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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NO. 1-5591

PENNZOIL-QUAKER STATE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 76-0200625
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
PENNZOIL PLACE, P.O. BOX 2967
HOUSTON, TEXAS 77252-2967
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

Registrant's telephone number, including area code: (713) 546-4000

Securities registered pursuant to Section 12(b) of the Act:

NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, par value $0.10 per share New York Stock Exchange
Pacific Exchange
Rights to Purchase Preferred Stock New York Stock Exchange
Pacific Exchange

Securities registered pursuant to Section 12(g) of the Act: None
------------------------

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 ____

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X

Aggregate market value of the voting stock held by non-affiliates of the
registrant: $1.2 billion as of January 31, 1999.

Number of shares outstanding of each class of the registrant's classes of
common stock, as of the latest practicable date, January 31, 1999: Common Stock,
par value $0.10 per share -- 77,619,765.

DOCUMENTS INCORPORATED BY REFERENCE: PORTIONS OF THE PROXY STATEMENT TO BE
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO REGULATION 14A
UNDER THE SECURITIES EXCHANGE ACT OF 1934 IN CONNECTION WITH THE COMPANY'S 1999
ANNUAL MEETING OF SHAREHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III
HEREOF (TO THE EXTENT SET FORTH IN ITEMS 10, 11, 12 AND 13 OF PART III OF THIS
ANNUAL REPORT ON FORM 10-K).
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2

FORWARD-LOOKING STATEMENTS -- SAFE HARBOR PROVISIONS

This annual report on Form 10-K of Pennzoil-Quaker State Company for the
year ended December 31, 1998 contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are
intended to be covered by the safe harbors created thereby. To the extent that
such statements are not recitations of historical fact, such statements
constitute forward-looking statements which, by definition, involve risks and
uncertainties. In particular, statements (i) under the captions (a) "Lubricants
and Consumer Products," (b) "Base Oil and Specialty Products" and (c) "Fast Lube
Operations" under "Item 1. Business and Item 2. Properties" and (ii) under the
captions (a) "Results of Operations," (b) "Disclosures About Market Risk," (c)
"Capital Resources and Liquidity" and (d) "Year 2000 Issues" under "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" contain forward-looking statements. Where, in any forward-looking
statement, Pennzoil-Quaker State Company expresses an expectation or belief as
to future results or events, such expectation or belief is expressed in good
faith and believed to have a reasonable basis, but there can be no assurance
that the statement of expectation or belief will result or be achieved or
accomplished.

The following are factors that could cause actual results or events to
differ materially from those anticipated, and include but are not limited to
general economic, financial and business conditions; commodity prices for crude
oil; competition in the motor oil marketing business; base oil margins and
supply and demand in the base oil business; the success and costs of advertising
and promotional efforts; mechanical failure in refining operations;
unanticipated environmental liabilities; changes in and compliance with
governmental regulations; changes in tax laws; and the costs and effects of
legal proceedings.
3

PART I

ITEM 1. BUSINESS AND ITEM 2. PROPERTIES.

Pennzoil-Quaker State Company (the "Company" or "Pennzoil-Quaker State") is
a premier worldwide automotive aftermarket products and consumer car care
company. The Company is engaged primarily in the manufacturing and marketing of
lubricants, car care products, base oils and specialty industrial products and
in the franchising, ownership and operation of fast lube centers.
Pennzoil-Quaker State has strong brand-name recognition in key product
categories such as motor oil with Pennzoil(R), Quaker State(R) and Wolf's
Head(R), fast lube centers with Jiffy Lube(R) and car care products with Slick
50(R), Rain-X(R), Blue Coral(R), Black Magic(R), Westley's(R), Medo(R),
Axius(R), Gumout(R), Fix-A-Flat(R), The Outlaw(R), Snap(R), Classic(R) car wax
and others.

Pennzoil-Quaker State is the result of the consolidation and separation on
December 30, 1998 (the "Spin-off") of the lubricants and consumer products, base
oil and specialty products and Jiffy Lube fast lube operations of Pennzoil
Company and the acquisition by the Company of Quaker State Corporation ("Quaker
State") in a merger transaction immediately following the separation. Reference
is made to Note 2 and Note 5 of Notes to Consolidated Financial Statements for
additional information.

SEGMENT FINANCIAL INFORMATION

Effective December 31, 1998, Pennzoil-Quaker State adopted Statement of
Financial Accounting Standards ("SFAS") No. 131, "Disclosure about Segments of
an Enterprise and Related Information." Prior period disclosures have been
restated to conform to the requirements of this statement.

Pennzoil-Quaker State's businesses are organized, managed and internally
reported as three segments. The segments, which are based on differences in
products and services, are (1) lubricants and consumer products, (2) base oils
and specialty products and (3) fast lube operations. These segments have
worldwide responsibility for virtually all of the Company's product lines.

Transactions between reportable segments are recorded at market. The
majority of intersegment sales are from the base oil and specialty products
segment to the lubricants and consumer products segment. The Company excludes
interest expense and income tax expense or benefit from segment profit or loss.
Reference is made to Note 14 of Notes to Consolidated Financial Statements for
additional segment financial information.

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1998 1997 1996
---------- ---------- ----------
(EXPRESSED IN THOUSANDS)

NET SALES(1)
Lubricants and Consumer Products......................... $ 960,493 $ 966,195 $ 947,002
Base Oil and Specialty Products(2)....................... 717,358 916,759 1,007,326
Fast Lube Operations..................................... 322,704 316,068 290,219
Other.................................................... 248 264 163
Intersegment Sales....................................... (199,127) (217,138) (283,394)
---------- ---------- ----------
$1,801,676 $1,982,148 $1,961,316
========== ========== ==========
OPERATING INCOME (LOSS)(1)(3)
Lubricants and Consumer Products......................... $ 55,923 $ 76,460 $ 73,038
Base Oil and Specialty Products(4)....................... 16,003 19,375 (19,711)
Fast Lube Operations(5).................................. (4,054) 24,492 21,383
Impairment of Long-Lived Assets(6)....................... (29,613) -- --
Other.................................................... (8,099) 1,919 708
---------- ---------- ----------
30,160 122,246 75,418
Corporate Administrative Expense......................... 44,422 54,810 30,639
Interest Expense......................................... 69,943 61,780 55,071
Income Tax Provision (Benefit)........................... (38,338) 6,245 (1,103)
---------- ---------- ----------
Net Loss....................................... $ (45,867) $ (589) $ (9,189)
========== ========== ==========

IDENTIFIABLE ASSETS(1)
Lubricants and Consumer Products......................... $1,667,429 $ 371,057 $ 287,536
Base Oil and Specialty Products(7)....................... 700,546 757,042 620,853
Fast Lube Operations..................................... 527,387 348,764 339,293
Other.................................................... 249,632 82,760 122,817
---------- ---------- ----------
$3,144,994 $1,559,623 $1,370,499
========== ========== ==========
DEPRECIATION AND AMORTIZATION(1)
Lubricants and Consumer Products......................... $ 23,709 $ 17,885 $ 17,125
Base Oil and Specialty Products.......................... 28,169 25,153 14,938
Fast Lube Operations..................................... 24,507 21,439 19,840
Other.................................................... 825 13 15
---------- ---------- ----------
$ 77,210 $ 64,490 $ 51,918
========== ========== ==========
CAPITAL EXPENDITURES(1)(8)
Lubricants and Consumer Products......................... $ 23,739 $ 32,310 $ 23,090
Base Oil and Specialty Products(9)....................... 18,352 89,648 208,587
Fast Lube Operations..................................... 28,651 25,836 19,509
Other.................................................... 17,598 -- --
---------- ---------- ----------
$ 88,340 $ 147,794 $ 251,186
========== ========== ==========

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(1) On December 30, 1998, the Company acquired Quaker State in a merger
transaction. Reference is made to Note 2 of Notes to Consolidated Financial
Statements for additional information. Net sales, operating income (loss),
depreciation and amortization and capital expenditures for 1998, 1997 and
1996 do not include Quaker State. The fair value of assets and liabilities
of Quaker State are included in the Company's consolidated balance sheet as
of December 31, 1998.

(2) In October 1997, the Company contributed most of its specialty industrial
products business to Penreco, a partnership with Conoco Inc. ("Conoco").
The partnership is accounted for under the equity method with the Company's
share of net earnings being reported as a component of other income.

(3) Total 1998 operating income includes one-time pretax charges of $10.6
million related to the acquisition of Quaker State on December 30, 1998.
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations" and Note 2 of
Notes to Consolidated Financial Statements for additional information.

(4) Operating income includes Pennzoil-Quaker State's share of income (loss)
from the Company's Excel Paralubes, Penreco and Bareco partnerships of
$32.9 million, $4.4 million and $(16.7) million for the years ending
December 31, 1998, 1997 and 1996,

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respectively. Reference is made to "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Base Oil and Specialty
Products" for additional information.

(5) The decrease in operating income in 1998 compared to 1997 includes $14.8
million of nonrecurring charges as a result of one-time acquisition
expenses, legal settlements and other liabilities.

(6) In December 1998, the fast lube operations segment recorded a pretax charge
of $29.6 million to reflect the impairment of long-lived assets as required
under SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of." These impairment charges have not
been included in depreciation and amortization expenses in the table above.
Reference is made to "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Fast Lube Operations and Note 3 of
Notes to Consolidated Financial Statements" for additional information.

(7) Identifiable assets includes $16.9 million, $32.5 million and ($18.9)
million in net investment in equity method investees at December 31, 1998,
1997 and 1996, respectively.

(8) Includes interest capitalized of $0.3 million, $7.4 million and $10.1
million in 1998, 1997 and 1996, respectively.

(9) Total 1997 and 1996 capital expenditures include $42.0 million and $147.3
million, respectively, relating to the upgrade of the Company's Shreveport
manufacturing facility.

Narrative descriptions of these business segments follow, with emphasis on
1998 developments. Unless otherwise indicated by the context, references to
Pennzoil-Quaker State include its subsidiaries.

LUBRICANTS AND CONSUMER PRODUCTS

The Company's lubricants and consumer products segment manufactures and
markets lubricants and other automotive aftermarket consumer products.

LUBRICANTS. The Company manufactures and markets Pennzoil(R), Quaker
State(R) and Wolf's Head(R) motor oil. The Company also manufactures and markets
transmission fluids, gear lubricants and greases, as well as specialty
lubricants designed for sport utility vehicles, heavy duty agricultural and
construction equipment, marine craft, motorcycles and snowmobiles. These other
lubricants are sold under the Pennzoil(R) and Quaker State(R) brand names and
certain private label and proprietary brand names. The Company also markets
automobile consumer products such as oil and air filters and antifreeze produced
by third parties and provides collection, transportation and recycling services
for used oil, antifreeze and used oil filters in certain regions of the United
States.

The primary markets for the Company's lubricants are mass merchandisers,
auto parts stores, lube centers and automobile dealerships. Secondary markets
include convenience stores, drug stores, grocery stores, tire stores and
independent automotive repair facilities. The Company markets its branded motor
oils in packages ranging in size from four ounces to 55 gallons and sells a
significant amount in bulk to the installed market. Packaged motor oil is
primarily sold in one quart plastic bottles.

Consumer marketing for the Company's lubricants focuses primarily on the
driving conditions experienced by vehicle owners and the technical benefits that
lubricants can provide under those conditions. Key components of the marketing
strategy include targeted media, motorsports participation, public relations and
consumer promotions. Targeted media includes national and local television,
radio and print advertising designed to reach specific populations of consumers
based upon their usage. Motorsports participation includes team sponsorships in
NASCAR(R), Indy Racing League(R), NHRA(R) and the sponsorship of the Pennzoil
World of Outlaws(R), a grass roots sprint car racing series. In addition,
several national and local racing events are sponsored by the Company.

In marketing its lubricants, the Company utilizes a brand management
structure. Under this approach, the Company centralizes all brand-related
activity under a single manager for each brand, allowing coordination of all
strategic and tactical decisions for advertising and promotions, product
packaging and positioning, formulation strategy and pricing. The brand manager
is responsible for developing the annual marketing plan that is designed to
enhance brand equity.

Motor oils and lubricants are produced by the Company by blending additives
and lubricant base oils in thirteen domestic blending and packaging plants.
These plants are located in Portland, Oregon; Vernon, California; Alameda,
California; Carson, California; Shreveport, Louisiana (where two are located);
Rouseville, Pennsylvania; Mundy's Corner, Pennsylvania; St. Louis, Missouri;
Marion, Illinois; Newell, West

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Virginia; Vicksburg, Mississippi; and San Antonio, Texas. The Newell, West
Virginia location is leased and the other locations are owned by the Company.
Base oils processed by the Company's blending and packaging plants are purchased
at prevailing market prices and supplied by the Company's manufacturing
facilities, Excel Paralubes (either directly or through exchanges) and other
outside suppliers. Substantially all additives are purchased from outside
suppliers. The Company believes that alternative sources of supply for base oils
and additives are readily available.

Lubricants are distributed domestically through 80 owned and operated
distribution facilities in 29 states. The Company's products are also
distributed through independent distributors and directly from third-party
suppliers.

The Company markets Pennzoil(R) and Quaker State(R) lubricants and car care
products in more than 80 countries outside of the United States through directly
and indirectly wholly and partly owned subsidiary companies, joint ventures,
licensees, distributors and jobbers. During 1998, the Company's largest national
markets outside the United States (by total lubricant sales volume) were Mexico,
Canada, Thailand, India and Indonesia. The Company's motor oil and other
lubricants are blended and packaged by wholly owned subsidiaries of the Company
in Australia and Spain, by a majority owned subsidiary in India, by joint
ventures in Bolivia, Malaysia and Peru, by licensees in Indonesia, the
Philippines and Thailand, and by a third-party contract with a joint venture in
South Africa.

CONSUMER PRODUCTS. The Company manufactures and markets automotive
polishes, car wash products and automotive air fresheners, and markets
automobile engine and fuel treatments, automotive window shades, automotive
glass treatments, tire inflators and automotive accessories. These products are
marketed under national brand names such as Slick 50(R), Rain-X(R), Blue
Coral(R), Black Magic(R), Westley's(R), Medo(R), Axius(R), Gumout(R), Snap(R),
Fix-A-Flat(R), The Outlaw(R), Classic(R) car wax and other proprietary brand
names. The divisions of the Company included in the consumer product segment are
described below.

The Blue Coral/Slick 50 division markets Slick 50(R) automotive engine
treatments and related automotive chemical products and manufactures and markets
Blue Coral(R) automobile appearance products. Slick 50(R) branded products are
produced by third party contract manufacturers and distributed directly to
customers or shipped to company locations for distribution to customers. Blue
Coral purchases chemicals, waxes and cleaners from a variety of suppliers and
blends and packages finished products at its leased facility in Cleveland, Ohio.
The Blue Coral/Slick 50 division also markets Rain-X(R), the leading brand of
rain repellant for automobile windows, Black Magic(R) non-waterbased tire
protectant and dressing products and Westley's(R) car washes and cleaners. The
majority of the Rain-X(R), Black Magic(R) and Westley's(R) brand products are
manufactured and distributed by third party contract manufacturers.

The Medo division designs, manufactures and markets air fresheners
primarily for use in automobiles. Medo purchases paperboard, containers and
fragrance from a variety of suppliers, and manufactures and distributes finished
air fresheners from a leased Baltimore, Maryland facility.

The Axius division designs and markets automotive window sun protection
products and automotive accessories. Axius purchases its automotive window sun
protection and other accessory products from a variety of suppliers and
distributes sunshades and other automotive accessories from a leased Moorepark,
California facility.

The Company's automotive chemicals division manufactures and markets
Fix-A-Flat(R) tire inflators, Gumout(R) fuel additives and cleaners, The
Outlaw(R) fuel additives, Snap(R) fuel additives, cleaners and performance
fluids, Classic(R) car waxes and washes and other private and house brand
automotive chemicals. Fix-A-Flat(R) is the number one seller of tire inflators
in the United States, and Gumout(R) is the number one seller of carburetor spray
cleaners in the United States. Fix-A-Flat(R), Gumout(R), The Outlaw(R), and
Snap(R) products are manufactured through arrangements with third party contract
manufacturers. Classic(R) products are manufactured at a leased facility in
Winter Haven, Florida and by third party contract manufacturers.

The Company's consumer products are marketed primarily to the consumer
through mass merchandisers and auto parts stores, and secondarily through the
installed market (lube centers, service stations, automobile dealerships, etc.).
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7

Outside the United States, the Company's consumer products are manufactured
by third parties in the United Kingdom. Products are sold in 48 countries
through wholly and partly owned subsidiaries, licensees, sales agents and
distributors.

BASE OIL AND SPECIALTY PRODUCTS

BASE OIL. The Company owns and operates two base oil and specialty product
manufacturing facilities, one located in Rouseville, Pennsylvania and the other
located in Shreveport, Louisiana. The paraffinic base oil produced by these
manufacturing facilities is used in the blending of motor oil and other
lubricants and for sale to industrial customers. The manufacturing facilities
also produce waxes, petrolatums, special cut kerosenes, transformer oils,
process oils and other naphthenic base oils for use in producing specialty
industrial products or for sale to industrial customers. In addition, the
Company markets gasoline and distillate products in eight states through
wholesale distributors to retail outlets under the Pennzoil(R) brand name or as
an unbranded product.

The Company and Conoco are equal partners in Excel Paralubes, which
operates a state-of-the-art base oil hydrocracker facility located at Conoco's
refinery near Lake Charles, Louisiana. The facility is capable of producing
approximately 18,000 barrels per day of high-quality base oils, the base
ingredient in finished lubricants. Conoco operates the plant with support
positions staffed by both Conoco and the Company. The Company purchases 50% of
base oil production volume of Excel Paralubes at contract rates based on
prevailing market prices.

SPECIALTY PRODUCTS. The Company and Conoco are partners in Penreco. The
Company contributed to Penreco its operations related to petrolatums, white
oils, ink solvents, sulfonates and other specialty petroleum products, including
its manufacturing facilities in Karns City, Pennsylvania and Dickinson, Texas.
Conoco contributed to Penreco its solvents business, which sells products
primarily into the drilling fluids, mining and cleaning products markets and as
carrier oils for many consumer products. Products from Penreco are marketed
under the Penreco(R), Magie Bros(R), Conosol(R) and LVT(R) brand names. Penreco
markets to manufacturers and end-users directly and through licensed
distributors.

The Company and Baker Petrolite Corporation, the specialty chemicals
division of Baker Hughes Incorporated, are equal partners in Bareco(R) Products,
which markets a broad line of wax products to domestic and international
purchasers of paraffin, microcrystalline and related synthetic waxes. The
Company transports partially refined feedstock from Utah to its Rouseville
manufacturing facility, which produces paraffinic and microcrystalline waxes and
related products. These wax products, along with certain waxes from Baker
Petrolite, waxes from the Company's Shreveport manufacturing facility and waxes
purchased from other suppliers, are marketed through the partnership under the
Be Square(R) and other brand names.

