 1998 decreased by
$0.8 million from the prior period due primarily to the Lobo Sale and the
resulting decrease in the number of producing wells. Pipeline and gathering
expenses decreased $2.1 million from the prior period due primarily to the
divestiture of the pipeline system. NGL costs decreased by $3.6 million from the
prior period primarily due to the Lobo Sale and the resulting decrease in the
volumes of natural gas processed. Drilling service expenses for the three months
ended July 31, 1998 increased $0.9 million primarily due to increased costs
related to providing services to the new operator of the Lobo Trend properties.
Depreciation, depletion and amortization expense for the three months ended
July 31, 1998 decreased $6.5 million due to the Lobo Sale and the resulting
decrease in TransTexas' undedicated natural gas production, partially offset by
a $0.34 per Mcfe increase in the depletion rate. General and administrative
expenses decreased by $3.3 million primarily as a result of a decrease in
litigation expense. Taxes other than income taxes decreased marginally over the
prior period due primarily to decreases in severance taxes associated with the
Lobo Sale and resulting decrease in the number of producing wells offset by
increases in ad valorem and excise taxes. The impairment loss of $21.8 million
for the quarter ended July 31, 1998 relates to a write-down of $16.3 million of
TransTexas' net capitalized costs of gas and oil properties to the cost center
ceiling and a $5.5 million write-down of an underutilized pipeline system that
is contemplated to be exchanged as part of a proposed settlement agreement of
certain natural gas delivery commitments.
Interest income for the three months ended July 31, 1998 decreased by $5.1
million as compared to the prior period due to lower cash balances available for
investment. TransTexas does not expect to earn significant interest income
during the remainder of fiscal year 1999. Interest expense decreased by $0.9
million primarily as a result of the retirement of the Senior Secured Notes in
June 1997, and an increase in the amount of interest capitalized in connection
with the acquisition of undeveloped leasehold acreage and interest associated
with the TransTexas Intercompany Loan.
SIX MONTHS ENDED JULY 31, 1998, COMPARED WITH THE SIX MONTHS ENDED JULY
31, 1997
Gas, condensate and NGL revenues for the six months ended July 31, 1998
decreased by $72.3 million from the prior period, due primarily to decreases in
gas, condensate and NGLs sales volumes attributable to the divestiture of
producing properties as a result of the Lobo Sale. The average monthly prices
received per Mcf of gas, ranged from $2.36 to $2.09 in the six months ended July
31, 1998, compared to a range of $2.29 to $1.49, excluding amounts dedicated to
volumetric production payments in the same period in the prior year. As of July
31, 1998, TransTexas had a total of 126 producing wells compared to 99 producing
wells at July 31, 1997. Transportation revenues decreased $12.1 million over the
prior period due primarily to the divestiture of the pipeline system as a result
of the Lobo Sale. Drilling services revenues increased by $4.4 million for the
six months ended July 31, 1998 due to an increase in services provided to third
parties. TransTexas recognized a pre-tax gain of $62.6 million the sale of
certain drilling services division assets and a pre-tax loss of $2.6 million due
to post-closing adjustments to the Lobo Sale purchase price.
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Lease operating expenses for the six months ended July 31, 1998 decreased
by $5.5 million from the prior period due primarily to the Lobo Sale and the
resulting decrease in the number of producing wells. Pipeline and gathering
expenses decreased by $7.7 million from the prior period due primarily to the
divestiture of the pipeline system. NGL costs decreased by $14.5 million from
the prior period due to the Lobo Sale and the resulting decrease in the volumes
of natural gas processed. Drilling service expenses for the six months ended
July 31, 1998 increased $1.5 million primarily due to increased costs related to
providing services to the new operator of the Lobo Trend properties.
Depreciation, depletion and amortization expense for the six months ended July
31, 1998 decreased $28.3 million due to the Lobo Sale and the resulting decrease
in TransTexas' undedicated natural gas production, partially offset by a $0.30
per Mcfe increase in the depletion rate. General and administrative expenses
decreased by $12.7 million primarily as a result of a decrease in litigation
expense. Taxes other than income taxes decreased by $4.2 million over the prior
period due primarily to decreases in ad valorem, severance and excise taxes
associated with the Lobo Sale and the resulting decrease in the number of
producing wells. The impairment loss of $21.8 million for the quarter ended
July 31, 1998 relates to a write-down of $16.3 million of TransTexas' net
capitalized costs of gas and oil properties to the cost center ceiling and a
$5.5 million write-down of an underutilized pipeline system that is contemplated
to be exchanged as part of a proposed settlement agreement of certain natural
gas delivery commitments.
