UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Quarter Ended September 30, 1999 Commission File No. 1-14501
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 Identification No.)
incorporation or organization)
Pennzoil Place, P.O. Box 2967
Houston, Texas 77252-2967
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 546-4000
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X . No .
Number of shares of stock were outstanding, as of latest
practicable date, October 31, 1999:
Common Stock, par value $0.10 per share, 77,973,067
shares.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
PENNZOIL-QUAKER STATE COMPANY
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1999 1998(A) 1999 1998(A)
----------- ----------- ----------- -----------
(Expressed in thousands except per share amounts)
(Note 2)
REVENUES $ 779,863 $ 474,852 $2,278,330 $1,417,264
COSTS AND EXPENSES
Cost of sales 557,618 336,011 1,613,006 920,258
Purchases from affiliate - 5,513 - 109,839
Selling, general and administrative 173,405 91,330 491,385 254,777
Depreciation and amortization 31,656 19,654 95,526 56,329
Taxes, other than income 4,677 2,969 12,492 9,051
Interest charges, net 20,143 3,028 58,965 8,975
Affiliated interest - 14,204 - 42,414
----------- ----------- ----------- -----------
INCOME(LOSS)BEFORE INCOME TAX (7,636) 2,143 6,956 15,621
Income tax provision (benefit) (892) 1,507 9,617 8,336
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (6,744) $ 636 $ (2,661) $ 7,285
=========== =========== =========== ===========
BASIC AND DILUTED EARNINGS(LOSS)PER SHARE $ (0.09) $ 0.01 $ (0.03) $ 0.15
=========== =========== =========== ===========
DIVIDENDS PER COMMON SHARE $ 0.1875 $ - $ 0.5625 $ -
=========== =========== =========== ===========
AVERAGE SHARES OUTSTANDING:
BASIC AND DILUTED 77,874 47,847 77,760 47,847
=========== =========== =========== ===========
END OF PERIOD SHARES OUTSTANDING 77,926 47,847 77,926 47,847
=========== =========== =========== ===========
<FN>
<F1>
(A) Excludes Quaker State Corporation results.
<F2>
See Notes to Condensed Consolidated Financial Statements.
</FN>
3
PART I. FINANCIAL INFORMATION - continued
PENNZOIL-QUAKER STATE COMPANY
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, December 31,
1999 1998
------------- -------------
(Unaudited)
(Expressed in thousands)
ASSETS
Current assets
Cash and cash equivalents $ 19,094 $ 14,899
Receivables 344,297 291,997
Inventories 304,297 306,512
Materials and supplies, at average cost 14,560 12,422
Deferred income taxes - 47,413
Other current assets 86,387 63,328
------------- -------------
Total current assets 768,635 736,571
Property, plant and equipment, net 984,466 1,032,076
Deferred income taxes 76,384 36,614
Goodwill 1,049,467 1,104,353
Other assets 195,847 235,380
------------- -------------
TOTAL ASSETS $ 3,074,799 $ 3,144,994
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt $ 1,074 $ 1,283
Accounts payable 273,534 245,721
Payroll accrued 25,526 18,734
Other current liabilities 121,936 147,609
------------- -------------
Total current liabilities 422,070 413,347
Total long-term debt, less current maturities 990,079 1,026,054
Capital lease obligations, less current maturities 70,092 74,464
Other liabilities 279,674 280,922
------------- -------------
TOTAL LIABILITIES 1,761,915 1,794,787
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY 1,312,884 1,350,207
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,074,799 $ 3,144,994
============= =============
<FN>
<F1>
See Notes to Condensed Consolidated Financial Statements.
</FN>
4
PART I. FINANCIAL INFORMATION - continued
PENNZOIL-QUAKER STATE COMPANY
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30
---------------------------------
1999 1998(A)
----------- -----------
(Expressed in thousands)
(Note 2)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (2,661) $ 7,285
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 95,526 56,329
Deferred income tax 6,751 20,421
Distributions from equity investees
in excess of earnings 2,100 8,856
Other non-cash items 14,407 12,238
Changes in other operating assets and liabilities (54,935) (102,501)
----------- -----------
Net cash provided by operating activities 61,188 2,628
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (50,395) (43,349)
Proceeds from sales of assets 95,513 17,982
Other investing activities (10,449) 8,916
----------- -----------
Net cash provided by (used in) investing activities 34,669 (16,451)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Debt and capital lease obligation repayments (637,581) (6,401)
Proceeds from note payable to affiliate - 17,735
Proceeds from issuances of debt 596,968 -
Dividends paid (43,747) -
Other financing activities (7,302) -
----------- -----------
Net cash provided by (used in) financing activities (91,662) 11,334
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,195 (2,489)
CASH AND CASH EQUIVALENTS, beginning of period 14,899 9,132
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 19,094 $ 6,643
=========== ===========
<FN>
<F1>
(A) Excludes Quaker State Corporations results.
