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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1998
REGISTRATION NUMBER 33-85930
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TRANSAMERICAN ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 76-0441642
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1300 NORTH SAM HOUSTON PARKWAY EAST 77032
SUITE 200 (Zip Code)
HOUSTON, TEXAS
(Address of principal executive offices)
(281) 986-8822
(Registrant's telephone number, including area code)
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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
December 21, 1998 was 9,000.
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TRANSAMERICAN ENERGY CORPORATION
TABLE OF CONTENTS
PAGE
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PART I.
FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheet as of October 31,
1998 and January 31, 1998............................. 2
Condensed Consolidated Statement of Operations for the
three and nine months ended October 31, 1998 and
1997.................................................. 3
Condensed Consolidated Statement of Cash Flows for the
nine months ended October 31, 1998 and 1997........... 4
Notes to Condensed Consolidated Financial Statements... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 30
Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................... 42
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings................................... 43
Item 5. Other Information................................... 43
Item 6. Exhibits and Reports on Form 8-K.................... 44
Signature.............................................. 45
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PART 1
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
OCTOBER 31, JANUARY 31,
1998 1998
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,374 $ 86,513
Restricted cash held in disbursement accounts............. -- 158,563
Cash restricted for interest.............................. 36,688 32,823
Investments held in trust................................. 9,010 9,114
Accounts receivable....................................... 23,500 17,926
Inventories............................................... 40,007 16,437
Other..................................................... 7,185 12,065
---------- ----------
Total current assets.............................. 119,764 333,441
---------- ----------
Property and equipment...................................... 2,879,715 2,350,060
Less accumulated depreciation, depletion and amortization... 916,149 741,952
---------- ----------
Net property and equipment -- based on the full cost
method of accounting for gas and oil properties of
which $69,419 and $120,694 was excluded from
amortization at October 31, 1998 and January 31, 1998,
respectively........................................... 1,963,566 1,608,108
---------- ----------
Restricted cash held in disbursement accounts............... -- 60,166
Cash restricted for interest................................ -- 16,348
Investments held in trust................................... -- 8,592
Receivable from affiliates.................................. 6,852 1,463
Other assets, net........................................... 76,322 103,321
---------- ----------
$2,166,504 $2,131,439
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable.......................................... $ 164,251 $ 84,181
Payable to affiliate...................................... 12,895 6,758
Accrued liabilities....................................... 84,673 52,326
Note payable.............................................. 7,000 --
Current maturities of long-term debt...................... 8,518 16,891
---------- ----------
Total current liabilities......................... 277,337 160,156
---------- ----------
Due to affiliates........................................... 6,005 6,827
Long-term debt, less current maturities..................... 1,865,431 1,761,689
Revolving credit agreement.................................. 5,050 7,917
Production payments, less current portion................... 54,464 4,121
Deferred income taxes....................................... -- 39,497
Other liabilities........................................... 24,181 25,668
Minority interest in net income of TransTexas............... -- 35,162
Commitments and contingencies (Note 8)...................... -- --
Stockholder's equity (deficit):
Common stock, $0.01 par value, 100,000 shares authorized;
9,000 shares issued and outstanding.................... -- --
Additional paid-in capital................................ 203,760 200,996
Accumulated deficit....................................... (269,724) (110,594)
---------- ----------
Total stockholder's equity (deficit).............. (65,964) 90,402
---------- ----------
$2,166,504 $2,131,439
========== ==========
See accompanying notes to condensed consolidated financial statements.
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TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------- --------------------
1998 1997 1998 1997
--------- ------- --------- --------
Revenues:
Gas, condensate and natural gas liquids................... $ 27,213 $28,303 $ 67,081 $140,151
Transportation............................................ -- -- -- 12,055
Product sales............................................. 58,326 -- 66,701 --
Gain on the sale of assets................................ 5,813 7,482 65,833 540,411
Other..................................................... 489 1,975 8,784 2,592
--------- ------- --------- --------
Total revenues..................................... 91,841 37,760 208,399 695,209
--------- ------- --------- --------
Costs and expenses:
Operating................................................. 69,719 9,983 94,078 57,870
Depreciation, depletion and amortization.................. 23,707 16,498 53,888 73,895
General and administrative................................ 9,468 11,696 33,448 41,463
Taxes other than income taxes............................. 3,614 3,020 9,384 12,555
Impairment loss on oil and gas properties................. 164,899 -- 186,742 --
--------- ------- --------- --------
Total costs and expenses........................... 271,407 41,197 377,540 185,783
--------- ------- --------- --------
Operating income (loss)................................. (179,566) (3,437) (169,141) 509,426
--------- ------- --------- --------
Other income (expense):
Interest income........................................... 797 7,830 7,200 16,944
Interest expense, net..................................... (23,013) (14,554) (71,192) (84,486)
Other, net................................................ (279) 374 (279) 1,109
--------- ------- --------- --------
Total other income (expense)....................... (22,495) (6,350) (64,271) (66,433)
--------- ------- --------- --------
Income (loss) before income taxes, minority interest,
extraordinary item and cumulative effect of a change
in accounting principle............................... (202,061) (9,787) (233,412) 442,993
Income tax expense (benefit)................................ (35,399) (712) (38,882) 171,771
--------- ------- --------- --------
Income (loss) before minority interest, extraordinary
item and cumulative effect of a change in accounting
principle............................................. (166,662) (9,075) (194,530) 271,222
Minority interest in net loss of TransTexas................. 33,743 -- 35,162 --
Extraordinary item -- early extinguishment of debt (net of
income tax benefit)....................................... -- 74 (2,436) (156,465)
Cumulative effect of a change in accounting principle....... -- -- 2,674 --
--------- ------- --------- --------
Net income (loss) before preferred stock dividend....... $(132,919) $(9,001) $(159,130) $114,757
========= ======= ========= ========
Series A preferred stock dividend........................... $ -- $ -- $ -- $ 19
========= ======= ========= ========
Net income (loss) available for common stockholders......... $(132,919) $(9,001) $(159,130) $114,738
========= ======= ========= ========
Basic and diluted net income (loss) per common share:
Income (loss) before extraordinary item and cumulative
effect of a change in accounting principle............ $ (14,769) $(1,008) $ (17,708) $ 30,136
Extraordinary item...................................... -- 8 (270) (17,385)
Cumulative effect of a change in accounting principle... -- -- 297 --
--------- ------- --------- --------
$ (14,769) $(1,000) $ (17,681) $ 12,751
========= ======= ========= ========
Weighted average number of shares outstanding for basic and
diluted net income (loss) per share....................... 9,000 9,000 9,000 9,000
========= ======= ========= ========
See accompanying notes to condensed consolidated financial statements.
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TRANSAMERICAN ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED
OCTOBER 31,
-----------------------
1998 1997
--------- -----------
Operating activities:
Net income (loss)......................................... $(159,130) $ 114,757
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Extraordinary item...................................... 2,436 156,465
Cumulative effect of a change in accounting principle... (2,674) --
Depreciation, depletion and amortization................ 53,888 73,895
Impairment loss on oil and gas properties............... 186,742 --
Amortization of discount on long-term debt.............. 25,277 22,703
Amortization of discount on subordinated notes.......... -- 4,941
Amortization of debt issue costs........................ 4,381 2,923
Gain on the sale of assets.............................. (65,833) (540,411)
Deferred income taxes................................... (38,882) 171,771
Minority interest in net loss of TransTexas............. (35,162) --
Repayment of volumetric production payments............. -- (45,134)
Amortization of deferred revenue........................ -- (9,420)
Changes in assets and liabilities:
Accounts receivable................................... (5,574) 47,198
Inventories........................................... (23,570) (4,300)
Other current assets.................................. 4,880 9,263
Accounts payable...................................... 52,752 23,215
Accrued liabilities................................... 31,885 (33,258)
Transactions with affiliates, net..................... 572 (77)
Other assets.......................................... 486 (2,414)
Other liabilities..................................... (1,216) 7,780
--------- -----------
Net cash provided (used) by operating activities.... 31,258 (103)
--------- -----------
Investing activities:
Capital expenditures...................................... (544,365) (509,896)
Proceeds from the sale of assets.......................... 135,110 1,035,188
Increase in investments held in trust..................... (419) --
Decrease in investments held in trust..................... 9,114 --
Increase in cash restricted for interest.................. -- (19,726)
Withdrawals from cash restricted for interest............. -- 46,000
Advances to affiliate..................................... -- (13,304)
Payment of advances by affiliate.......................... -- 56,354
Purchase of TARC warrants................................. -- (32,942)
TransTexas purchase of treasury stock..................... -- (61,424)
--------- -----------
Net cash provided (used) by investing activities.... (400,560) 500,250
--------- -----------
Financing activities:
Issuance of long-term debt................................ 40,625 1,403,706
Issuance of note payable.................................. 7,000 --
Principal payments on long-term debt...................... (40,963) (1,368,100)
Increase in restricted cash held in disbursement
accounts................................................ -- (429,841)
Withdrawals from disbursement accounts.................... 231,212 161,720
Issuance of production payments........................... 62,214 20,977
Principal payments on production payments................. (9,205) (27,472)
Revolving credit agreement, net........................... (2,867) (14,939)
Dividend payment on preferred stock....................... -- (19)
Advances from affiliates.................................. -- 15,026
Repayment of advances to affiliates....................... -- (66,000)
Increase in cash restricted for TransTexas share
repurchases............................................. -- (399,284)
Withdrawals from cash restricted for TransTexas share
repurchases............................................. -- 262,405
Dividend to TransAmerican................................. -- (23,000)
Debt issue costs.......................................... (1,405) (52,849)
Redemption of Series A preferred stock.................... -- (106)
Other..................................................... (448) (1,109)
--------- -----------
Net cash provided (used) by financing activities.... 286,163 (518,885)
--------- -----------
Decrease in cash and cash equivalents............... (83,139) (18,738)
Beginning cash and cash equivalents......................... 86,513 24,179
--------- -----------
Ending cash and cash equivalents............................ $ 3,374 $ 5,441
========= ===========
See accompanying notes to condensed consolidated financial statements.
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
TransAmerican Energy Corporation (the "Company" or "TEC") was formed on
July 12, 1994 to hold certain shares of common stock of TransTexas Gas
Corporation ("TransTexas") and all of the outstanding capital stock of
TransAmerican Refining Corporation ("TARC"). TEC is a wholly owned subsidiary of
TransAmerican Natural Gas Corporation ("TransAmerican"). Capitalized terms used
herein and not otherwise defined are as defined in the respective Annual Reports
on Form 10-K of TransTexas, TARC and the Company for the fiscal year ended
January 31, 1998. The condensed consolidated financial statements reflect all
adjustments, consisting of normal recurring accruals, which are, in the opinion
of management, necessary for a fair presentation of the results for the interim
periods. All significant intercompany transactions have been eliminated in
consolidation. Interim results of operations are not necessarily indicative of
the results that may be expected for the entire year. The financial information
presented herein should be read in conjunction with the financial statements and
notes included in the Company's annual report on Form 10-K for the year ended
January 31, 1998.
Prior to December 15, 1998, TARC owned a refinery located in the Gulf Coast
region along the Mississippi River approximately 20 miles from New Orleans,
Louisiana. Its business strategy was to modify, expand and reactivate its
refinery and to maximize its refining margins by converting low cost, heavy
sour, crude oils into light petroleum products, including gasoline and heating
oil. As a result of the Transaction (as defined in Note 2 below), TARC no longer
owns the refinery, but maintains a non-controlling equity interest in TCR
Holding Corporation, a Delaware corporation ("TCR Holding"). TCR Holding owns a
controlling equity interest in TransContinental Refining Corporation, a Delaware
corporation ("TransContinental"), the corporation that owns the refinery.
TransContinental intends to operate the existing units and to complete the
construction of additional units. Accordingly, for periods subsequent to
December 15, 1998 the financial statements of TARC will no longer reflect
ownership and operation of the refinery but will reflect the results of TARC's
investment in TCR Holding using the equity method.
Consolidation
As of October 31, 1998, the TEC Notes Indenture (defined below) contained
restrictions that could substantially limit the Company's ability to use the
assets of one subsidiary to satisfy the liabilities of the other. Accordingly,
the condensed consolidated financial statements should be read in conjunction
with the separate condensed financial statements of TransTexas and TARC filed on
their respective quarterly reports on Form 10-Q for the quarter ended October
31, 1998.
Below is selected financial information for each consolidated entity (in
thousands of dollars):
OCTOBER 31, 1998
------------------------------------------------------------------
CONSOLIDATED
TRANSTEXAS TARC TEC ENTRIES CONSOLIDATED
---------- ---------- ---------- ------------ ------------
BALANCE SHEET DATA
Working capital
deficit............ $ (96,381) $ (61,288) $ (1,862) $ 1,958 $ (157,573)
Total assets.......... 651,628 1,514,791 1,828,608 (1,828,523) 2,166,504
Long-term debt........ 629,206 1,111,463 1,520,203 (1,335,927) 1,924,945
Equity (deficit)...... (130,735) 249,096 285,677 (470,002) (65,964)
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NINE MONTHS ENDED OCTOBER 31, 1998
-------------------------------------------------------------------
CONSOLIDATED
TRANSTEXAS TARC TEC ENTRIES CONSOLIDATION
---------- ---------- ---------- ------------ -------------
OPERATIONS DATA
Revenues.............. $ 137,699 $ 70,700 $ -- $ -- $ 208,399
Operating loss........ (133,127) (35,703) (311) -- (169,141)
Net loss.............. (155,372) (41,181) (2,391) 39,814 (159,130)
CASH FLOW DATA
Operating
activities......... 14,564 (4,851) 1,554 19,991 31,258
Investing
activities......... (46,975) (333,594) (126,391) 106,400 (400,560)
Financing
activities......... (3,478) 329,050 86,982 (126,391) 286,163
2. REFINERY CONSTRUCTION AND DISPOSITION
In February 1995, TARC began a construction and expansion program (the
"1995 Program") designed to reactivate the refinery and increase its complexity.
From February 1995 through May 1997, TARC spent approximately $251 million on
the 1995 Program, procured a majority of the equipment required and completed
substantially all of the process design engineering and a substantial portion of
the remaining engineering necessary for its completion.
In order to capitalize on the progress on the refinery made through its
expenditures on the 1995 Program, in June 1997 TARC commenced a modified
two-phase construction and expansion program (the "Capital Improvement
Program"), which had a budget of $427 million. Phase I of the Capital
Improvement Program includes the completion and start-up of several units,
including the Delayed Coking Unit, one of the refinery's major conversion units,
which commenced operation in September 1998. Phase II of the Capital Improvement
Program includes the completion and start-up of the Fluid Catalytic Cracking
Unit (utilizing state-of-the-art MSCC(SM) technology) and the installation of
additional equipment expected to allow for a significant increase in the
refinery's capacity to produce gasoline.
Since June 1997, TARC experienced unanticipated cost increases resulting
primarily from (i) acceleration of the construction schedule for the Capital
Improvement Program, resulting in extensive overtime charges, low overall labor
productivity and increased costs to expedite deliveries of equipment, (ii)
inadequate engineering quality on the Hydrodesulfurization Unit, resulting in
substantial rework and lower labor productivity, (iii) extensive required
refurbishment of used equipment, (iv) inadequate contractor estimates and cost
controls, work planning and reporting and (v) increased competition for labor
requiring higher labor compensation. Because of these factors, TARC has incurred
costs substantially in excess of the June 1997 budget for the Capital
Improvement Program. At October 31, 1998, TARC reviewed its current estimates of
refining margins and costs of expansion and modification of the refinery, and
believes that future undiscounted cash flows will be sufficient to recover the
cost of the refinery over its estimated useful life. However, due to the
inherent uncertainties in estimating future refining margins, and in
constructing and operating a large scale refinery, there can be no assurance
that TARC will ultimately recover the cost of the refinery. Based upon TARC's
revised budget as of October 31, 1998, estimated expenditures from June 13, 1997
to completion of the Capital Improvement Program are anticipated to exceed the
original budget by approximately $285 million. At October 31, 1998, TARC had
spent an aggregate of $501.3 million on the Capital Improvement Program and had
incurred accounts payable and other short-term obligations relating thereto in
the aggregate amount of $59.0 million. TARC estimates that, as of October 31,
1998, construction costs of $138 million to $159 million (in addition to
accounts payable) were required to complete the Capital Improvement Program,
depending upon the extent to which an unallocated contingency amount of $21
million is used. The Capital Improvement Program, including the budget, is
subject to change by TransContinental.