Interest income for the six months ended July 31, 1998 decreased by $6.3
million as compared to the prior period due to lower cash balances available for
investment. TransTexas does not expect to earn significant interest income
during the remainder of fiscal year 1999. Interest expense decreased by $6.7
million primarily as a result of the retirement of the Senior Secured Notes in
June 1997.
LIQUIDITY AND CAPITAL RESOURCES
TransTexas makes substantial capital expenditures for the exploration and
development of natural gas reserves. TransTexas historically has financed its
capital expenditures, debt service and working capital requirements with cash
flow from operations, public and private offerings of debt and equity
securities, the sale of production payments, asset sales, an accounts receivable
revolving credit facility and other financings. Cash flow from operations is
sensitive to the prices TransTexas receives for its natural gas. Proceeds from
natural gas sales are received at approximately the same time that
production-related burdens, such as royalties, production taxes and drilling
program obligations, are payable.
For the six months ended July 31, 1998, total capital expenditures were
$128 million, including $12 million for lease acquisitions, $107 million for
drilling and development, and $9 million for gas gathering, other equipment and
seismic acquisitions. Subject to cash availability, capital expenditures for
fiscal year 1999 are estimated to be approximately $177 million, which is in
excess of projected cash flow from operations. A reduction in planned capital
spending could result in less than anticipated cash flow from operations in
fiscal year 1999 and later years which could have a material adverse effect on
TransTexas. To finance its capital expenditure and working capital requirements,
TransTexas will be required to supplement its anticipated cash flow from
operations with a combination of asset sales and financings which may include
borrowings or production payments. TransTexas' debt covenants may limit its
ability to obtain additional financing or to sell properties, and there is no
assurance that adequate funds can be obtained on a timely basis from such
sources.
In March 1998, TransTexas executed an amended and restated note in the
principal amount of approximately $14.9 million consolidating equipment
financing debt previously incurred. Concurrently, TransTexas incurred an
additional $14 million in equipment financing debt, evidenced by a promissory
note. These notes were repaid in June 1998 with proceeds from the sale of
TransTexas' drilling rigs.
In February 1998, TransTexas entered into a production payment drilling
program agreement with an unaffiliated third party for the reimbursement of
certain drilling costs with respect to wells drilled by TransTexas. Pursuant to
the
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17
agreement, upon the approval of the third party of a recently drilled or
currently drilling well for inclusion in the program, the third party will
commit to the reimbursement of all or a portion of the cost of such well, up to
an aggregate maximum for all such wells of $75 million. The program wells are
subject to a dollar-denominated production payment equal to the primary sum of
such reimbursed costs, plus an amount equivalent to a 15% annual interest rate
on the unpaid portion of such primary sum. As of July 31, 1998, the outstanding
balance on the production payment was $51.4 million.
As of July 31, 1998, TEC had advanced an aggregate of approximately $29.7
million to TransTexas pursuant to a promissory note which matures on June 14,
2002. The note bears interest in an amount equal to a fixed semi-annual interest
payment of $2.8 million, prorated based on the average outstanding balance of
all notes (other than the note evidencing the TransTexas Intercompany Loan)
between TransTexas and TEC and the average outstanding balance of all notes
(other than the note evidencing the TARC Intercompany Loan) between TARC and
TEC.
TransTexas and BNY Financial Corporation are parties to a Second Amended
and Restated Accounts Receivable Management and Security Agreement (the "BNY
Facility"), dated as of October 14, 1997. As of July 31, 1998, outstanding
advances under the BNY Facility totaled approximately $7.2 million. Interest
accrues on advances at the rate of (i) the higher of (a) the prime rate of The
Bank of New York or (b) the Federal Funds Rate plus 1/2 of 1% plus (ii) 1/2 of
1%. Obligations under the BNY Facility are secured by liens on TransTexas'
receivables and inventory.