<F2>
See Notes to Condensed Consolidated Financial Statements.
</FN>
5
PART I. FINANCIAL INFORMATION - continued
PENNZOIL-QUAKER STATE COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) General -
The condensed consolidated financial statements included
herein have been prepared by Pennzoil-Quaker State Company
("Pennzoil-Quaker State" or the "Company") without audit and should
be read in conjunction with the financial statements and the notes
thereto included in Pennzoil-Quaker State's latest annual report.
The foregoing financial statements include only normal recurring
accruals and all adjustments which Pennzoil-Quaker State considers
necessary for a fair presentation. Certain prior period items have
been reclassified in the condensed consolidated financial
statements in order to conform with the current year presentation.
(2)Spin-off from Pennzoil Company and Acquisition of Quaker State -
On December 30, 1998, Pennzoil Company distributed to its
stockholders 47.8 million shares of common stock of its wholly
owned subsidiary Pennzoil-Quaker State (the "Spin-off")
representing all of the shares of Pennzoil-Quaker State owned by
Pennzoil Company, renamed PennzEnergy Company.
Also, on December 30, 1998, Pennzoil-Quaker State acquired
Quaker State Corporation ("Quaker State") in a merger transaction,
and Quaker State became a wholly owned subsidiary of Pennzoil-
Quaker State. As a result of the acquisition, stockholders of
Quaker State received 0.8204 of a share of common stock of Pennzoil-
Quaker State in exchange for each share of Quaker State capital
stock previously owned.
Pennzoil-Quaker State accounted for the acquisition using the
purchase method of accounting and, accordingly, has included the
results of operations of Quaker State beginning on the date
acquired. 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
condensed consolidated financial statements and is being amortized
on a straight-line basis over 40 years.
The condensed consolidated financial statements reflect the
preliminary allocation of the 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 this
allocation.
At December 31, 1998, Pennzoil-Quaker State recognized certain
liabilities related to the merger. Those liabilities related to
Quaker State operations ($27.9 million) were recognized as an
adjustment to the purchase price. Other liabilities accrued of
$10.6 million that related to the acquiror (Pennzoil-Quaker State)
were expensed. During the three months and nine months ended
September 30, 1999, the $27.9 million liability related to the
Quaker State operations was reduced by $.7 million and $13.1
million, respectively, primarily for severance paid to certain
Quaker State employees. No additional liabilities were recorded in
connection with the acquisition during the nine months ended
September 30, 1999. The remaining accrual of $14.8 million at
September 30, 1999 includes amounts for severance costs and
relocation costs for certain Quaker State employees.
6
PART I. FINANCIAL INFORMATION - continued
During the three months and nine months ended September 30,
1999, the $10.6 million accrued liability related to the acquiror
was reduced by $0.2 million and $4.5 million, respectively,
primarily related to payments for resolving certain conflicts
between Jiffy Lube and Q Lube franchise-operated service centers.
No additional liabilities resulting from restructuring or
reorganizations related to the acquisition of Quaker State were
accrued during the nine months ended September 30, 1999. The
remaining accrual of $6.1 million at September 30, 1999 includes
amounts for costs of closing some Jiffy Lube company-operated fast
lube service centers. During the three months and nine months
ended September 30, 1999, the Company also incurred approximately
$18.5 million and $46.1 million, respectively, in previously
unaccrued expenses primarily due to post year-end acquisition-
related systems integration costs, rationalization of Q Lube
centers, Quaker State employee transition bonuses and key employee
bonuses earned during the period.
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 in mid 2000.
The following unaudited pro forma information for the nine
months ended September 30, 1998 has been prepared as if the
acquisition of Quaker State occurred on January 1, 1998 after
including the additional 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, nor is it necessarily indicative of
future results of operations or results that would have actually
occurred had the acquisition of Quaker State been consummated on
January 1, 1998.
Nine months ended
September 30, 1998
------------------------------
(Expressed in thousands except
per share amounts)
Revenues $ 2,331,292
Net income 27,953
Basic and diluted earnings per share 0.36
(3) New Accounting Standards -
In June 1998, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
("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. SFAS No. 133 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 formally document,
designate, and assess the effectiveness of transactions that
receive hedge accounting. In June 1999, the FASB issued SFAS No.
137, deferring the effective date of SFAS No. 133 until fiscal
years beginning after June 15, 2000. The effect of adopting SFAS
7
PART I. FINANCIAL INFORMATION - continued
No. 133 has not been determined, but is not expected to have a
material impact on Pennzoil-Quaker State's results of operations.