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following Transaction was consummated on December 15, 1998 in order to
provide additional capital for construction of the refinery.
The Transaction included the following:
(i) the issuance by TARC of $150 million aggregate principal amount of
its 15% Senior Secured Notes due 2003 (the "Notes") to certain purchasers
(the "New Lenders");
(ii) the transfer by TARC to TCR Holding of substantially all of its
assets (the "Refinery Assets") in exchange for (x) all of the capital stock
of TCR Holding, which includes the following,
(a) Class A Participating Preferred Stock, Series A and Class A
Participating Preferred Stock, Series B (the "TCR Voting Preferred
Stock"),
(b) Class B junior non-voting participating preferred Stock ("Class
B Preferred Stock"), Class C junior non-voting participating preferred
Stock ("Class C Preferred Stock") and Class D junior non-voting
participating preferred Stock ("Class D Preferred Stock," and together
with the Class B Preferred Stock and Class C Preferred Stock, the "TCR
Repurchasable Preferred Stock"),
(c) Class E junior non-voting participating preferred Stock (the
"TCR Non-Repurchasable Preferred Stock" and, together with the TCR
Repurchasable Preferred Stock, the "TCR Non-Voting Preferred Stock"),
(d) Class A Voting Common Stock, Series A (the "TCR Voting Common
Stock"), and
(e) Class B Non-Voting Common Stock (the "TCR Non-Voting Common
Stock" and, together with the TCR Voting Common Stock, the "TCR Common
Stock"),
and (y) the assumption of debt and other specified obligations of TARC
(including the Notes, approximately $43.5 million in post-Transaction
intercompany debt to TEC (the "TARC Working Capital Loan") and
approximately $36 million in debt secured by certain tank storage and
terminal facilities (the "Tank Storage Debt")) other than (a) the debt
issued pursuant to the Loan Agreement dated as of June 13, 1997, as
amended, between TEC and TARC (the "TARC Intercompany Loan"), (b) TARC's
Series A 16% Senior Subordinated Notes due 2003 (the "Series A Notes"),
(c) TARC's Series C 16% Senior Subordinated Notes due 2003 (the "Series C
Notes" and, together with the Series A Notes, the "TARC Subordinated
Notes") and (d) certain accounts payable and other liabilities;
(iii) the transfer by TCR Holding to TransContinental of the Refinery
Assets as a capital contribution and the assumption by TransContinental of
the debt and other obligations of TARC assumed by TCR Holding on the date
of such transfer (including the Notes and the Tank Storage Debt) other than
the TARC Working Capital Loan;
(iv) the acquisition from TARC by the New Lenders, certain holders
(the "TEC Holders") of TEC's 11 1/2% Senior Secured Notes due 2002 and 13%
Senior Secured Discount Notes due 2003 (the "TEC Notes") and certain of the
holders of the TARC Subordinated Notes (together with the TEC Holders, the
"Purchasers") of TCR Repurchasable Preferred Stock representing 30.0% of
the Residual Equity of TCR Holding and TCR Non-Repurchasable Preferred
Stock representing 29.6% of the Residual Equity of TCR Holding. Affiliates
of Trust Company of the West (the "TCW Affiliates") received the TCR
Non-Voting Common Stock representing 5% of the Residual Equity of TCR
Holding. Certain of the Purchasers acquired the TCR Voting Common Stock
representing 0.4% of the Residual Equity and 59% of the voting power of TCR
Holding. TARC retained the TCR Voting Preferred Stock representing 30.6% of
the Residual Equity and 41% of the voting power of TCR Holding. The
remaining 4.4% of the Residual Equity of TCR Holding, in the form of TCR
Non-Repurchasable Preferred Stock,
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
initially will be retained by TARC and is expected to be offered to holders
of certain of TARC's outstanding common stock purchase warrants (the "TARC
Warrants") in exchange for such TARC Warrants. "Residual Equity" means the
interest of the indicated stockholders in the assets of TCR Holding upon a
liquidation or winding up of TCR Holding, which interest is subject to the
prior payment of the liquidation preference of the TCR Voting Preferred
Stock and the TCR Non-Voting Preferred Stock;
(v) the grant by TARC of a security interest in the TCR Voting
Preferred Stock to secure the TARC Intercompany Loan and the collateral
assignment of such security interest by TEC to secure the TEC Notes, the
grant by TCR Holding to TEC of a security interest in the common stock of
TransContinental to secure the TARC Working Capital Loan, the collateral
assignment of such security interest to secure the TEC Notes, and the
provision in the TCR Voting Preferred Stock of the right of holders of such
stock in certain circumstances to require TCR Holding to sell common stock
of TransContinental held by TCR Holding, or any assets received on exchange
or sale therefor, and apply the proceeds to reduce the liquidation
preference and certain accrued but unpaid dividend amounts on the TCR
Voting Preferred Stock; and
(vi) the purchase from TransContinental by the New Lenders of the
TransContinental's 6% Participating Preferred Stock ("TransContinental
Preferred Stock").
As part of the Transaction, (i) the holders of TCR Holding capital stock
entered into a stockholders agreement providing for the election of two nominees
of TARC, two nominees of the TCW Affiliates and one nominee of an affiliate of
one of the Purchasers as directors of TCR Holding and the election of two
nominees of TARC and two nominees of the TCW Affiliates as directors of
TransContinental, (ii) the stockholders of TransContinental entered into an
agreement providing for the election of one nominee of the holders of the
TransContinental Preferred Stock (which initially shall be a nominee of an
affiliate of one of the Purchasers) and four nominees of TCR Holding as
directors of TransContinental, (iii) the holders of the TransContinental
Preferred Stock would have the right to elect a majority of the directors of
TransContinental if either of such stockholders agreements has been breached, is
not being complied with or has been adjudicated to be unenforceable, (iv)
TransAmerican, as the sole stockholder of TEC, and TEC, as the sole stockholder
of TARC, would agree to elect a representative of the TCW Affiliates as a
director of TEC and of TARC, respectively, (v) TCR Holding and TransContinental
would enter into registration rights agreements or otherwise provide for certain
registration rights relating to their respective securities being issued to the
New Lenders in the Transaction, (vi) TCR Holding and TransContinental,
respectively, would enter into services agreements with TransTexas providing for
certain services to be rendered to TCR Holding and TransContinental by
TransTexas and (vii) TEC or one of its affiliates will be granted certain rights
to repurchase shares of the TCR Repurchasable Preferred Stock (which would
become voting stock upon exercise of such rights), which could result in TEC and
its affiliates owning a majority of the capital stock of TCR Holding and being
entitled to elect a majority of the directors of TCR Holding and, indirectly,
TransContinental. Such repurchase rights would only be exercisable after the
Notes, the TEC Notes and the TARC Subordinated Notes have been fully repaid and
certain financial performance tests have been met. In addition, TARC would have
the right to repurchase the shares of TCR Non-Voting Common Stock issued to the
TCW Affiliates pursuant to the Transaction for $5 million at any time during the
two-year period commencing with the Issue Date (as defined); provided, however,
that if the TCR Voting Preferred Stock remains outstanding after July 31, 1999,
TARC will have the option to repurchase such stock at a nominal cost.
All of the above-described transactions, as well as other agreements and
transactions necessary to facilitate or related to the foregoing, are referred
to herein as the "Transaction."
As a result of the Transaction, subsequent to December 15, 1998, TARC no
longer owns the Refinery Assets. TARC's investment in TCR Holding consists of
TCR Voting Preferred Stock representing 30.6% of the Residual Equity and 41% of
the voting power of TCR Holding. The TCR Voting Preferred Stock will be
8
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
recorded at a carrying value equal to the carrying value of the TARC
Intercompany Loan and the TARC Subordinated Notes at December 15, 1998. The
Residual Equity interest will be recorded based on the remaining carry over
basis in the net assets transferred after considering the effects of the sale of
the majority interest. TEC also expects to report a loss on disposition of the
stock of TCR Holding of approximately $115 million in the fourth quarter of
fiscal 1999.
The following unaudited pro forma condensed financial information of TEC
illustrates the effect of the Transaction. The unaudited pro forma condensed
balance sheet has been prepared assuming that the Transaction was completed on
October 31, 1998. The unaudited pro forma condensed statements of operations
have been prepared assuming that the Transaction was completed on February 1,
1997.
The unaudited pro forma adjustments and the resulting unaudited pro forma
condensed financial information are based on the assumptions noted in the
footnotes thereto. The unaudited pro forma condensed financial information does
not purport to represent what TEC's results of operations would have been had
the Transaction actually occurred on the dates indicated or the results of
operations for any future date or period.
The allocation of the proceeds of the Transaction is based on preliminary
estimates by the Company of the fair values of the various securities issued.
The Company does not believe that the final estimates will differ materially
from the estimates used in these unaudited pro forma condensed financial
statements.
9
11
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
OCTOBER 31, 1998
(IN THOUSANDS OF DOLLARS)
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ----------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,374 $ 150,000(a) $ 4,474
(10,000)(a)
(138,900)(b)
1,100(c)
(1,100)(d)
Cash restricted for interest.............................. 36,688 (4,680)(b) 32,008
Investments held in trust................................. 9,010 -- 9,010
Accounts receivable....................................... 23,500 (3,403)(b) 20,097
Inventories............................................... 40,007 (30,649)(b) 9,358
Other..................................................... 7,185 (2,304)(b) 4,881
---------- ----------- ----------
Total current assets............................... 119,764 (39,936) 79,828
---------- ----------- ----------
Property and equipment...................................... 2,879,715 (1,409,548)(b) 1,470,167
Accumulated depreciation and amortization................... 916,149 (32,271)(b) 883,878
---------- ----------- ----------
Net property and equipment......................... 1,963,566 (1,377,277) 586,289
---------- ----------- ----------
Receivables from affiliates................................. 6,852 -- 6,852
Note receivable from affiliate.............................. -- 46,967(b) 46,967
Other assets, net........................................... 76,322 188(g) 67,490
6,500(a)
1,100(d)
(16,620)(b)
Investment in subsidiary.................................... -- 1,218,079(b) 1,086,508
(1,100)(c)
(166)(c)
(1,100)(c)
(188)(g)
(129,017)(c)
---------- ----------- ----------
$2,166,504 $ (292,570) $1,873,934
========== =========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable.......................................... $ 164,251 $ (93,617)(b) $ 70,634
Payable to affiliates..................................... 12,895 (9,723)(b) 3,172
Accrued liabilities....................................... 84,673 (8,839)(b) 75,834
Note payable.............................................. 7,000 (7,000)(b) --
Current maturities of long-term debt...................... 8,518 -- 8,518
---------- ----------- ----------
Total current liabilities.......................... 277,337 (119,179) 158,158
---------- ----------- ----------
Due to affiliates........................................... 6,005 -- 6,005
Long-term debt, less current maturities..................... 1,865,431 150,000(a) 1,829,431
(1,100)(c)
(184,900)(b)
Revolving credit agreement.................................. 5,050 -- 5,050
Production payments, less current portion................... 54,464 -- 54,464
Other liabilities........................................... 24,181 (4,708)(b) 19,473
Stockholder's deficit:
Common stock.............................................. -- -- --
Additional paid-in capital................................ 203,760 (166)(c) 203,594
Accumulated deficit....................................... (269,724) (129,017)(c) (402,241)
(3,500)(a)
---------- ----------- ----------
Total stockholder's deficit........................ (65,964) (132,683) (198,647)
---------- ----------- ----------
$2,166,504 $ (292,570) $1,873,934
========== =========== ==========
10
12
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED OCTOBER 31, 1998
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
Revenues:
Gas, condensate and natural gas liquids............. $ 67,081 $ -- $ 67,081
Product sales....................................... 66,701 (66,701)(e) --
Gain on the sale of assets.......................... 65,833 -- 65,833
Other............................................... 8,784 (3,999)(e) 4,785
--------- --------- ---------
Total revenues.............................. 208,399 (70,700) 137,699
--------- --------- ---------
Costs and expenses:
Operating........................................... 94,078 (76,984)(e) 17,094
Depreciation, depletion and amortization............ 53,888 (8,679)(e) 45,209
General and administrative.......................... 33,448 (17,152)(e) 16,296
Taxes other than income taxes....................... 9,384 (3,588)(e) 5,796
Impairment loss..................................... 186,742 -- 186,742
--------- --------- ---------
Total costs and expenses.................... 377,540 (106,403) 271,137
--------- --------- ---------
Operating (loss)................................. (169,141) 35,703 (133,438)
--------- --------- ---------
Other income (expense):
Interest income..................................... 7,200 (3,429)(e) 3,771
Interest expense, net............................... (71,192) 1,317(e) (69,875)
Equity in loss of TCR Holding....................... -- (10,056)(f) (10,056)
Other, net.......................................... (279) 279(e) --
--------- --------- ---------
Total other income (expense)................ (64,271) (11,889) (76,160)
--------- --------- ---------
Loss before income taxes, minority interest,
extraordinary item and cumulative effect of a
change in accounting principle................. (233,412) 23,814 (209,598)
Income tax benefit.................................... (38,882) -- (38,882)
--------- --------- ---------
Loss before minority interest, extraordinary item
and cumulative effect of a change in accounting
principle...................................... (194,530) 23,814 (170,716)
Minority interest in net loss of TransTexas........... 35,162 -- 35,162
--------- --------- ---------
Net loss before extraordinary item and cumulative
effect of a change in accounting principle.......... $(159,368) $ 23,814 $(135,554)
========= ========= =========
Basic and diluted net loss per share.................. $ (17,708) $ (15,062)
========= =========
Weighted average number of common shares outstanding
for basic and diluted net income loss per share (in
thousands).......................................... 9 9
========= =========
11
13
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED JANUARY 31, 1998
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
Revenues:
Gas, condensate and natural gas liquids............. $ 164,172 $ -- $ 164,172
Transportation...................................... 12,055 -- 12,055
Gain on the sale of assets.......................... 543,365 -- 543,365
Other............................................... 6,141 (2,828)(e) 3,313
--------- -------- ---------
Total revenues.............................. 725,733 (2,828) 722,905
--------- -------- ---------
Costs and expenses:
Operating........................................... 68,836 (18,245)(e) 50,591
Depreciation, depletion and amortization............ 91,075 (8,416)(e) 82,659
General and administrative.......................... 68,210 (19,196)(e) 49,014
Taxes other than income taxes....................... 14,769 (3,369)(e) 11,400
--------- -------- ---------
Total costs and expenses.................... 242,890 (49,226) 193,664
--------- -------- ---------
Operating income............................ 482,843 46,398 529,241
--------- -------- ---------
Other income (expense):
Interest income..................................... 21,952 (5,039)(e) 16,913
Interest expense, net............................... (113,233) 122(e) (113,111)
Equity in loss of TCR Holding....................... -- (12,647)(f) (12,647)
Other, net.......................................... 5 (5)(e) --
--------- -------- ---------
Total other income (expense)................ (91,276) (17,569) (108,845)
--------- -------- ---------
Income (loss) before income taxes, minority interest
and extraordinary item.............................. 391,567 28,829 420,396
Income taxes (benefit)................................ 161,669 -- 161,669
--------- -------- ---------
Income (loss) before minority interest and
extraordinary item............................... 229,898 28,829 258,727
Minority interest in net income of TransTexas......... (35,162) -- (35,162)
--------- -------- ---------
Net income before extraordinary item.................. $ 194,736 $ 28,829 $ 223,565
========= ======== =========
Basic and diluted net income per share................ $ 21,637 $ 24,841
========= =========
Weighted average number of common shares outstanding
for basic and diluted net income per share (in
thousands).......................................... 9 9
========= =========
12
14
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS
(a) To initially record the proceeds of the Notes and payment of $6.5
million of debt issue costs which will be amortized as a yield adjustment to the
Notes and $3.5 million in transaction costs which will be charged to operations.