The Company is currently evaluating its manufacturing assets and
investments and their importance to the Company's strategic plan and future
direction. As a result of this evaluation, the Company may determine to dispose
of or discontinue the operations of some or all of its manufacturing assets and
investments. The Company cannot currently predict the timing or the financial
impact of any such dispositions or discontinuances, which could result in cash
or non-cash charges, depending on the manner and timing of any such dispositions
or discontinuances.

FAST LUBE OPERATIONS

The Company provides fast automotive preventive maintenance services in the
United States through Jiffy Lube(R) and Q Lube(R) service centers.

As of December 31, 1998, 1,588 Jiffy Lube(R) service centers were open in
metropolitan areas throughout the United States with a heavy concentration of
centers in the northeastern and eastern part of the United States. Franchisees
operated 1,009 of these service centers and the other 579 service centers were
owned and operated by Jiffy Lube, including 31 franchised service centers and
134 company-operated service centers at Sears Auto Centers across the country.

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As of December 31, 1998, 619 Q Lube(R) service centers were open in 28
states, primarily in the western, midwestern and southern United States and in
Canada. Franchisees operated 123 of these service centers, 438 of these service
centers were owned and operated by Q Lube and the other 58 service centers were
operated by joint ventures between Q Lube and franchisees. Fast lube centers
owned by Q Lube and its franchisees are operated under the names Q Lube(R),
McQuik's Oilube(R) or Quaker State Minit-Lube(R). During the next two years, the
Company intends to rebrand all existing Q Lube(R) centers to Jiffy Lube(R)
service centers to achieve single system synergies.

Jiffy Lube's standard full service includes an oil change and filter
replacement, chassis lubrication, checking for proper tire inflation, window
washing, interior vacuuming, checking and topping off transmission,
differential, windshield washer, battery and power steering fluid levels and air
filter and windshield wiper examination. The standard full service can generally
be performed in ten minutes or less. Jiffy Lube service centers also provide
other authorized services and products at an additional cost. Pennzoil motor oil
is the featured motor oil in company-operated service centers and most
franchise-operated centers. Pennzoil supplied approximately 87% of the
lubricants to Jiffy Lube centers in 1998.

Jiffy Lube has been recognized as a "super brand" in BrandWeek's annual
rating of the top 2000 brands in America. Jiffy Lube has been named first in
growth in the automotive aftercare market (Entrepreneur Magazine, February,
1998), the number one franchise in the automotive oil change category
(Entrepreneur Magazine, January, 1998) and in the fast oil change industry
(Franchise Times, December, 1997).

COMPETITION

The lubricants business is highly competitive. The major competitors of the
Company and their principal brands of motor oil in the United States are Ashland
Inc. (Valvoline(R)), Texaco, Inc. (Havoline(R)), Burmah Castrol PLC
(Castrol(R)), and Mobil Oil Corporation (Mobil(R)). The Company also competes
with a number of independent blending and packaging companies. Outside of the
United States, the Company also competes with major fuels marketers and
state-owned petroleum companies. The principal methods of competition in the
motor oil business are breadth of product portfolio, product quality, price,
distribution capability, advertising and sales promotion. Some of the
competitors, particularly the major integrated oil companies, have greater
financial resources than the Company.

The car care consumer products business is highly competitive and very
fragmented. The car care industry is composed of several categories, such as
maintenance chemicals, appearance chemicals, tire cleaners and air fresheners.
Major branded competitors in these categories are STP(R), primarily a
maintenance chemical, and appearance products Armor All(R) and Turtle Wax(R).
Many other national brands exist in each of the various categories, although, in
general, they have small market shares. Private label brands also compete with
the national brands with respect to certain car care products. The principal
methods of competition in car care products are specific product benefits,
distribution capability and advertising and sales promotion.

The base oil and specialty products business is highly competitive. The
major competitors are Witco Corporation, Petro-Canada and Lyondell Chemical
Company in the white oils business and several major integrated oil companies in
base oil (primarily Exxon and Equilon) and the solvents business. Wax products
major competitors are Moore and Munger, Allied Signal Inc., International Group
Inc. and National Wax, a division of Burmah Castrol. Specialty industrial
products compete on the basis of product quality, customer service and price.

The fast lube business is highly competitive. Major competitors include
Ashland Inc. through its Valvoline Instant Oil Change(R) centers. A large number
of independent fast lube chains also compete with Jiffy Lube and Q Lube on a
regional or local basis. In addition to competing with other fast lube centers,
Jiffy Lube(R) and Q Lube(R) service centers compete with automobile dealers,
service stations and garages. The principal methods of competition are quality
of service, speed, location, warranty, price, convenience, reliability and sales
promotion.

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PATENTS AND TRADEMARKS

Most of the Company's brand name consumer products are protected by
registered trademarks. Pennzoil-Quaker State's brand names and trademarks are
extremely important to its business, and the Company pursues a course of
vigorous action against apparent infringements. The Company's numerous
trademarks have been registered in the United States and throughout the world
where the Company's products are sold. The Company's rights in these trademarks
endure for as long as they are used or registered.

The Company currently has 110 active patents related to lubricants,
synthetic lubricants, lubricant additives, hydrocarbon gel and automotive
chemicals. Although some products are covered by patents, the Company does not
believe that patents are material to its business.

RESEARCH AND DEVELOPMENT

Research and development activities are directed toward continued
improvement of motor oils, other lubricants and engine additives and the
development of new products. Research and development personnel develop quality
control programs to assure the continuous production of high quality products
and provide extensive technical services to the manufacturing, packaging, sales
and marketing operations as well as to customers and consumers.

The Company spent approximately $12.1 million on research activities and
quality testing in 1998. These activities are carried out in a 65,700 square
foot facility in The Woodlands, Texas. The Company also operates a
state-of-the-art base oil refinery pilot plant at this location. A 6,200 square
foot mechanical automotive testing laboratory, including an engine dynamometer,
was added in early 1998.

EMPLOYEES

As of December 31, 1998 the Company and its subsidiaries had approximately
13,200 employees, of whom approximately 9,300 were full-time employees and
approximately 3,900 were temporary and part-time employees. Approximately 4
percent of the Company's employees are represented by various labor unions.
Collective bargaining agreements are in force with most of the unions.

The Company is subject to various federal and state laws and regulations
governing employment practices and working conditions, including, but not
limited to, Title VII of the Civil Rights Act of 1964, as amended, the Civil
Rights Act of 1866, as amended, the Equal Pay Act of 1963, the Civil Rights Act
of 1991, the Americans with Disabilities Act of 1990, the Family and Medical
Leave Act of 1993, the Drug Free Workplace Act of 1989, the Age Discrimination
in Employment Act of 1967, as amended, the Rehabilitation Act of 1973, as
amended, the Vietnam Era Veterans' Readjustment Assistance Act of 1974, as
amended, the Occupational Safety and Health Act of 1970, the Fair Labor
Standards Act of 1938, as amended, the National Labor Relations Act of 1935, as
amended, and Executive Order 11246.

GOVERNMENTAL REGULATION

The Company's operations are affected from time to time in varying degrees
by political developments and federal, state and local laws and regulations.

ENVIRONMENTAL MATTERS. The operations of the Company in the United States
are subject to numerous federal, state and local laws and regulations
controlling the discharge of materials into the environment or otherwise
relating to the protection of the environment and human health and safety.

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measures to implement these new standards will be adopted over the next five to
seven years. Similarly, the multi-state OTAG and OTR groups are developing lists
of suggested controls to limit interstate ozone transport. The EPA has issued a
proposal to require states to begin adopting many of these suggested controls
over the next few years.

The precise effect of these actions on the Company and other industrial
companies is uncertain because most of the requirements will be implemented
through EPA regulations to be issued over a period of years. For example, fuels
produced at one or both of the Company's refineries will likely be required to
be reformulated to a composition significantly different from the fuels
currently produced, which would involve the installation of additional refining
equipment. However, current estimates indicate that expenditures associated with
the installation of such equipment would not have a material effect on the
Company's results of operations.

The Company is also subject to certain laws and regulations relating to
environmental remediation activities associated with past operations, such as
the Comprehensive Environmental Response, Compensation, and Liability Act, the
Resource Conservation and Recovery Act and similar state statutes. In response
to liabilities associated with these activities, accruals have been established
when reasonable estimates are possible. The Company adjusts the accruals when
new remediation responsibilities are discovered and probable costs become
estimable, or when current remediation estimates must be adjusted to reflect new
information.

The Company's assessment of the potential impact of these environmental
laws is subject to uncertainty due to the difficult process of estimating
remediation costs that are subject to ongoing and evolving change. Initial
estimates of remediation costs reflect a broad-based analysis of site conditions
and potential environmental and human health impacts derived from preliminary
site investigations (including soil and water analysis, migration pathways and
potential risk). Later changes in these initial estimates may be based on
additional site investigations, completion of feasibility studies (comparing and
selecting from among various remediation methods and technologies) and risk
assessments (determining the degree of current and future risk to the
environment and human health, based on current scientific and regulatory
criteria) and the actual implementation of the remediation plan. This process
occurs over relatively long periods of time and is influenced by regulatory and
community approval processes and is subject to the ongoing development of
remediation technologies. The Company's assessment analysis takes into account
the condition of each site at the time of estimation, the degree of uncertainty
surrounding the estimates for each phase of remediation and other site-specific
factors.

From January 1996 through December 1998, capital outlays of approximately
$10.6 million have been made by the Company with respect to environmental
protection. Capital expenditures for environmental control facilities are
currently expected to be approximately $0.6 million in 1999. Reference is made
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations for Pennzoil-Quaker State -- Capital Resources and
Liquidity -- Environmental" for additional information.

FAST LUBE OPERATIONS MATTERS. Jiffy Lube and Q Lube are subject to, and
devote substantial efforts to compliance with, a variety of federal and state
laws governing franchise sales and marketing and franchise trade practices.
Although the regulatory environment differs by state, applicable laws and
regulations generally require disclosure of business information in connection
with the sale of franchises. Certain state regulations also affect the ability
of the franchisor to revoke or refuse to renew a franchise. Jiffy Lube and Q
Lube seek to comply with applicable regulatory requirements. However, given the
scope of the fast lube business and the nature of franchise regulations,
compliance problems can be encountered from time to time.

ITEM 3. LEGAL PROCEEDINGS.

(a) LOUISIANA FEDERAL COURT EMPLOYMENT ACTION. In September 1997, a lawsuit
styled Kenneth Epperson, et al. v. Pennzoil Co., et al., was filed in the United
States District Court for the Western District of Louisiana, Shreveport
Division. The amended complaint filed by nine named plaintiffs alleges
discriminatory employment policies and practices against African-American and
other minority employees and seeks attorneys' fees and costs, various forms of
injunctive and equitable relief, $50.0 million in damages for back
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pay, front pay and emotional distress, and a minimum of three times that amount
in punitive damages. The Company vigorously denies these allegations and will
oppose plaintiffs' efforts to have the case certified as a class action by the
court.

(b) DURA LUBE. In July 1997, Dura Lube Corporation and certain of its
affiliated companies filed suit in the United States District Court for the
District of Delaware. The complaint names Quaker State and its subsidiary, Slick
50, Inc., as defendants and asserts claims under the Sherman Act and the Clayton
Act, for tortious interference with business relations and for civil conspiracy.
Plaintiffs allege that defendants attempted and conspired to monopolize the
market for engine treatment by, among other things, entering into exclusive
dealing arrangements with major automotive parts retailers around the country.
Plaintiffs seek treble damages, punitive damages, attorneys' fees and costs as
well as injunctive relief. The Company is contesting this action vigorously.

(c) BLUE CORAL. In May 1997, a class action lawsuit was filed in the United
States District Court for the Northern District of Illinois on behalf of a class
of persons who purchased wax, polish or protectant products sold by a number of
defendants. The action names as defendants a number of car wax manufacturers,
including Blue Coral, Inc., a subsidiary of the Company, and certain of its
present and former officers. The complaint alleges that the defendants falsely
advertised and marketed such products and seeks treble damages, attorneys' fees
and costs for the class for alleged violations of the federal Racketeer
Influenced and Corrupt Organizations Act and compensatory damages for alleged
violations of the Ohio Consumer Sales Practices Act as well as for breach of
express warranty. On January 5, 1999, the court certified a nationwide class
consisting of all persons who purchased products marketed, produced or
distributed as "car wax" by the defendants. While no class period has been
specified by the court, the plaintiffs are seeking a class period dating back
four years prior to the filing of the action. On February 2, 1999, the
plaintiffs proposed a joint settlement fund equal to ten percent of each
defendant's 1997 gross revenue from the products. The Company is contesting this
action vigorously.

(d) OIL CHANGER. In July 1998, Oil Changer, Inc. ("Oil Changer") and
several corporations affiliated with Oil Changer filed a suit in the Superior
Court of the State of California, Alameda County, against Quaker State, certain
former executives of Quaker State and other individuals. The complaint alleges
that Quaker State and Oil Changer were "strategic partners" in an alleged
partnership to develop quick lubrication centers in Northern California. Oil
Changer alleges that Quaker State breached the alleged agreement by developing
quick lubrication centers with another entity. The complaint asserts claims for
fraud, breach of fiduciary duty and usurpation of partnership opportunity,
partnership accounting, breach of contract, conspiracy and violation of Section
17200 of the California Business Professions Code. Plaintiffs seek compensatory
damages of $50 million, punitive damages, restitution, attorneys' fees and costs
as well as injunctive relief.

In addition, in July 1998, Oil Changer and several corporations affiliated
with Oil Changer filed a complaint in the United States District Court for the
Northern District of California against Quaker State and Pennzoil Company. The
complaint asserts claims under Sections 1 and 2 of the Sherman Act, Section 7 of
the Clayton Act and Sections 16720 and 17200 of the California Business
Professions Code, alleging that the merger of the Company and Pennzoil Company's
downstream business will substantially lessen competition in, or result in
monopolization of, the markets for motor oil and quick lubrication services in
certain areas of California. Plaintiffs sought compensatory and treble damages,
restitution, attorneys' fees and costs as well as injunctive relief enjoining
the proposed acquisition of Quaker State by the Company. On September 4, 1998,
the Company filed a motion to dismiss this complaint, which was granted in part
resulting in a dismissal of the claims under the California Business Professions
Code and certain Sherman Act and Clayton Act claims. On October 8, 1998,
Plaintiffs filed a notice of motion for a preliminary injunction to enjoin the
proposed acquisition of Quaker State by the Company, which was denied on
December 7, 1998. Plaintiffs are appealing the denial of the injunction. The
Company is contesting these actions vigorously.

(e) TEXAS FEDERAL COURT EMPLOYMENT ACTION SETTLED. The parties have reached
a settlement in the lawsuit styled Donna Alexander, et al. v. Pennzoil Company,
et al., pending in the United States District Court for the Southern District of
Texas, Houston Division. The suit was filed by eleven named plaintiffs and

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alleged wrongful and illegal discrimination by Pennzoil Company and subsidiaries
against African-American employees. The settlement was approved by the court on
March 8, 1999.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

ITEM S-K 401(b) EXECUTIVE OFFICERS OF THE REGISTRANT.

(a) Set forth below are the names and ages of the executive officers of
Pennzoil-Quaker State Company (at February 28, 1999). Positions, unless
otherwise specified, are with Pennzoil-Quaker State Company.

DAVID P. ALDERSON II (49)
Group Vice President, Chief Financial Officer and Treasurer

CLYDE W. BEAHM (61)
Executive Vice President -- Lubricants and
Consumer Products

LINDA F. CONDIT (51)
Vice President and Corporate Secretary

MICHAEL J. MARATEA (54)
Vice President and Controller

JAMES L. PATE (63)(1)
Chairman of the Board and Chief Executive Officer

JAMES J. POSTL (53)(1)
President and Chief Operating Officer

WILLIAM M. ROBB (54)
Group Vice President -- Base Oil and
Specialty Products

JAMES W. SHADDIX (52)
General Counsel

PAUL B. SIEGEL (53)
Vice President

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(1) Director of Pennzoil-Quaker State Company and member of Executive Committee.

(b) Officers are appointed annually to serve for the ensuing year or until
their successors have been appointed. Officers listed above have held their
present offices for at least the past five years except for those named below,
who have had the business experience indicated during that period. Positions,
unless specified otherwise, are with Pennzoil-Quaker State Company.

DAVID P. ALDERSON II -- Group Vice President, Chief Financial Officer and
Treasurer since December 1998. Group Vice President -- Finance and Accounting of
Pennzoil Company from December 1995 to December 1998. Treasurer of Pennzoil
Company from August 1989 to June 1996. Group Vice President -- Finance of
Pennzoil Company from February 1992 to December 1995. Vice President of Pennzoil
Products Company from March 1998 to December 1998.

CLYDE W. BEAHM -- Executive Vice President -- Lubricants and Consumer
Products since December 1998. Group Vice President -- Products Marketing of
Pennzoil Company from January 1996 to December 1998. Group Vice
President -- Franchise Operations of Pennzoil Company prior thereto. Vice
President of Pennzoil Products Company from March 1998 to December 1998.

LINDA F. CONDIT -- Vice President and Corporate Secretary since December
1998. Vice President of Pennzoil Company from December 1995 to December 1998.
Corporate Secretary of Pennzoil Company from March 1990 to December 1998. Vice
President and Secretary of Pennzoil Products Company from March 1998 to December
1998.

MICHAEL J. MARATEA -- Vice President and Controller since December 1998.
Vice President of Pennzoil Company from February 1996 to December 1998 and
Controller of Pennzoil Company from May 1995 to December 1998. Vice
President -- Process Improvement of Pennzoil Exploration and Production Company
prior thereto. Controller of Pennzoil Products Company from March 1998 to
December 1998.

JAMES L. PATE -- Chairman of the Board and Chief Executive Officer since
December 1998. Chairman of the Board of Pennzoil Company since May 1994 and
Chief Executive Officer of Pennzoil Company from May 1990 to December 1998.
President of Pennzoil Company from March 1990 to December 1997. Chief Executive
Officer of Pennzoil Products Company from October 1998 to December 1998 and
President of Pennzoil Products Company from March 1998 to October 1998.

JAMES J. POSTL -- President and Chief Operating Officer since December
1998. President of Pennzoil Products Company from October 1998 to December 1998.
President of Nabisco Biscuit Company from

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December 1995 to February 1998. President and Chief Executive Officer of Nabisco
International prior thereto.

WILLIAM M. ROBB -- Group Vice President -- Base Oil and Specialty Products
since December 1998. Group Vice President -- Products Manufacturing of Pennzoil
Company prior thereto. Vice President of Pennzoil Products Company from March
1998 to December 1998.

JAMES W. SHADDIX -- General Counsel since December 1998. General Counsel of
Pennzoil Company prior thereto. Vice President of Pennzoil Products Company from
March 1998 to December 1998.

PAUL B. SIEGEL -- Vice President since December 1998. Senior Vice
President -- Legal of Pennzoil Products Group from February 1995 to December
1998. Vice President -- Legal of Pennzoil Products Group prior thereto. Vice
President of Pennzoil Products Company from March 1998 to December 1998.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.