(4) Summarized Financial Data of Excel Paralubes -
Summarized financial information for Excel Paralubes, an
equal partnership with Conoco Inc., which produces base oils for
Pennzoil-Quaker State's lubricants business, for the three months
and nine months ended September 30, 1999 and 1998 on a 100% basis
follows:
Three months ended September 30 Nine months ended September 30
------------------------------- ------------------------------
1999 1998 1999 1998
----------- ----------- ------------ -----------
(Expressed in thousands)
(Unadudited)
Revenues $ 91,079 $ 77,079 $ 216,217 $ 208,098
Operating earnings 13,492 21,531 38,093 47,778
Net income 3,839 12,256 9,124 19,307
Pennzoil-Quaker State's net investment in Excel Paralubes,
carried as a credit balance of $53.0 million and $51.8 million at
September 30, 1999 and December 31, 1998, respectively, is netted
against other equity investments and included in other assets on
the condensed consolidated balance sheet. Pennzoil-Quaker State's
equity in Excel Paralubes' pretax income for the three months ended
September 30, 1999 and 1998 of $1.9 million and $6.1 million,
respectively, is included in revenues in the condensed consolidated
statement of income. Pennzoil-Quaker State's equity in Excel
Paralubes' pretax income for the nine months ended September 30,
1999 and 1998 was $4.6 million and $9.7 million, respectively.
(5) Debt -
In January 1999, Pennzoil-Quaker State, using funds from its
commercial paper and money market facilities, repaid $370.0 million
of borrowings under a Quaker State revolving credit agreement and
terminated the revolving credit agreement. On March 30, 1999,
Pennzoil-Quaker State issued debt in the form of $200.0 million of
6 3/4% Notes ("Notes") due April 1, 2009 and $400.0 million of 7
3/8% Debentures ("Debentures") due April 1, 2029. The net proceeds
of $592.2 million from the Notes and Debentures were used to pay
down variable rate debt. Due to the issuance of the Notes and
Debentures, Pennzoil-Quaker State reduced the capacity under its
revolving credit facility from $1.0 billion to $700 million on
March 30, 1999 as required by the credit facility agreement. There
were no borrowings under this facility during the nine months ended
September 30, 1999.
As of September 30, 1999, borrowings under Pennzoil-Quaker
State's commercial paper programs totaling $226.0 million have been
classified as long-term debt. Such debt classification is based
upon the availability of long-term credit facilities to refinance
this facility and the Company's intent to maintain such commitments
in excess of one year. Pennzoil-Quaker State also maintains a long-
term credit facility with Canadian banks, which provides for up to
C$27 million through October 29, 2000 with any outstanding
borrowings on such date being converted into a term credit facility
terminating on October 29, 2001. As of September 30, 1999,
borrowings under the Company's Canadian facility totaling US$8.9
million have been classified as long-term debt.
8
PART I. FINANCIAL INFORMATION - continued
(6) Earnings Per Share -
Computations for basic and diluted earnings (loss) per share
for the three months and nine months ended September 30, 1999 and
1998 consist of the following:
Three Months ended September 30 Nine months ended September 30
------------------------------- ------------------------------
1999 1998(A) 1999 1998(A)
------------- ------------ ------------ -----------
(Expressed in thousands except per share amounts)
Net income(loss) $ (6,744) $ 636 $ (2,661) $ 7,285
Basic and diluted weighted
average shares (B) 77,874 47,847 77,760 47,847
Basic and diluted earnings(loss)
per share (0.09) 0.01 (0.03) 0.15
<FN>
<F1> (A) Excludes Quaker State Corporation results and shares issued in the acquisition.
<F2> (B) A weighted average number of options to purchase 6.9 million shares of common stock were
outstanding for the three months and nine months ended September 30, 1999 and awards of 269.2
thousand and 291.3 thousand shares of common stock were outstanding for the three months and
nine months ended September 30, 1999, respectively, but were not included in the computation
of diluted earnings per share because these options and awards would have resulted in an
antidilutive per share amount.
</FN>
(7) Use of Derivatives -
In August 1999, Pennzoil-Quaker State approved a tactical
hedging program to lock in the margin on up to fifty percent of its
production of certain refined fuel products through the end of
1999. Pursuant to this strategy, Pennzoil-Quaker State entered
into several futures contracts in August 1999. A gain of $0.2
million related to current period operations was recognized in cost
of sales during the third quarter of 1999. The estimated fair
value of the unrealized gain associated with the open futures
contracts was $0.1 million at September 30, 1999.
In order to hedge interest rate exposure on the Debentures
issued in March 1999, in August 1998, Pennzoil-Quaker State entered
into four interest rate locks covering a total of $100 million,
based upon the 30-year Treasury rate. To achieve its hedged
position, Pennzoil-Quaker State entered into forward rate
agreements in which it would 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.
These transactions qualified as a hedge of an anticipated
transaction, whereby gains or losses from the interest rate hedges
were deferred during the interim period with the offset to a
payable or receivable. The hedge contracts matured in March 1999
when the Company issued $400 million of 30-year Debentures. The
total loss of $ 2.1 million on the interest rate hedges was treated
as an adjustment to the issue price of the Debentures, effectively
creating a discount that will be amortized over the life of the
borrowings.