(b) To record, at carryover basis, (i) the transfer to TCR Holding of the
Refinery Assets and (ii) the assumption of debt and other specified obligations
of TARC other than the TARC Intercompany Loan and the TARC Subordinated Notes in
exchange for all of the capital stock of TCR Holding, which includes the
following:
Class A Participating Preferred Stock Series A and B, $0.01 par value,
18,360,000 shares authorized; 18,360,000 shares issued and outstanding
Class B Junior Non-Voting Participating Preferred Stock, $0.01 par
value, 7,500,000 shares authorized; 6,000,000 shares issued and outstanding
Class C Junior Non-Voting Participating Preferred Stock, $0.01 par
value, 4,125,000 shares authorized; 3,300,000 shares issued and outstanding
Class D Junior Non-Voting Participating Preferred Stock, $0.01 par
value, 10,875,000 shares authorized; 8,700,000 shares issued and
outstanding
Class E Junior Non-Voting Participating Preferred Stock, $0.01 par
value, 24,900,000 shares authorized; 20,400,000 shares issued and
outstanding
Class A Voting Common Stock, Series A, $0.01 par value, 240,000 shares
authorized; 240,000 shares issued and outstanding
Class B Non-Voting common stock, $0.01 par value, 3,000,000 shares
authorized, issued and outstanding
Subsequent to October 31, 1998, TEC obtained bridge financing in an aggregate
principal amount of $25 million, the proceeds of which were loaned to TARC.
Concurrent with the transfer to TCR Holding described above, approximately $25
million of the proceeds from the Notes was used to repay the bridge financing,
and substantially concurrently with the transfer to TransContinental,
approximately $47.0 million of accounts payable have been or will be paid.
(c) To record (i) the acquisition of the TCR Voting Common Stock
representing 0.4% of the Residual Equity and the TCR Non-Repurchasable Preferred
Stock representing 29.6% of Residual Equity by allocating $1.1 million of
proceeds from the Notes to the investment account based on the estimated fair
value of the securities, (ii) the acquisition by the Purchasers of a portion of
the TCR Repurchasable Preferred Stock representing 30% of the Residual Equity
for $1.1 million in cash with a corresponding reduction in the investment
account, (iii) the issuance of TCR Non-Repurchasable Preferred Stock
representing 4.4% of Residual Equity with a fair value of $166,000 to the TARC
warrant holders in exchange for the TARC warrants and (iv) a net loss of $134.8
million on the sale of 69.4% of the Residual Equity of TCR Holding in (i), (ii)
and (iii) above. After consummation of the Transaction, TEC's investment in TCR
Holding will consist of:
Class A Participating Preferred Stock, Series A... $ 836,427
Class A Participating Preferred Stock, Series B... 192,069
Residual Equity Interest.......................... 58,012
----------
$1,086,508
==========
13
15
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(d) To record the payment of consent fees of $1.1 million to TEC Note
holders and TARC Subordinated Debt holders.
(e) To reflect the transfer to TCR Holding of operations associated with
the Refinery Assets as a result of the exchange described in (b). The unaudited
condensed pro forma statements exclude an estimated pro forma loss of $134.8
million on disposition of the stock of TCR Holding. The actual loss will be
recorded by TEC during the fourth quarter of fiscal 1999.
(f) To reflect TARC's 30.6% Residual Equity in the net loss of TCR Holding.
As a result of the Transaction, TARC will account for its interest in TCR
Holding using the equity method.
(g) To record the issuance of 3,000,000 shares of TCR Non-Voting Common
Stock with a fair value of $188,000 to the TCW Affiliates as debt issue cost
with a corresponding reduction in the investment account.
14
16
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LIQUIDITY
TEC's only source of funds for its holding company operations and debt
service will be from working capital, interest payments on the Intercompany
Loans to TransTexas and TARC, dividends from its subsidiaries, payments made by
TARC on behalf of TEC pursuant to the Services Agreement (as defined) and, in
limited circumstances as permitted by the TEC Notes Indenture, sales of stock
TEC holds in its subsidiaries.
Through June 1999, TEC anticipates that its annual cash needs for holding
company operations will be approximately $2.0 million, which TEC expects to be
paid on its behalf by TARC pursuant to the Services Agreement, and TEC's annual
cash interest expense will be approximately $54.6 million. In addition, TEC and
its subsidiaries will pay $2.5 million in the aggregate per year to
TransAmerican for advisory services and other benefits provided by
TransAmerican. TransTexas will be required to pay TEC approximately $48.9
million in interest annually on the TransTexas Intercompany Loan. TEC expects to
use this interest income together with working capital, if any, to satisfy its
cash needs, including its cash interest payments. If TEC incurs unforeseen
expenses, there is no assurance that its capital resources will be sufficient to
fund those expenses in addition to anticipated holding company expenses and debt
service.
The TEC Notes Indenture prohibits TEC from selling stock of TransTexas and
TARC through June 1999 unless the proceeds from such sales would be used to make
an offer to purchase the TEC Notes. Consequently, through June 1999, unless
holders of the TEC Notes rejected all or a portion of any such offer to
purchase, sales of such stock would not be a source of funds to supplement TEC's
other resources in order to pay unforeseen expenses.
TransTexas makes substantial capital expenditures for the exploration and
development of natural gas reserves. TransTexas historically has financed its
capital expenditures, debt service and working capital requirements with cash
flow from operations, public and private offerings of debt and equity
securities, the sale of production payments, asset sales, an accounts receivable
revolving credit facility and other financings. Cash flow from operations is
sensitive to the level of capital expenditures and the prices TransTexas
receives for its natural gas.
During the nine months ended October 31, 1998, TransTexas' capital
expenditures were $181 million, including $15 million for lease acquisitions,
$156 million for drilling and development, and $10 million for gas gathering,
other equipment and seismic acquisitions. Subject to cash availability, capital
expenditures for fiscal 1999 are estimated to be approximately $203 million,
which is in excess of projected cash flow from operations. TransTexas has
reduced planned capital expenditures for the remainder of fiscal year 1999 and
for fiscal year 2000. Capital expenditures for the fourth quarter of fiscal year
1999 and for fiscal year 2000 are estimated to be $22 million and $95 million,
respectively. However, these amounts are still in excess of anticipated cash
flows from operating activities. A further reduction in planned capital spending
or an extended decline in gas and oil prices 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. TransTexas has substantial
accounts payable outstanding. The vendors under certain of such accounts payable
have filed liens against TransTexas' properties. TransTexas is currently
assessing the amount and validity of the obligations underlying such liens and
believes that such obligations are not material; however, if the total accounts
payable are not reduced and additional liens are filed, a default under
TransTexas' debt documents may result. Moreover, a foreclosure of such liens
could negatively affect the security interest of the TEC
15
17
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Indenture. TransTexas intends to substantially reduce its accounts payable with
the proceeds of asset sales and additional financings, but there can be no
assurance that such proceeds, if any, will be sufficient.
As a result of the Transaction, TARC will be dependent primarily on
dividends from TCR Holding in order to meet its debt service and working capital
requirements. TCR Holding is a holding company with no business operations. TCR
Holding's only sources of liquidity will be dividends on the TransContinental
common stock that it holds and proceeds from the sale of such TransContinental
common stock. TransContinental will have no obligation to make dividends or
other distributions to TCR Holding. TransContinental will be able to pay
dividends only if it has sufficient cash from operations. In addition,
TransContinental's ability to make dividends or other distributions on its
common stock is restricted by the Indenture governing the Notes and terms of the
TransContinental Preferred Stock. TransContinental's ability to make dividends
or other distributions under the Indenture will be dependent, in part, on a
determination by the independent engineer who will be appointed in connection
with the Transaction to monitor construction of the refinery on behalf of the
holders of the Notes (the "Independent Engineer") of whether the following funds
are sufficient to complete the Capital Improvement Program: funds in the
Disbursement Account (as defined), plus 50% of Projected Net Operating Cash Flow
(as defined) for the 90-day period commencing on the date a dividend is
declared, plus an amount equal to the portion of the proceeds of the Port
Commission Bond Financing (as defined) held by the entity serving as collateral
agent or in a similar capacity with respect to such financing plus, without
duplication, cash on hand that has been approved by TransContinental's Board of
Directors to be escrowed in a segregated account and allocated only for the
purpose of completion of the Capital Improvement Program. If any capital project
is added to the Capital Improvement Program that cannot be fully funded out of
cash flow (as defined) during the relevant 90-day period plus such other sources
of funds, the Indenture will prohibit payment of dividends to TCR Holding. The
Capital Improvement Program may be amended at any time by TransContinental's
Board of Directors. Dividends or distributions might not be made by
TransContinental on its common stock, or, if made, might not be sufficient to
satisfy TCR Holding's obligations, including under the terms of the TCR Voting
Preferred Stock and the TARC Working Capital Loan. Therefore, TARC may not be
able to satisfy its debt service obligations. As a result, TARC's investment in
TCR Holding, including the carrying value of the TCR Voting Preferred Stock,
could be impaired or TARC may not be able to meet its obligations as they become
due. The financial statements do not include any adjustments that might result
from the outcome of these uncertainties.
4. ACCOUNTING CHANGES
Effective May 1, 1998, the Company changed its method of accounting for
turnaround costs. Turnaround costs consist of required periodic maintenance on
major processing units including the shutdown and restart of the units.
Previously, the Company estimated the costs of a scheduled turnaround and
ratably accrued these costs over the period until the next scheduled turnaround.
To provide for better matching of turnaround costs with revenues and to be more
consistent with industry standards, the Company changed its method of accounting
for turnaround costs to one that results in the amortization of incurred costs
on a straight-line basis over the period of time estimated to lapse until the
next scheduled turnaround. The cumulative effect of this accounting change
through January 31, 1998 was a decrease in net loss for the nine months ended
October 31, 1998 of $2.7 million or $297 per common share. Excluding the
cumulative effect, the change decreased net loss for the three and nine months
ended October 31, 1998 by $0.2 million or $21 per common share and $0.6 million
or $63 per common share, respectively.
16
18
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pro forma amounts assuming the change in accounting principle is applied
retroactively are as follows (in thousands of dollars except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------- --------------------
1998 1997 1998 1997
--------- ------- --------- --------
Income (loss) before extraordinary
items................................... $(132,919) $(8,884) $(159,368) $271,795
Basic and diluted net income (loss) per
share before extraordinary items:
As reported.......................... (14,769) (1,008) (17,708) 30,136
Pro forma............................ (14,769) (987) (17,708) 30,199
Net income (loss)......................... (132,919) (8,810) (161,804) 115,311
Basic and diluted net income (loss) per
share:
As reported.......................... (14,769) (1,000) (17,681) 12,751
Pro forma............................ (14,769) (979) (17,978) 12,812
TARC's inventories consist primarily of feedstocks and refined products and
are stated at the lower of cost or market. Effective May 1, 1998, TARC changed
its method of inventory pricing for feedstocks and refined products from the
average cost method to the first-in-first-out method. Historically, sales of
refined products have been limited and sporadic due to intermittent operations
of the refinery during periods of construction and expansion. Upon completion of
the Capital Improvement Program, the refinery will be capable of producing
multiple refined products from a variety of feedstocks. TARC believes the change
from the average cost to the first-in-first-out method will provide a more
efficient means of valuing inventory and a better matching of revenues and
costs. Furthermore, TARC believes the first-in-first-out method is more widely
used than the average cost method in the refining industry and desires to
present more comparative information. There was no cumulative effect of this
accounting change for any period presented.
5. 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
nine months ended October 31, 1998, TransTexas recorded a $10.9 million pre-tax
gain as a result of this sale including a $0.2 million pre-tax gain recorded in
the three months ended October 31, 1998 as a result of post-closing adjustments.
On June 26, 1998, TransTexas sold its drilling rigs and related facilities
to an unaffiliated third party for a sales price of $75 million. On August 17,
1998, TransTexas sold its remaining drilling services assets to an unaffiliated
third party for a sales price of $20.5 million. TransTexas recorded pre-tax
gains of $52.0 and $5.5 million, respectively, as a result of these sales.
Additional purchase price adjustments related to the sale of a TransTexas
subsidiary, TransTexas Transmission Corporation ("TTC"), referred to herein as
the Lobo Sale, resulted in a pre-tax loss on the sale of assets of $2.6 million,
during the nine months ended October 31, 1998.
In December 1998, TransTexas sold certain gas and oil properties for net
proceeds of approximately $16.7 million.
6. DISBURSEMENT ACCOUNTS
Pursuant to a disbursement agreement dated June 13, 1997, as amended
December 30, 1997 (the "Disbursement Agreement") among TARC, TEC, Firstar Bank
of Minnesota, N.A., as trustee (the "TEC Indenture Trustee"), Firstar Bank of
Minnesota, N.A., as disbursement agent (the "Disbursement Agent"), and Baker &
O'Brien, Inc., as construction supervisor (the "Construction Supervisor"), $208
million of the
17
19
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
net proceeds from the sale of the TEC Notes was placed into accounts
(collectively, the "TARC Disbursement Account") to be held and invested by the
Disbursement Agent until disbursed. In addition, proceeds to TEC and TARC of
approximately $201 million from the TransTexas share repurchase program were
deposited in the TARC Disbursement Account. On December 30, 1997, TARC deposited
$119 million of the net proceeds from the issuance of its Series A Senior
Subordinated Notes into the TARC Disbursement Account for use in the Capital
Improvement Program. All funds in the TARC Disbursement Account are pledged as
security for the repayment of the TEC Notes. TEC disbursements for TARC
expenditures are treated as capital contributions.
The Disbursement Agent makes disbursements for the Capital Improvement
Program out of the TARC Disbursement Account in accordance with requests made by
TARC and approved by the Construction Supervisor. The Construction Supervisor is
required to review each such disbursement request by TARC. Disbursements from
the TARC Disbursement Account are generally restricted to reimbursement for
expenses incurred in connection with the Capital Improvement Program.
Disbursements for general and administrative expenses ($1.5 million monthly)
and, upon Mechanical Completion of certain units, for feedstock purchases (up to
a maximum aggregate of $50 million) are also permitted. Interest income from the
TARC Disbursement Account may be used for the Capital Improvement Program or
disbursed to fund administrative and other costs of TARC and TEC. As of October
31, 1998, substantially all of the amounts deposited in the TARC Disbursement
Account had been expended for the designated purposes.
7. INVENTORIES
The major components of inventories are as follows (in thousands of
dollars):
OCTOBER 31, JANUARY 31,
1998 1998
----------- -----------
Refinery feedstocks and blendstocks......................... $11,885 $ --
Intermediate and refined products........................... 18,764 --
Tubular goods and other..................................... 9,358 16,437
------- -------
$40,007 $16,437
======= =======
As noted in Note 4, TARC's inventories are valued using the
first-in-first-out method. TransTexas' inventories are valued using the average
cost method.
8. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
Arabian Offshore Partners. On June 27, 1997, Arabian Offshore Partners
filed a lawsuit against TransTexas in the 14th Judicial District Court, Dallas
County, Texas, seeking $20 million in damages in connection with TransTexas'
refusal to proceed with the acquisition of two jack-up drilling rigs.
TransTexas' motion for summary judgment was granted on January 13, 1998. The
plaintiffs have appealed.