The common stock of Pennzoil-Quaker State began trading "regular way" on
the New York Stock Exchange on December 31, 1998. The closing sales price for
the common stock of Pennzoil-Quaker State on December 31, 1998 was $14.75 as
reported on the New York Stock Exchange (consolidated transactions reporting
system), the principal market in which the common stock is traded. The common
stock is also listed for trading on the Pacific Exchange.

Pennzoil-Quaker State did not pay dividends in 1998.

As of December 31, 1998, Pennzoil-Quaker State had 15,054 record holders of
its common stock.

ITEM 6. SELECTED FINANCIAL DATA.

The following table contains selected financial data for the five years
indicated.

AS OF AND FOR THE YEARS ENDED DECEMBER 31
-------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -----------
(UNAUDITED)
(EXPRESSED IN MILLIONS EXCEPT PER SHARE AMOUNTS)

Revenues(1)................................... $1,850.1 $2,013.2 $1,968.0 $1,807.7 $1,748.3
Net loss(2)................................... $ (45.9) $ (0.6) $ (9.2) $ (53.2) $ (16.0)
Basic and diluted loss per share.............. $ (0.96) $ (0.01) $ (0.19) $ (1.11) $ (0.34)
Dividends per common share.................... -- -- -- -- --
Total assets(3)............................... $3,145.0 $1,559.6 $1,370.5 $1,278.7 $1,056.1
Total debt and capital lease
obligations(3)(4)........................... $1,105.6 $ 458.6 $ 458.5 $ 435.2 $ 140.0
Total shareholders' equity(3)................. $1,350.2 $ 256.4 $ 235.7 $ 224.8 $ 211.7

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(1) The decrease in revenues for the year ended December 31, 1998 compared to
the year ended December 31, 1997 was primarily the result of the Company's
contribution of most of its specialty industrial products business to a
partnership with Conoco called Penreco in October 1997. Beginning in the
fourth quarter of 1997, the Company's share of Penreco's earnings, net of
expenses, are reflected in revenues. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Base Oil and
Speciality Products" for additional information.

(2) The 1998 net loss includes nonrecurring after-tax charges of $59.0 million
($91.9 million pretax). These charges include $10.6 million in pretax
expenses related to the December 30, 1998 acquisition of Quaker State, $29.6
million in pretax charges for the impairment of fast lube assets required
under SFAS No. 121, $25.0 million in pretax charges for the voluntary
withdrawal and reformulation of Fix-A-Flat(R) tire inflator products and
$26.7 million in pretax charges for litigation settlement expenses, net loss
on sales of assets and other matters. The 1997 net loss includes pretax
one-time charges of $22.0 million allocated to the Company by its former
parent company. The 1996 net loss includes a pretax charge of $24.4 million
for pre-operating expenses of Excel Paralubes. The 1995 net loss includes
pretax charges of $20.0 million relating to a fire at the Company's
Rouseville manufacturing facility, $10.0 million for a settlement of certain
franchisee litigation, $9.0 million for pre-operating expenses of Excel
Paralubes, $5.7 million

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associated with international marketing restructuring charges and $8.2 million
associated with a general and administrative cost reduction program. The 1994
net loss includes a pretax charge of $32.5 million for cessation of crude oil
processing at the Company's Roosevelt manufacturing facility. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
for additional information related to 1996 through 1998.

(3) On December 30, 1998 the Company acquired Quaker State. Reference is made to
Note 2 of Notes to Consolidated Financial Statements for additional
information.

(4) Includes current maturities of long-term debt and current portion of capital
lease obligations.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

Reference is made to Segment Financial Information included in Item 1.
Business and Item 2. Properties and the Consolidated Financial Statements
beginning on page F-3 for additional information.

Pennzoil-Quaker State Company is the result of the consolidation and
separation on December 30, 1998 of the lubricants and consumer products, base
oil and specialty products and fast lube operations of Pennzoil Company and the
acquisition by the Company of Quaker State in a merger transaction immediately
following the separation.

Results of operations for Pennzoil-Quaker State do not include Quaker
State's results prior to the acquisition. In addition, operating results include
certain affiliated charges for interest and services provided by Pennzoil
Company to Pennzoil-Quaker State in 1998 and prior periods that will not be
incurred by Pennzoil-Quaker State in future periods. The fair value of assets
and liabilities of Quaker State are included in the Company's consolidated
balance sheet as of December 31, 1998.

RESULTS OF OPERATIONS

The Company had net sales of $1,801.7 million for the year ended December
31, 1998, a decrease of $180.5 million and $159.6 million from the comparable
periods in 1997 and 1996, respectively. The decrease was primarily due to the
contribution of most of the Company's specialty industrial products business to
the Penreco partnership in October 1997. Prior to the creation of this
partnership, net sales from the contributed operations were consolidated in the
financial statements of the Company. The Company's share of Penreco earnings are
now accounted for under the equity method of accounting and reported as a
component of other income, net. Net sales associated with the contributed
specialty industrial products operations were $121.2 million and $148.5 million
for the years ended 1997 and 1996, respectively.

Excluding the net sales associated with the contributed specialty
industrial products operations in 1997 and 1996, net sales revenue for 1998 was
$59.3 million below 1997 and $11.1 million below 1996. The decrease in 1998
compared to the same periods in 1997 and 1996 was primarily due to lower
lubricating product and fuels net sales prices. Lower market prices, primarily
the result of lower petroleum feedstock costs, more than offset increases in
product sales volumes.

Excluding the impact of specialty industrial products operations
contributed to Penreco, gross margin (i.e., net sales less cost of sales and
purchases from affiliates) in 1998 decreased 6.7% from 1997. Gross margin for
1997, adjusted to exclude the impact of specialty industrial products operations
contributed to Penreco, was up 10.9% over 1996.

A net loss of $45.9 million was recorded for 1998 compared to a net loss of
$.6 million and $9.2 million in 1997 and 1996, respectively. Results of
operations for 1998 include $10.6 million in pretax expenses related to the
December 30, 1998 acquisition of Quaker State, $29.6 million in pretax charges
for the impairment of fast lube assets required under SFAS No. 121, $25.0
million in pretax charges for the voluntary withdrawal and reformulation of
Fix-A-Flat(R) tire inflator products and $26.7 million in pretax charges for
litigation settlement expenses, net loss on sales of assets and other matters.
Depreciation expense increased $12.7 million for 1998 compared to 1997, and
$12.6 million for 1997 compared to 1996, primarily due to the Shreveport
manufacturing facility upgrade and the implementation of a new information
technology system in January 1998. Reference is made to Note 2, Note 3 and Note
12 of Notes to Consolidated Financial Information for additional information.

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LUBRICANTS AND CONSUMER PRODUCTS. Net sales for the lubricants and consumer
products segment in 1998 were $960.5 million, essentially even with 1997
revenues. Operating income from this segment was $55.9 million for 1998 compared
to $76.5 million in 1997. Excluding nonrecurring charges of $39.2 million and
$3.5 million in 1998 and 1997, respectively, operating income was $95.1 million
in 1998, an increase of $15.1 million, or 18.9%, over 1997. Nonrecurring charges
in 1998 include $25.0 million for charges taken in association with the
voluntary withdrawal and reformulation of Fix-A-Flat(R) tire inflator products
and $14.2 million for impairments, write-offs and other charges. The
year-over-year increase in operating income was due to a full year's impact of
income from acquisitions made in late 1997, lower raw material costs and lower
expenses, partially offset by increased promotional spending from lubricants and
lower filter and automotive chemicals sales volumes.

Net sales for this segment in 1997 were $966.2 million, a $19.2 million
increase over 1996. Operating income for this segment in 1997 was $76.5 million
compared to $73.0 million in 1996. Excluding nonrecurring items of $3.5 million
and $2.5 million in 1997 and 1996, respectively, operating income in 1997 was
$80.0 million, a $4.5 million increase over 1996. The improvement was due
primarily to lower raw material costs and higher filter sales volume, partially
offset by lower domestic motor oil sales volumes and higher selling and
operating expenses.

BASE OIL AND SPECIALTY PRODUCTS. Net sales for the base oil and specialty
products segment decreased 21.8% for 1998 compared to the same period in 1997.
The decrease was primarily due to the Company's contribution of most of its
specialty industrial products business to the Penreco partnership. Excluding the
net sales associated with the contributed specialty industrial business, net
sales decreased 9.8% in 1998 compared to the same period in 1997 primarily due
to lower average sales prices for base oils, fuels and other refined petroleum
products. The decline in sales prices generally followed the market price
decrease of crude oil and other petroleum feedstocks. Partially offsetting this
decrease was an increase in fuels production volumes as a result of the
completion of the Shreveport manufacturing facility upgrade in April 1997.

Gross margin decreased $35.4 million in 1998 from the same period in 1997.
The decrease was primarily due to lower fuels margins, which were primarily
caused by lower fuels sales prices, which decreased faster than crude oil and
other feedstock prices.

Other income for this segment increased $24.2 million in 1998 compared to
the same period in 1997 primarily due to higher equity income in partnerships,
which was up $28.5 million in 1998 compared to the same period in 1997. Equity
income related to Excel Paralubes increased $20.0 million in 1998 over 1997,
primarily due to higher base oil volumes. In addition, equity income
attributable to the Penreco partnership increased $7.0 million in 1998 compared
to 1997.

Other income for 1998 includes income of $1.6 million related to the sale
of the Company's refinery in Roosevelt, Utah.

Selling, general and administrative expenses decreased $8.5 million in 1998
compared to the same period in 1997 due in part to the impact of the specialty
industrial products operations contributed to Penreco.

Operating income for the segment decreased $3.4 million in 1998 compared to
the same period in 1997.

Net sales for the year-ended 1997 decreased $90.6 million, or 9.0% from the
same period in 1996. The decrease was primarily due to the contribution of most
of the specialty industrial products business to the Penreco partnership in
October 1997. Excluding the net sales associated with the contributed specialty
industrial business, net sales decreased 7.4% in 1997 compared to the same
period in 1996 primarily due to lower average sales prices for base oils.
Partially offsetting this decrease was an increase in fuels production volumes
as a result of the completion of the Shreveport manufacturing facility upgrade
in April 1997.

Gross margin increased approximately $26.4 million in 1997 from the same
period in 1996. The increase was primarily due to higher fuels volumes resulting
from the completion of the Shreveport manufacturing facility upgrade in April
1997. The increase in fuels volumes was partially offset by the decrease in base
oil margins. Base oil margins in 1997 were depressed as the market absorbed new
capacity from Excel Paralubes,

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which began commercial production in late December 1996, and a Petro Canada
facility which also began production in 1996.

Other income for the base oil and specialty products segment increased
$25.8 million in 1997 from the same period in 1996. The increase was primarily
due to higher equity income in partnerships. Equity income related to Excel
Paralubes increased $21.5 million in 1997 over the same period in 1996 primarily
as a result of pre-operating expenses recorded during 1996. In addition, equity
income attributable to the Penreco partnership was $4.0 million in 1997.

Depreciation and amortization expense increased $10.2 million in 1997
compared to 1996 primarily as a result of completion of the Shreveport
manufacturing facility upgrade in April 1997 and implementation of a new
information technology system in December 1996.

Operating income for the base oil and specialty products segment was $19.4
million in 1997 compared to a loss of $19.7 million in 1996.

The Company is currently evaluating its manufacturing assets and
investments and their importance to the Company's strategic plan and future
direction. As a result of this evaluation, the Company may determine to dispose
of or discontinue the operations of some or all of its manufacturing assets and
investments. The Company cannot currently predict the timing or the financial
impact of any such dispositions or discontinuances, which could result in cash
or noncash charges, depending on the manner and timing of any such dispositions
or discontinuances.

FAST LUBE OPERATIONS. Net sales recorded by the fast lube operations
segment, operating through Jiffy Lube, increased 2.1% for 1998 compared to 1997.
The increase in net sales was due primarily to an increase in the number of
service centers. Net sales reported by the fast lube operations segment consist
of sales revenues from company-operated service centers and franchise fees,
royalty revenues, rental income and automotive product sales proceeds from
franchisee operated service centers. System-wide sales increased $52.6 million
to $817.6 million for 1998 compared to 1997 as a result of an increased number
of service centers open and an increase in the average ticket price. System-wide
average ticket prices increased to $36.71 in 1998 compared with $35.87 for the
same period in 1997, as customers continue to take advantage of additional
authorized services and products available at service centers. There were 1,588
service centers (including 579 company-operated service centers) open as of
December 31, 1998.

Net sales recorded by the fast lube operations segment were up $25.8
million in 1997 compared to 1996. This increase was due to an increase in the
number of company-operated service centers and an increase in franchise
royalties. The increase in the number of service centers was primarily due to
placing service centers in Sears Auto Centers and partially due to acquisitions.

In December 1998, the fast lube operations segment recorded a pretax charge
of $29.6 million to reflect the impairment of long-lived assets as required
under SFAS No. 121.

The fast lube operations segment reported an operating loss of $4.1 million
for the year ended December 31, 1998 compared to operating income of $24.5
million during 1997 and operating income of $21.4 million in 1996. Included in
1998 results are nonrecurring charges of $14.8 million for one-time acquisition
expenses, legal settlements and other liabilities. Adjusted to exclude these
nonrecurring charges, operating income totaled $10.7 million in 1998 compared to
$24.5 million in 1997. The year-over-year decline in earnings was due to
increased salaries and other operating costs within company-operated centers,
higher selling, general and administrative costs and higher depreciation
expense. The improvement in 1997 results compared to 1996 was due primarily to
higher company service center sales, lower operating expenses as a result of
fewer new service center openings and increased royalty income.

During 1998, Jiffy Lube acquired 22 centers along with related real estate
in exchange for cash of $8.6 million and liabilities and debt assumed of $3.5
million. Also, during 1998, 16 centers were sold for $6.5 million in cash.

During 1997, Jiffy Lube acquired 35 centers along with related real estate
in exchange for cash of $17.8 million and liabilities and debt assumed of $2.5
million. Also, during 1997, 24 centers were sold for
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$3.1 million in cash and $0.4 million in forgiveness of debt. Also during 1997,
six company-owned service centers were exchanged for six franchisee-operated
stores.

During 1996, Jiffy Lube acquired 16 centers along with related real estate
in exchange for $4.7 million in cash and $2.8 million in liabilities and debt
assumed. Also during 1996, 36 centers were sold for $4.4 million in cash and
$0.6 million in forgiveness of debt.

OTHER. Other operating income in 1998 was a loss of $8.1 million, compared
to income of $1.9 million in 1997 and income of $0.7 million in 1996. The
decrease in 1998 compared to 1997 was primarily due to the writedown of fixed
assets at corporate headquarters.

CORPORATE ADMINISTRATIVE CHARGES

Pennzoil Company provided administrative services to the Company during
1998, 1997 and 1996 and charged the Company for all direct costs associated with
its operations. In addition, certain administrative costs incurred by Pennzoil
Company not directly charged to the Company were historically allocated through
a monthly charge based on a formula that considered the relative total assets,
sales and employees of its subsidiary companies. These charges totaled $44.4
million, $54.8 million and $30.6 million for the years ended December 31, 1998,
1997 and 1996, respectively. The increase in charges in 1998 and 1997 was
primarily due to one-time expenses incurred by Pennzoil Company. The Company's
share of these expenses were approximately $9.9 million and $22.0 million,
respectively.

DISCLOSURES ABOUT MARKET RISK

Pennzoil-Quaker State is exposed to market risk, including adverse changes
in interest rates and foreign currency exchange rates.

INTEREST. At December 31, 1998, the fair value of the Company's long-term
debt, including commercial paper and short-term variable rate credit agreements,
is projected to be $1.0 billion using quoted market prices or, where such prices
are not available, on estimated year-end interest rates of debt with the same
remaining average maturities and credit quality. Such fair value exceeded the
long-term debt carrying value by $26.4 million. Reference is made to Note 9 of
Notes to Consolidated Financial Statements for additional information. A
hypothetical 10 percent adverse change in market interest rate relative to the
aforementioned securities would not have had a material effect on the Company's
results of operations for the fiscal year ending December 31, 1998.

HEDGING ACTIVITIES. Pennzoil-Quaker State enters into forward exchange
contracts and options to hedge the impact of foreign currency fluctuations on
certain monetary liabilities and commitments denominated in foreign currencies.
The purpose of entering into these hedges is to minimize the impact of foreign
currency fluctuations on the results of operations. The unrealized gains and
losses on these contracts are deferred and recognized in the results of
operations in the period in which the hedged transaction is consummated.
Unrealized gains at December 31, 1998 are not material.

Pennzoil-Quaker State also uses interest rate locks and swaps to reduce its
exposure to interest rate movements. In 1998, the Company entered into four
interest rate locks, based upon the 30-year Treasury rate to hedge future
issuances of long-term indebtedness. To accomplish its hedged position, the
Company entered into forward rate agreements in which it will pay or receive the
difference between (1) the 30-year Treasury rate at the time the forward was
entered into and (2) the 30-year Treasury rate at the time of maturity. Under
current accounting standards, these transactions qualify as a hedge of an
anticipated transaction. Any gains or losses from the interest rate hedges are
deferred during the interim period with the offset to a payable or receivable.
Upon maturity of the hedge contracts, any gain or loss will be treated as an
adjustment to the issue price of the debt instrument, effectively creating a
premium or discount that is amortized over the life of the borrowings. The
estimated value of the amount payable by the Company under its open interest
rate hedge was $8.3 million at December 31, 1998, which has been recorded as a
deferred charge in other assets.

16
19

INTEREST CHARGES, NET

Interest charges, net, for the Company increased $8.2 million for the
twelve months ended December 31, 1998 compared to the same period in 1997. The
increase was primarily due to a decrease in interest capitalized as a result of
the completion of the Shreveport manufacturing facility upgrade in April 1997.

Interest charges, net, increased $6.7 million in 1997 compared to 1996
primarily due to increased borrowings by the fast lube operations segment from
Pennzoil Company and lower capitalized interest.

YEAR ENDED DECEMBER 31
---------------------------
1998 1997 1996
------- ------- -------
(EXPRESSED IN THOUSANDS)

Interest expense........................................ $13,826 $12,847 $12,208
Affiliated interest charges............................. 56,372 56,374 52,966
Less: interest capitalized.............................. (255) (7,441) (10,103)
------- ------- -------
$69,943 $61,780 $55,071
======= ======= =======

CAPITAL RESOURCES AND LIQUIDITY

CASH FLOW. The Company had cash and cash equivalents of $14.9 million, $9.1
million and $15.8 million at December 31, 1998, 1997 and 1996, respectively.
Cash flow generated from operating activities before changes in operating assets
and liabilities was $125.4 million, $149.6 million and $86.3 million for the
years ended December 31, 1998, 1997 and 1996, respectively. The increase in cash
flow from operations before changes in operating assets and liabilities for the
year ended December 31, 1997 compared to the same period in 1996 was primarily
due to cash distributions from Excel Paralubes. The Company's cash flow from
operations for the year ended December 31, 1998 decreased by $281.0 million
compared to the same period in 1997. Reference is made to Note 3 of Notes to
Consolidated Financial Statements for additional information.