9
PART I. FINANCIAL INFORMATION - continued
(8) Comprehensive Income -
Effective January 1, 1998, Pennzoil-Quaker State adopted SFAS
No. 130, "Reporting Comprehensive Income," which requires that
certain items that are excluded from net income but included as a
component of total shareholders' equity be presented in the
Company's financial statements. The components of Pennzoil-Quaker
State's comprehensive income consist of foreign currency
translation adjustments, unrealized holding gains and losses on
available-for-sale securities and minimum pension liability.
Comprehensive income for the three and nine months ended September
30, 1999 and 1998 is as follows:
Three months ended Nine months ended
September 30 September 30
---------------------------- ----------------------------
1999 1998(A) 1999 1998 (A)
----------- ----------- ----------- -----------
(Expressed in thousands)
(Unadudited)
Net income(loss) $ (6,744) $ 636 $ (2,661) $ 7,285
Other comprehensive income, net of tax 7,145 (1,098) 6,206 (2,182)
------------ ------------ ------------ ------------
Comprehensive income $ 401 $ (462) $ 3,545 $ 5,103
============ ============ ============ ============
<FN>
<F1> (A) Excludes Quaker State Corporation results.
</FN>
(9) Transactions with PennzEnergy Company -
As a result of the Spin-off, PennzEnergy and Pennzoil-Quaker
State entered into 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 by the
Company with at least 30 days prior written notice of the
discontinuation. Where corporate administrative costs can be
directly associated with Pennzoil-Quaker State or PennzEnergy, now
Devon Energy Corporation, fees are paid based upon actual costs of
providing these services. Indirect administrative costs incurred
are allocated through a monthly charge based on a formula that
considers the relative total assets, sales and employees of the
companies.
(10) Cash Flow Information -
Cash paid for interest during the nine months ended September
30, 1999 and 1998 was $30.5 million and $8.7 million, respectively.
Pennzoil-Quaker State Company received a $27.3 million income tax
refund in the third quarter of 1999. Income taxes paid, net of the
tax refund, during the nine months ended September 30, 1999 was a
net refund of $26.6 million. There were no income tax payments
made or refunds during the nine months ended September 30, 1998.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Pennzoil-Quaker State's operations are conducted primarily
through the following three segments: (1) Lubricants and Consumer
Products, (2) Base Oil and Specialty Products and (3) Fast Lube
Operations.
Results of operations of Pennzoil-Quaker State do not include
Quaker State's results of operations for 1998. The assets and
liabilities of Quaker State are included in Pennzoil-Quaker State's
condensed consolidated balance sheet for the periods presented. In
addition, operating results for the three months and nine months
ended September 30, 1998 include certain affiliated charges for
interest and services provided by Pennzoil Company prior to the
Spin-off.
10
PART I. FINANCIAL INFORMATION - continued
Results of Operations
Net sales for Pennzoil-Quaker State for the quarter and nine
months ended September 30, 1999 were $766.8 million and $2,248.3
million, respectively. This compares with net sales of $457.7
million for the quarter ended September 30, 1998 and $1,369.9
million for the nine months ended September 30, 1998. The
increases for the quarter and nine months ended September 30, 1999
compared to the same periods in 1998 are primarily due to the
acquisition of Quaker State. Purchases from affiliate for the three
and nine months ended September 30, 1998 relate to purchases of
crude oil at market prices from Pennzoil Company. Pennzoil-Quaker
State began purchasing crude oil primarily from unrelated third
parties in the third quarter of 1998.
Net loss for the quarter and nine months ended September 30,
1999 was $6.7 million, or 9 cents per basic share and $2.7 million,
or 3 cents per basic share, respectively. This compares with net
income of $.6 million, or 1 cent per basic share for the quarter
ended September 30, 1998 and $7.3 million, or 15 cents per basic
share for the nine months ended September 30, 1998. Net income for
three months and nine months ended September 30, 1999 included
pretax charges of $18.5 million and $46.1 million, respectively,
due to one-time costs (legal, severance, rationalization of Q Lube
centers and other charges) associated with the Company's merger
with Quaker State.
Lubricants and Consumer Products
Net sales for this segment for the quarter and nine months
ended September 30, 1999 were $485.5 million and $1,502.6 million,
respectively. This compares to net sales of $242.2 million and
$723.5 million, respectively, for the same periods in 1998. The
increases in net sales are primarily due to the acquisition of
Quaker State and higher lubricating product sales volumes. Other
income for this segment for the quarter and nine months ended
September 30, 1999 was $2.4 million and $8.2 million, respectively.
This compares to $1.8 million and $7.5 million, respectively, for
the same periods in 1998. Operating income from this segment for
the quarter and nine months ended September 30, 1999 was $45.1
million and $138.7 million, respectively. This compares to $27.0
million and $72.7 million, respectively, for the same periods in
1998. The increases were also primarily due to the acquisition of
Quaker State. Higher lubricating products sales volumes also
contributed to the increases, which were partially offset by one-
time merger costs.