Subsequent to the Lobo Sale, TransTexas' exploration and production
activities were no longer concentrated in the Laredo, Texas area nor comparable
to those historically conducted. Therefore, the utilization of a centrally
located drilling services operation in Laredo was no longer as efficient or cost
effective. In April 1998, TransTexas sold its oilfield stimulation, cementing
and coiled tubing equipment and related facilities for a sales price of $30
million, subject to post-closing adjustments. In June 1998, TransTexas sold its
drilling rigs and related assets for a sales price of $75 million. TransTexas
sold its remaining drilling services assets in August 1998 for a sales price of
$20.5 million. TransTexas expects that its future general and administrative
expenses and operating expenses will be reduced as a result of these sales.
CONTINGENT LIABILITIES
TransTexas has significant contingent liabilities, including liabilities
with respect to the litigation matters described in Note 3 of Notes to Condensed
Consolidated Financial Statements. These matters, individually and in the
aggregate, amount to significant potential liability which, if adjudicated in a
manner adverse to TransTexas in one reporting period, could have a material
adverse effect on TransTexas' cash flows or results of operations for that
period.
Pursuant to the Lobo Sale Agreement, TransTexas is required to indemnify
the buyer for certain liabilities related to the assets previously owned by TTC.
Although TransTexas does not anticipate that it will incur any material
indemnity liability, no assurance can be given that TransTexas will have
sufficient funds to satisfy any such indemnity obligation or that any payment
thereof will not have a material adverse effect on its ability to fund its debt
service, capital expenditure and working capital requirements.
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 475 MMcf per day to specified delivery points.
TransTexas will incur certain charges if it does not deliver specified
quantities under the contracts. Such charges totaled $1.4 million and $2.4
million during the three and six months ended July 31, 1998, respectively. Under
a proposed settlement agreement, delivery commitments of approximately 350 MMcf
per day will be released in exchange for TransTexas' interest in a pipeline,
elimination of amounts due TransTexas pursuant to the Lobo Sale Agreement and a
cash payment by TransTexas of $2.7 million. TransTexas reduced the gain on the
sale of assets by $3.4 million as a result of this proposed settlement.
POTENTIAL TAX LIABILITY
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and of a
contingent liability for interest of $102 million owed by TransAmerican.
TransAmerican has taken the federal tax position that the entire amount of this
debt cancellation is excluded from its income under the cancellation of
indebtedness provisions (the "COD Exclusion") of the Internal Revenue Code of
1986, as amended, and has reduced its tax attributes (including its net
operating loss and credit carryforwards) as a consequence of the COD Exclusion.
No federal tax opinion was rendered with respect to this transaction, however,
and TransAmerican has not obtained a ruling from the Internal Revenue Service
(the "IRS") regarding this transaction. TransTexas believes that there is
substantial legal authority to support the position that the COD Exclusion
applies to the cancellation of TransAmerican's indebtedness. However, due to
factual and legal uncertainties, there can be no assurance that the IRS
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18
will not challenge this position, or that such challenge would not be upheld.
Under an agreement between TransTexas, TransAmerican and certain of
TransAmerican's subsidiaries (the "Tax Allocation Agreement"), TransTexas has
agreed to pay an amount equal to any federal tax liability (which would be
approximately $25.4 million) attributable to the inapplicability of the COD
Exclusion. Any such tax would be offset in future years by alternative minimum
tax credits and retained loss and credit carryforwards to the extent recoverable
from TransAmerican. As a member of the TNGC Consolidated Group (defined below),
each of TransTexas, TEC and TARC will be severally liable for any tax liability
resulting from the above-described transactions. The IRS has commenced an audit
of the consolidated federal income tax returns of the TNGC Consolidated Group
for its taxable years ended July 31, 1995 and 1994. At this time, it is not
possible to predict the scope of the IRS' review or whether any tax deficiencies
will be proposed by the IRS as a result of its review.