CAPITAL EXPENDITURES. Capital expenditures were $88.3 million in 1998,
$147.8 million in 1997 and $251.2 million in 1996. Capital expenditures in 1997
and 1996 included $42.0 million and $147.3 million, respectively, for the
upgrade of the Company's Shreveport manufacturing facility. Capital expenditures
in 1997 also included $17.0 million for the installation of facilities near the
Company's motor oil packaging facilities to store base oils manufactured by
Excel Paralubes and $12.8 million for the implementation of new information
technology software. Capital expenditures in 1996 included $8.6 million for
improvements at the Company's Rouseville manufacturing facility to enable
production of additional waxes in connection with the Company's Bareco joint
venture. The 1999 capital budget for the Company is estimated to be
approximately $117.3 million. The Company believes that its cash flow from
operations, supplemented as required by additional borrowings, provides it with
sufficient resources to finance operations and planned capital needs.

ACCOUNTS RECEIVABLE. The increase in current receivables at December 31,
1998 compared to December 31, 1997 is primarily due to the acquisition of Quaker
State, which resulted in a $152.0 million increase in current receivables.
Current receivables include trade accounts and notes receivable and are net of
allowances for doubtful accounts of $18.2 million and $7.7 million at December
31, 1998 and 1997, respectively. Long-term receivables consist of notes
receivable and are net of allowances for doubtful accounts of $0.9 million at
December 31, 1998 and 1997.

At December 31, 1998 and 1997, current receivables included notes
receivable of $16.6 million and $12.4 million, respectively. Other assets
included long-term notes receivable of $53.2 million and $41.4 million at
December 31, 1998 and 1997, respectively. The long-term receivables are loans
that are made to customers to enhance their operations. Each loan requires a
promissory note between the customer and the Company, and most require payment
of principal and interest. Similar to other incentive programs, sales agreements
normally accompany the loans.

The Company's net accounts receivable sold under its receivables sales
facility totaled $115.0 million and $103.3 million at December 31, 1998 and
1997, respectively. The Company entered into a new one-year

17
20

receivables sales facility in February 1999 that provides for ongoing sales of
up to $120.0 million of accounts receivable.

CREDIT FACILITIES. During 1999, the Company intends to refinance a portion
of its commercial paper borrowings with the issuance of longer term debt
securities. The Company expects to finance operations and planned capital needs
from operating cash flow, supplemented as required by additional borrowings
under its revolving credit facility, commercial paper programs or short-term
variable-rate credit arrangements.

The Company's primary revolving credit facility with a group of banks
provides for up to $1.0 billion of committed unsecured revolving credit
borrowings through November 16, 1999, with any outstanding borrowings on such
date being converted into a term credit facility terminating on November 16,
2000. There were no borrowings outstanding under this revolving credit facility
at December 31, 1998. The Company had borrowings under a Quaker State revolving
credit agreement of $370.0 million at December 31, 1998. In January 1999, the
Company repaid these borrowings with borrowings under its commercial paper
facility and terminated the Quaker State revolving credit facility. The average
interest rate applicable to the outstanding Quaker State revolving credit
borrowings was 5.8% during 1998.

The Company currently limits aggregate borrowings under its commercial
paper programs to $1.0 billion. Borrowings under commercial paper facilities
totaled $488.4 million at December 31, 1998. The average interest rate
applicable to outstanding commercial paper was 6.0% at year-end 1998.

The Company had one short-term variable-rate credit arrangement with a bank
at year-end 1998 and intends to enter into several more. The Company currently
limits its aggregate borrowings under these types of credit arrangements to
$300.0 million. There were no outstanding borrowings at December 31, 1998. None
of the banks under these credit arrangements has any obligation to continue to
extend credit after the maturities of outstanding borrowings or to extend the
maturities of any borrowings.

In December 1998, in connection with its separation from Pennzoil Company,
the Company repaid $430.0 million of intercompany indebtedness and accounts
payable to Pennzoil Company. Intercompany indebtedness of $412.4 million to
Pennzoil Company was not repaid and was treated as a capital contribution to the
Company in connection with the separation.

The Company has a long-term credit facility with a Canadian bank that
provides for borrowings of up to C$27.0 million through October 25, 1999.
Outstanding borrowings under the credit facility totaled US$9.6 million and
US$12.2 million at December 31, 1998 and 1997, respectively. The average
interest rates applicable to amounts outstanding under the credit facility were
5.0% and 3.4% during 1998 and 1997, respectively.

Reference is made to Note 9 of Notes to Consolidated Financial Statements
for additional information regarding the Company's indebtedness and credit
facilities.

CLASSIFICATION OF BORROWINGS UNDER CREDIT FACILITIES. As of December 31,
1998, borrowings under Pennzoil-Quaker State's commercial paper programs and the
Company's Canadian credit facility totaling $498.0 have been classified as
long-term debt. Such debt classification is based upon the availability of
committed long-term credit facilities to refinance such short-term facilities
and the Company's intent to maintain such commitments in excess of one year.

ENVIRONMENTAL. The Company is subject to certain laws and regulations
relating to environmental remediation activities associated with past
operations, such as the Comprehensive Environmental Response, Compensation, and
Liability Act ("CERCLA"), the Resource Conservation and Recovery Act and similar
state statutes. In response to liabilities associated with these activities,
accruals have been established when reasonable estimates are possible. Such
accruals primarily include estimated costs associated with remediation. The
Company has not used discounting in determining its accrued liabilities for
environmental remediation, and no claims for possible recovery from third-party
insurers or other parties related to environmental costs have been recognized in
the Company's combined financial statements. The Company adjusts the accruals
when new remediation responsibilities are discovered and probable costs become
estimable, or when current remediation estimates must be adjusted to reflect new
information.

18
21

Certain of the Company's subsidiaries are involved in matters in which it
has been alleged that such subsidiaries are potentially responsible parties
("PRPs") under CERCLA or similar state legislation with respect to various waste
disposal areas owned or operated by third parties. In addition, certain of the
Company's subsidiaries are involved in other environmental remediation
activities, including the removal, inspection and replacement, as necessary, of
underground storage tanks. As of December 31, 1998 and 1997, the Company's
consolidated balance sheet included accrued liabilities for environmental
remediation of $27.2 million and $11.6 million, respectively. Of these reserves,
$4.2 million and $2.4 million are reflected on the consolidated balance sheet as
current liabilities as of December 31, 1998 and 1997, respectively, and $23.0
million and $9.2 million are reflected as other liabilities as of December 31,
1998 and 1997, respectively. The Company does not currently believe there is a
reasonable possibility of incurring additional material costs in excess of the
current accruals recognized for such environmental remediation activities. With
respect to the sites in which the Company subsidiaries are PRPs, the Company's
conclusion is based in large part on (i) the availability of defenses to
liability, including the availability of the "petroleum exclusion" under CERCLA
and similar state laws, and/or (ii) the Company's current belief that its share
of wastes at a particular site is or will be viewed by the Environmental
Protection Agency or other PRPs as being de minimis. As a result,
Pennzoil-Quaker State's monetary exposure is not expected to be material beyond
the amounts reserved.

YEAR 2000 ISSUES

The Company has conducted a review of its key computer systems and has
identified a number of systems that were affected by the year 2000 issue. The
Company has completed conversion of these non-compliant financial, operating,
human resource and payroll systems to a new information technology system in
1998. In addition, the Company is currently upgrading electronic commerce
systems to compliant versions. Conversion of operating and financial software as
well as desktop hardware and software used in international locations for the
Company to compliant versions began in the second quarter of 1998, with
completion expected in the second quarter of 1999. Upgrades and standardization
of network, infrastructure, desktop and communications systems to make these
assets compliant are in progress. This effort is scheduled for completion in the
first quarter of 1999 following the release of compliant updates from the
vendors. The only system replacements that have been accelerated to remedy
non-compliance are the Company voicemail systems and the international desktop
hardware, software, financial and operational systems. No major information
technology projects have been deferred due to year 2000 compliance matters.
Contingency planning will be started for the information technology systems in
the first quarter of 1999, and will include backup, standby and storage service
solutions to reduce the impact of critical service providers.

The Company has conducted a comprehensive inventory and assessment of
systems and devices with embedded chips in the manufacturing and
non-manufacturing environments. The manufacturing environment which consists of
refining, blending, storage and the movement of petrochemicals has the greatest
inherent risk since embedded chip systems control and monitor these processes.
At this time, two Company manufacturing facilities have non-compliant control
systems. These deficiencies will be addressed upon the release of a compliant
version of the software from the vendor, which is expected during the first
quarter of 1999. These systems will first undergo a pilot test at the Company's
research facility, followed by a full system test at the manufacturing
facilities during a scheduled plant shutdown. If for any reason these systems
are still found to be non-compliant, additional plant or operations shutdowns
could be necessary to conduct further remediation and testing. In addition, all
currently compliant control systems that have the potential for environmental,
safety or business interruption impact will be tested during scheduled
maintenance. In order to prevent safety and environmental problems due to
non-compliant embedded-chip systems, operation of these systems would be reduced
or discontinued. Contingency planning is also underway to provide alternatives
in the event these systems are partially or completely inoperable.

The Company is contacting key suppliers, banks, customers and other
unaffiliated companies that have business relationships with the Company to
assess their year 2000 compliance programs. The Company could be adversely
affected by the failure of these unaffiliated companies to adequately address
the year 2000 issue. This assessment includes activities such as face-to-face
meetings, reviews of year 2000 readiness and cooperative testing. Contingency
planning will be included in this assessment to identify arrangements to

19
22

mitigate the impact of disruptions from outside sources. In addition, the
Company has implemented internal procedures to respond cooperatively to
inquiries from regulatory agencies and other businesses about its year 2000
program.

As with most companies, the Company anticipates more issues arising from
international business partners, especially in the banking, utility, shipping
and governmental segments. The Company is currently reviewing all banking
relationships in international locations. In addition, the Company is actively
involved in a joint industry effort through the American Petroleum Institute to
collectively address the readiness of their common business partners such as
utilities and governmental agencies, and to share approaches to solving the
specific problems of each international location.

If these steps are not completed successfully in a timely manner, the
Company's operations and financial performance could be adversely affected
through disruptions in operations. Costs associated with such disruptions
currently cannot be estimated.

Both incremental historical and estimated future costs related to the year
2000 issue are not expected to be material to the financial position or results
of operations of the Company for several reasons. Most of the remediation is
being accomplished with upgrades to existing software that are under maintenance
contracts. The implementation of the major information technology systems was
not accelerated to remedy year 2000 problems. Independent quality assurance
services and tools are to be used to assure the reliability of the assessment
and costs. These services will be supplemented with Company resources. Costs for
all year 2000 activities are estimated to be less than $7.0 million.

On December 30, 1998, the Company acquired Quaker State. During 1998,
Quaker State continued to make progress in addressing the issue of computer
systems and embedded computer chips that may be unable to accommodate the year
2000. As of the acquisition date, Quaker State had completed reviews of computer
systems and embedded technologies at all locations other than its blending and
packaging facilities. It is expected that the assessment at the blending and
packaging facilities will be completed by the end of the first quarter of 1999.
In addition, certain aspects of Quaker State's year 2000 program included not
upgrading or replacing certain systems as they were deemed to be redundant as a
result of the acquisition by the Company. These systems are currently being
evaluated and replaced.

The Company has a June 30, 1999 target readiness date for all major phases
of its year 2000 preparations. The Company's existing emergency response plan
will be re-evaluated in the fourth quarter of 1999, using the latest information
available for infrastructure services such as utilities. Adjustments to this
plan will be made based on this information.

Forward-looking statements contained under this "Year 2000 Issues" subpart
should be read in conjunction with the Company's disclosures under the heading:
"Forward-Looking Statements - Safe Harbor Provisions."

OTHER MATTERS. The Company does not currently consider the impact of
inflation to be significant in the businesses in which the Company operates.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information required by Item 305 of Regulation S-K is included under
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations."

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The consolidated financial statements of Pennzoil-Quaker State, together
with the report thereon of Arthur Andersen LLP dated March 11, 1999 and the
supplementary financial data specified by Item 302 of Regulation S-K, are set
forth on pages F-1 through F-32 hereof. (See Item 14 for Index.)

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not Applicable.

20
23

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

The information appearing under the captions "Nominees," "Directors with
Terms Expiring in 2000 and 2001" and "Compliance with Section 16(a) of the
Exchange Act" set forth within the section entitled "Election of Directors" in
the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934 is incorporated herein by reference.
See also Item S-K 401(b) appearing in Part I of this Annual Report on Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION.

The information appearing under the captions "Director Remuneration" set
forth within the section entitled "Election of Directors" and under the captions
"Executive Compensation" and "Compensation Committee Interlocks and Insider
Participation" in the Company's definitive Proxy Statement to be filed pursuant
to Regulation 14A under the Securities Exchange Act of 1934 is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The information appearing under the caption "Security Ownership of
Directors and Officers" set forth within the section entitled "Election of
Directors" and under the caption "Security Ownership of Certain Shareholders"
set forth within the section entitled "Additional Information" in the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A under the
Securities Exchange Act of 1934 is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

The information appearing under the captions "Director Remuneration" and
"Certain Transactions" set forth within the section entitled "Election of
Directors" and under the caption "Security Ownership of Certain Shareholders"
set forth within the section entitled "Additional Information" and under the
caption "Compensation Committee Interlocks and Insider Participation" in the
Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934 is incorporated herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

(A)(1) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

PAGE
----

Report of Independent Public Accountants.................... F-1
Consolidated Statement of Operations........................ F-3
Consolidated Balance Sheet.................................. F-4
Consolidated Statement of Shareholders' Equity.............. F-6
Consolidated Statement of Cash Flows........................ F-7
Consolidated Statement of Comprehensive Income.............. F-8
Notes to Consolidated Financial Statements.................. F-9

The supplementary financial data specified by Item 302 of Regulation S-K
are included in "Supplemental Financial and Statistical
Information -- Unaudited" beginning on page F-32.

21
24

(a)(2) FINANCIAL STATEMENT SCHEDULES.

Schedules of the Company and its subsidiaries are omitted because of the
absence of the conditions under which they are required or because the required
information is included in the financial statements or notes thereto.

(a)(3) EXHIBITS.

EXHIBIT INDEX

EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------

*3.2 -- Restated Certificate of Incorporation of the Company
(filed as exhibit 4.2 to the Current Report on Form 8-K
of the Company filed on December 29, 1998 (File No.
001-14501) and incorporated herein by reference).
*3.4 -- By-Laws of the Company (filed as Exhibit 4.2 to the
Registration Statement on Form S-8 of the Company
(Registration No. 333-72835) and incorporated herein by
reference).
*3.5 -- Form of Common Stock Certificate of the Company (filed as
Exhibit 3.5 to the Registration Statement on Form S-4 of
the Company (Registration No. 333-61541) and incorporated
herein by reference).
*3.6 -- Rights Agreement dated as of December 18, 1998 between
the Company and The Chase Manhattan Bank (filed as
Exhibit 1 to the Current Report on Form 8-K of the
Company filed on December 18, 1998 (File No. 001-14501)
and incorporated herein by reference).
10.1 -- Credit Agreement dated as of November 17, 1998 among
Pennzoil Products Company and the lenders named therein
+*10.2 -- Pennzoil-Quaker State Company 1998 Incentive Plan (filed
as Exhibit 4.3 to the Registration Statement of the
Company on Form S-8 (Registration No. 333-69837) and
incorporated herein by reference).
+*10.3 -- Form of Indemnification Agreement between Pennzoil-Quaker
State Company and directors and executive officers of the
Company (filed as Exhibit 10.7 to the Registration
Statement of the Company on Form S-4 (Registration No.
333-61541) and incorporated herein by reference).
+10.4 -- Pennzoil-Quaker State Company Deferred Compensation Plan
+10.5 -- Pennzoil-Quaker State Company Medical Expenses
Reimbursement Plan
+10.6 -- Pennzoil-Quaker State Company Supplemental Disability
Plan
+10.7 -- Pennzoil-Quaker State Company Salary Continuation Plan
+10.8 -- Pennzoil-Quaker State Company Supplemental Life Insurance
Plan
+10.9 -- Pennzoil-Quaker State Company Executive Severance Plan
+10.10 -- Form of Pennzoil-Quaker State Company Supplemental
Medical and Retirement Benefits Agreement
+10.11 -- Employment Agreement between the Company and James J.
Postl
12.1 -- Computation of Ratio of Earnings to Fixed Charges for the
years ended December 31, 1998, 1997, 1996, 1995 and 1994.
21.1 -- Subsidiaries of Pennzoil-Quaker State Company

22
25

EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------

23.1 -- Consent of Arthur Andersen LLP.
23.2 -- Consent of PricewaterhouseCoopers LLP.
24.1 -- Powers of Attorney
27.1 -- Financial Data Schedule.
99.1 -- Financial Statements of Excel Paralubes.

- ---------------

* Incorporated by reference as indicated.

+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.

(b) REPORTS ON FORM 8-K.

Pennzoil-Quaker State filed the following Current Reports on Form 8-K with
the Securities and Exchange Commission during the quarter ended December 31,
1998:

DATE OF REPORT ITEMS REPORTED
-------------- --------------

December 14, 1998.................................. Adoption of a shareholder rights plan.
December 29, 1998.................................. Change of the Company's name to Pennzoil-Quaker
State Company.

23
26

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

PENNZOIL-QUAKER STATE COMPANY

By: /s/ JAMES L. PATE
------------------------------------
(James L. Pate, Chairman of the
Board and
Chief Executive Officer)

Date: March 15, 1999

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----

/s/ JAMES L. PATE Principal Executive Officer March 15, 1999
- ----------------------------------------------------- and Director
(James L. Pate, Chairman of the Board and
Chief Executive Officer)

/s/ DAVID P. ALDERSON II Principal Financial and March 15, 1999
- ----------------------------------------------------- Accounting Officer
(David P. Alderson II, Group Vice President,
Chief Financial Officer and Treasurer
HOWARD H. BAKER, JR.*
W. L. LYONS BROWN, JR.*
ERNEST H. COCKRELL*
ALFONSO FANJUL*
C. FREDERICK FETTEROLF*
FORREST R. HASELTON* A majority of the Directors March 15, 1999
BERDON LAWRENCE* of the Registrant
L. DAVID MYATT*
JAMES J. POSTL*
GERALD B. SMITH*
LORNE R. WAXLAX*

*By: /s/ DAVID P. ALDERSON II
------------------------------------------------
(David P. Alderson II, Attorney-In-Fact)

24
27

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Pennzoil-Quaker State Company:

We have audited the accompanying consolidated balance sheet of
Pennzoil-Quaker State Company (a Delaware corporation) and subsidiaries, as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity, cash flows and comprehensive income for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of Excel Paralubes (a
50%-owned equity investee of Pennzoil-Quaker State Company), the investment in
which is reflected in the accompanying financial statements using the equity
method of accounting. The equity in Excel Paralubes net income represents 17
percent of Pennzoil-Quaker State Company's net loss for the year ended December
31, 1998. The summarized financial data for Excel Paralubes contained in Note 5
are derived from the financial statements of Excel Paralubes. We also did not
audit the financial statements of Quaker State Corporation as of and for the
years ended December 31, 1997 and 1996. The summarized financial data for Quaker
State Corporation contained in Note 5 are derived from the financial statements
of Quaker State Corporation. The financial statements of Excel Paralubes and
Quaker State Corporation were audited by other auditors whose reports have been
furnished to us and our opinion, insofar as it relates to the amounts and
disclosures included for Excel Paralubes and Quaker State Corporation for the
indicated periods described above, is based solely on the reports of the other
auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of the other auditors provide a
reasonable basis for our opinion.