Base Oil and Specialty Products
Net sales for this segment for the quarter and nine months
ended September 30, 1999 were $236.7 million and $576.0 million,
respectively. This compares to net sales of $184.4 million and
$558.9 million, respectively, for the same periods in 1998. The
increase in sales revenue is primarily due to increases in the
average sales prices for fuels, base oils and other petroleum
products, whose sales prices have increased as a result of higher
costs of crude oil and other feedstocks. Sales prices of refined
products, while increasing, generally have not kept pace with
rising costs of crude oil and other feedstocks resulting in a
deterioration of product margin. Product margin, defined as net
sales less feedstock costs, decreased $21.9 million for the third
quarter ended September 30, 1999 compared to the same period in
1998. Product margin for the nine months ended September 30, 1999
decreased $54.1 million compared to the same period in 1998.
Partially offsetting these decreases in product margins were lower
operating expenses for both the quarter and nine months ended
September 30, 1999, as compared to the same periods in 1998. Other
income for the quarter and nine months ended September 30, 1999 was
$10.4 million and $22.5 million, respectively. This compares to
other income of $12.2 million and $32.6 million, respectively, for
the same periods in 1998. The decrease in other income for the
quarter and nine months ended September 30, 1999 is primarily due
to lower results from Excel Paralubes, Pennzoil-Quaker State's base
oil partnership with Conoco Inc.. Lower results from Excel
Paralubes were primarily due to lower base oil margins as a result
of higher feedstock costs.
11
PART I. FINANCIAL INFORMATION - continued
Primarily as a result of the lower margins discussed above,
the segment reported an operating loss of $9.1 million for the
quarter ended September 30, 1999 compared to operating income of
$4.6 million for the same period in 1998. The segment reported an
operating loss of $18.7 million for the nine months ended September
30, 1999 compared to operating income of $16.1 million for the same
period in 1998
Fast Lube Operations
Net sales for this segment for the quarter and nine months
ended September 30, 1999 were $101.1 million and $331.5 million,
respectively. This compares to net sales of $83.4 million and
$244.3 million, respectively, for the same periods in 1998. The
increase in net sales is primarily due to the addition of Quaker
State's Q Lube operations. Other income for this segment for the
quarter and nine months ended September 30, 1999 was $2.0 million
and $2.8 million, respectively. This compares to $4.5 million and
$11.4 million, respectively, for the same periods in 1998. The
decrease in other income was primarily due to lower gains on sales
of assets. Operating loss from this segment for the quarter and
nine months ended September 30, 1999 was $.3 million and $1.2
million, respectively. This compares to operating income of $1.0
million and $12.5 million, respectively, for the same periods in
1998. The decreases were primarily due to increased operating
costs within company operated centers and higher selling, general
and administrative expenses primarily related to one-time merger
costs.
During the third quarter of 1999, the Company sold and closed
a significant number of company operated centers as part of the
merging of the Q Lube stores into the Jiffy Lube system. Various
company operated centers have been closed and others sold to
franchisees to settle territorial and other disputes. As of
September 30, 1999, the Company owned and operated approximately
661 centers. As of December 31, 1998 the Company owned and
operated approximately 993 centers. Approximately $15.5 million in
expenses were accrued in the fourth quarter of 1998 related to
store closings. No additional accruals have been recorded related
to store closings. No material gain or loss has been recognized
related to sales of Company stores.
Corporate Administrative Expense
Corporate administrative expense for the quarter and nine
months ended September 30, 1999 was $17.5 million and $58.0
million, respectively. This compares to $12.5 million and $32.0
million, respectively, for the same periods in 1998. The increases
are primarily due to the addition of Quaker State and one-time
merger costs.
As a result of the Spin-off, PennzEnergy and Pennzoil-Quaker
State entered into 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 by the
Company with at least 30 days prior written notice of the
discontinuation. Where corporate administrative costs can be
directly associated with Pennzoil-Quaker State or PennzEnergy, now
Devon Energy Corporation, fees are paid based upon actual costs of
providing these services. Indirect administrative costs incurred
are allocated through a monthly charge based on a formula that
considers the relative total assets, sales and employees of the
companies.
Prior to the Spin-off, Pennzoil Company charged Pennzoil-Quaker
State for all direct costs associated with its operations and
indirect administrative costs were allocated through a monthly
charge.
12
PART I. FINANCIAL INFORMATION - continued
Capital Resources and Liquidity
Cash Flow. As of September 30, 1999, Pennzoil-Quaker State
had cash and cash equivalents of $19.1 million. During the nine
months ended September 30, 1999, cash and cash equivalents
increased $4.2 million. For the nine months ended September 30,
1999 cash flow generated from operations of $61.2 million and net
proceeds received from the sale of assets of $95.5 million were
used primarily for the reduction of long-term debt, for payment of
cash dividends, capital expenditures and one-time costs associated
with the merger with Quaker State.