Finkelstein. On April 22, 1991, H. S. Finkelstein filed a suit against
TransAmerican and various affiliates in the 49th Judicial District Court, Zapata
County, Texas, alleging an improper calculation of overriding royalties
allegedly owed to the plaintiff and seeking damages and attorneys' fees in
excess of $33.7 million. On November 18, 1993, the plaintiff added TransTexas as
an additional defendant. The parties arbitrated this matter in January 1997. In
May 1998, the arbitration panel awarded $13 million to plaintiff, and plaintiff
subsequently obtained a judgment against TransTexas for the awarded amount.
Pursuant to a settlement agreement, TransTexas will pay the amount awarded over
a 24-month period. If payments are not made, plaintiff will have the right to
enforce its judgment.
18
20
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. If the motion is not granted, TransTexas intends to vigorously defend
against these claims.
Zurich. On May 5, 1998, The Home Insurance Company and Zurich Insurance
Company filed suit against TransTexas in the United States District Court,
Southern District of New York, to enforce a $10 million arbitration award
relating to workers' compensation policies. TransTexas filed a motion to dismiss
on June 4, 1998, and intends to vigorously defend this claim.
EEOC. On September 30, 1997, the U.S. Equal Employment Opportunity
Commission ("EEOC") issued a Determination (the "Determination") as a result of
the Commissioner's Charge that had been filed in August 1995 against TARC and
Southeast Louisiana Contractors of Norco, Inc. ("Southeast Contractors")
pursuant to Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C.
sec.2000e et seq. ("Title VII"). In the Determination, the EEOC stated that it
found reasonable cause to believe that each of TARC and Southeast Contractors
had discriminated based on race and gender in its hiring and promotion
practices. Each violation of Title VII (for each individual allegedly
aggrieved), if proven, potentially could subject TARC and Southeast Contractors
to liability for (i) monetary damages for backpay and front pay in an
undetermined amount, and for compensatory damages and punitive damages in an
amount not to exceed $300,000 per plaintiff, (ii) injunctive relief, (iii)
attorney's fees, and (iv) interest. During the period covered by the
Commissioner's Charge and the Determination, TARC and Southeast Contractors
estimate that they received a combined total of approximately 23,000 to 30,000
employment applications and hired (or rehired) a combined total of approximately
3,400 to 4,100 workers, although the total number of individuals who ultimately
are covered in any conciliation proposal or any subsequent lawsuit may be
higher. TARC and Southeast Contractors deny engaging in any unlawful employment
practices. TARC and Southeast Contractors intend vigorously to defend against
the allegations contained in the Commissioner's Charge and the findings set
forth in the Determination in any proceedings in state or federal court. If TARC
or Southeast Contractors is found liable for violations of Title VII based on
the matters asserted in the Determination, TARC can make no assurance that such
liability would not have a material adverse effect on its financial position,
results of operations or cash flows. TransContinental will provide to TARC an
indemnity with respect to this matter. Such indemnity is limited, however, and
there can be no assurance that such indemnity will be adequate to cover all
potential liability.
Rineheart. On October 8, 1996, Carlton Gene Rineheart, et al., and as
representative of a class of persons similarly situated, filed suit against 84
individuals and corporations, including TARC, in the U.S. District Court, Middle
District of Louisiana alleging negligent and improper storage, handling,
treatment, and disposal of hazardous materials from 1976 to the present at two
sites in Iberville Parish, Louisiana. The suit claims damages for physical,
mental, and property damage in the communities of Bayou Sorrel, Bayou Pigeon and
Indian Village. On October 2, 1998, plaintiff's motion for class certification
was denied. TARC and TransContinental intend to vigorously defend this claim.
Shell Oil. On September 27, 1996, Shell Oil filed a third party suit
against TARC in the U.S. District Court, Eastern District of Louisiana for
contribution and/or indemnity relating to alleged environmental contamination of
Bayou Trepagnier and surrounding lands near Norco, Louisiana. In March 1997,
TARC obtained a voluntary dismissal from Shell. Shell proceeded to trial on the
main case and settled with the plaintiffs during trial by purchasing their land
for $5 million. On June 27, 1997, Shell amended its third party action to bring
TARC back into the case. However, TARC has not yet been served in the case.
Based on the
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amount of Shell's settlement and TARC's evaluation of its potential share of
this liability, TARC anticipates that its liability, if any, in this case will
not be material. TARC and TransContinental intend to defend the case vigorously.
General. TransTexas and TARC are also named defendants in other ordinary
course, routine litigation incidental to their businesses. Although the outcome
of these lawsuits cannot be predicted with certainty, the Company does not
expect these matters to have a material adverse effect on its financial
position, results of operations or cash flows. The litigation matters discussed
above amount to significant potential liability which, if adjudicated in a
manner adverse to TARC or TransTexas in one reporting period could have a
material adverse effect on the Company's results of operations or cash flows for
that period. At October 31, 1998, the possible range of estimated losses related
to all of the aforementioned claims in addition to the estimates accrued by
TransTexas and TARC is $0 to $20 million.
Environmental Matters
TransTexas' operations and properties are subject to extensive federal,
state, and local laws and regulations relating to the generation, storage,
handling, emission, transportation, and discharge of materials into the
environment. Permits are required for various of TransTexas' operations, and
these permits are subject to revocation, modification, and renewal by issuing
authorities. TransTexas also is subject to federal, state, and local laws and
regulations that impose liability for the cleanup or remediation of property
that has been contaminated by the discharge or release of hazardous materials or
wastes into the environment. Governmental authorities have the power to enforce
compliance with their regulations, and violations are subject to fines or
injunctions, or both. Certain aspects of TransTexas' operations may not be in
compliance with applicable environmental laws and regulations, and such
noncompliance may give rise to compliance costs and administrative penalties. It
is not anticipated that TransTexas will be required in the near future to expend
amounts that are material to the financial condition or operations of TransTexas
by reason of environmental laws and regulations, but because such laws and
regulations are frequently changed and, as a result, may impose increasingly
strict requirements, TransTexas is unable to predict the ultimate cost of
complying with such laws and regulations.
Compliance Matters. TARC has been, and TransContinental will be, subject to
federal, state and local laws, regulations and ordinances ("Pollution Control
Laws"), which regulate activities such as discharges to air and water and the
handling and disposal of solid and hazardous wastes. Such laws may require
substantial capital expenditures to ensure compliance and impose material civil
and criminal penalties and other sanctions for failure to comply. In general,
during the process of construction and start-up of the refinery, TARC has sought
to comply with Pollution Control Laws, including cooperating, as appropriate,
with regulatory authorities in an effort to ensure compliance and mitigate the
risk of enforcement action. TARC is not aware of any pending or threatened
enforcement action that it likely to have a material adverse effect on its
future financial position, results of operations or cash flow. TARC made
environmental compliance and permitting issues an integral part of its
refinery's start-up plans and has budgeted for such capital expenditures in the
Capital Improvement Program. There can be no assurance, however, that
TransContinental will not incur material capital expenditures in excess of the
amounts currently budgeted. In addition, Pollution Control Laws that may be
enacted in the future, as well as enforcement of existing Pollution Control
Laws, may require TransContinental to make material additional capital
expenditures in order to comply with such laws and regulations or result in
liabilities that could have a material adverse effect on TransContinental's
future financial position, results of operations or cash flow.
In the past, the refinery has been the subject of certain environmental
enforcement actions, and has incurred certain fines, as a result of certain of
TARC's operations. TARC also was previously subject to enforcement proceedings
relating to its prior production of leaded gasoline and air emissions. TARC
believes that, with minor exception, all of these past matters were resolved
prior to or in connection with the resolution
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TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of the bankruptcy proceedings of its predecessor in interest, TransAmerican, or
are no longer applicable to TARC's operations. As a result, TARC believes that
such matters will not have a material adverse effect on TransContinental's
future financial position, results of operations or cash flow.
Requirements Under the Federal Clean Air Act
Permitting. The federal Clean Air Act requires certain owners or operators
of facilities with air emissions to obtain permits before beginning construction
or modification of their facilities. Under Title V of the Clean Air Act, states
are required to implement an operating permit program that codifies all
federally enforceable limitations that are applicable to a particular source.
The Environmental Protection Agency (the "EPA") has approved Louisiana's
operating permit program. The operating permit is necessary for TransContinental
to produce at projected levels upon completion of the Capital Improvement
Program. TARC has submitted its Title V operating permit application covering
the refinery and the adjacent tank storage facility. TARC's initial Title V
permit application under the Clean Air Act was deemed administratively complete.
As the construction of the refinery has progressed, however, TARC has revised
the design and operation of the refinery. As a result, TARC reviewed its permit
application and determined that there may have been changes in the
configuration, start-up and potential emissions of certain of its air sources,
including the tank storage and terminaling facility. Consequently, in early
1998, TARC submitted a modified Title V permit application based on the
developments since the permit application was originally submitted. TARC is in
the process of evaluating and discussing with the Louisiana Department of
Environmental Quality (the "LDEQ") how the changes to its permit application may
affect its anticipated Title V permit. As a result, there can be no assurances
the application will be approved as submitted or that additional expenditures
required pursuant to such operating permit will not have a material adverse
effect on TransContinental's financial position, results of operations or cash
flow.
In a related matter, TARC has obtained a permit from the LDEQ under the
federal prevention of significant deterioration program. Pursuant to that
program, and as a result of the modifications to its Clean Air Act permit
application, the LDEQ recently informed TARC that it will be required to conduct
certain modeling of air emissions and additional review of new or modified
sources. The refinery may be required to modify its plans for refinery
construction or operations as a result of such modeling results, review or other
information submitted in connection with the revised Clean Air Act permit
application. Such modifications may result in material additional capital or
operating expenditures or lost revenue. In addition, the necessary Clean Air Act
permits may not be received by TransContinental in time for the start-up of
Phase II. In that event, TransContinental may not be able to run certain
equipment at maximum capacity until such permits are received.
Benzene Waste NESHAPS. The National Emission Standards for Hazardous Air
Pollutants for Benzene Waste Operations (the "Benzene Waste NESHAPS"),
promulgated in January 1993 pursuant to the Clean Air Act, regulate benzene
emissions from numerous industries, including petroleum refineries. The Benzene
Waste NESHAPS require all existing, new, modified or reconstructed sources to
reduce benzene emissions to a level that will provide an ample margin of safety
to protect public health. TransContinental will be required to comply with the
Benzene Waste NESHAPS as its refinery operations start up. TARC believes that
compliance with the Benzene Waste NESHAPS will not have a material adverse
effect on TransContinental's financial position, results of operations or cash
flow. Until the refinery is in full operation, however, there can be no
assurance that the regulations will not have such an effect.
Hazardous Organic NESHAPS. In addition, in 1995, the EPA promulgated
National Emission Standards for Hazardous Air Pollutants for Hazardous Organics
(the "Hazardous Organic NESHAPS") regulations for petroleum refineries under the
Clean Air Act, and subsequently has amended such regulations. These regulations
set Maximum Achievable Control Technology ("MACT") standards for petroleum
refineries. The LDEQ has incorporated MACT standards into TARC's air permits
under federal and state air
21
23
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
pollution prevention laws. TARC believes that compliance with the Hazardous
Organics NESHAPS will not have a material adverse effect on TransContinental's
financial position, results of operations or cash flow. Until the refinery is in
full operation, however, there can be no assurance that the regulations will not
have such an effect.
Reformulated Gasoline Program. The EPA has promulgated federal regulations
pursuant to the Clean Air Act to control fuels and fuel additives (the "Gasoline
Standards") that could have a material adverse effect on TransContinental. Under
these regulations, only reformulated gasoline can be sold in certain domestic
geographic areas in which the EPA has mandated or approved its use. Reformulated
gasoline must contain a minimum amount of oxygen, have a lower vapor pressure,
and have reduced sulfur, olefins, benzene and aromatics compared to the average
1990 gasoline. The EPA recently promulgated final National Ambient Air Quality
Standards ("NAAQS") that revise the standards for particulate matter and ozone.
The number and extent of the areas subject to reformulated gasoline standards
likely will increase in the future after the NAAQS are implemented. Conventional
gasoline may be used in all other domestic markets; however, a refiner's
post-1994 average conventional gasoline must not be more polluting than it was
in 1990. With limited exceptions, to determine its compliance as of January 1,
1995, a refiner must compare its post-1994 and 1990 average values of controlled
fuel parameters and emissions. The Gasoline Standards recognize that many
gasoline refiners may not be able to develop an individual 1990 baseline for a
number of reasons, including, for example, lack of adequate data or the absence
or limited scope of operations in 1990. Under such circumstances, the refiner
must use a statutory baseline reflecting the 1990 industry average. The EPA has
authority, upon a showing of extenuating circumstances by a refiner, to grant an
individual adjusted baseline or other appropriate regulatory relief to that
refiner.
TARC filed a petition with the EPA requesting an individual baseline
adjustment or other appropriate regulatory relief based on extenuating
circumstances, including that the refinery was not in operation in 1990 (and
thus there is no 1990 average for purposes of the necessary comparison) and the
fact that the start-up of the refinery is to occur on a phased-in basis. The EPA
denied TARC's initial request for an individual baseline adjustment and other
regulatory relief. TARC recently submitted a revised petition. TransContinental
anticipates that it will continue to pursue regulatory relief with the EPA.
However, regulatory relief may not be granted. Any action taken by the EPA may
have a material adverse effect on TransContinental's future financial position,
results of operations or cash flow.
Requirements Under the Federal Clean Water Act. The federal Clean Water Act
regulates the discharge of industrial wastewater and stormwater into waters of
the United States through the use of discharge permits. The EPA has delegated
the federal pollution discharge permit program in Louisiana to the LDEQ. TARC's
pollution discharge permit expired in 1992; however, TARC submitted a permit
renewal application to the LDEQ before the expiration date, which allowed TARC
to continue to operate under the old permit beyond its original expiration date.
Since then, TARC has identified engineering, design and process changes to its
wastewater discharges and treatment system that are not currently reflected in
its permit application. TARC has informed the LDEQ that it will be submitting an
amended permit application to reflect these changes in the near future. The LDEQ
may include more stringent discharge limitation in the new permit or request
certain changes to processes at the refinery that may require additional
expenditures that could have a material adverse effect on TransContinental's
financial position, results of operations or cash flow.
Cleanup Matters. The refinery is subject to federal, state and local laws,
regulations and ordinances that impose liability for the costs of clean up
related to, and certain damages resulting from, past spills, disposals or other
releases of hazardous substances and govern the use, storage, handling and
disposal of such substances. The refinery's operations generate, and in the past
have generated, hazardous substances. Over the past several years, TARC has
been, and to a limited extent continues to be, engaged in environmental cleanup
or remedial work relating to or arising out of operations or activities at the
refinery. In addition, TARC has been engaged in upgrading its solid waste
facilities, including the closure of several waste management units. Similar to
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24
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
numerous other industrial sites in the state, the refinery has been listed by
the LDEQ on the federal Comprehensive Environmental Response, Compensation and
Liability Information System, as a result of TARC's prior waste management
activities (as discussed below).
In 1991, the EPA performed a facility assessment at the refinery. A follow
up assessment was commenced in March 1996. In July 1996, the EPA and the LDEQ
agreed that the LDEQ was would serve as the lead agency with respect to the
investigation and remediation of areas of concern identified in the
investigations. TARC, under a voluntary initiative approved by the LDEQ,
submitted a work plan to the LDEQ to determine which areas may require further
investigation and remediation. The LDEQ requested additional information and
TARC submitted such information in January 1998. Based on the workplan submitted
and additional requests by the LDEQ, TARC believes that any further action will
not have a material adverse effect on TransContinental's financial position,
results of operations or cash flow. However, because the work plans have not yet
been approved, the LDEQ or the EPA may require additional remediation or
investigation.