In our opinion, based on our audits and the reports of the other auditors,
the financial statements referred to above present fairly, in all material
respects, the financial position of Pennzoil-Quaker State Company and
subsidiaries as of December 31, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Houston, Texas
March 11, 1999

F-1
28

[THIS PAGE INTENTIONALLY LEFT BLANK]

F-2
29

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

YEAR ENDED DECEMBER 31
------------------------------------
1998 1997 1996
---------- ---------- ----------
(EXPRESSED IN THOUSANDS EXCEPT FOR
PER SHARE AMOUNTS)

REVENUES
Net sales.............................................. $1,801,676 $1,982,148 $1,961,316
Other income, net...................................... 48,462 31,012 6,697
---------- ---------- ----------
1,850,138 2,013,160 1,968,013
COSTS AND EXPENSES
Cost of sales.......................................... 1,279,220 1,182,742 1,202,909
Purchases from affiliate............................... 115,703 336,413 342,046
Selling, general and administrative.................... 339,799 350,123 315,022
Depreciation and amortization.......................... 77,210 64,490 51,918
Acquisition related expenses (Note 2).................. 10,645 -- --
Impairment of long-lived assets (Note 3)............... 29,613 -- --
Taxes, other than income............................... 12,210 11,956 11,339
Interest charges....................................... 13,826 12,847 12,208
Affiliated interest.................................... 56,372 56,374 52,966
Interest capitalized................................... (255) (7,441) (10,103)
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAX.......................... (84,205) 5,656 (10,292)
Income tax provision (benefit)........................... (38,338) 6,245 (1,103)
---------- ---------- ----------
NET LOSS................................................. $ (45,867) $ (589) $ (9,189)
========== ========== ==========
BASIC AND DILUTED LOSS PER SHARE......................... $ (0.96) $ (0.01) $ (0.19)
========== ========== ==========

See Notes to Consolidated Financial Statements.

F-3
30

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

ASSETS

DECEMBER 31
------------------------
1998 1997
---------- ----------
(EXPRESSED IN THOUSANDS)

CURRENT ASSETS (NOTE 2)
Cash and cash equivalents................................. $ 14,899 $ 9,132
Receivables............................................... 291,997 143,303
Inventories
Crude oil.............................................. 6,911 14,245
Motor oil and refined products......................... 299,601 184,028
Materials and supplies, at average cost................... 12,422 11,814
Deferred income taxes..................................... 47,413 --
Other current assets...................................... 63,328 36,838
---------- ----------
TOTAL CURRENT ASSETS.............................. 736,571 399,360
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, at cost
Lubricants and consumer products.......................... 336,946 238,958
Fast lube operations...................................... 399,447 228,048
Base oil and specialty products........................... 937,039 943,972
Other..................................................... 47,562 297
---------- ----------
TOTAL PROPERTY, PLANT AND EQUIPMENT............... 1,720,994 1,411,275
Less accumulated depreciation and amortization............ 688,918 621,098
---------- ----------
NET PROPERTY, PLANT AND EQUIPMENT................. 1,032,076 790,177
---------- ----------
DEFERRED INCOME TAXES....................................... 36,614 --
OTHER ASSETS
Goodwill.................................................. 1,104,353 158,489
Other..................................................... 235,380 211,597
---------- ----------
TOTAL OTHER ASSETS................................ 1,339,733 370,086
---------- ----------
TOTAL ASSETS................................................ $3,144,994 $1,559,623
========== ==========

See Notes to Consolidated Financial Statements.

F-4
31

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

LIABILITIES AND SHAREHOLDERS' EQUITY

DECEMBER 31
-------------------------
1998 1997
----------- -----------
(EXPRESSED IN THOUSANDS)

CURRENT LIABILITIES (NOTE 2)
Current maturities of long-term debt...................... $ 1,283 $ 2,363
Accounts payable.......................................... 245,721 120,577
Payable to affiliate...................................... -- 544,390
Payroll accrued........................................... 18,734 17,825
Other current liabilities................................. 147,609 46,161
---------- ----------
TOTAL CURRENT LIABILITIES......................... 413,347 731,316
---------- ----------
LONG-TERM DEBT, less current maturities
Long-term debt payable to affiliate....................... -- 336,172
Long-term debt............................................ 1,026,054 49,798
---------- ----------
TOTAL LONG-TERM DEBT, less current maturities..... 1,026,054 385,970
---------- ----------
DEFERRED INCOME TAXES....................................... -- 1,179
CAPITAL LEASE OBLIGATIONS................................... 74,464 67,136
OTHER LIABILITIES........................................... 280,922 117,642
---------- ----------
TOTAL LIABILITIES................................. 1,794,787 1,303,243
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 12)
SHAREHOLDERS' EQUITY
Common stock, par value $0.10 per share -- authorized
100,000,000 shares, issued and outstanding shares of
77,619,765 at December 31, 1998 and 47,846,502 at
December 31, 1997...................................... 7,762 4,785
Additional capital........................................ 1,532,531 395,233
Accumulated deficit....................................... (180,216) (134,349)
Net unrealized holding loss on investments in
securities............................................. (843) (1,768)
Cumulative foreign currency translation adjustment........ (9,027) (7,521)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY........................ 1,350,207 256,380
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $3,144,994 $1,559,623
========== ==========

See Notes to Consolidated Financial Statements.

F-5
32

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

YEAR ENDED DECEMBER 31
-------------------------------------------------------------
1998 1997 1996
------------------- ------------------ ------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ---------- ------ --------- ------ ---------
(EXPRESSED IN THOUSANDS)

COMMON STOCK, $0.10 par --
Authorized 100,000,000 shares
Balance January 1....................... 47,847 $ 4,785 47,847 $ 4,785 47,847 $ 4,785
Acquisition of Quaker State
Corporation........................ 29,773 2,977 -- -- -- --
------ ---------- ------ --------- ------ ---------
Balance December 31..................... 77,620 7,762 47,847 4,785 47,847 4,785
------ ---------- ------ --------- ------ ---------
ADDITIONAL CAPITAL
Balance January 1....................... 395,233 366,653 345,422
Capital contribution from
affiliate.......................... 412,448 28,580 21,231
Acquisition of Quaker State
Corporation........................ 724,850 -- --
---------- --------- ---------
Balance December 31..................... 1,532,531 395,233 366,653
---------- --------- ---------
ACCUMULATED DEFICIT
Balance January 1....................... (134,349) (133,760) (124,389)
Net loss............................. (45,867) (589) (9,189)
Dividends on common stock............ -- -- (182)
---------- --------- ---------
Balance December 31..................... (180,216) (134,349) (133,760)
---------- --------- ---------
NET UNREALIZED HOLDING LOSS ON INVESTMENTS
IN SECURITIES
Balance January 1....................... (1,768) -- --
Change in unrealized holding loss.... 925 (1,768) --
---------- --------- ---------
Balance December 31..................... (843) (1,768) --
---------- --------- ---------
CUMULATIVE FOREIGN CURRENCY TRANSLATION
ADJUSTMENT
Balance January 1....................... (7,521) (1,937) (1,023)
Change in translation adjustment..... (1,506) (5,584) (914)
---------- --------- ---------
Balance December 31..................... (9,027) (7,521) (1,937)
------ ---------- ------ --------- ------ ---------
TOTAL SHAREHOLDERS' EQUITY................ 77,620 $1,350,207 47,847 $ 256,380 47,847 $ 235,741
====== ========== ====== ========= ====== =========

See Notes to Consolidated Financial Statements.

F-6
33

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

YEAR ENDED DECEMBER 31
---------------------------------
1998 1997 1996
--------- --------- ---------
(EXPRESSED IN THOUSANDS)

CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................ $ (45,867) $ (589) $ (9,189)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization........................ 77,210 64,490 51,918
Impairment of long-lived assets...................... 29,613 -- --
Deferred income taxes (benefit)...................... (38,814) 36,029 28,628
Gain on sales of assets.............................. (4,357) (3,072) (10,904)
Distributions from equity investees in excess of
earnings........................................... 27,834 23,774 --
Non-cash accruals.................................... 53,830 25,366 17,248
Other non-cash items................................. 25,969 3,555 8,558
Change in operating assets and liabilities (Note
3)................................................. (221,605) 35,227 111,949
--------- --------- ---------
Net cash provided by (used in) operating
activities.................................... (96,187) 184,780 198,208
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures.................................... (88,340) (147,794) (251,186)
Acquisition of Snap Automotive Products assets.......... -- (41,000) --
Proceeds from sales of assets........................... 26,539 14,350 13,457
Other investing activities.............................. 14,634 (28,222) (3,043)
--------- --------- ---------
Net cash used in investing activities........... (47,167) (202,666) (240,772)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Commercial paper borrowings............................. 488,409 -- 1,673
Debt repayments......................................... (8,405) (10,457) (17,304)
Proceeds from issuances of debt......................... 13,457 8,500 43,679
Proceeds from note payable to affiliate................. 25,622 13,178 19,845
Payment of intercompany indebtedness to affiliate....... (369,962) -- --
--------- --------- ---------
Net cash provided by financing activities....... 149,121 11,221 47,893
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...... 5,767 (6,665) 5,329
CASH AND CASH EQUIVALENTS, beginning of period............ 9,132 15,797 10,468
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of period.................. $ 14,899 $ 9,132 $ 15,797
========= ========= =========

See Notes to Consolidated Financial Statements.

F-7
34

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
-------- -------- --------
(EXPRESSED IN THOUSANDS)

NET LOSS.................................................... $(45,867) $ (589) $ (9,189)
Change in:
Foreign currency translation adjustment................... (1,506) (5,584) (914)
Unrealized loss on investment in securities............... 925 (1,768) --
-------- -------- --------
(581) (7,352) (914)
-------- -------- --------
COMPREHENSIVE LOSS.......................................... $(46,448) $ (7,941) $(10,103)
======== ======== ========

See Notes to Consolidated Financial Statements.

F-8
35

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) SPIN-OFF FROM PENNZOIL COMPANY AND PRINCIPLES OF CONSOLIDATION --

Spin-off from Pennzoil Company --

On December 30, 1998, Pennzoil Company distributed (the "Spin-off") to its
stockholders 47.8 million shares of common stock of its wholly owned subsidiary
Pennzoil-Quaker State Company ("Pennzoil-Quaker State" or the "Company")
representing all of the shares of the Company owned by Pennzoil Company. As a
result of the distribution, Pennzoil Company, now renamed PennzEnergy Company
("PennzEnergy"), and Pennzoil-Quaker State are no longer affiliated entities.

Principles of Consolidation --

Pennzoil-Quaker State is engaged primarily in the manufacturing and
marketing of lubricants, car care products, base oils and specialty industrial
products and in the franchising, ownership and operation of fast lube centers.
The accompanying consolidated financial statements include all majority-owned
subsidiaries of the Company, including Jiffy Lube International, Inc. ("Jiffy
Lube"), Pennzoil Sales Company, certain assets and liabilities of Pennzoil
Company's captive insurance company (that is now a subsidiary of the Company)
and certain assets and liabilities previously reported in Pennzoil Company's
corporate segment. These financial statements reflect the historical costs and
results of operations of Pennzoil-Quaker State. All significant intercompany
accounts and transactions within Pennzoil-Quaker State have been eliminated.
Pennzoil-Quaker State follows the equity method of accounting for investments in
20% to 50% owned entities.

(2) ACQUISITIONS --

Acquisition of Quaker State --

On December 30, 1998, the Company acquired Quaker State Corporation
("Quaker State") in a merger transaction, and Quaker State became a wholly owned
subsidiary of the Company. As a result of the acquisition, stockholders of
Quaker State received .8204 of a share of common stock of the Company in
exchange for each share of Quaker State capital stock previously owned. The
total purchase price, including acquisition-related costs and expenses, was
$812.1 million.

Pennzoil-Quaker State has accounted for the acquisition using the purchase
method of accounting. The purchase price, which was calculated based on the
market capitalization of Quaker State, was allocated to the assets and
liabilities acquired based upon the estimated fair value of those assets and
liabilities as of the acquisition date. The excess of the aggregate purchase
price over estimated fair value of the net assets acquired has been reflected as
goodwill in the consolidated financial statements and is being amortized on a
straight-line basis over 40 years. The purchase price was allocated as follows
(in thousands):

Fair value of assets acquired............................... $659,071
Goodwill and intangible assets.............................. 943,398
Fair value of liabilities assumed........................... (874,642)
--------
Net purchase price.......................................... 727,827
Quaker State acquisition-related costs and expenses......... 80,557
Pennzoil-Quaker State acquisition-related costs and
expenses.................................................. 3,720
--------
Total purchase price........................................ $812,104
========

The consolidated financial statements reflect the preliminary allocation of
purchase price. A final allocation of the purchase price will be made by the end
of 1999. Pennzoil-Quaker State does not anticipate material changes in the
allocation of the purchase price.

Pennzoil-Quaker State recognized certain liabilities assumed in connection
with the acquisition of Quaker State totaling $27.9 million and adjusted the
purchase cost accordingly. The preliminary allocation of

F-9
36
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the purchase price to liabilities assumed included (a) $16.6 million in
severance costs for certain Quaker State employees, (b) $9.0 million in closing
costs of Quaker State's Q Lube company-operated fast lube service centers and
(c) $2.3 million in relocation costs of certain Quaker State employees.

Pennzoil-Quaker State also incurred $10.6 million in 1998 expenses related
to the acquisition of Quaker State. These charges were the result of
management's changes in strategic plans, restructurings and reorganizations
related to the acquisition and were primarily due to the estimated costs of
closing Jiffy Lube company-operated fast lube service centers and the resolution
of certain conflicts between Jiffy Lube and Q Lube franchise-operated service
centers.

The Company expects to incur additional acquisition-related costs and
expenses in future periods and will adjust the preliminary purchase price
allocation or charge these amounts to income, as appropriate, depending on their
nature. These future costs and expenses relate to additional facility closings,
conflict resolution between franchise-operated service centers, employee
severance, systems integration and conversion costs of Q Lube franchise-operated
service centers. These costs and expenses are not accruable until a plan is
formulated and approved and amounts are paid or certain obligations are
contractually committed. The restructurings and reorganizations related to the
Quaker State acquisition are expected to be completed by the end of 1999.

Acquisition-related expenses incurred by Quaker State prior to the
acquisition of $80.6 million were recognized in Quaker State's 1998 results of
operations and are not included in Pennzoil-Quaker State's results of operations
for 1998.

The following unaudited pro forma information has been prepared as if the
acquisition of Quaker State occurred on January 1, 1997 after including
amortization of goodwill, brands and other intangible assets, interest expense
and related income tax effects. The unaudited pro forma information does not
reflect adjustments for any estimated general and administrative expense
savings, operational efficiencies and one-time costs related to the acquisition
of Quaker State. The unaudited pro forma information is not necessarily
indicative of results that would have actually occurred had the acquisition of
Quaker State been consummated on January 1, 1997 or future results of
operations.

YEARS ENDED DECEMBER 31,
-------------------------
1998 1997
----------- -----------
(EXPRESSED IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

Revenues.................................................... $3,021,565 $3,217,020
Net loss(1)................................................. (33,191) (1,729)
Basic and diluted loss per share............................ (0.43) (0.02)

- ---------------

(1) The 1998 net loss includes certain nonrecurring after-tax charges of $82.5
million ($124.5 million pretax) related to the acquisition of Quaker State,
impairment of long-lived assets, restructuring and other matters.

Acquisition of Assets of Snap Automotive Products --

In November 1997, the Company acquired the marketing and distribution
assets of Snap Automotive Products, Inc. for $41.0 million in cash. The
acquisition was accounted for using the purchase method of accounting, and the
results of operations of Snap subsequent to November 1997 have been included in
Pennzoil-Quaker State's consolidated statement of operations.

(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --

Use of Estimates --

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and

F-10
37
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

Receivables --

Current receivables include trade accounts and notes receivable and are net
of allowances for doubtful accounts of $18.2 million and $7.7 million at the end
of 1998 and 1997, respectively. Long-term receivables consist of notes
receivable and are net of allowances for doubtful accounts of $0.9 million at
the end of 1998 and 1997.

The Company's net accounts receivable sold under its receivables sales
facility totaled $115.0 million and $103.3 million as of December 31, 1998 and
1997, respectively. The Company entered into a new one-year receivables sales
facility in February 1999 that provides for ongoing sales of up to $120.0
million of accounts receivable.

The Company maintains a lube center receivable purchase and sale agreement,
which provides for the sale of certain notes receivables up to $150.0 million.
The agreement terminates on March 13, 2001 or on the date on which the aggregate
purchase price reaches $150.0 million. The Company's notes receivable sold under
the agreement totaled $97.3 million and $70.8 million as of December 31, 1998
and 1997, respectively.

Inventories --

A majority of inventories is reported at cost using the last-in, first-out
("LIFO") method, which is lower than market. Substantially all other inventories
are reported at cost using the first-in, first-out method. Inventories valued on
the LIFO method totaled $187.5 million and $146.4 million at December 31, 1998
and 1997, respectively. The current cost of LIFO inventories was approximately
$187.5 million and $170.7 million at December 31, 1998 and 1997, respectively.

Property, Plant and Equipment and Depreciation and Amortization --

Property, plant and equipment additions are recorded at cost. Depreciation
of property, plant and equipment is computed using the straight-line or
accelerated methods over estimated useful lives. Pennzoil-Quaker State
capitalizes the interest cost associated with major construction projects based
on the effective interest rate on aggregate borrowings.

Impairment of Long-Lived Assets --

Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" requires that long-lived assets be reviewed for impairment whenever there is
evidence that the carrying amount of such assets may not be recoverable. This
consists of comparing the carrying amount of the asset with its expected future
undiscounted cash flows without interest costs. If the asset carrying amount is
less than such cash flow estimate, it is written down to its fair value.
Estimates of expected future cash flows are to represent management's best
estimate based on reasonable and supportable assumptions. Any impairment
recognized in accordance with SFAS No. 121 is permanent and may not be restored.
Due principally to the incurrence of operating losses at certain Jiffy Lube
company-operated stores, an impairment totaling $29.6 million was recorded with
respect to such stores during 1998. No long-lived asset impairments were
required during 1997 or 1996.

F-11
38
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Intangible Assets --

Substantially all intangible assets relate to goodwill recognized in
business combinations accounted for as purchases. Goodwill is being amortized on
a straight-line basis over periods ranging from 20 to 40 years. Amortization
expense recorded in 1998, 1997 and 1996 was $14.1 million, $13.1 million and
$10.6 million, respectively.