For purposes of the condensed consolidated statement of cash
flows, all highly liquid investments purchased with a maturity of
three months or less are considered to be cash equivalents.
Debt Instruments and Repayments. In January 1999, Pennzoil-
Quaker State, using funds from its commercial paper and money
market facilities, repaid $370.0 million of borrowings under a
Quaker State revolving credit agreement and terminated the
revolving credit agreement. On March 30, 1999, Pennzoil-Quaker
State issued debt in the form of $200.0 million of 6 3/4% Notes due
April 1, 2009 and $400.0 million of 7 3/8% Debentures due April 1,
2029. The net proceeds of $592.2 million from the Notes and
Debentures were used to pay down variable rate debt. Due to the
issuance of the Notes and Debentures, Pennzoil-Quaker State
reduced the capacity under its revolving credit facility from $1.0
billion to $700 million on March 30, 1999 as required by the credit
facility agreement. There were no borrowings under this facility
during the nine months ended September 30, 1999.
As of September 30, 1999, borrowings under Pennzoil-Quaker
State's commercial paper programs totaling $226.0 million have been
classified as long-term debt. Such debt classification is based
upon the availability of long-term credit facilities to refinance
this facility and the Company's intent to maintain such commitments
in excess of one year. Pennzoil-Quaker State also maintains a long-
term credit facility with a Canadian bank, which provides for up to
C$27 million through October 29, 2000 with any outstanding
borrowings on such date being converted into a term credit facility
terminating on October 29, 2001. As of September 30, 1999,
borrowings under the Company's Canadian facility totaling US$8.9
million have been classified as long-term debt.
Accounts Receivable. Pennzoil-Quaker State Company, through
its wholly owned subsidiary Pennzoil Receivables Company ("PRC"),
sells certain of its accounts receivable to a third party
purchaser. PRC is a special limited purpose corporation and the
assets of PRC are available solely to satisfy the claims of its
own creditors and not those of Pennzoil-Quaker State or its
affiliates. The Company increased and extended its one-year
receivables sales facility in June 1999 to provide for ongoing
sales of up to $160.0 million of accounts receivable. The Company's
net accounts receivable sold under this facility totaled $150.6
million at September 30, 1999.
The Company maintains a lube center receivable purchase and
sale agreement, which provides for the sale of certain notes
receivable up to $200.0 million, through a wholly owned subsidiary,
Pennzoil Lube Center Acceptance Corporation ("PLCAC"). PLCAC is a
special limited purpose corporation and the assets of PLCAC are
available solely to satisfy the claims of its own creditors and not
those of Pennzoil-Quaker State or its affiliates. Through
September 30, 1999, the Company has sold a total of $168.9 million
of notes receivable under this agreement, of which $137.7 million
were outstanding to the third party purchaser at September 30,
1999.
13
PART I. FINANCIAL INFORMATION - continued
Year 2000 Issues
The Company has conducted a review of its key computer systems
and identified a number of systems that were affected by the year
2000 issue. The Company completed conversion of these non-compliant
financial, operating, human resources and payroll systems to a new
information technology system in 1998. In addition, the Company
upgraded electronic commerce systems to compliant versions during
the second quarter of 1999. Upgrades and standardization of
network, infrastructure, desktop and communications systems to make
these assets compliant were also completed in the second quarter of
1999. Critical end-user spreadsheets and databases have been
reviewed and converted to handle year 2000 processing. Validation
testing of all critical hardware and software was completed during
the second quarter of 1999 except for four third-party datasets for
the Jiffy Lube systems, which will be completed by the end of
November 1999. The Jiffy Lube Point of Sale ("POS") system is year
2000 ready notwithstanding a third-party auxiliary component that
provides electronic lookup of vehicle make and model part
information. The programming needed to load certain models to the
POS system will be completed by November 30, 1999. In the
meantime, this information can be manually retrieved from printed
catalogs.
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
for the information technology systems includes backup, standby and
storage of critical equipment and parts to reduce the impact of
major service providers as well as providing for alternate
processing locations and performing manual processes in the event
of system unavailability. Contingency planning and testing of
contingency plans will be completed by November 30, 1999.
The Company has conducted a comprehensive inventory and
assessment of systems and devices with embedded chips, which
included 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. Critical embedded chip systems have been remediated and
tested for year 2000 readiness and were completed in the third
quarter of 1999.
The Company employed an independent engineering firm to
inventory and assess the embedded chip equipment in use at selected
company lube centers. All equipment was identified and assessed as
year 2000 ready except for the emissions testing and a component of
the car wash equipment because the internal software and hardware
were inaccessible. These two items require additional follow up
with the vendor or the state agency issuing this equipment, which
will be completed by November 30, 1999. However, this type of
equipment is not a critical service to lube operations and in the
event of an equipment failure, they would be temporarily
discontinued until remediation is completed.