TARC has been identified as a potentially responsible party under the
Comprehensive Environmental Response, Compensation, and Liability Act of 1980,
as amended ("CERCLA" or "Superfund"), for the cleanup of contamination from
hazardous substances at three Superfund sites. It has been alleged that TARC, or
its predecessors, sent hazardous substances in the past to these sites. CERCLA
requires cleanup of sites from which there has been a "release" or threatened
release of "hazardous substances" (as such terms are defined under CERCLA). Past
and present owners and operators of a site, as well as generators and
transporters of wastes to a site from which hazardous substances are released,
may be considered potentially responsible for the costs of investigating and
cleaning up such releases, among other damages. Courts have interpreted CERCLA
to impose strict, joint and several liability upon all persons liable for the
entire amount of necessary cleanup costs. As a practical matter, at sites where
there are multiple potentially responsible parties for a cleanup, the costs of
cleanup typically are allocated according to a volumetric or other standard
among the parties. A number of states have laws similar to Superfund, pursuant
to which cleanup operations, or the costs thereof, also may be imposed.
At one Superfund site, TARC has submitted information to the EPA indicating
that it should have no liability for this matter. With respect to the remaining
two sites, TARC's liability for each such matter has not been determined. TARC
anticipates that it may incur costs related to the cleanup at each such site
(and possibly including additional costs arising in connection with any recovery
or other actions brought pursuant or relating to such matters). TARC believes
that its or TransContinental's ultimate environmental liabilities will not be
significant. This determination is based in part on review of the data available
to TARC regarding the basis of TARC's alleged liability at each site. Depending
on the circumstances of the particular Superfund site, other factors are
analyzed, including, for example, the relationship of TARC to each such site,
the volume of wastes TARC is alleged to have contributed to each such site in
comparison to other responsible parties (without giving effect to the ability of
any other responsible parties to contribute to or pay for any liabilities
incurred) and the range of likely cleanup costs at each such site. However, it
is not possible at this time to determine the ultimate environmental
liabilities, if any, that may arise from the matters discussed above.
In September 1997, TARC purchased a tank storage facility located adjacent
to the refinery for a cash purchase price of $40 million (which does not include
a $3.1 million liability recorded for environmental remediation, as discussed
below). Environmental investigations conducted by the previous owner of the
facilities indicated soil and groundwater contamination in several areas on the
property. As a result, the former owner submitted to the LDEQ plans for the
remediation of significant indicated contamination in such areas. TARC has
analyzed these investigations and has carried out further Phase II environmental
assessments to verify their results. TARC intends to incorporate any required
remediation into its ongoing work at the refinery. In connection with the
purchase of the facilities, TARC agreed to indemnify the seller for all cleanup
costs and certain other damages resulting from contamination of the property.
TARC created a $5 million
23
25
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
escrow account to fund required remediation costs and indemnification claims by
the seller. As a result of TARC's Phase II Environmental Assessment, TARC
believes that the amount in escrow should be sufficient to fund the remediation
costs associated with identified contamination. However, because the LDEQ has
not yet approved certain of the remediation plans, the funds set aside in the
escrow account may not be sufficient to pay all required remediation costs. As
of October 31, 1998, TARC had recognized a liability of $3.1 million for this
contingency.
TEC and TARC have indemnified TCR Holding, TransContinental and the
Purchasers with respect to certain representations and warranties made in the
Securities Purchase Agreement and Asset Transfer Agreements executed in
connection with the Transaction, including representations and warranties
regarding environmental compliance.
Purchase Commitments
TARC has various purchase commitments for materials, supplies and services
incidental to the ordinary course of business and for the Capital Improvement
Program. As of October 31, 1998, TARC had commitments for refinery construction
and maintenance of approximately $48.0 million.
Processing Agreements
In April 1996, TARC entered into a processing agreement with a third party
to process feedstocks. Under the terms of the agreement, the processing fee
earned from the third party is based on the margin earned by the third party, if
any, after deducting all of its related costs such as feedstock acquisition,
hedging, transportation, processing and inspections plus a commission for each
barrel processed. During the three and nine months ended October 31, 1998 and
1997, TARC processed approximately 0.8 million barrels, 1.6 million barrels, 0
barrels and 6.4 million barrels, respectively, pursuant to the processing
agreement. Income (loss) from this processing agreement was $2.1 million, $3.9
million, $(0.1) million and $3.1 million for the three and nine months ended
October 31, 1998 and 1997, respectively.
Production Payments
In April 1997, TransTexas sold to an unaffiliated third party a term
overriding royalty in the form of a dollar-denominated production payment in
certain of TransTexas' producing properties for net proceeds of $20 million. The
production payment calls for the repayment of the primary sum plus an amount
equivalent to a 16% annual interest rate on the unpaid portion of such primary
sum. As of October 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 October 31, 1998, the
outstanding balance of the production payment was $46.5 million.
In September 1998, 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 $10 million. The
production payment calls for the repayment of the primary sum plus an amount
equivalent to a 16% annual interest rate on the unpaid portion of such primary
sum. As of October 31, 1998, the outstanding balance of the production payment
was $10 million.
24
26
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Potential Tax Liability
Part of the refinancing of TransAmerican's debt in 1993 involved the
cancellation of approximately $65.9 million of accrued interest and a contingent
liability for interest of $102 million owed by TransAmerican. TransAmerican has
taken the federal tax position that the entire amount of this debt cancellation
is excluded from its income under the cancellation of indebtedness provisions
(the "COD Exclusion") of the Internal Revenue Code of 1986, as amended, and has
reduced its tax attributes (including its net operating loss and credit
carryforwards) as a consequence of the COD Exclusion. No federal tax opinion was
rendered with respect to this transaction, however, and TransAmerican has not
obtained a ruling from the Internal Revenue Service (the "IRS") regarding this
transaction. TransTexas believes that there is substantial legal authority to
support the position that the COD Exclusion applies to the cancellation of
TransAmerican's indebtedness. However, due to factual and legal uncertainties,
there can be no assurance that the IRS will not challenge this position, or that
such challenge would not be upheld. Under the Tax Allocation Agreement (defined
below), TransTexas has agreed to pay an amount equal to any federal tax
liability (which would be approximately $25.4 million) attributable to the
inapplicability of the COD Exclusion. Any such tax would be offset in future
years by alternative minimum tax credits and retained loss and credit
carryforwards to the extent recoverable from TransAmerican. As a member of the
TNGC Consolidated Group (defined below), each of TransTexas, TEC and TARC will
be severally liable for any tax liability resulting from the above-described
transactions. The IRS has commenced an audit of the consolidated federal income
tax returns of the TNGC Consolidated Group for its taxable years ended July 31,
1995 and 1994. At this time, it is not possible to predict the scope of the IRS'
review or whether any tax deficiencies will be proposed by the IRS as a result
of its review.
Based in part upon independent legal advice, TransTexas has taken the
position that it will not incur any significant federal income tax liability as
a result of the Lobo Sale. There are, however, significant uncertainties
regarding TransTexas' tax position and no assurance can be given that its
position will be sustained if challenged by the IRS. TransTexas is part of an
affiliated group for tax purposes (the "TNGC Consolidated Group"), which
includes TNGC Holdings Corporation, the sole stockholder of TransAmerican
("TNGC"), TransAmerican, TEC and TARC. No letter ruling has been or will be
obtained from the IRS regarding the Lobo Sale by any member of the TNGC
Consolidated Group. If the IRS were to successfully challenge TransTexas'
position, each member of the TNGC Consolidated Group would be severally liable
under the consolidated tax return regulations for the resulting taxes, in the
estimated amount of up to $270 million (assuming no reduction for 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 recorded
a liability of 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.
25
27
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Tax Allocation Agreement requires each of TransAmerican's subsidiaries
to pay to TransAmerican each year its allocable share of the federal income tax
liabilities of the consolidated group ("Allocable Share"). The Tax Allocation
Agreement provides for a reallocation of the group's consolidated federal income
tax liabilities among the members if the IRS or the courts ultimately
redetermine the group's regular tax or alternative minimum tax liability. In the
event of an IRS audit or examination, the Tax Allocation Agreement generally
gives TransAmerican the authority to compromise or settle disputes and to
control litigation, subject to the approval of TARC, TEC or TransTexas, as the
case may be, where such compromise or settlement affects the determination of
the separate tax liability of that company.
Under the Tax Allocation Agreement, each subsidiary's Allocable Share for
each tax year will generally equal the amount of federal income tax it would
have owed had it filed a separate federal income tax return for each year except
that each subsidiary will be able to utilize net operating losses and credits of
TransAmerican and the other members of the consolidated group effectively to
defer payment of tax liabilities that it would have otherwise owed had it filed
a separate federal income tax return. Each subsidiary will essentially pay the
deferred taxes at the time TransAmerican (or the member whose losses or credits
are utilized by such subsidiary) begins generating taxable income or tax. This
will have the effect of deferring a portion of such subsidiary's tax liability
to future years. The parties to the Tax Allocation Agreement amended such
agreement in connection with the Lobo Sale to include additional affiliates as
parties, and further amended the Tax Allocation Agreement in June 1997 to
allocate to TransAmerican, as among the parties, any tax liability associated
with the Lobo Sale.
Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation were to occur
during the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the IRS
successfully challenged TransTexas' position on the Lobo Sale. Each member of a
consolidated group filing a consolidated federal income tax return is severally
liable to the IRS for the consolidated federal income tax liability of the
consolidated group. There can be no assurance that each TNGC Consolidated Group
member will have the ability to satisfy any tax obligation attributable to these
transactions at the time due and, therefore, other members of the group,
including TEC, TransTexas or TARC, may be required to pay the tax.
Potential Effects of a Change of Control
The TransTexas Subordinated Notes Indenture provides that, upon the
occurrence of a Change of Control, each holder of the TransTexas Subordinated
Notes will have the right to require TransTexas to repurchase such holder's
TransTexas Subordinated Notes at 101% of the principal amount thereof plus
accrued and unpaid interest. Pursuant to the terms of the TransTexas
Intercompany Loan, upon the occurrence of a Change of Control, TEC would have
the right to require TransTexas to repay the principal of the TransTexas
Intercompany Loan in an amount equal to a pro rata share of the amount TEC is
required to pay under the TEC Notes Indenture. Such pro rata share would be
calculated using the ratio of the outstanding principal amount of the TransTexas
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan. Pursuant to the terms of the
TARC Intercompany Loan, upon the occurrence of a Change of Control, TEC would
have the right to require TARC to repay the
26
28
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
principal of the TARC Intercompany Loan in an amount equal to a pro rata share
of the amount TEC is required to pay under the TEC Indenture. Such pro rata
share would be calculated using the ratio of the accreted value of the
outstanding principal amount of the TARC Intercompany Loan to the sum of (i) the
outstanding principal amount of the TransTexas Intercompany Loan plus (ii) the
accreted value of the outstanding principal amount of the TARC Intercompany
Loan.
A Change of Control would be deemed to occur under the TransTexas
Subordinated Notes Indenture in the case of certain changes or other events in
respect of the ownership of TransTexas, including any circumstances pursuant to
which any person or group other than John R. Stanley (or his heirs, his estate,
or any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the TransTexas Subordinated Notes is
downgraded or withdrawn. A Change of Control would be deemed to occur under the
TransTexas Intercompany Loan in the case of certain changes or other events in
respect of the ownership or control of TEC or TransTexas, including any
circumstance pursuant to which (i) any person or group, other than John R.
Stanley (or his heirs, his estate, or any trust in which he or his immediate
family members have, directly or indirectly, a beneficial interest in excess of
50%) and his subsidiaries or the TEC Indenture Trustee is or becomes the
beneficial owner of more than 50% of the total voting power of TEC's then
outstanding voting stock, or (ii) TEC or any of its subsidiaries own some of
TransTexas' capital stock, but less than 50% of the total voting stock or
economic value of TransTexas, unless the TEC Notes have an investment grade
rating for the period of 120 days thereafter. A Change of Control would be
deemed to occur under the TEC Notes Indenture or the TARC Intercompany Loan in
the case of certain changes or other events in respect of the ownership or
control of TEC, TARC or TransTexas including any circumstance pursuant to which
(i) any person or group, other than John R. Stanley (or his heirs, his estate or
any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TEC's then outstanding voting stock, or (ii) TEC or any of
its subsidiaries own some of TARC's or TransTexas' capital stock, respectively,
but less than 50% of the total voting stock or economic value of TARC or
TransTexas, respectively, unless (in the case of either (i) or (ii) above) the
TEC Notes have an investment grade rating for the period of 120 days thereafter.
The term "person," as used in the definition of Change of Control, means a
natural person, company, government or political subdivision, agency or
instrumentality of a government and also includes a "group," which is defined as
two or more persons acting as a partnership, limited partnership or other group.
In addition, certain changes or other events in respect of the ownership or
control of TransTexas that do not constitute a Change of Control under the
TransTexas Subordinated Notes Indenture, the TEC Notes Indenture or the
TransTexas Intercompany Loan may result in a "change of control" of TransTexas
under the terms of the BNY Facility. Such an occurrence could create an
obligation for TransTexas to repay any amounts due under the BNY Facility. At
October 31, 1998, TransTexas had approximately $5.1 million of indebtedness
subject to such right of repayment. In the event of a Change of Control under
the TransTexas Subordinated Notes Indenture, the TEC Notes Indenture or the
Intercompany Loans, or a "change of control" under the terms of the BNY
Facility, there can be no assurance that TransTexas or TARC will have sufficient
funds to satisfy any such payment obligations. A change of control or other
event that results in Deconsolidation of TransTexas and TransAmerican for
federal income tax purposes could result in acceleration of a substantial amount
of federal income taxes.
Lobo Sale
Pursuant to the Lobo Sale, TransTexas is required to indemnify the buyer
for certain liabilities related to the assets owned by TTC. Although TransTexas
does not anticipate that it will incur any material indemnity liability, no
assurance can be given that TransTexas will have sufficient funds to satisfy any
such indemnity
27
29
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
obligation or that any payment thereof will not have a material adverse effect
on its ability to fund its debt service, capital expenditure and working capital
requirements.
Delivery Commitments
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 125 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 $0.8 million and $1.1
million during the three and nine months ended October 31, 1998, respectively.
In August 1998, TransTexas entered into a settlement agreement whereby delivery
commitments of approximately 350 MMcf per day were 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. In July 1998, TransTexas reduced the gain on sale of assets by $3.4
million as a result of this settlement.
Registration Rights Agreement
TARC had an obligation under its Registration Rights Agreement with the
holders of its Senior Subordinated Notes to have its registration statement on
Form S-4 relating to the Exchange Offer for the Senior Subordinated Notes
declared effective by the Securities and Exchange Commission by July 28, 1998.
As a result of its failure to meet its obligation under the Registration Rights
Agreement, TARC had accrued approximately $0.1 million in liquidated damages as
of October 31, 1998. Such amount accrued at a rate of $10,000 per week from July
28, 1998 until November 25, 1998, and thereafter at a rate of $30,000 per week
until such date as the registration statement is declared effective.
9. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
The following information reflects the Company's noncash investing and
financing activities (in thousands of dollars):
NINE MONTHS ENDED
OCTOBER 31,
------------------
1998 1997
------- --------
Accounts payable for property and equipment................. $84,198 $ 58,851
Accrued interest on long-term debt capitalized in property
and equipment............................................. 69,064 48,046
Exchange of TransTexas Subordinated Notes................... -- 115,815
10. CREDIT AGREEMENT
TransTexas and BNY Financial Corporation ("BNY") are parties to a Second
Amended and Restated Accounts Receivable Management and Security Agreement (the
"BNY Facility"), dated as of October 14, 1997. As of October 31, 1998,
outstanding advances under the BNY Facility totaled approximately $5.1 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. As of October 31,
1998, TransTexas was not in compliance with these covenants, and BNY has agreed
to waive the noncompliance. Additional waivers may be required in the future.