Deferred Refinery Turnaround Costs --

A turnaround is a periodically required standard procedure for maintenance
of a refinery, which involves the shutdown and inspection of major processing
units and generally occurs approximately every three years. The estimated costs
of major maintenance, including turnarounds at refineries, are accrued. Accruals
for turnarounds included in other current and long-term liabilities in the
accompanying consolidated balance sheet were $15.2 million and $10.0 million at
December 31, 1998 and 1997, respectively. Other expenditures for maintenance and
repairs are charged to expense when incurred. Renewals and improvements are
treated as additions to property, plant and equipment, and items replaced are
treated as retirements.

Environmental Expenditures --

Environmental expenditures are expensed or capitalized in accordance with
generally accepted accounting principles. Liabilities for these expenditures are
recorded when it is probable that obligations have been incurred and the amounts
can be reasonably estimated. Reference is made to Note 12 for a discussion of
amounts recorded for these liabilities.

Cash Flow Information --

For purposes of the consolidated statement of cash flows, all highly liquid
investments purchased with a maturity of three months or less are considered to
be cash equivalents. The effect of changes in foreign exchange rates on cash
balances has been immaterial. No cash was paid or received for income taxes in
1998, 1997 or 1996.

Changes in operating assets and liabilities consist of the following:

YEAR ENDED DECEMBER 31
-------------------------------
1998 1997 1996
--------- -------- --------
(EXPRESSED IN THOUSANDS)

Receivables................................................. $ (31,277) $(30,432) $118,567
Inventories................................................. (21,077) (34,121) (13,115)
Other assets................................................ (21,855) (30,011) 8,040
Payable to Pennzoil Company(1).............................. (60,000) 153,535 56,131
Other current liabilities................................... (43,824) (1,751) (20,918)
Other operating assets and liabilities...................... (43,572) (21,993) (36,756)
--------- -------- --------
Decrease (increase) in operating assets and liabilities..... $(221,605) $ 35,227 $111,949
========= ======== ========
Cash paid during the period for:
Interest (net of amounts capitalized)..................... $ 13,256 $ 4,954 $ 1,708

- ---------------

(1) Historically, changes in operating cash flows pertaining to intercompany
balances were a function of the timing of intercompany settlements, level of
investment activity and operating performance of the user of such funds.

F-12
39
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Earnings Per Share --

Pennzoil-Quaker State computes earnings per share in accordance with SFAS
No. 128, "Earnings Per Share." Under the provisions of SFAS No. 128, basic
earnings per share are computed based on the weighted average shares of common
stock outstanding, while diluted earnings per share also reflects the impact of
potentially dilutive securities such as outstanding options. Computations for
basic and diluted loss per share for the years ended 1998, 1997 and 1996 consist
of the following:

YEAR ENDED DECEMBER 31
-------------------------------
1998 1997 1996
--------- -------- --------
(EXPRESSED IN THOUSANDS EXCEPT
PER SHARE AMOUNTS)

Net loss.................................................... $(45,867) $ (589) $(9,189)
Basic and diluted weighted average shares(1)................ 48,009 47,847 47,847
Basic and diluted loss per share............................ (0.96) (0.01) (0.19)

- ---------------

(1) At December 31, 1998, options to purchase 3,409,474 shares of common stock
and awards of 137,636 were outstanding, but were not included in the
computation of diluted per share income because the impact of these options
and awards was antidilutive.

International Operations --

Pennzoil-Quaker State's income (loss) before income tax includes losses of
$0.3 million, $9.3 million and $8.9 million from international operations in
1998, 1997 and 1996, respectively.

Foreign Currency Translation --

For subsidiaries whose functional currency is deemed to be other than the
U.S. dollar, asset and liability accounts are translated at year-end exchange
rates and revenue and expenses are translated at average exchange rates
prevailing during the year. Translation adjustments are included as a separate
component of shareholders' equity. Any gains or losses on transactions or
monetary assets or liabilities in currencies other than the functional currency
are included in net income in the current period.

Comprehensive Income --

Effective January 1, 1998, Pennzoil-Quaker State adopted SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
display of comprehensive income and its components. SFAS No. 130 requires
companies to report, in addition to net income, other components of
comprehensive income including unrealized gains or losses on available-for-sale
securities and foreign currency translation adjustments and the related tax
effects. For the years ended December 31, 1998 and 1997, unrealized holding
gains (losses) on marketable securities includes income tax (benefit) of $0.5
million and ($1.0) million, respectively. There were no unrealized holding gains
or losses on investments in securities in 1996. There has been no recorded tax
benefit associated with foreign currency translation losses through December 31,
1998.

Recent Accounting Pronouncements --

In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosure about Segments of an Enterprise and Related Information."
Under the new standard, companies are required to report information about
operating segments in consolidated financial statements. Operating segments are
determined based on the method by which management organizes its business for
making operating decisions and assessing performance. Pennzoil-Quaker State,
which has three reportable segments, adopted the provisions of SFAS No. 131 and
has included segment financial information in Note 14.

In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for
F-13
40
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Internal Use." SOP No. 98-1 is effective for fiscal years beginning after
December 15, 1998 and earlier adoption is permitted. The adoption of SOP No.
98-1 is not expected to have a material impact on Pennzoil-Quaker State's
financial position or results of operations.

In April 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of
Start-Up Activities." The SOP is effective for financial statements for fiscal
years beginning after December 15, 1998 and earlier adoption is permitted.
Pennzoil-Quaker State is currently evaluating the implementation of SOP No.
98-5.

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
The SFAS requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting. SFAS No. 133 is effective for
fiscal years beginning after June 15, 1999 and early adoption is permitted. The
effect of adopting SFAS No. 133 has not been determined, but is not expected to
have a material impact on Pennzoil-Quaker State's financial position or results
of operations.

(4) TRANSACTIONS WITH PENNZOIL COMPANY --

Purchases from Affiliate --

Purchases from affiliate include purchases of crude oil from Pennzoil
Company at market prices of $115.7 million, $336.4 million and $342.0 million in
1998, 1997 and 1996, respectively.

Allocated General and Administrative Expenses and Other Items --

PennzEnergy and Pennzoil-Quaker State have an arrangement to share certain
services for a period of up to one year after the date of the Spin-off. Any or
all of the services being provided may be discontinued with at least 30 days
prior written notice of the discontinuation. Shared services include legal,
environmental, human resources, finance, treasury, accounting, information
technology, corporate communications, corporate secretary, executive and
government relations. Fees are paid based upon actual costs of providing these
services.

Prior to the Spin-off, Pennzoil Company charged Pennzoil-Quaker State for
all direct costs associated with its operations. In addition, certain indirect
administrative costs incurred by Pennzoil Company that were not directly charged
to Pennzoil-Quaker State were historically allocated through a monthly charge
based on a formula that considered the relative total assets, sales and
employees of its subsidiary companies. These charges totaled $76.0 million,
$63.8 million and $42.0 million for the years ended December 31, 1998, 1997 and
1996, respectively.

Receivable from Affiliate --

At December 31, 1998, receivables included amounts due from PennzEnergy of
$11.8 million for borrowings by PennzEnergy after the Spin-off. The full amount
was repaid in 1999.

F-14
41
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(5) SUMMARIZED FINANCIAL DATA --

Quaker State Corporation --

Summarized balance sheet and operations information for Quaker State as of
December 31, 1998 and 1997 and for the three years in the period ended December
31, 1998 follow:

DECEMBER 31
-------------------------
1998 1997
------------ ----------
(EXPRESSED IN THOUSANDS)

Current assets.............................................. $ 316,057 $317,748
Noncurrent assets........................................... 1,286,412 851,967
Current liabilities......................................... 236,513 212,370
Noncurrent liabilities...................................... 638,129 625,444

YEAR ENDED DECEMBER 31
------------------------------------
1998 1997 1996
---------- ---------- ----------
(EXPRESSED IN THOUSANDS)

Revenues........................................... $1,171,427 $1,203,860 $1,121,178
Operating income................................... 85,047 78,361 60,444
Income (loss) from continuing operations........... (74,848) (7,389) 9,651
Net income (loss).................................. (74,848) 23,088 13,723

At December 31, 1998, Quaker State had total debt of $472.7 million,
consisting of $99.6 million of 6.625% Notes due 2005, $370.0 million of variable
rate borrowings under a revolving credit facility and $3.1 million in various
notes due in installments through 2005. On January 4, 1999, variable rate
borrowings under the revolving credit facility were repaid by Pennzoil-Quaker
State.

Excel Paralubes --

The Company and Conoco Inc. ("Conoco") are equal partners in Excel
Paralubes, which operates a state-of-the-art base oil hydro-cracker located at
Conoco's refinery in Lake Charles, Louisiana. The facility is capable of
producing approximately 18,000 barrels per day of high-quality base oils, the
base ingredient in finished lubricants. Conoco operates the plant with support
positions staffed by both companies. Commercial production commenced at the
facility in December 1996.

Pennzoil-Quaker State's net investment in Excel Paralubes, carried as a
credit balance of $51.8 million and $37.4 million at December 31, 1998 and 1997,
respectively, is netted against other equity investments and included in other
assets on the consolidated balance sheet. Pennzoil-Quaker State's 1998, 1997 and
1996 equity in Excel Paralubes' pretax income (loss) of $14.7 million, $(2.8)
million and $(24.3) million, respectively, is included in other income on the
consolidated statement of operations.

Summarized balance sheet and operations information for Excel Paralubes (on
a 100% basis) as of December 31, 1998 and 1997 and for the three years in the
period ended December 31, 1998 follows:

DECEMBER 31
------------------------
1998 1997
---------- -----------
(EXPRESSED IN THOUSANDS)

Current assets.............................................. $ 53,273 56,446
Noncurrent assets........................................... 442,763 457,556
Current liabilities......................................... 80,912 81,617
Noncurrent liabilities...................................... 518,765 507,164
Partners' deficit........................................... (103,641) (74,779)

F-15
42
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
-------- -------- --------
(EXPRESSED IN THOUSANDS)

Revenues............................................... $279,329 $264,388 $ 14,528
Operating earnings (loss).............................. 67,180 32,023 (35,769)
Net income (loss)...................................... 29,488 (5,677) (48,713)

At December 31, 1998, Excel Paralubes had total debt of $559.2 million,
consisting of $240.0 million of 7.125% senior bonds due 2011, $250.0 million of
7.43% senior bonds due 2015, and $69.2 million of variable rate borrowings under
commercial paper facilities with banks. Borrowings under commercial paper
facilities are due in 1999 and are classified as short-term. Recourse for the
partners under the bonds is limited to the revenues and assets of Excel
Paralubes. Certain restrictive covenants may limit the ability of Excel
Paralubes to incur debt, make distributions to the partners, make investments or
create liens. Conoco and Pennzoil-Quaker State maintain an agreement with Excel
Paralubes to provide support to Excel Paralubes up to an aggregate amount of $60
million during the existence of a liquidity cash flow deficit.

(6) BENEFIT PLANS --

Pensions and Other Postretirement Benefits --

Substantially all Pennzoil-Quaker State employees are covered by
non-contributory defined benefit pension plans which provide benefits based on
the participants' years of service and compensation or stated amounts for each
year of service. Contributions to the plans are made in accordance with the
minimum funding provisions of ERISA where applicable, but not in excess of the
maximum amount that can be deducted for federal income tax purposes.

In addition, Pennzoil-Quaker State sponsors unfunded defined benefit
postretirement plans that cover substantially all of its employees. The plans
provide medical and life insurance benefits and are, depending on the type of
plan, either contributory or non-contributory. The accounting for the health
care plans anticipates future cost-sharing changes that are consistent with
Pennzoil-Quaker State's expressed intent to increase, where possible,
contributions from future retirees to a minimum of 30% of the total annual cost.
Furthermore, future contributions for both current and future retirees have been
limited, where possible, to 200% of the average 1992 benefit cost.

Prior to the Spin-off, Pennzoil-Quaker State employees participated in
Pennzoil Company's defined benefit pension and postretirement plans. On December
30, 1998, obligations under the Pennzoil Company plans relating to
Pennzoil-Quaker State's employees and retirees were assumed by Pennzoil-Quaker
State plans. Assets that were formerly held by Pennzoil Company's pension trusts
will be divided between the trusts for Pennzoil Company and Pennzoil-Quaker
State. The pension benefit obligation and plan assets transferred to
Pennzoil-Quaker State from Pennzoil Company as of December 31, 1998 were $175.8
million and $225.6 million, respectively.

Also on December 31, 1998, Pennzoil-Quaker State established postretirement
benefit plans for its employees and retirees separate from Pennzoil Company. The
accumulated postretirement benefit obligation transferred to Pennzoil-Quaker
State from Pennzoil Company as of December 31, 1998 was $37.3 million.

As a result of the acquisition of Quaker State, Pennzoil-Quaker State
assumed the obligations and assets of the pension and postretirement benefit
plans for Quaker State employees. The pension benefit obligation and plan assets
assumed by Pennzoil-Quaker State as of December 31, 1998 are $157.8 million and
$172.6 million, respectively. The accumulated postretirement benefit obligation
assumed by Pennzoil-Quaker State from Quaker State as of December 31, 1998 was
$86.9 million.

F-16
43
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table presents the Pennzoil-Quaker State plans' benefit
obligations, plan assets, reconciliation of funded status, amounts recognized in
the consolidated balance sheets, components of net periodic benefit cost, and
the actuarial assumptions used in determining the recognized obligations:

PENSION BENEFITS OTHER BENEFITS
AS OF DECEMBER 31 AS OF DECEMBER 31
------------------- --------------------
1998 1997 1998 1997
-------- -------- --------- --------
(EXPRESSED IN THOUSANDS)

CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year.......... $159,060 $136,011 $ 39,406 $ 41,935
Service cost.................................. 7,143 5,934 579 761
Interest cost................................. 11,891 10,499 2,607 2,734
Plan amendments............................... 2,342 11,701 -- --
Acquisitions.................................. 157,815 -- 86,902 --
Special termination benefits.................. -- (933) -- --
Benefits paid................................. (7,377) (5,980) (3,266) (2,769)
Actuarial (gain) or loss...................... 2,748 1,828 (2,073) (3,255)
-------- -------- --------- --------
Benefit obligation at end of year................ $333,622 $159,060 $ 124,155 $ 39,406
======== ======== ========= ========
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year... $186,169 $148,692 $ -- $ --
Actual return on plan assets.................. 46,274 44,220 -- --
Acquisitions.................................. 172,600 -- -- --
Employer contributions........................ 515 170 3,266 2,769
Benefits paid................................. (7,377) (5,980) (3,266) (2,769)
Settlement payments........................... -- (933) -- --
-------- -------- --------- --------
Fair value of plan assets at end of year......... $398,181 $186,169 $ -- $ --
======== ======== ========= ========
RECONCILIATION OF FUNDED STATUS:
Over (under) funded status.................... $ 64,559 $ 27,109 $(124,155) $(39,406)
Unrecognized actuarial gain................... (79,899) (59,399) (2,690) (604)
Unrecognized transition asset................. (696) (908) -- --
Unrecognized prior service cost............... 23,686 23,920 -- --
-------- -------- --------- --------
Net amount over (under) funded at year-end....... $ 7,650 $ (9,278) $(126,845) $(40,010)
======== ======== ========= ========
AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE
SHEET CONSIST OF:
Prepaid benefit cost.......................... $ 38,420 $ 11,563 $ -- $ --
Accrued benefit liability..................... (34,060) (24,233) (126,845) (40,010)
Intangible asset.............................. 3,131 3,370 -- --
Accumulated other comprehensive income........ 159 22 -- --
-------- -------- --------- --------
Net asset (liability) recognized at year-end..... $ 7,650 $ (9,278) $(126,845) $(40,010)
======== ======== ========= ========
Other comprehensive income attributable to
change in additional minimum liability
recognition................................. 137 (45)

The benefit obligation for the defined benefit pension plans with benefit
obligations in excess of plan assets was $15.9 million and $114.7 million, as of
December 31, 1998 and December 31, 1997, respectively. The fair value of plan
assets related to these underfunded plans was $105.8 million as of December 31,
1997. No plan assets related to the underfunded plans existed for the plans at
December 31, 1998. A majority of the underfunded plans in 1997 became funded in
1998.

The projected benefit obligation and accumulated benefit obligation for the
defined benefit pension plans with accumulated benefit obligations in excess of
plan assets were $15.9 million and $13.6 million, respectively, as of December
31, 1998, and $8.2 million and $6.3 million, respectively, as of December 31,
1997. The fair value of plan assets was $0.3 million as of December 31, 1997. No
plan assets related to the

F-17
44
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

underfunded plans existed for these plans at December 31, 1998. A majority of
the underfunded plans in 1997 became funded in 1998.

Net periodic benefit cost included the following components:

PENSION BENEFITS OTHER BENEFITS
------------------------------ ------------------------
1998 1997 1996 1998 1997 1996
-------- -------- -------- ------ ------ ------
(EXPRESSED IN THOUSANDS)

COMPONENTS OF NET PERIODIC BENEFIT COST:
Service cost........................ $ 7,142 $ 5,934 $ 5,888 $ 579 $ 760 $ 848
Interest cost....................... 11,891 10,499 9,439 2,607 2,734 2,975
Expected return on plan assets...... (19,810) (16,406) (12,586) -- -- --
Amortization of prior service
cost.............................. 2,570 2,197 1,711 -- -- --
Amortization of transition asset.... (212) (212) (212) -- -- --
Recognized actuarial gain........... (3,252) (2,682) (407) -- -- --
-------- -------- -------- ------ ------ ------
Net periodic benefit cost.............. $ (1,671) $ (670) $ 3,833 $3,186 $3,494 $3,823
======== ======== ======== ====== ====== ======
Additional (gain) or loss recognized due
to:
Curtailment......................... -- -- (903)
Settlement.......................... -- -- 465

Weighted-average assumptions were:

PENSION BENEFITS OTHER BENEFITS
AS OF DECEMBER 31 AS OF DECEMBER 31
----------------------- --------------------
1998 1997 1996 1998 1997 1996
----- ----- ----- ---- ---- ----

Discount rates................................ 7.00% 7.25% 7.50% 7.00% 7.25% 7.50%
Expected long-term rate of return on plan
assets...................................... 10.50% 10.50% 10.50% -- -- --
Rate of compensation increase................. 4.20% 4.60% 4.60% -- -- --

For measurement purposes, a 7% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1998; the rate was assumed
to decrease gradually to 5% through the year 2002 and remain at that level
thereafter. Assumed health care cost trend rates have a significant effect on
the amounts reported for the health care plan. A one percentage-point change in
assumed health care cost trend rates would have the following effects:

ONE-PERCENTAGE ONE-PERCENTAGE
POINT INCREASE POINT DECREASE
-------------- --------------
(EXPRESSED IN THOUSANDS)

Effect on total of service and interest cost components for
1998...................................................... $ 105 $ (112)
Effect on year-end 1998 postretirement benefit obligation... 11,031 (9,722)

Contribution Plans --

Prior to the Spin-off, employees of Pennzoil-Quaker State who had completed
one year of service were also covered by a defined contribution plan of Pennzoil
Company. Employee contributions of not less than 1% to not more than 6% of each
covered employee's compensation were matched between 50% and 100% by Pennzoil
Company. Pennzoil-Quaker State assumed responsibility for the defined
contribution plans related to Pennzoil-Quaker State employees. Pennzoil-Quaker
State was charged $6.2 million, $6.5 million and $6.3 million for such
contributions in 1998, 1997 and 1996, respectively.