Based in part upon independent legal advice, TransTexas has taken the
position that it will not incur any significant federal income tax liability as
a result of the Lobo Sale. There are, however, significant uncertainties
regarding TransTexas' tax position and no assurance can be given that its
position will be sustained if challenged by the IRS. TransTexas is part of an
affiliated group for tax purposes (the "TNGC Consolidated Group"), which
includes TNGC Holdings Corporation, the sole stockholder of TransAmerican. No
letter ruling has been or will be obtained from the IRS regarding the Lobo Sale
by any member of the TNGC Consolidated Group. If the IRS were to successfully
challenge TransTexas' position, each member of the TNGC Consolidated Group
would be severally liable under the consolidated tax return regulations for the
resulting taxes, in the estimated amount of up to $250 million (assuming the
use of existing tax attributes of the TNGC Consolidated Group), possible
penalties equal to 20% of the amount of the tax, and interest at the statutory
rate (currently 8%) on the tax and penalties (if any). The Tax Allocation
Agreement provides that TransAmerican will be obligated to fund the entire tax
deficiency (if any) resulting from the Lobo Sale. There can be no assurance
that TransAmerican would be able to fund any such payment at the time due and
the other members of the TNGC Consolidated Group, thus, may be required to pay
the tax. TransTexas has reserved approximately $75 million with respect to the
potential tax liability for financial reporting purposes to reflect a portion
of the federal tax liability that TransAmerican might not be able to pay. If
TransTexas were required to pay this tax deficiency, it is likely that it would
be required to sell significant assets or raise additional debt or equity
capital to fund the payment.
Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation were to occur
during the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the IRS
successfully challenged TransTexas' position on the Lobo Sale. Each member of a
consolidated group filing a consolidated federal income tax return is severally
liable to the IRS for the consolidated federal income tax liability of the
consolidated group. There can be no assurance that each TNGC Consolidated Group
member will have the ability to satisfy any tax obligation attributable to these
transactions at the time due and, therefore, other members of the group,
including TEC, TransTexas or TARC, may be required to pay the tax.
Generally, under the Tax Allocation Agreement, if net operating losses of
TransTexas are used by other members of the TNGC Consolidated Group, then
TransTexas is entitled to the benefit (through reduced current taxes payable) of
such losses in later years to the extent TransTexas has taxable income, remains
a member of the TNGC Consolidated Group and the other group members have the
ability to pay such taxes. If TransAmerican or TEC transfers shares of common
stock of TransTexas (or transfers options or other rights to acquire such
shares) and, as a result of such transfer, Deconsolidation of TransTexas occurs,
TransTexas would not thereafter receive any benefit pursuant to the Tax
Allocation Agreement for net operating losses of TransTexas used by other
members of the TNGC Consolidated Group prior to the Deconsolidation of
TransTexas.
TransTexas is required, under the Tax Allocation Agreement, to pay any
Texas franchise tax (which is estimated not to exceed $11.4 million)
attributable to prior year transactions. As of July 31, 1998, TransTexas had
paid approximately $8.4 million of these franchise taxes and estimates that it
will pay approximately $3.0 million during the remainder of fiscal year 1999.
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POTENTIAL EFFECTS OF CHANGE OF CONTROL
The Subordinated Notes Indenture provides that, upon the occurrence of a
Change of Control, each holder of the Subordinated Notes will have the right to
require TransTexas to repurchase such holder's Subordinated Notes at 101% of the
principal amount thereof plus accrued and unpaid interest. Pursuant to the terms
of the TransTexas Intercompany Loan, upon the occurrence of a Change of Control,
TEC would have the right to require TransTexas to repay the principal of the
TransTexas Intercompany Loan in an amount equal to a pro rata share of the
amount TEC is required to pay under the TEC Notes Indenture. Such pro rata share
would be calculated using the ratio of the outstanding principal amount of the
TransTexas Intercompany Loan to the sum of (i) the outstanding principal amount
of the TransTexas Intercompany Loan plus (ii) the accreted value of the
outstanding principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the Subordinated Notes
Indenture in the case of certain changes or other events in respect of the
ownership of TransTexas, including any circumstances pursuant to which any
person or group other than John R. Stanley (or his heirs, his estate, or any
trust in which he or his immediate family members have, directly or indirectly,
a beneficial interest in excess of 50%) and his subsidiaries or the TEC
Indenture Trustee is or become the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the Subordinated Notes is downgraded or
withdrawn. A Change of Control would be deemed to occur under the TransTexas
Intercompany Loan in the case of certain changes or other events in respect of
the ownership or control of TEC or TransTexas including any circumstance
pursuant to which (i) any person or group, other than John R. Stanley (or his
heirs, his estate, or any trust in which he or his immediate family members
have, directly or indirectly, a beneficial interest in excess of 50%) and his
subsidiaries or the TEC Indenture Trustee is or becomes the beneficial owner of
more than 50% of the total voting power of TEC's then outstanding voting stock,
or (ii) TEC or any of its subsidiaries own some of TransTexas' capital stock,
but less than 50% of the total voting stock or economic value of TransTexas,
unless the TEC Notes have an investment grade rating for the period of 120 days
thereafter. The term "person," as used in the definition of Change of Control,
means a natural person, company, government or political subdivision, agency or
instrumentality of a government and also includes a "group," which is defined as
two or more persons acting as a partnership, limited partnership or other group.