11. TRANSACTIONS WITH AFFILIATES
On June 13, 1997, a services agreement was entered into among
TransAmerican, TEC, TARC and TransTexas. Under the services agreement,
TransTexas provided accounting, legal, administrative and other
28
30
TRANSAMERICAN ENERGY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
services to TARC, TEC and TransAmerican and its affiliates. TransAmerican will
provide advisory services to TransTexas, TARC and TEC. As of October 31, 1998
and January 31, 1998, the payable to TransAmerican for such services was $3.4
million and $1.6, respectively. In connection with the Transaction, TransTexas
will enter into an Amended and Restated Services Agreement with TransAmerican
and its affiliates (other than TCR Holding and TransContinental) and an Amended
and Restated Services Agreement (the "TCR Group Services Agreement") with TCR
Holding and TransContinental. Pursuant to the TCR Group Services Agreement,
TransTexas expects to provide accounting, legal, administrative and other
services to the TCR Group through December 15, 2000 and receive payment for such
services, through February 28, 1999, in the amount of $200,000 per month.
Subsequent to February 28, 1999, the monthly fee will be adjusted based on an
assessment of the cost to TransTexas as of providing such services.
Southeast Contractors, a subsidiary of TransAmerican, has provided
construction personnel to TARC in connection with the Capital Improvement
Program and will continue to provide such personnel to TransContinental under a
new contract. These construction workers are temporary employees, and the number
and composition of the workforce will vary throughout the Capital Improvement
Program. Southeast Contractors charged TARC for the direct costs it incurs
(which consist solely of employee payroll and benefits) plus administrative
costs and fees of up to $2.0 million per year. Total labor costs charged by
Southeast Contractors for the three and nine months ended October 31, 1998 and
1997 were $19.8 million, $101.8 million, $17.1 million and $26.8 million,
respectively, of which $9.7 million and $2.0 million were payable at October 31,
1998 and January 31, 1998, respectively.
12. IMPAIRMENT LOSS
TransTexas uses the full cost method of accounting for exploration and
development costs. Under this method of accounting, net capitalized costs of gas
and oil properties are limited to the lower of unamortized cost or the cost
center ceiling. As of October 31, 1998 and July 31, 1998, TransTexas' net
capitalized costs of gas and oil properties exceeded the cost center ceiling.
TransTexas adjusted its net capitalized costs resulting in a non-cash pre-tax
loss of approximately $164.9 million for the three months ended October 31, 1998
and $16.3 million for the three months ended July 31, 1998.
In July 1998, TransTexas evaluated the carrying value of a pipeline system
which was underutilized. Based on then existing production levels, TransTexas
determined that the pipeline would remain significantly underutilized and
recorded a non-cash pre-tax impairment loss of approximately $5.5 million
related to this pipeline.
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31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The condensed consolidated financial statements of TEC reflect the results
of operations of TEC's wholly and majority owned subsidiaries, TARC and
TransTexas. As of October 31, 1998, TransTexas' operations consisted of
exploration and production of natural gas, condensate and natural gas liquids
("E&P"). TARC's business is refining and storage operations ("Refining"). As
described in Note 1 of Notes to Condensed Consolidated Financial Statements,
transactions between TransTexas and TARC are significantly restricted. The
following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto of the Company included
elsewhere in this report.
TRANSTEXAS
Results of Operations
TransTexas' results of operations are dependent upon natural gas production
volumes and unit prices from sales of natural gas, condensate and NGLs. The
profitability of TransTexas also depends on its ability to minimize finding and
lifting costs and maintaining its reserve base while maximizing production. On
May 29, 1997, TransTexas consummated a stock purchase agreement with an
unaffiliated buyer (the "Lobo Sale Agreement"), with an effective date of March
1, 1997, to effect the sale (the "Lobo Sale") of the stock of TransTexas
Transmission Corporation ("TTC"), its subsidiary that owned substantially all of
TransTexas' Lobo Trend producing properties and related pipeline transmission
system, for an adjusted sales price of approximately $1.1 billion. Accordingly,
TransTexas' reported results for the three and nine months ended October 31,
1998 reflect the effects of reduced sales volumes as a result of the Lobo Sale.
TransTexas' operating data for the three and nine months ended October 31,
1998 and 1997, is as follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
--------------- ---------------
1998 1997 1998 1997
------ ------ ------ ------
Sales volumes:
Gas (Bcf)(1)..................................... 10.2 10.3 26.7 63.5
NGLs (MMgal)..................................... 5.6 -- 8.9 61.7
Condensate (MBbls)............................... 449 92 668 518
Average prices:
Gas (dry) (per Mcf)(2)........................... $ 1.94 $ 2.66 $ 2.11 $ 2.04
NGLs (per gallon)................................ .20 -- .21 .29
Condensate (per Bbl)............................. 12.22 18.55 12.36 19.52
Number of gross wells drilled...................... 8 21 36 79
Percentage of wells completed...................... 38% 76% 64% 63%
- ---------------
(1) Sales volumes for the nine months ended October 31, 1997 include 7.3 Bcf
delivered prior to the third quarter pursuant to volumetric production
payments.
(2) Average prices for the three and nine months ended October 31, 1997 include
amounts delivered under volumetric production payments. The average gas
price for TransTexas' undedicated production for these periods were $2.06
per Mcf and $1.91 per Mcf, respectively. Gas prices do not include the
effect of hedging agreements.
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32
A summary of TransTexas' operating expenses is set forth below (in millions
of dollars):
THREE MONTHS NINE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
------------- -------------
1998 1997 1998 1997
----- ----- ----- -----
Operating costs and expenses:
Lease.................................................. $2.1 $3.0 $ 8.8 $15.2
Pipeline and gathering................................. 1.7 2.7 5.4 14.1
Natural gas liquids.................................... -- -- -- 14.5
Drilling services...................................... 0.7 1.4 2.9 2.1
---- ---- ----- -----
4.5 7.1 17.1 45.9
Taxes other than income taxes(1)....................... 2.3 2.1 5.8 9.8
---- ---- ----- -----
$6.8 $9.2 $22.9 $55.7
==== ==== ===== =====
- ---------------
(1) Taxes other than income taxes include severance, property, and other taxes.
TransTexas' average depletion rates have been as follows:
THREE MONTHS NINE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
------------- -------------
1998 1997 1998 1997
----- ----- ----- -----
Depletion rates (per Mcfe)............................. $1.43 $1.09 $1.38 $1.04
===== ===== ===== =====
THREE MONTHS ENDED OCTOBER 31, 1998, COMPARED WITH THE THREE MONTHS ENDED
OCTOBER 31, 1997
Gas, condensate and NGL revenues for the three months ended October 31,
1998 decreased $1.1 million from the prior period, due primarily to lower
natural gas and condensate price. The average monthly prices received per Mcf of
gas ranged from $1.86 to $2.02 in the three months ended October 31, 1998,
compared to a range of $2.30 to $2.94, excluding amounts dedicated to volumetric
production payments, in the prior period. As of October 31, 1998, TransTexas had
a total of 142 producing wells compared to 106 producing wells at October 31,
1997. Drilling services revenues decreased by $1.3 million for the three months
ended October 31, 1998, due to the sale of drilling service assets to an
unaffiliated third party. For the three months ended October 31, 1998,
TransTexas recognized a pre-tax gain of $5.8 million on the sale of certain
drilling services division assets.
Lease operating expenses for the quarter ended October 31, 1998 decreased
by $0.9 million from the prior period due primarily to the decrease in materials
and supplies and well service and testing. Pipeline and gathering expenses
decreased $1.0 million from the prior period due primarily to the settlement
agreement whereby delivery commitments were released. Drilling service expenses
for the three months ended October 31, 1998 decreased $0.7 million primarily due
to the sale of drilling service assets. Depreciation, depletion and amortization
expense for the three months ended October 31, 1998 increased $6.2 million due
to a $0.34 per Mcfe increase in the depletion rate resulting from higher cost
properties and unsuccessful drilling results. General and administrative
expenses decreased by $1.0 million primarily as a result of a decrease in
professional fees. Taxes other than income taxes increased $0.2 million over the
prior period due primarily to increases in franchise taxes. The impairment loss
relates to a write-down of $164.9 million of TransTexas' net capitalized costs
of gas and oil properties to the cost center ceiling in accordance with the full
cost method of accounting.
Interest income for the three months ended October 31, 1998 decreased by
$3.9 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
increased by $5.0 million primarily as a result of the issuance of
dollar-denominated production payments and a decrease in the amount of interest
capitalized in connection with the acquisition of undeveloped leasehold acreage.
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33
NINE MONTHS ENDED OCTOBER 31, 1998, COMPARED WITH THE NINE MONTHS ENDED OCTOBER
31, 1997
Gas, condensate and NGL revenues for the nine months ended October 31, 1998
decreased by $73.4 million from the prior period, due primarily to decreases in
gas 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 $1.86 to $2.36 in the nine months ended October 31,
1998, compared to a range of $1.49 to $2.94, excluding amounts dedicated to
volumetric production payments in the same period in the prior year. As of
October 31, 1998, TransTexas had a total of 142 producing wells compared to 106
producing wells at October 31, 1997. Transportation revenues decreased $12.1
million over the prior period due primarily to the divestiture of the pipeline
system in connection with the Lobo Sale. Drilling services revenues increased by
$2.8 million for the nine months ended October 31, 1998 due to an increase in
services provided to third parties prior to the sale of the drilling services
division. TransTexas' net gain on the sale of assets includes a pre-tax gain of
$68.4 million for the sale of certain drilling services division assets and a
pre-tax loss of $2.6 million due to post-closing adjustments to the Lobo Sale
purchase price.
Lease operating expenses for the nine months ended October 31, 1998
decreased by $6.4 million from the prior period due primarily to the Lobo Sale.
Pipeline and gathering expenses decreased by $8.7 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 nine months ended October 31, 1998 increased $0.8 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 nine
months ended October 31, 1998 decreased $22.0 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 $13.7 million primarily as a result of a
decrease in litigation expense. Taxes other than income taxes decreased by $4.0
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 offset partially by an increase in
franchise taxes. The impairment loss of $186.7 million for the nine months ended
October 31, 1998 relates to a write-down of $181.2 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.
Interest income for the nine months ended October 31, 1998 decreased by
$10.2 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 $1.7 million primarily as a result of the retirement of the Senior
Secured Notes in June 1997, offset in part by an increase in interest
attributable to the issuance of dollar-denominated production payments and a
decrease in the amount of interest capitalized in connection with the
acquisition of undeveloped leasehold acreage.
TARC
Results of Operations
TARC's refinery was inoperative from January 1983 through February 1994.
During this period, TARC's revenues were derived primarily from tank rentals and
its expenses consisted of maintenance and repairs, tank rentals, general and
administrative expenses and property taxes. The No. 2 Vacuum Unit was operated
intermittently between March 1994 and January 1997. The No. 2 Vacuum Unit
recommenced operations in May 1998 and the No. 2 Crude Unit commenced operations
in June 1998. The Delayed Coking Unit, HDS Unit and Sulfur Recovery System have
also commenced operations. TARC does not consider its historical results to be
indicative of future results.
TARC's historical results of operations are dependent on the operating
status of certain units within its refinery, which determines the types of
feedstocks processed and refined product yields. The results are also affected
by the unit costs of purchased feedstocks and the unit prices of refined
products, which can vary significantly. The Capital Improvement Program is
designed to significantly change the refinery's throughput capacity, the
feedstocks processed, and refined product yields.
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34
As described in Note 2 to the accompanying condensed financial statements,
on December 15, 1998, TARC completed the Transaction resulting in the transfer
of the refinery assets to TCR Holding in exchange for an equity interest in TCR
Holding. TCR Holding subsequently transferred the refinery assets to its wholly
owned subsidiary, TransContinental. Also as part of the Transaction, TARC sold a
majority of the capital stock of TCR Holding to third parties. As a result,
subsequent to December 15, 1998, TARC will not report any operating results, but
will report its pro rata share of net earnings and losses of TCR Holding,
dividend income, if any on the TCR Voting Preferred Stock and interest expense
on the TARC Intercompany Loan and the TARC Subordinated Notes. TEC expects to
report a loss on disposition of the stock of TCR Holding of approximately $115
million in the fourth quarter of fiscal 1999.
Three Months Ended October 31, 1998, Compared with the Three Months Ended
October 31, 1997
TARC's revenues for the three months ended October 31, 1998 resulted
primarily from sales of finished and intermediate products. The average price of
approximately 0.9 million barrels of finished products sold was $15.45 per
barrel, and the average price of 3.4 million barrels of intermediate products
sold was $13.29 per barrel. Finished products include primarily distillate,
diesel, kerosene, No. 2 fuel oil and liquid petroleum gas. Intermediate products
include primarily cutter, vacuum gas oil and naphtha. Other revenues consisted
primarily of rental income from TARC's tank storage facility acquired in
September 1997.
Cost of products sold of $59.0 million for the three months ended October
31, 1998 related to the refining of approximately 4.2 million barrels of
feedstocks at an average price of $14.15 per barrel.
During 1998 and 1997, TARC entered into processing arrangements whereby
TARC did not take title to feedstocks or refined products but processed
feedstocks in exchange for a fee based on margins, if any, realized by the
counterparty to the arrangement. TARC retained all market and production risks
related to barrels processed. These arrangements, which are recorded net in the
statement of operations, resulted in income of $2.1 million and a loss of $0.01
million for the three months ended October 31, 1998 and 1997, respectively.
Operations and maintenance expense for the three months ended October 31,
1998 increased to $8.3 million from $2.8 million for the same period in 1997,
primarily due to the commencement of operations of certain units in Phase I of
the Capital Improvement Program.
Depreciation and amortization expense for the three months ended October
31, 1998 increased to $4.2 million from $2.0 million for the same period in
1997, primarily due to placing into operation certain units in Phase I of the
Capital Improvement Program.
General and administrative expenses for the three months ended October 31,
1998 decreased to $5.2 million from $6.0 million for the same period in 1997.
The decrease was primarily due to a write-off of certain intangible assets
offset by an increase in payroll.
Taxes other than income taxes for the three months ended October 31, 1998
increased to $1.3 million from $0.9 million for the same period in 1997,
primarily due to increased franchise taxes.
Interest income for the three months ended October 31, 1998 decreased to
$0.7 million from $2.0 million for the same period in 1997, primarily due to
lower cash balances available for investment. Net interest expense for the three
months ended October 31, 1998 decreased to $2.8 million from $7.1 million for
the same period in 1997, due primarily to increased interest capitalization.
During the three months ended October 31, 1998, TARC capitalized approximately
$43.4 million of interest related to Capital Improvement Program additions
compared to $23.3 million for the three months ended October 31, 1997.
In September 1997, TARC sold approximately 8.5 million shares of TransTexas
common stock pursuant to the TransTexas Share Repurchase Program. TARC received
$136.2 million in connection with the repurchase, of which $124.5 million
(representing the excess of the cash received over TARC's carrying value of the
stock) was recorded as a capital contribution.
33
35
Nine Months Ended October 31, 1998, Compared with the Nine Months Ended
October 31, 1997
TARC's revenues for the nine months ended October 31, 1998 resulted
primarily from sales of finished and intermediate products. The average price of
approximately 1.0 million barrels of finished products sold was $15.42 per
barrel, and the average price of the 3.9 million barrels of intermediate
products sold was $13.39 per barrel. Finished products primarily include
distillate, diesel, kerosene, No. 2 fuel oil and liquid petroleum gas.
Intermediate products primarily include cutter, vacuum gas oil, and naphtha.
Other revenues consisted primarily of rental income from TARC's tank storage
facility acquired in September 1997.
Cost of products sold of $66.8 million for the nine months ended October
31, 1998 related to the refining of approximately 4.8 million barrels of
feedstocks at an average price of $14.06 per barrel.