F-18
45
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(7) CAPITAL STOCK AND STOCK OPTIONS --

Common Stock --

Pennzoil-Quaker State's Restated Certificate of Incorporation authorizes
the issuance of up to 100,000,000 shares of common stock. At December 31, 1998,
77,619,765 shares were issued and outstanding.

Preferred Stock --

Pennzoil-Quaker State's Restated Certificate of Incorporation authorizes
the issuance of up to 10,000,000 shares of preferred stock. None of these shares
were issued or outstanding at December 31, 1998. On December 14, 1998, the Board
of Directors of Pennzoil-Quaker State declared a dividend of one right to
purchase preferred stock ("Right") for each outstanding share of the
Pennzoil-Quaker State common stock, to stockholders of record at the close of
business on December 18, 1998. Each Right entitles the registered holder to
purchase from Pennzoil-Quaker State a unit consisting of one one-hundredth of a
share of Series A Junior Participating Preferred Stock at a purchase price of
$90 per share upon the occurrence of certain specified events.

Stock Option Plans --

In connection with the Spin-off on December 30, 1998, Pennzoil-Quaker State
issued 3,397,474 stock options, on a one-for-one basis, to the holders of
Pennzoil Company stock options outstanding on that date. The exercise prices
were based upon the original exercise prices of the Pennzoil Company options
allocated in proportion to the market value of common stock of Pennzoil-Quaker
State relative to the market value of common stock of PennzEnergy immediately
following the Spin-off. Also on December 30, 1998, Pennzoil-Quaker State issued
12,000 stock options to former holders of Quaker State stock options who elected
not to redeem their options for cash in connection with the Quaker State
acquisition. The exercise price was based on the original exercise prices of the
Quaker State options adjusted for antidilution. Options issued on December 30,
1998 have a maximum term of ten years and are exercisable under the terms of the
respective option agreements. At December 31, 1998, expiration dates for the
outstanding options ranged from October 1999 to October 2008 and the average
exercise price per share was $26.54. Payment of the exercise price may be made
in cash or in shares of Pennzoil-Quaker State common stock previously owned by
the optionee, valued at the then-current market value.

Such awards are accounted for under the provisions of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." APB
Opinion No. 25 does not require compensation costs to be recorded on options
which have exercise prices at least equal to the market price of the stock on
the date of grant. Accordingly, no compensation cost has been recognized for the
Pennzoil-Quaker State's employee participation in the stock based plans. Prior
to the Spin-off, Pennzoil-Quaker State employees participated in Pennzoil
Company's stock-based compensation plans. The Company was charged $0.8 million,
$1.2 million and $0.6 million in 1998, 1997 and 1996, respectively, for costs
attributable to its employees' participation in those plans.

The following table summarizes information about stock options outstanding
at December 31, 1998:

OPTIONS OUTSTANDING AND EXERCISABLE
-------------------------------------------
NUMBER OF
OPTIONS WEIGHTED WEIGHTED
OUTSTANDING AVERAGE AVERAGE
AND EXERCISABLE CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES AT DEC. 31, 1998 LIFE IN YEARS PRICE
------------------------ ---------------- ------------- --------

$ 5.63-$15.00............................................ 12,000 8.4 $ 6.33
$15.01-$23.00............................................ 1,002,546 6.8 $20.36
$23.01-$30.00............................................ 1,290,478 6.4 $25.76
$30.01-$39.29............................................ 1,104,450 6.7 $33.26
---------
$ 5.63-$39.29............................................ 3,409,474 $26.54

F-19
46
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On December 30, 1998, holders of 137,636 units of Pennzoil Company common
stock granted to participating employees under Pennzoil Company's conditional
stock award programs were granted, on a one-for-one basis, units of
Pennzoil-Quaker State common stock. Awards under the programs are made in the
form of units which entitle the recipient to receive, at the end of a specific
period, subject to certain conditions of continued employment, a number of
shares of Pennzoil-Quaker State common stock equal to the number of units
granted. At December 31, 1998, units covering 137,636 shares of Pennzoil-Quaker
State common stock were outstanding.

(8) INCOME TAXES --

Accounting for Income Taxes --

Pennzoil-Quaker State accounts for income taxes under the provisions of
SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 requires recognition
of deferred tax liabilities and assets for the expected future tax consequences
of events that have been included in the financial statements or tax returns.
Under this method, deferred tax liabilities and assets are determined based on
the difference between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.

Prior to the Spin-off, Pennzoil-Quaker State was included in Pennzoil
Company's consolidated income tax returns. Each subsidiary of Pennzoil Company
with taxable income was charged an amount equal to its taxable income multiplied
by the highest rate imposed on corporations, less allowable credits. If the
subsidiary had a taxable loss, it received credit equal to its taxable loss
multiplied by the highest rate imposed on corporations, plus allowable credits,
for its pro rata share of the tax savings to the consolidated group. Each
subsidiary accrued deferred income taxes on temporary differences between the
book and tax basis of its assets and liabilities.

Federal, State and Foreign --

Federal, state and foreign income tax expense (benefit) consists of the
following:

YEAR ENDED DECEMBER 31
------------------------------
1998 1997 1996
-------- -------- --------
(EXPRESSED IN THOUSANDS)

Current
United States...................................... $ -- $(30,044) $(30,010)
Foreign............................................ 700 239 317
State.............................................. (224) 20 (37)
Deferred
United States...................................... (37,104) 32,470 27,863
Foreign............................................ -- (442) (874)
State.............................................. (1,710) 4,002 1,638
-------- -------- --------
$(38,338) $ 6,245 $ (1,103)
======== ======== ========

F-20
47
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Pennzoil-Quaker State's net deferred tax liability (asset) is as follows:

YEAR ENDED DECEMBER 31
-------------------------
1998 1997
----------- -----------
(EXPRESSED IN THOUSANDS)

Deferred tax liability...................................... $ 194,457 $ 145,641
Deferred tax asset.......................................... (302,327) (166,745)
Valuation allowance......................................... 23,843 22,283
--------- ---------
Net deferred tax liability (asset)................ $ (84,027) $ 1,179
========= =========

Temporary differences and carryforwards which gave rise to significant
portions of deferred tax assets and liabilities are as follows:

YEAR ENDED DECEMBER 31
-------------------------
1998 1997
----------- -----------
(EXPRESSED IN THOUSANDS)

Inventory................................................... $(10,310) $ --
Product liability........................................... (8,750) --
Property, plant and equipment............................... 154,563 103,262
Investments in foreign subsidiaries......................... (7,373) (17,256)
Benefit related accruals.................................... (86,322) (15,283)
Environmental cleanup....................................... (11,088) (4,874)
Alternative minimum tax credit carryforward................. (35,229) (32,595)
Net operating loss carryforwards............................ (52,530) (29,973)
Other, net.................................................. (49,255) (24,385)
Valuation allowance......................................... 22,267 22,283
-------- --------
Net deferred tax liability (asset)................ $(84,027) $ 1,179
======== ========

The principal items accounting for the difference in income taxes on income
computed at the federal statutory rate and income taxes as recorded are as
follows:

YEAR ENDED DECEMBER 31
-----------------------------
1998 1997 1996
-------- ------- --------
(EXPRESSED IN THOUSANDS)

Income tax provision (benefit) at statutory rate...... $(29,472) $ 1,980 $ (3,602)
Increases (reductions) resulting from:
State income taxes, net............................. (1,257) 2,592 1,000
Taxes on foreign income less than statutory rate.... 456 (149) (532)
Nondeductible goodwill.............................. 1,040 1,173 1,173
Spin-off from Pennzoil(1)........................... (9,721) -- --
Other, net.......................................... 616 649 858
-------- ------- --------
Income tax provision (benefit)........................ $(38,338) $ 6,245 $ (1,103)
======== ======= ========

- ---------------

(1) Pennzoil-Quaker State's income tax expense was decreased by approximately
$9.7 million due to the Spin-off from Pennzoil Company. This decrease was
primarily caused by (1) reallocation of net operating losses between
Pennzoil-Quaker State and Pennzoil Company pursuant to Internal Revenue
Service regulations ($4.2 million) and (2) reallocation of income and
expense pursuant to a tax separation agreement ($5.5 million).

In connection with the Spin-off, Pennzoil-Quaker State entered into a tax
separation agreement with PennzEnergy which provides, among other things, that
(1) Pennzoil-Quaker State will be responsible for and

F-21
48
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

indemnify PennzEnergy against all taxes that are attributable to certain
inventory adjustments, (2) PennzEnergy will be responsible for and indemnify
Pennzoil-Quaker State against any other consolidated federal or state income tax
liability for periods ended on or before the date of the Spin-off, (3) any other
taxes will be borne by the party on whom such taxes are imposed by law and (4)
Pennzoil-Quaker State will make a payment to PennzEnergy equal to the greater of
(a) 38% of the aggregate regular taxable income or (b) 24% of the alternative
minimum taxable income for the year ended December 31, 1998. The agreement also
establishes procedures for the conduct and settlement of certain tax audits and
related proceedings. Pennzoil-Quaker State and Quaker State will file separate
tax returns for the 1998 tax year. Pennzoil-Quaker State will file a
consolidated tax return beginning in 1999.

As of December 31, 1998, Pennzoil-Quaker State had a United States net
operating loss carryforward of approximately $60.2 million, which is available
to reduce future federal income taxes payable. Additionally, for the purposes of
determining alternative minimum tax, an approximate $46.6 million net operating
loss is available to offset future alternative minimum taxable income. If not
used, these carryovers will expire in 2018. In addition, Pennzoil-Quaker State
has a separate return limitation loss of $4.5 million and an approximate $3.1
million net operating loss which is available to offset alternative minimum
taxable income. Utilization of these regular and alternative minimum tax net
operating losses, to the extent generated in separate return years, is limited
based on the separate taxable income of the subsidiary, or its successor,
generating the loss. If not used, these carryovers will expire in the years 2000
to 2006. In addition, Pennzoil-Quaker State has approximately $35.2 million of
alternative minimum tax credits indefinitely available to reduce regular tax
liability to the extent it exceeds the related alternative minimum tax otherwise
due. All net operating loss and credit carryover amounts are subject to
examination by the tax authorities.

Pennzoil-Quaker State also had state net operating loss carryforwards, the
tax effect of which was approximately $31.5 million as of December 31, 1998. A
valuation allowance of approximately $22.1 million has been established to
offset the portion of this deferred tax asset related to state tax loss
carryforwards expected to expire before their utilization.

(9) DEBT --

Debt outstanding was as follows:

DECEMBER 31
-------------------------
1998 1997
------------ ----------
(EXPRESSED IN THOUSANDS)

Amounts due Pennzoil Company under revolving credit
arrangements.............................................. $ -- $566,168
6.625% Notes due 2005, net of discount...................... 99,578 --
Pollution control bonds, net of discount.................... 50,544 33,050
International debt facilities............................... 11,033 12,466
Other debt.................................................. 7,773 6,645
Quaker State variable-rate revolving credit agreements...... 370,000 --
Commercial paper............................................ 488,409 --
---------- --------
Total debt........................................ 1,027,337 618,329
Less amounts classified as current maturities............... (1,283) (232,359)
---------- --------
Total long-term debt.............................. $1,026,054 $385,970
========== ========

F-22
49
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

January 1999, the Company repaid these borrowings with borrowings under its
commercial paper facility and terminated the Quaker State revolving credit
facility. The average interest rate applicable to the outstanding Quaker State
revolving credit borrowings was 5.8% during 1998.

Prior to Spin-off, the Company had revolving credit arrangements with
Pennzoil Company that provided for borrowings of up to $590.0 million through
December 31, 1998 and $340.0 million through December 31, 2004. Amounts borrowed
under the credit arrangements bore interest at variable and fixed rates.

In December 1998, in connection with its separation from Pennzoil Company,
the Company repaid $430.0 million in intercompany indebtedness and certain
accounts payable to Pennzoil Company. Intercompany indebtedness of $412.4
million to Pennzoil Company was not repaid and was treated as a capital
contribution to the Company in connection with the separation. This amount was
reclassified from payable to affiliate to shareholders' equity. At December 31,
1997, there was $230.0 million outstanding classified as payable to affiliate
and $336.2 million outstanding classified as long-term debt payable to
affiliate. Interest associated with the affiliated debt was $56.4 million for
the years ended December 31, 1998 and 1997 and $53.0 million for the year ended
December 31, 1996. The average interest rates applicable to amounts outstanding
under these credit arrangements during 1998 was 9.8%.

In December 1997, Pennzoil Company made a capital contribution of $28.6
million to the Company. This amount was reclassified from payable to affiliate
to shareholders' equity.

The Company has a total of $50.5 million, net of discount, in pollution
control bonds issued by three authorities. Issuances by the Industrial
Development Board of the Parish of Caddo, Inc. include $24.6 million issued
December 23, 1996, $8.5 million issued December 19, 1997 and $11.8 million net
of discount, issued December 22, 1998. The three issuances are scheduled for
retirement on December 1, 2026, December 1, 2027 and December 1, 2028,
respectively. Proceeds from the bonds were used to help fund an upgrade to the
Company's Shreveport refinery. The interest rates for the bonds issued in 1996
and 1997 are currently reset weekly and interest is paid monthly. The interest
rate is fixed at 5.6% for the bonds issued in 1998 and interest is paid
semi-annually. Both the Venango Industrial Development Authority pollution
control bonds of $3.4 million and the Butler County Industrial Development
Authority pollution control bonds of $2.3 million were issued on December 21,
1982 and are scheduled for retirement on December 1, 2012. The interest rate on
both bond issuances is currently reset weekly and interest is paid monthly.
Proceeds from the issuances were used to help fund pollution control facilities
related to the Company's refinery and specialty processing facilities in
Pennsylvania, respectively.

As part of the Quaker State acquisition, Pennzoil-Quaker State assumed
$100.0 million of 6.625% notes due 2005 and other debt of $3.1 million due in
various installments through 2005.

The Company's long-term credit facility with a Canadian bank provides for
borrowings of up to C$27.0 million through October 25, 1999. Outstanding
borrowings under the credit facility totaled US$9.6 million and US$12.2 million
at December 31, 1998 and 1997, respectively. The average interest rate
applicable to amounts outstanding under the credit facility were 5.0% and 3.4%
during 1998 and 1997, respectively.

F-23
50
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As of December 31, 1998, borrowings under Pennzoil-Quaker State's
commercial paper programs and the Company's Canadian credit facility totaling
$498.0 have been classified as long-term debt. Such debt classification is based
upon the availability of committed long-term credit facilities to refinance such
short-term facilities and the Company's intent to maintain such commitments in
excess of one year.

At December 31, 1998, aggregated maturities of long-term debt for the years
ending December 31, 1999 through 2003 were $1.3 million, $869.0 million, $0.8
million, $0.7 million and $0.5 million, respectively.

(10) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF
CREDIT RISK --

Financial Instruments With Off-Balance-Sheet Risk --

Pennzoil-Quaker State is a party to various financial instruments with
off-balance-sheet risk as part of its normal course of business, including
financial guarantees and contractual commitments to extend financial guarantees,
credit and other assistance to customers, franchisees and other third parties.
These financial instruments involve, to varying degrees, elements of credit risk
which are not recognized in Pennzoil-Quaker State's consolidated balance sheet.

Other financial guarantees include debt and lease obligation guarantees
with expiration dates of up to 15 years issued to third parties to guarantee the
performance of customers and franchisees in the fast lube industry. Commitments
to extend credit are also provided to fast lube industry participants to finance
equipment purchases, working capital needs and, in some cases, the acquisition
of land and construction of improvements.

Contractual commitments to extend credit and other assistance are in effect
as long as certain conditions established in the respective contracts are met.
Contractual commitments to extend financial guarantees are conditioned on the
occurrence of specified events.

Following are the amounts related to Pennzoil-Quaker State's financial
guarantees and contractual commitments to extend financial guarantees, credit
and other assistance as of December 31, 1998 and 1997.

CONTRACT OR
NOTIONAL AMOUNTS
DECEMBER 31
-----------------
1998 1997
------- -------
(EXPRESSED IN
THOUSANDS)

Financial guarantees relating to Excel Paralubes............ $17,710 $16,790
Other financial guarantees.................................. 20,892 27,902
Commitments to extend financial guarantees:
Guarantees of letters of credit........................... 21,537 28,535
Other guarantees.......................................... 8,930 9,557
------- -------
Total............................................. $69,069 $82,784
======= =======

Pennzoil-Quaker State's exposure to credit losses in the event of
nonperformance by the other parties to these financial instruments is
represented by the contractual or notional amounts. Decisions to extend
financial guarantees and commitments and the amount of remuneration and
collateral required are based on management's credit evaluation of the
counterparties on a case-by-case basis. The collateral held varies but may
include accounts receivable, inventory, equipment, real property, securities and
personal assets. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements.

F-24
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PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Use of Derivatives --

In order to lock in future interest rates covering pending debenture
issuances of $100 million, Pennzoil-Quaker State entered into four interest rate
locks, based upon the 30-year Treasury rate. To accomplish its hedged position,
Pennzoil-Quaker State entered into forward rate agreements in which it will pay
or receive the difference between (1) the 30-year Treasury rate at the time the
forward was entered into and (2) the 30-year Treasury rate at the time of
maturity. Under current accounting standards, these transactions qualify as a
hedge of an anticipated transaction. Any gains or losses from the interest rate
hedges are deferred during the interim period with the offset to a payable or
receivable. Upon maturity of the hedge contracts, any gain or loss will be
treated as an adjustment to the issue price of the debt instrument, effectively
creating a premium or discount that is amortized over the life of the
borrowings. The estimated value of the amount payable by Pennzoil-Quaker State
under its open interest rate hedge was $8.3 million at December 31, 1998, which
has been recorded as a deferred charge in other assets.

Concentrations of Credit Risk --

Pennzoil-Quaker State extends credit to various companies in the lubricants
and consumer products, base oil and specialty products and fast lube operations
segments in the normal course of business. Within these industries, certain
concentrations of credit risk exist. These concentrations of credit risk may be
similarly affected by changes in economic or other conditions and may,
accordingly, impact Pennzoil-Quaker State's overall credit risk. However,
management believes that Pennzoil-Quaker State's receivables are well
diversified, thereby reducing potential credit risk to Pennzoil-Quaker State,
and that allowances for doubtful accounts are adequate to absorb estimated
losses as of December 31, 1998. Pennzoil-Quaker State's policies concerning
collateral requirements and the types of collateral obtained for
on-balance-sheet financial instruments are the same as those described above
under "Financial Instruments With Off-Balance-Sheet Risk."