In addition, certain changes or other events in respect of the ownership
or control of TransTexas that do not constitute a Change of Control under the
Subordinated Notes Indenture or the TransTexas Intercompany Loan may result in
a "change of control" of TransTexas under the terms of the BNY Facility. Such
an occurrence could create an obligation for TransTexas to repay any amounts
due under the BNY Facility. At July 31, 1998, TransTexas had approximately $7.2
million of indebtedness subject to such right of repayment. In the event of a
Change of Control under the Subordinated Notes Indenture or the TransTexas
Intercompany Loan or a "change of control" under the terms of the BNY Facility,
there can be no assurance that TransTexas will have sufficient funds to satisfy
any such payment obligations. A change of control or other event that results
in Deconsolidation of TransTexas and TransAmerican for federal income tax
purposes could result in acceleration of a substantial amount of federal income
taxes.
IMPACT OF YEAR 2000
The year 2000 issue relates to computer programs or computer equipment
designed to use two digits rather than four digits to define the applicable
year. As a result, computer systems with time-sensitive software may not
accurately calculate, store or use a date subsequent to December 31, 1999. This
could result in system failures or miscalculations and disruptions of
operations, including among other things, a temporary inability to process
transactions or engage in other normal business activities.
In June 1997, management began a company-wide program to prepare its
computer systems for year 2000 compliance. In January 1998, TransTexas began
implementation of new client/server based systems which are anticipated to be
completed and tested by January 1999. TransTexas estimates the cost of
upgrading its computer systems to be approximately $2 million. In addition,
TransTexas is currently assessing its state of readiness for non-informational
technological systems and the readiness of significant third parties with whom
TransTexas conducts business. As of July 31, 1998, no contingency plans have
been developed to mitigate TransTexas' year 2000 issues.
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FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
are included throughout this report. All statements other than statements of
historical facts included in this report regarding TransTexas' financial
position, business strategy, and plans and objectives of management for future
operations, including, but not limited to words such as "anticipates,"
"expects," "estimates," "believes" and "likely" indicate forward-looking
statements. TransTexas' management believes its current views and expectations
are based on reasonable assumptions; however, there are significant risks and
uncertainties that could significantly affect expected results. Factors that
could cause actual results to differ materially from those in the
forward-looking statements include fluctuations in the commodity prices for
natural gas, crude oil, condensate and natural gas liquids; the extent of
TransTexas' success in discovering, developing and producing reserves;
conditions in the equity and capital markets; competition and the ultimate
resolution of litigation.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 3 to the condensed consolidated financial statements for a
discussion of TransTexas' legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its 1998 Annual Meeting of Stockholders on June 22,
1998. Thomas McDade, Class II Director of the Company, was re-elected for a term
of three years. Holders of 56,821,386 shares voted for the nominee and 25,260
shares withheld from voting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
10.1 -- Asset Purchase Agreement dated May 26, 1998 by and among the
Company, Bayard Drilling, L.P. and Bayard Drilling Technologies,
Inc. (filed as an exhibit to TransTexas' Current Report on
Form 8-K dated June 26, 1998, and incorporated herein by
reference).
15.1 -- Letter of Independent Accountants regarding awareness of
incorporation by reference.
27.1 -- Financial Data Schedule
(b) REPORTS ON FORM 8-K
On July 9, 1998, the Company filed a current report on Form 8-K dated
June 26, 1998 to report under Item 2 the sale of its drilling rigs.
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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.
TRANSTEXAS GAS CORPORATION
(Registrant)
By: /s/ Ed Donahue
----------------------------------
Ed Donahue, Vice President
and Chief Financial Officer
September 14, 1998
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INDEX TO EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- ------- -------
10.1 Asset Purchase Agreement dated May 26, 1998 by and among the
Company, Bayard Drilling, L.P. and Bayard Drilling Technologies,
Inc. (filed as an exhibit to TransTexas' Current Report on
Form 8-K dated June 26, 1998, and incorporated herein by
reference).
15.1 Letter of Independent Accountants regarding awareness of
incorporation by reference.
27.1 Financial Data Schedule