During 1998 and 1997, TARC entered into processing arrangements whereby
TARC did not take title to feedstocks or refined products but processed
feedstocks in exchange for a fee based on margins, if any, realized by the
counterparty to the arrangement. TARC retained all market and production risks
related to barrels processed. These arrangements, which are recorded net in the
statement of operations, resulted in income of $3.9 million and $3.1 million for
the nine months ended October 31, 1998 and 1997, respectively.
Operations and maintenance expense for the nine months ended October 31,
1998 increased to $14.1 million from $10.7 million for the same period in 1997,
primarily due to the commencement of operations of certain units in Phase I of
the Capital Improvement Plan.
Depreciation and amortization expense for the nine months ended October 31,
1998 increased to $8.7 million from $5.4 million for the same period in 1997,
primarily due to placing into operations certain units in Phase I of the Capital
Improvement Program.
General and administrative expenses increased to $17.2 million for the nine
months ended October 31, 1998 from $11.0 million for the same period in 1997.
The increase was primarily due to increased salaries and training for personnel
added upon commencement of refinery operations, services agreement fees and
increased professional fees.
Taxes other than income taxes for the nine months ended October 31, 1998
increased to $3.6 million from $2.7 million for the same period in 1997,
primarily due to increased franchise taxes.
Loss on purchase commitments of $4.8 million for the nine months ended
October 31, 1997 related to a commitment to purchase 0.6 million barrels of
feedstock. These barrels have been sold to a third party and the Company has
processed the barrels pursuant to a processing agreement with the third party.
Interest income for the nine months ended October 31, 1998 increased to
$4.4 million from $3.0 million for the same period in 1997, primarily due to the
temporary investment of proceeds from the TARC Intercompany Loan and Senior
Subordinated Notes. Net interest expense for the nine months ended October 31,
1998 decreased to $10.8 million from $13.9 million for the same period in 1997,
due primarily to increased interest capitalization. During the nine months ended
October 31, 1998, TARC capitalized approximately $118.7 million of interest
related to Capital Improvement Program additions compared to $64.9 million for
the nine months ended October 31, 1997.
The equity in loss of TransTexas for the nine months ended October 31, 1998
of $(0.2) million reflects TARC's equity interest in TransTexas through April
30, 1998. TARC distributed all of its shares of TransTexas common stock to TEC
in April 1998. Equity in income of TransTexas before extraordinary item for the
nine months ended October 31, 1997 of $45.2 million was due primarily to a $540
million gain on the sale by TransTexas of a subsidiary. In September 1997, TARC
sold approximately 8.5 million shares of TransTexas common stock pursuant to the
TransTexas Share Repurchase Program. TARC received $136.2 million in connection
with the repurchase, of which $124.5 million (representing the excess of the
cash received over TARC's carrying value of the stock) was recorded as a capital
contribution. TARC recognized equity in an extraordinary item of TransTexas of
$(10.2) million for the nine months ended October 31, 1997. The extraordinary
loss of TransTexas is attributable to a loss on the early extinguishment of debt
as a result of the repurchase by TransTexas of its Senior Secured Notes and the
Subordinated Notes Exchange Offer.
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36
The loss on the early extinguishment of debt of $1.3 million for the nine
months ended October 31, 1998 is a result of the redemption of $7.0 million of
TARC Notes in February 1998. The loss on the early retirement of debt of $84.4
million for the nine months ended October 31, 1997 was a result of the
completion of the TARC Notes Tender Offer.
The cumulative effect of a change in accounting principle of $2.7 million
for the nine months ended October 31, 1998 relates to TARC's change to the
deferred method of accounting for turnaround costs from the accrual method, as
described in Note 4 of Notes to Condensed Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
TransTexas makes substantial capital expenditures for the exploration and
development of natural gas and oil 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 and oil.
Proceeds from natural gas and oil 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 nine months ended October 31, 1998, TransTexas' total capital
expenditures were $181 million, including $15 million for lease acquisitions,
$156 million for drilling and development, and $10 million for gas gathering,
other equipment and seismic acquisitions. Capital expenditures for fiscal year
1999 will exceed the $177 million originally estimated, and have significantly
exceeded cash flow from operations. TransTexas has reduced planned capital
expenditures for the remainder of fiscal year 1999 and for fiscal year 2000.
Capital expenditures for the fourth quarter of fiscal year 1999 and for fiscal
year 2000 are estimated to be $22 million and $95 million, respectively.
However, these amounts are still in excess of anticipated cash flows from
operating activities. A further reduction in planned capital spending or an
extended decline in gas and oil prices 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. TransTexas has substantial accounts payable
outstanding. The vendors under certain of such accounts payable have filed liens
against TransTexas' properties. TransTexas is currently assessing the amount and
validity of the obligations underlying such liens and believes that such
obligations are not material; however, if the total accounts payable are not
reduced and additional liens are filed, a default under TransTexas' debt
documents may result. Moreover, a foreclosure of such liens could negatively
affect the security interest of the TEC Indenture. TransTexas intends to
substantially reduce its accounts payable with the proceeds of asset sales and
additional financings, but there can be no assurance that such proceeds, if any,
will be sufficient.
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 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 October 31, 1998, the
outstanding balance of the production payment was $46.5 million.
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In September 1998, 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 $10 million. The
production payment calls for the repayment of the primary sum plus an amount
equivalent to a 16% annual interest rate on the unpaid portion of such primary
sum. As of October 31, 1998, the outstanding balance of the production payment
was $10 million.
TransTexas and BNY Financial Corporation are parties to a Second Amended
and Restated Accounts Receivable Management and Security Agreement (the "BNY
Facility"), dated as of October 14, 1997. As of October 31, 1998, outstanding
advances under the BNY Facility totaled approximately $5.1 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. As of October 31, 1998, TransTexas was not in
compliance with these covenants, and BNY has agreed to waive the noncompliance.
Additional waivers may be required in the future.
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.
TARC has historically incurred losses and negative cash flow from operating
activities as a result of limited refinery operations that did not cover the
fixed costs of maintaining the refinery, increased working capital requirements
(including debt service) and losses on refined product sales and processing
arrangements. As a result of the Transaction, TARC will no longer operate the
refinery, and will be dependent primarily on dividends from TCR Holding in order
to meet its debt service and working capital requirements. TCR Holding is a
holding company with no business operations. TCR Holding's only sources of
liquidity will be dividends on the TransContinental common stock that it holds
and proceeds from the sale of such TransContinental common stock.
TransContinental will have no obligation to make dividends or other
distributions to TCR Holding. TransContinental will be able to pay dividends
only if it has sufficient cash from operations. In addition, TransContinental's
ability to make dividends or other distributions on its common stock is
restricted by the Indenture governing the Notes and terms of the
TransContinental Preferred Stock. TransContinental's ability to make dividends
or other distributions under the Indenture will be dependent, in part, on a
determination by the independent engineer who will be appointed in connection
with the Transaction to monitor construction of the refinery on behalf of the
holders of the Notes (the "Independent Engineer") of whether the following funds
are sufficient to complete the Capital Improvement Program: funds in the
Disbursement Account (as defined), plus 50% of Projected Net Operating Cash Flow
(as defined) for the 90-day period commencing on the date a dividend is
declared, plus an amount equal to the portion of the proceeds of the Port
Commission Bond Financing (as defined) held by the entity serving as collateral
agent or in a similar capacity with respect to such financing plus, without
duplication, cash on hand that has been approved by TransContinental's Board of
Directors to be escrowed in a segregated account and allocated only for the
purpose of completion of the Capital Improvement Program. If any capital project
is added to the Capital Improvement Program that cannot be fully funded out of
cash flow (as defined) during the relevant 90-day period plus such other sources
of funds, the Indenture will prohibit payment of dividends to TCR Holding. The
Capital Improvement Program may be amended at any time by TransContinental's
Board of Directors. Dividends or distributions might not be made by
TransContinental on its common stock, or, if made, might not be sufficient to
satisfy TCR Holding's obligations, including under the terms of the TCR Voting
Preferred Stock and the TARC Working Capital Loan. Therefore, TARC may not be
able to satisfy its working capital and debt service obligations. As a result,
TARC's investment in TCR Holding, including the carrying value of the TCR Voting
Preferred Stock, could be impaired or TARC may not be able to meet its
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obligations as they become due. The financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
As of October 31, 1998, TARC and TEC had deposited an aggregate of $529
million into accounts (collectively, the "TARC Disbursement Account") from which
disbursements are made pursuant to a disbursement agreement, as amended (the
"Disbursement Agreement") among TARC, TEC, Firstar Bank of Minnesota, N.A., as
trustee (the "TEC Indenture Trustee") under the indenture governing the TEC
Notes (the "TEC Notes Indenture"), Firstar Bank of Minnesota, N. A., as
Disbursement Agent, and Baker & O'Brien, Inc., as Construction Supervisor. See
Note 6 of Notes to Condensed Consolidated Financial Statements. Of these funds,
$427 million was designated for the Capital Improvement Program, approximately
$25.5 million was designated for general and administrative expenses, $7 million
was designated for outstanding accounts payable, $50 million was designated for
working capital upon completion of the Delayed Coking Unit and certain
supporting units and $19 million was designated for the payment of interest on,
or the redemption, purchase, defeasance or other retirement of, the outstanding
TARC Notes. As of October 31, 1998, substantially all of the amounts deposited
in the TARC Disbursement Account had been expended for the designated purposes.
In April 1996, TARC entered into a processing agreement with a third party
to process feedstocks. Under the terms of the agreement, the processing fee
earned from the third party is based on the margin earned by the third party, if
any, after deducting all of its related costs such as feedstock acquisition,
hedging, transportation, processing and inspections plus a commission for each
barrel processed. During the nine months ended October 31, 1998 and 1997, TARC
processed approximately 1.6 million barrels and 6.4 million barrels,
respectively, pursuant to the processing agreement. Income from this processing
agreement was $3.9 million and $3.1 million for the nine months ended October
31, 1998 and 1997, respectively.
TARC had an obligation under its Registration Rights Agreement with the
holders of its Senior Subordinated Notes to have its registration statement on
Form S-4 relating to the Exchange Offer for the Senior Subordinated Notes
declared effective by the Securities and Exchange Commission by July 28, 1998.
As a result of its failure to meet its obligation under the Registration Rights
Agreement, TARC had accrued approximately $0.1 million in liquidated damages as
of October 31, 1998. Such amount accrued at a rate of $10,000 per week from July
28, 1998 until November 25, 1998, and thereafter at a rate of $30,000 per week
until such date as the registration statement is declared effective.
Subsequent to October 31, 1998, TEC obtained an aggregate of $25 million in
bridge financing, the proceeds of which were loaned by TEC to TARC. In
connection with the Transaction, approximately $25 million of the proceeds of
the Notes was used to repay the bridge loan.
In connection with the Transaction, TARC, TEC and TransContinental expect
to enter into an expense reimbursement agreement pursuant to which certain of
TARC's and TEC's expenses related to compliance with existing debt instruments
will be reimbursed by TransContinental.
TEC's only source of funds for its holding company operations and debt
service will be from working capital, interest payments on the Intercompany
Loans to TransTexas and TARC, dividends from its subsidiaries, payments made by
TARC on behalf of TEC pursuant to the Services Agreement and, in limited
circumstances as permitted by the TEC Notes Indenture, sales of stock TEC holds
in its subsidiaries.
Through June 1999, TEC anticipates that its annual cash needs for holding
company operations will be approximately $2.0 million, which TEC expects to be
paid on its behalf by TARC pursuant to the Services Agreement, and TEC's annual
cash interest expense will be approximately $54.6 million. In addition, TEC and
its subsidiaries will pay $2.5 million in the aggregate per year to
TransAmerican for advisory services and other benefits provided by
TransAmerican. TransTexas will be required to pay TEC approximately $48.9
million in interest annually on the TransTexas Intercompany Loan. TEC expects to
use this interest income together with working capital, if any, to satisfy its
cash needs, including its cash interest payments. If TEC incurs unforeseen
expenses, there is no assurance that its capital resources will be sufficient to
fund those expenses in addition to anticipated holding company expenses and debt
service.
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The TEC Notes Indenture prohibits TEC from selling stock of TransTexas and
TARC through June 1999 unless the proceeds from such sales would be used to make
an offer to purchase the TEC Notes. Consequently, through June 1999 unless
holders of the TEC Notes rejected all or a portion of any such offer to
purchase, sales of such stock would not be a source of funds to supplement TEC's
other resources in order to pay unforeseen expenses.
Environmental compliance and permitting issues are an integral part of the
capital expenditures anticipated in connection with the expansion and
modification of the refinery. TARC does not expect TransContinental to incur any
additional significant expenses for environmental compliance during fiscal 1999
other than those budgeted for the Capital Improvement Program; however,
TransContinental will control any changes to the Capital Improvement Program and
the budget therefor. There is no assurance that costs incurred to comply with
environmental laws will not have a material adverse effect on TARC's future
financial condition, results of operations or cash flow.
Contingent Liabilities
The Company has significant contingent liabilities, including liabilities
with respect to the litigation matters described in Note 8 of Notes to Condensed
Consolidated Financial Statements. These matters, individually and in the
aggregate, amount to significant potential liability which, if adjudicated in a
manner adverse to the Company in one reporting period, could have a material
adverse effect on the Company's cash flows or results of operations for that
period.
Pursuant to the Lobo Sale Agreement, TransTexas is required to indemnify
the buyer for certain liabilities related to the assets owned by TTC. Although
TransTexas does not anticipate that it will incur any material indemnity
liability, no assurance can be given that TransTexas will have sufficient funds
to satisfy any such indemnity obligation or that any payment thereof will not
have a material adverse effect on its ability to fund its debt service, capital
expenditure and working capital requirements.
TransTexas has entered into various contracts whereby TransTexas is
required to deliver approximately 125 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 $0.8 million and $1.1
million during the three and nine months ended October 31, 1998, respectively.
In August 1998, TransTexas entered into a settlement agreement whereby delivery
commitments of approximately 350 MMcf per day were 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. In July 1998, TransTexas reduced the gain on 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 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
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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 $270 million (assuming no
reduction for existing tax attributes of the TNGC Consolidated Group), possible
penalties equal to 20% of the amount of the tax, and interest at the statutory
rate (currently 8%) on the tax and penalties (if any). The Tax Allocation
Agreement provides that TransAmerican will be obligated to fund the entire tax
deficiency (if any) resulting from the Lobo Sale. There can be no assurance that
TransAmerican would be able to fund any such payment at the time due and the
other members of the TNGC Consolidated Group may be required to pay the tax.
TransTexas has reserved approximately $75 million with respect to the potential
tax liability for financial reporting purposes to reflect a portion of the
federal tax liability that TransAmerican might not be able to pay. If TransTexas
were required to pay this tax deficiency, it is likely that it would be required
to sell significant assets or raise additional debt or equity capital to fund
the payment.
Under certain circumstances, TransAmerican or TEC may sell or otherwise
dispose of shares of TransTexas common stock. If, as a result of any sale or
other disposition of TransTexas' common stock, the aggregate ownership of
TransTexas by members of the TNGC Consolidated Group (excluding TransTexas) is
less than 80% (measured by voting power and value), TransTexas will no longer be
a member of the TNGC Consolidated Group for federal tax purposes
("Deconsolidation") and, with certain exceptions, will no longer be obligated
under the terms and conditions of, or entitled to the benefits of, the Tax
Allocation Agreement. Upon a Deconsolidation of TransTexas, members of the TNGC
Consolidated Group that own TransTexas' common stock could incur a substantial
amount of federal income tax liability. If such Deconsolidation were to occur
during the fiscal year ending January 31, 1999, the aggregate amount of this tax
liability is estimated to be approximately $100 million, assuming no reduction
for tax attributes of the TNGC Consolidated Group. However, such tax liability
generally would be substantially reduced or eliminated in the event that the IRS
successfully challenged TransTexas' position on the Lobo Sale. Each member of a
consolidated group filing a consolidated federal income tax return is severally
liable to the IRS for the consolidated federal income tax liability of the
consolidated group. There can be no assurance that each TNGC Consolidated Group
member will have the ability to satisfy any tax obligation attributable to these
transactions at the time due and, therefore, other members of the group,
including TEC, TransTexas or TARC, may be required to pay the tax.