The Company has contacted and continues to monitor year
2000 readiness of key suppliers, banks, customers and other
unaffiliated companies that have business relationships with the
Company. The Company could be adversely affected by the failure of
these unaffiliated companies to adequately address the year 2000
issue. These assessments include activities such as face-to-face
meetings, reviews of their year 2000 readiness programs and
cooperative testing. Assessments for all business units are
complete except for final follow-up with governmental agencies,
third-party service providers, and key suppliers to the blending
facilities and Jiffy Lube locations. Contingency plans include
arrangements to mitigate the impact of disruptions from outside
sources and to ensure that supplies of critical lubricants and
parts will not be interrupted due to a year 2000 problem. The
above efforts will be completed by November 30, 1999.
14
PART I. FINANCIAL INFORMATION - continued
Although the Company's primary focus has been to identify and
remediate mission critical non-compliant systems and equipment, all
non-critical systems and equipment have been included in this
review.
In addition, the Company has implemented internal
procedures to respond cooperatively to inquiries from regulatory
agencies and other businesses about its year 2000 program. 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 specific
problems.
Quaker State is continuing its year 2000 program after the
merger. Quaker State has completed reviews of computer systems and
embedded technologies at all locations, including its blending and
packaging facilities. Hardware, software, and embedded systems
were upgraded or replaced by October 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. The operating and
financial systems for the lubricants business segments and the
Canadian facility were made compliant by converting their business
processes to the current Pennzoil-Quaker State systems, which was
completed at the end of July 1999. At present, the Q Lube POS
software utilized in Q Lube stores is not year 2000 compliant. The
software vendor released a compliant version in the second quarter
of 1999. Current plans include the conversion of Q Lube locations,
including information systems, to Jiffy Lube stores, which utilize
compliant POS software. In the event the conversion is delayed,
contingency plans provide for the remaining stores to upgrade to
the compliant version of the Q Lube POS software. This upgrade
would begin in December 1999 to allow enough time to complete the
conversions.
International operations represents approximately 7% of total
Pennzoil-Quaker State Company revenues, and consists predominantly
of sales and marketing offices and blending and packaging
operations which generally have less integrated complex systems and
equipment. Nevertheless, international operations continue its
efforts to complete its year 2000 program. Upgrades and
standardization of network, infrastructure, desktop and
communications systems for the majority of the international
locations are now complete with the exception of three locations.
The remaining upgrading and testing will be completed by the end of
November 1999. All international sites now have compliant end user
systems and financial software with the exception of one site.
This site is finalizing its conversion in November 1999. The
majority of the sites have also completed validation testing of
their financial software. Testing is expected to be complete by
the end of November 1999, as well.
Replacement and upgrades of embedded chip systems at
international locations has been completed, and management is
conducting a final review of several mission critical laboratory,
process control and environmental systems, which is to be completed
by mid-November 1999. The majority of this type of equipment is
used to monitor and control production only. If, for any reason,
these systems are still found to be non-compliant after this
review, they will be operated in a manual mode until further
renovation and testing is completed. In addition, all currently
compliant control systems that have potential for environmental,
safety, or business interruption impact will be tested during
scheduled maintenance. Contingency planning is also underway to
ensure smooth transitions to alternatives such as manual processes
in the event these systems are partially or completely inoperable.
15
PART I. FINANCIAL INFORMATION - continued
As with most companies, the Company anticipates more issues
arising from international business partners, especially in the
banking, utility, shipping and governmental segments.
International operations has contacted and continues to monitor the
year 2000 readiness of key suppliers, banks, customers and other
unaffiliated companies that have business relationships with the
Company. These assessments include activities such as face-to-face
meetings, reviews of their year 2000 readiness programs and
cooperative testing. This assessment is currently underway and is
approximately 80% complete. Final contingency planning includes
efforts to lessen the impact of disruptions from these outside
sources. This planning effort will be completed by the end of
November 1999.
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 are being made based on this
information.
If the above steps are not completed successfully in a timely
manner, the Company's operations and financial performance could be
adversely affected through disruptions in operations. Even if
these steps are completed disruptions in operations could occur.
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 being 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 $5.0 million.
Forward-looking statements contained under "Year 2000
Issues" should be read in conjunction with the Company's
disclosures under the heading: "Forward-Looking Statements - Safe
Harbor Provisions."
Forward-Looking Statements - Safe Harbor Provisions
This quarterly report on Form 10-Q of Pennzoil-Quaker State
for the quarter ended September 30, 1999 contains certain forward-
looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which are intended to
be covered by the safe harbors created thereby. To the extent that
such statements are not recitations of historical fact, such
statements constitute forward-looking statements which, by
definition, involve risks and uncertainties. Where, in any forward-
looking statements, Pennzoil-Quaker State 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; competition in the motor oil and marketing business;
base oil margins and supply and demand in the base oil business;
the success and cost of advertising and promotional efforts;
mechanical failure in refining operations; unanticipated
environmental liabilities; changes in and compliance with
governmental regulations; changes in tax laws; and the cost and
effects of legal proceeding.