As of December 31, 1998, receivables related to group concentration in the
lubricants and consumer products, base oil and specialty products and fast lube
operations segments were $274.0 million, $37.4 million and $40.1 million,
respectively, compared with $143.9 million, $16.1 million and $31.5 million,
respectively, at December 31, 1997.

(11) FAIR VALUE OF FINANCIAL INSTRUMENTS --

Balance Sheet Financial Instruments --

The carrying amounts of Pennzoil-Quaker State's short-term financial
instruments, including cash equivalents, other investments, trade accounts
receivable, trade accounts payable and notes payable, approximate their fair
values based on the short maturities of those instruments.

The following table summarizes the carrying amounts and estimated fair
values of Pennzoil-Quaker State's other balance sheet financial instruments.

DECEMBER 31, 1998 DECEMBER 31, 1997
----------------------- ---------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- -------- ----------
(EXPRESSED IN THOUSANDS)

Notes receivable................................ $ 69,848 $ 70,212 $ 52,610 $ 51,314
Debt............................................ 1,027,337 1,000,970 52,161 52,332
Amounts due to affiliate under revolving credit
agreements.................................... -- -- 566,168 644,884

F-25
52
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following methods and assumptions were used to estimate the fair value
of each class of financial instrument included above:

Notes Receivable. The estimated fair value of notes receivable is
based on discounting future cash flows using estimated year-end interest
rates at which similar loans have been made to borrowers with similar
credit ratings for the same remaining maturities.

Debt. The estimated fair value of long-term debt is based on quoted
market prices or, where such prices are not available, on estimated
year-end interest rates of debt with the same remaining average maturities
and credit quality.

Off-Balance-Sheet Financial Instruments --

The estimated fair value of certain financial guarantees written and
commitments to extend financial guarantees was $13.2 million and $16.7 million
as of December 31, 1998 and 1997, respectively. The estimated fair value of
certain financial guarantees written and commitments to extend financial
guarantees is based on the estimated cost to Pennzoil-Quaker State to obtain
third party letters of credit to relieve Pennzoil-Quaker State of its
obligations under such guarantees or, in the case of certain lease guarantees
related to Jiffy Lube franchisees, the present value of expected future cash
flows using a discount rate commensurate with the risks involved.

(12) COMMITMENTS AND CONTINGENCIES --

Environmental Matters --

The operations of the Company in the United States are subject to numerous
federal, state and local laws and regulations controlling the discharge of
materials into the environment or otherwise relating to the protection of the
environment and human health and safety.

The Company is subject to a variety of state and federal Clean Air Act
rules requiring air emission reductions from its operating units and fuels.
Currently, the U.S. Environmental Protection Agency ("EPA"), the Ozone Transport
Assessment Group ("OTAG"), Ozone Transport Region ("OTR") and several states are
examining new standards and/or controls which could impose significant costs on
the Company. The EPA has recently adopted new, more stringent national ambient
air quality standards for ozone and particulate matter. Under the new standards,
many more areas of the country will be considered high pollution areas and will
be subject to additional regulatory controls, including possible fuel
specification requirements. Control measures to implement these new standards
will be adopted over the next five to seven years. Similarly, the multi-state
OTAG and OTR groups are developing lists of suggested controls to limit
interstate ozone transport. The EPA has issued a proposal to require states to
begin adopting many of these suggested controls over the next few years.

The precise effect of these actions on the Company and other industrial
companies is uncertain because most of the requirements will be implemented
through EPA regulations to be issued over a period of years. For example, fuels
produced at one or both of the Company's refineries will likely be required to
be reformulated to a composition significantly different from the fuels
currently produced which would involve the installation of additional refining
equipment. However, current estimates indicate that expenditures associated with
the installation of such equipment would not have a material effect on the
Company's results of operations.

Pennzoil-Quaker State is subject to certain laws and regulations relating
to environmental remediation activities associated with past operations, such as
the Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), the Resource Conservation and Recovery Act and similar state
statutes. In response to liabilities associated with these activities, accruals
have been established when

F-26
53
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

reasonable estimates are possible. Such accruals primarily include estimated
costs associated with remediation. Pennzoil-Quaker State has not used
discounting in determining its accrued liabilities for environmental
remediation, and no claims for possible recovery from third party insurers or
other parties related to environmental costs have been recognized in
Pennzoil-Quaker State's combined financial statements. Pennzoil-Quaker State
adjusts the accruals when new remediation responsibilities are discovered and
probable costs become estimable, or when current remediation estimates must be
adjusted to reflect new information.

Certain of Pennzoil-Quaker State's subsidiaries are involved in matters in
which it has been alleged that such subsidiaries are potentially responsible
parties ("PRPs") under CERCLA or similar state legislation with respect to
various waste disposal areas owned or operated by third parties. In addition,
certain of Pennzoil-Quaker State's subsidiaries are involved in other
environmental remediation activities, including the removal, inspection and
replacement, as necessary, of underground storage tanks. As of December 31, 1998
and 1997, Pennzoil-Quaker State's consolidated balance sheet included accrued
liabilities for environmental remediation of $27.2 million and $11.6 million,
respectively. Of these reserves, $4.2 million and $2.4 million are reflected on
the consolidated balance sheet as current liabilities as of December 31, 1998
and 1997, respectively, and $23.0 million and $9.2 million are reflected as
other liabilities as of December 31, 1998 and 1997, respectively.
Pennzoil-Quaker State does not currently believe there is a reasonable
possibility of incurring additional material costs in excess of the current
accruals recognized for such environmental remediation activities. With respect
to the sites in which Pennzoil-Quaker State subsidiaries are PRPs,
Pennzoil-Quaker State's conclusion is based in large part on (i) the
availability of defenses to liability, including the availability of the
"petroleum exclusion" under CERCLA and similar state laws, and/or (ii)
Pennzoil-Quaker State's current belief that its share of wastes at a particular
site is or will be viewed by the Environmental Protection Agency or other PRPs
as being de minimis. As a result, Pennzoil-Quaker State's monetary exposure is
not expected to be material beyond the amounts reserved.

From January 1995 through December 1998, capital outlays of approximately
$14.1 million have been made by the Company with respect to environmental
protection. Capital expenditures for environmental control facilities are
currently expected to be approximately $0.6 million in 1999.

Louisiana Federal Court Employment Action --

In September 1997, a lawsuit styled Kenneth Epperson, et al. vs. Pennzoil
Co., et al., was filed in the United States District Court for the Western
District of Louisiana, Shreveport Division. The amended complaint filed by nine
named plaintiffs alleges discriminatory employment policies and practices
against African-American and other minority employees and seeks attorney's fees
and costs, various forms of injunctive and equitable relief, $50.0 million in
damages for back pay, front pay, and emotional distress, and a

F-27
54
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

minimum of three times that amount in punitive damages. The Company vigorously
denies these allegations and will oppose plaintiffs' efforts to have the case
certified as a class action by the court.

Dura Lube --

In July 1997, Dura Lube Corporation and certain of its affiliated companies
filed suit in the United States District Court for the District of Delaware. The
complaint names Quaker State and its subsidiary, Slick 50, Inc., as defendants
and asserts claims under the Sherman Act and the Clayton Act, for tortious
interference with business relations and for civil conspiracy. Plaintiffs allege
that the defendants attempted and conspired to monopolize the market for engine
treatment by, among other things, entering into exclusive dealing arrangements
with major automotive parts retailers around the country. Plaintiffs seek treble
damages, punitive damages, attorneys' fees and costs as well as injunctive
relief. The Company is contesting this action vigorously.

Blue Coral --

In May 1997, a class action lawsuit was filed in the United States District
Court for the Northern District of Illinois on behalf of a class of persons who
purchased wax, polish or protectant products sold by a number of defendants. The
action names as defendants a number of car wax manufacturers including the Blue
Coral, Inc., a subsidiary of the Company and certain of its present and former
officers. The complaint alleges that the defendants falsely advertised and
marketed such products and seeks treble damages, attorneys' fees and costs for
the class for alleged violations of the federal Racketeer Influenced and Corrupt
Organizations Act and compensatory damages for alleged violations of the Ohio
Consumer Sales Practices Act as well as for breach of express warranty. On
January 5, 1999, the court certified a nationwide class consisting of all
persons who purchased products marketed, produced or distributed as "car wax" by
the defendants. While no class period has been specified by the court, the
plaintiffs are seeking a class period dating back four years prior to the filing
of the action. On February 2, 1999, the plaintiffs proposed a joint settlement
fund equal to ten percent of each defendant's 1997 gross revenue from the
products. The Company is contesting this action vigorously.

Oil Changer --

In July 1998, Oil Changer, Inc. ("Oil Changer") and several corporations
affiliated with Oil Changer filed a suit in the Superior Court of the State of
California, Alameda County, against Quaker State, certain former executives of
Quaker State and other individuals. The complaint alleges that Quaker State and
Oil Changer were "strategic partners" in an alleged partnership to develop quick
lubrication centers in Northern California. Oil Changer alleges that Quaker
State breached the alleged agreement by developing quick lubrication centers
with another entity. The complaint asserts claims for fraud, breach of fiduciary
duty and usurpation of partnership opportunity, partnership accounting, breach
of contract, conspiracy and violation of Section 17200 of the California
Business Professions Code. Plaintiffs seek compensatory damages of $50 million,
punitive damages, restitution, attorneys' fees and costs as well as injunctive
relief.

In addition, in July 1998, Oil Changer and several corporations affiliated
with Oil Changer filed a complaint in the United States District Court for the
Northern District of California against the Company and Pennzoil Company. The
complaint asserts claims under Sections 1 and 2 of the Sherman Act, Section 7 of
the Clayton Act and Sections 16720 and 17200 of the California Business
Professions Code, alleging that the merger of the Company and Pennzoil Company's
downstream business will substantially lessen competition in, or result in
monopolization of, the markets for motor oil and quick lubrication services in
certain areas of California. Plaintiffs sought compensatory and treble damages,
restitution, attorneys' fees and costs as well as injunctive relief enjoining
the proposed acquisition of Quaker State by the Company. On September 4, 1998,
the Company filed a motion to dismiss this complaint, which was granted in part
resulting in a dismissal of the claims under the California Business Professions
Code and certain Sherman Act and Clayton Act claims. On

F-28
55
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

October 8, 1998, Plaintiffs filed a notice of motion for a preliminary
injunction to enjoin the proposed merger, which was denied on December 7, 1998.
Plaintiffs are appealing the denial of the injunction. The Company is contesting
these actions vigorously.

Texas Federal Court Employment Action Settled --

The parties have reached a settlement in the lawsuit styled Donna
Alexander, et al. v. Pennzoil Company, et. al., pending in the United States
District Court for the Southern District of Texas, Houston Division. The suit
was filed by eleven named plaintiffs and alleged wrongful and illegal
discrimination by Pennzoil Company and subsidiaries against African-American
employees. The settlement was approved by the court on March 8, 1999.

Voluntary Withdrawal and Reformulation of Fix-A-Flat(R)

In February 1999, the Company announced a voluntary withdrawal and
reformulation of its Fix-A-Flat(R) tire inflator products. The Company's action
was in response to reported uses of the product in a manner inconsistent with
safe automotive tire repair procedures and contrary to explicit warnings on
Fix-A-Flat(R) product labels. In rare instances, an explosion may occur if a
tire repaired with the Fix-A-Flat(R) tire inflator product is subjected to
extreme heat by welding on, or applying a flame to, the wheel rim with the tire
still on the rim. Reformulated Fix-A-Flat(R) products are being distributed by
the Company. Accrued 1998 charges associated with the product withdrawal and
reformulation totaled $25.0 million. The Company is currently a defendant in one
lawsuit alleging injuries as a result of Fix-A-Flat(R) products. After
consideration of its accrued reserve, the Company believes that this matter will
not have a material adverse effect on the Company's financial condition or
results of operations.

Other --

Pennzoil-Quaker State and its subsidiaries are involved in various other
claims, lawsuits and other proceedings relating to a wide variety of matters.
While uncertainties are inherent in the final outcome of all claims, lawsuits
and other proceedings and it is presently impossible to determine the actual
costs that ultimately may be incurred, management currently believes that the
resolution of such uncertainties and the incurrence of such costs should not
have a material adverse effect on Pennzoil-Quaker State's financial condition or
results of operations.

(13) LEASES --

As Lessee --

Pennzoil-Quaker State leases various assets and office space with lease
periods of one to 20 years. Additionally, Pennzoil-Quaker State leases sites and
equipment which are subleased to franchisees or used in the operation of
automotive fast lubrication and fluid maintenance service centers operated by
Pennzoil-Quaker State. The typical lease period for the service centers is 20
years with escalation clauses generally increasing the lease payments by 9%
every third year, with some leases containing renewal options generally for
periods of five years. These leases, excluding leases for land that are
classified as operating leases, are accounted for as capital leases and are
capitalized using interest rates appropriate at the inception of each lease.

Certain operating and capital lease payments are contingent upon such
factors as the consumer price index or the prime interest rate with any future
changes reflected in income as accruable. The effects of these changes are not
considered material.

F-29
56
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Total operating lease rental expenses for Pennzoil-Quaker State were $61.9
million, $55.1 million and $55.2 million for 1998, 1997 and 1996, respectively.
Interest expense related to Pennzoil-Quaker State's capital lease obligations
was $8.3 million during 1998 and $8.6 million in 1997 and 1996.

Future minimum commitments under noncancellable leasing arrangements as of
December 31, 1998 are as follows:

AMOUNTS PAYABLE
AS LESSEE
------------------------
CAPITAL OPERATING
LEASES LEASES
--------- ----------
(EXPRESSED IN THOUSANDS)

YEAR ENDING DECEMBER 31:
1999........................................................ $ 13,232 $ 81,209
2000........................................................ 13,441 72,713
2001........................................................ 13,517 63,056
2002........................................................ 13,450 56,048
2003........................................................ 13,451 51,277
Thereafter.................................................. 65,529 302,029
-------- --------
Net minimum future lease payments........................... $132,620 $626,332
========
Less interest............................................... 55,193
--------
Present value of net minimum lease payments at December 31,
1998...................................................... $ 77,427
========

Assets recorded under capital lease obligations of $74.5 million and $12.9
million at December 31, 1998 are classified as property, plant and equipment and
other assets, respectively, in the accompanying consolidated balance sheet.
Assets recorded under capital lease obligations of $58.2 million and $13.3
million at December 31, 1997 are classified as property, plant and equipment and
other assets, respectively, in the accompanying consolidated balance sheet.

As Lessor --

Pennzoil-Quaker State owns or leases numerous service center sites which
are leased or subleased to franchisees. Buildings owned or leased that meet the
criteria for direct financing leases are carried at the gross investment in the
lease less unearned income. Unearned income is recognized in such a manner as to
produce a constant periodic rate of return on the net investment in the direct
financing lease. Any buildings leased or subleased that do not meet the criteria
for a direct financing lease and any land leased or subleased are accounted for
as operating leases. The typical lease period is 20 years and some leases
contain renewal options. The franchisee is responsible for the payment of
property taxes, insurance and maintenance costs related to the leased property.
The net investment in direct financing leases is classified as other assets in
the accompanying consolidated balance sheet.

F-30
57
PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Future minimum lease payment receivables under noncancellable leasing
arrangements as of December 31, 1998 are as follows:

AMOUNTS RECEIVABLE
AS LESSOR
-------------------------
DIRECT
FINANCING OPERATING
LEASES LEASES
---------- ----------
(EXPRESSED IN THOUSANDS)

YEAR ENDING DECEMBER 31:
1999........................................................ $ 4,694 $ 18,624
2000........................................................ 4,762 17,539
2001........................................................ 4,794 16,264
2002........................................................ 4,817 15,267
2003........................................................ 4,786 14,136
Thereafter.................................................. 24,740 121,671
------- --------
Net minimum future lease payments........................... $48,593 $203,501
========
Less unearned income........................................ 20,811
-------
Net investment in direct financing leases at December 31,
1998...................................................... $27,782
=======

(14) SEGMENT FINANCIAL INFORMATION --

Information with respect to revenues, operating income and other data by
operating segment is presented in Item 1. Business and Item 2. Properties of
this Annual Report on Form 10-K. The tabular presentation below sets forth
certain financial information regarding Pennzoil-Quaker State's net sales by
classes of similar products and services and net sales and identifiable assets
by geographic area for the years ended December 31, 1998, 1997, and 1996.

YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
(EXPRESSED IN THOUSANDS)

NET SALES BY CLASSES OF SIMILAR PRODUCTS OR
SERVICES:
Lubricants............................................... $ 818,166 $ 840,383 $ 833,598
Consumer Products........................................ 56,310 31,284 26,589
Base Oils................................................ 263,421 258,061 420,931
Specialty Products(1).................................... 65,336 210,602 191,933
Fast Lube Operations..................................... 322,704 316,068 290,219
All Other Products....................................... 474,866 542,888 481,440
Intersegment Sales(2).................................... (199,127) (217,138) (283,394)
---------- ---------- ----------
Total.......................................... $1,801,676 $1,982,148 $1,961,316
========== ========== ==========

YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
(EXPRESSED IN THOUSANDS)

GEOGRAPHIC AREAS:
Net Sales
Domestic............................................... $1,695,453 $1,875,264 $1,853,073
Foreign................................................ 106,223 106,884 108,243
Identifiable Assets
Domestic............................................... $2,948,320 $1,422,777 $1,237,727
Foreign................................................ 196,674 136,846 132,772

- ---------------

(1) In October 1997, the Company contributed most of its specialty industrial
products business to Penreco, a partnership with Conoco. The partnership is
accounted for under the equity method with the Company's share of net
earnings being reported as a component of other income.

(2) Intersegment sales are priced at market. The majority of intersegment sales
are from the base oil and specialty products segment to the lubricants and
consumer products segments.

F-31
58

PENNZOIL-QUAKER STATE COMPANY AND SUBSIDIARIES

SUPPLEMENTAL FINANCIAL INFORMATION -- UNAUDITED

QUARTERLY RESULTS --

BASIC AND
NET DILUTED
OPERATING INCOME EARNINGS (LOSS)
REVENUES INCOME (LOSS)(1) (LOSS) PER SHARE
---------- ---------------- -------- ---------------
(EXPRESSED IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

1997
First Quarter........................... $ 502,707 $ 20,811 $ 336 $ 0.01
Second Quarter.......................... 526,608 31,308 1,315 0.03
Third Quarter........................... 515,656 39,333 5,199 0.11
Fourth Quarter.......................... 468,189 30,794 (7,439) (0.16)
---------- -------- -------- -------
$2,013,160 $122,246 $ (589) $ (0.01)
========== ======== ======== =======
1998
First Quarter........................... $ 443,442 $ 28,748 $ 599 $ 0.01
Second Quarter.......................... 498,969 38,460 6,050 0.13
Third Quarter........................... 474,852 31,843 636 0.01
Fourth Quarter.......................... 432,875 (68,891) (53,152) (1.11)
---------- -------- -------- -------
$1,850,138 $ 30,160 $(45,867) $ (0.96)
========== ======== ======== =======

- ---------------

(1) Operating income is defined as net revenues less costs and operating
expenses.

F-32
59

INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------

- ---------------

* Incorporated by reference as indicated.

+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.