Generally, under the Tax Allocation Agreement, if net operating losses of
TransTexas or TARC are used by other members of the TNGC Consolidated Group,
then TransTexas and TARC are entitled to the benefit (through reduced current
taxes payable) of such losses in later years to the extent TransTexas or TARC
has taxable income, remains a member of the TNGC Consolidated Group and the
other group members have the ability to pay such taxes. If TransAmerican or TEC
transfers shares of common stock of TransTexas (or transfers options or other
rights to acquire such shares) and, as a result of such transfer,
Deconsolidation of TransTexas occurs, TransTexas would not thereafter receive
any benefit pursuant to the Tax Allocation Agreement for net operating losses of
TransTexas used by other members of the TNGC Consolidated Group prior to the
Deconsolidation of TransTexas.
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Potential Effects of Change of Control
The TransTexas Subordinated Notes Indenture provides that, upon the
occurrence of a Change of Control, each holder of the TransTexas Subordinated
Notes will have the right to require TransTexas to repurchase such holder's
TransTexas Subordinated Notes at 101% of the principal amount thereof plus
accrued and unpaid interest. Pursuant to the terms of the TransTexas
Intercompany Loan, upon the occurrence of a Change of Control, TEC would have
the right to require TransTexas to repay the principal of the TransTexas
Intercompany Loan in an amount equal to a pro rata share of the amount TEC is
required to pay under the TEC Notes Indenture. Such pro rata share would be
calculated using the ratio of the outstanding principal amount of the TransTexas
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan. Pursuant to the terms of the
TARC Intercompany Loan, upon the occurrence of a Change of Control, TEC would
have the right to require TARC to repay the principal of the TARC Intercompany
Loan in an amount equal to a pro rata share of the amount TEC is required to pay
under the TEC Indenture. Such pro rata share would be calculated using the ratio
of the accreted value of the outstanding principal amount of the TARC
Intercompany Loan to the sum of (i) the outstanding principal amount of the
TransTexas Intercompany Loan plus (ii) the accreted value of the outstanding
principal amount of the TARC Intercompany Loan.
A Change of Control would be deemed to occur under the TransTexas
Subordinated Notes Indenture in the case of certain changes or other events in
respect of the ownership of TransTexas, including any circumstances pursuant to
which any person or group other than John R. Stanley (or his heirs, his estate,
or any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TransTexas' then outstanding voting stock, and during the
90 days thereafter, the rating of the TransTexas Subordinated Notes is
downgraded or withdrawn. A Change of Control would be deemed to occur under the
TransTexas Intercompany Loan in the case of certain changes or other events in
respect of the ownership or control of TEC or TransTexas, including any
circumstance pursuant to which (i) any person or group, other than John R.
Stanley (or his heirs, his estate, or any trust in which he or his immediate
family members have, directly or indirectly, a beneficial interest in excess of
50%) and his subsidiaries or the TEC Indenture Trustee is or becomes the
beneficial owner of more than 50% of the total voting power of TEC's then
outstanding voting stock, or (ii) TEC or any of its subsidiaries own some of
TransTexas' capital stock, but less than 50% of the total voting stock or
economic value of TransTexas, unless the TEC Notes have an investment grade
rating for the period of 120 days thereafter. A Change of Control would be
deemed to occur under the TEC Notes Indenture or the TARC Intercompany Loan in
the case of certain changes or other events in respect of the ownership or
control of TEC, TransTexas or TARC including any circumstance pursuant to which
(i) any person or group, other than John R. Stanley (or his heirs, his estate or
any trust in which he or his immediate family members have, directly or
indirectly, a beneficial interest in excess of 50%) and his subsidiaries or the
TEC Indenture Trustee is or becomes the beneficial owner of more than 50% of the
total voting power of TEC's then outstanding voting stock, or (ii) TEC or any of
its subsidiaries own some of TARC's or TransTexas' capital stock, respectively,
but less than 50% of the total voting stock or economic value of TARC or
TransTexas, respectively, unless (in the case of either (i) or (ii) above) the
TEC Notes have an investment grade rating for the period of 120 days thereafter.
The term "person," as used in the definition of Change of Control, means a
natural person, company, government or political subdivision, agency or
instrumentality of a government and also includes a "group," which is defined as
two or more persons acting as a partnership, limited partnership or other group.
In addition, certain changes or other events in respect of the ownership or
control of TransTexas that do not constitute a Change of Control under the
TransTexas Subordinated Notes Indenture, the TEC Notes Indenture or the
TransTexas Intercompany Loan may result in a "change of control" of TransTexas
under the terms of the BNY Facility. Such an occurrence could create an
obligation for TransTexas to repay any amounts due under the BNY Facility. At
October 31, 1998, TransTexas had approximately $5.1 million of indebtedness
subject to such right of repayment. In the event of a Change of Control under
the TransTexas Subordinated Notes Indenture, the TEC Notes Indenture or the
Intercompany Loans, or a "change of
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control" under the terms of the BNY Facility, there can be no assurance that
TransTexas or TARC will have sufficient funds to satisfy any such payment
obligations. A change of control or other event that results in Deconsolidation
of TransTexas and TransAmerican for federal income tax purposes could result in
acceleration of a substantial amount of federal income taxes.
Lack of Complete Year 2000 Compliance
The widespread use of computer programs that rely on two-digit date
programs to perform computations and decision-making functions may cause
information technology ("IT") systems to malfunction in and around the Year
2000. Such malfunctions may lead to significant business delays in the U.S. and
internationally. The Year 2000 problem will potentially impact the production of
gas and oil and the refining industry because information necessary to produce,
transport and market gas and oil and monitor and control various process units
in a refinery is controlled by computers. In addition to potential problems from
computer systems, potential problems could arise from equipment with embedded
chips used in the production, transportation and refining of hydrocarbons.
The Company has defined a Year 2000-compliant system as one capable of
correct identification, manipulation and calculation when processing data in
connection with the year change from December 31, 1999 to January 1, 2000. A
Year 2000-compliant system is also capable of correct identification,
manipulation and calculation using leap years both along and in conjunction with
other dates.
Not all of the Company's systems that were transferred to TransContinental
are compliant under the above definition. However, as of October 31, 1998, the
Company has addressed and will continue to address the issues associated with
this problem in the following manner:
- In the first stage, the Company commenced preparation of an inventory of
all IT and non-IT systems, as well as equipment that could have embedded
chips, whether or not critical to the operation of the refinery. The
Company also compiled a listing of material relationships with third
parties with which the Company conducts business. These relationships
include contractors, suppliers and public utilities. This stage of the
Year 2000 compliance process is approximately 95% complete.
- In stage two, the Company is assessing the results of the inventory done
in the first stage to determine the Year 2000 impact and what actions
need to be taken to obtain Year 2000 compliance. For internal systems,
actions needed range from obtaining vendor certification of Year 2000
compliance, remediating internal systems or replacing systems and
equipment that cannot be remediated. This stage is approximately 85%
complete with respect to internal systems. Major outstanding items
include receipt of vendor certifications and installation of Year 2000
upgrades for certain non-critical systems. The Company has determined a
course of action for remediation or replacement of all identified
critical internal systems. This stage will also include surveying and
obtaining information about Year 2000 readiness of its material
third-party relationships, including those of service providers such as
TransTexas. Contingency plans will be developed for those third parties
that cannot satisfactorily demonstrate Year 2000 compliance.
- The third stage includes the repair, replacement or retirement of
systems. This stage of the Year 2000 process is ongoing and is dependent
upon the availability of upgrades from the refinery's vendors, technician
time to implement the upgrades and notification from other third parties
of Year 2000 compliance. The Company has been upgrading packaged software
throughout the organization. The Company began implementation of a new
financial reporting software system on September 1, 1998 that will handle
the recording of all financial transactions to the general ledger,
accounts payable, accounts receivable and other subledgers, as well as
facilitate the reporting of financial results. Several operational
systems are in various stages of implementation, which should be
completed prior to June 1999. The vendors of these new systems have
provided certification that their respective software packages are Year
2000 compliant according to the Company's definition. In certain areas of
operations, the company is also heavily dependent upon the power
infrastructure serving the production and processing facilities and would
be subject to business interruptions as a result of the failure of those
systems. The Company opened communication with these third parties in
order to obtain assurances regarding Year 2000 readiness.
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- The last stage of the implementation process, which is approximately 40%
complete, includes testing all of the changes implemented individually
and integrating those changes with all of the systems of the refinery and
its suppliers and customers. Various forms of testing are used depending
on the type of change implemented. Each upgrade, to the extent
economically feasible, will be run through a test environment before it
is implemented. It is then tested to see how well it integrates into the
refinery's overall IT environment. The Company has not employed any
independent verification processes of its systems' tests.
As of October 31, 1998, the Company had incurred costs of approximately
$5.0 million with respect to its Year 2000 compliance program. The Company
anticipates additional costs of approximately $1.5 million to complete the Year
2000 compliance program.
Despite the Company's best efforts to ready its systems and infrastructure
for the Year 2000, there are many factors outside of its control that could
affect readiness for the Year 2000. Although the Company believes that Year 2000
compliance will be accomplished by the implementation of the program described
above, there could be operational issues with the new systems implemented that
prevent resolution of the Year 2000 compliance issue in a timely manner. In such
event, the Company could be required to implement a contingency plan for Year
2000 compliance. Substantial completion of a contingency plan is expected by
September 30, 1999 with continual refinement to the plans ongoing until all of
the Company's critical systems and all critical third-party relationships have
demonstrated Year 2000 compliance.
Prior to the Transaction, the Company implemented a year 2000 compliance
program for the refinery that was substantially the same as the Company's
program described above. The refinery Year 2000 compliance program was
approximately at the same stage of completion as of October 31, 1998. Completion
of that program will be the responsibility of TransContinental. If
TransContinental experiences Year 2000 problems, it could have a material
adverse effect on TARC and the Company.
The potential impact of the Year 2000 problem on the Company could be
material, as virtually every aspect of operations will be affected. The Company
may be adversely affected by this problem, depending on whether it and the
entities with which it does business address this issue successfully.
FORWARD-LOOKING STATEMENTS
Forward-looking statements, within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
are included throughout this report. All statements other than statements of
historical facts included in this Quarterly Report on Form 10-Q regarding TEC's
financial position, business strategy, plans and objectives of management for
future operations, sources of funds and capital expenditures, including but not
limited to words such as "anticipates," "expects," "believes," "estimates,"
"intends," "projects" and "likely" indicate forward-looking statements. TEC's
management believes that its current views and expectations are based on
reasonable assumptions; however, there are significant risks and uncertainties
that could significantly affect expected results. Factors that could cause
actual results to differ materially from those in the forward-looking statements
include, without limitation, fluctuations in the commodity prices for natural
gas, crude oil, condensate and natural gas liquids, the extent of TransTexas'
success in discovering, developing and producing reserves, engineering problems,
work stoppages, further cost overruns, personnel or materials shortages,
fluctuations in commodity prices for petroleum and refined products, casualty
losses, conditions in the equity and capital markets, the ultimate resolution of
litigation, competition and lack of majority control over the operations of
TransContinental.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note 8 of Notes to Condensed Consolidated Financial Statements for a
discussion of the Company's legal proceedings.
ITEM 5. OTHER INFORMATION
The following table sets forth certain information with respect to the
Capital Improvement Program, including the original budget as of June 13, 1997,
expenditures as of October 31, 1998 and the revised budget as of October 31,
1998.
ORIGINAL EXPENDITURES TO REVISED
BUDGET(1) OCTOBER 31, 1998(2) BUDGET(3)
----------- ------------------- -----------
(DOLLARS IN (DOLLARS IN (DOLLARS IN
MILLIONS) MILLIONS) MILLIONS)
PHASE I:
Crude Unit................................... $ 3.0 $ 8.4 $ 8.9
Delayed Coking Unit.......................... 27.0 77.9 81.2
Naphtha Pretreater........................... 12.0 21.5 24.0
No. 2 Reformer(4)............................ 9.0 2.1 14.6
HDS Unit..................................... 24.0 40.8 49.5
Sulfur Recovery System....................... 53.0 65.8 73.7
Offsite Facilities/Tankage................... 46.0 87.8 96.6
Other........................................ 3.0 0.5 0.4
Engineering and Administrative............... 7.0 16.2 16.2
Contingencies(4)............................. 39.0 -- 5.0
------ ------ ------
Total Phase I........................ 223.0 321.0 370.1
------ ------ ------
PHASE II:
FCC Unit..................................... 115.0 127.3 204.4
FCC Flue Gas Scrubber........................ 14.0 9.8 14.4
Alkylation Unit.............................. 24.0 21.8 57.6
Offsite Facilities/Tankage................... 26.0 19.6 40.7
Other........................................ 2.0 -- --
Engineering and Administrative............... 3.0 1.8 4.0
Fee to Contractor............................ -- -- 5.0
Contingencies(5)............................. 20.0 -- 16.0
------ ------ ------
Total Phase II....................... 204.0 180.3 342.1
------ ------ ------
Total Phase I and Phase II........... $427.0 $501.3 $712.2
====== ====== ======
- ---------------
(1) Budget as of June 13, 1997 for estimated expenditures from June 13, 1997 to
completion.
(2) From June 13, 1997 through October 31, 1998. In addition to these
expenditures, approximately $52 million of work has been completed but not
yet paid as of October 31, 1998.
(3) Revised budget as of October 31, 1998 for estimated expenditures from June
13, 1997 to completion.
(4) The No. 2 Reformer will not be considered part of Phase I for purposes of
the Phase I performance tests required to be met by the Indenture governing
the Notes.
(5) To the extent expenditures have exceeded or are expected to exceed the
approved capital budget for a unit or units, the contingencies portion of
the budget is allocated to specific units.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
27.1 -- Financial Data Schedule
99.1 -- Financial statements of TransTexas dated October 31, 1998
(filed as part of TransTexas' Quarterly Report on Form
10-Q/A for the quarter ended October 31, 1998, and
incorporated herein by reference thereto).
99.2 -- Financial statements of TARC dated October 31, 1998
(filed as part of TARC's Quarterly Report on Form 10-Q for
the quarter ended October 31, 1998, and incorporated
herein by reference thereto).
(b) Reports on Form 8-K
1. The following reports on Form 8-K were filed during the quarter ended
October 31, 1998:
a. Form 8-K dated August 31, 1998 to report under Item 5 information
contained in a press release issued by TARC on the same day.
b. Form 8-K dated September 1, 1998 to report under Item 5 information
contained in a press release issued by TARC on the same day.
2. The following report on Form 8-K was filed subsequent to October 31,
1998:
a. Form 8-K dated December 11, 1998 to report under Item 5 the filing
of certain documents related to the Transaction.
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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.
TRANSAMERICAN ENERGY CORPORATION
(Registrant)
By: /s/ ED DONAHUE
-------------------------------------
Ed Donahue,
Vice President and Chief Financial
Officer
December 21, 1998
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
27.1 -- Financial Data Schedule
99.1 -- Financial statements of TransTexas dated October 31, 1998
(filed as part of TransTexas' Quarterly Report on Form
10-Q/A for the quarter ended October 31, 1998, and
incorporated herein by reference thereto).
99.2 -- Financial statements of TARC dated October 31, 1998
(filed as part of TARC's Quarterly Report on Form 10-Q
for the quarter ended October 31, 1998, and incorporated
herein by reference thereto).
46