16
PART I. FINANCIAL INFORMATION - continued
The following table shows revenues and operating income by segment
and other components of income.
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1999 1998(A) 1999 1998(A)
----------- ----------- ----------- -----------
(Dollar amounts expressed in thousands)
(unaudited)
REVENUES
Net sales
Lubricants and Consumer Products $ 485,476 $ 242,196 $1,502,642 $ 723,446
Base Oil and Specialty Products 236,682 184,406 576,026 558,920
Fast Lube Operations 101,078 83,356 331,507 244,310
Intersegment sales and other (56,394) (52,254) (161,904) (156,773)
----------- ----------- ----------- -----------
766,842 457,704 2,248,271 1,369,903
----------- ----------- ----------- -----------
Other income, net
Lubricants and Consumer Products 2,353 1,779 8,208 7,469
Base Oil and Specialty Products 10,427 12,157 22,482 32,597
Fast Lube Operations 1,994 4,539 2,771 11,431
Other (1,753) (1,327) (3,402) (4,136)
----------- ----------- ----------- -----------
13,021 17,148 30,059 47,361
----------- ----------- ----------- -----------
Total revenues $ 779,863 $ 474,852 $2,278,330 $1,417,264
=========== =========== =========== ===========
OPERATING INCOME
Lubricants and Consumer Products $ 45,051 $ 26,955 $ 138,697 $ 72,659
Base Oil and Specialty Products (9,103) 4,606 (18,709) 16,082
Fast Lube Operations (330) 985 (1,196) 12,547
Other (5,622) (703) 5,158 (2,237)
----------- ----------- ----------- -----------
Total operating income 29,996 31,843 123,950 99,051
Corporate administrative expense 17,489 12,468 58,029 32,041
Interest charges, net 20,143 17,232 58,965 51,389
----------- ----------- ----------- -----------
Income(loss)before income tax (7,636) 2,143 6,956 15,621
Income tax provision (benefit) (892) 1,507 9,617 8,336
----------- ----------- ----------- -----------
NET INCOME(LOSS) $ (6,744) $ 636 $ (2,661) $ 7,285
=========== =========== =========== ===========
RATIO OF EARNINGS TO FIXED CHARGES 1.10 1.25
=========== ===========
<FN>
<F1>
(A) Excludes Quaker State Corporation results.
</FN>
17
PART I. FINANCIAL INFORMATION - continued
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------ ------------------------------
1999 1998(A) 1999 1998(A)
------------ ------------ ------------ ------------
(unaudtied)
OPERATING DATA
- --------------
LUBRICANTS AND CONSUMER PRODUCTS
Total revenues (in thousands):
Lubricants $ 353,107 $ 199,978 $ 1,083,752 $ 599,026
Consumer Products 80,968 15,092 265,483 44,205
International 53,662 28,527 161,681 87,257
Eliminations & other 92 378 (66) 427
------------ ------------ ------------ ------------
Total revenues $ 487,829 $ 243,975 $ 1,510,850 $ 730,915
============ ============ ============ ============
Operating income (in thousands):
Lubricants $ 37,711 $ 28,989 $ 110,572 $ 81,380
Consumer Products 8,819 2,609 33,129 7,521
International 3,436 (2,156) 9,098 (5,257)
Division overhead (4,915) (2,487) (14,102) (10,985)
------------ ------------ ------------ ------------
Total operating income $ 45,051 $ 26,955 $ 138,697 $ 72,659
============ ============ ============ ============
FAST LUBE OPERATIONS
Domestic systemwide sales (in thousands) $ 253,579 $ 209,961 $ 809,386 $ 610,402
Same center sales Jiffy Lube (in thousands)(B) $ 201,428 $ 197,750 $ 582,163 $ 569,434
Centers open 2,117 1,574 2,117 1,574
BASE OIL AND SPECIALTY PRODUCTS (C)
Raw materials processed (barrels per day) 74,895 70,857 70,548 72,064
Refining capacity (barrels per day) 76,000 76,000 76,000 76,000
Refiner's margin ($ per barrel) $ 5.01 $ 8.36 $ 5.55 $ 8.09
Operating costs ($ per barrel) $ 4.67 $ 6.14 $ 4.58 $ 6.08
Depreciation ($ per barrel) $ 1.08 $ 1.14 $ 1.16 $ 1.11
Refinery Feedstocks:
Paraffinic Crude Oil 62% 65% 66% 67%
Naphthenic Crude Oil 8% 7% 7% 7%
Other Feedstocks and Blendstocks 30% 28% 27% 26%
Refinery Yields:
Gasolines 27% 28% 28% 29%
Distillates 33% 30% 33% 31%
Lube Base Stocks 27% 27% 27% 25%
Waxes 2% 2% 2% 2%
Other Products 11% 13% 10% 13%
Market Data:
WTI Crude Oil ($ per barrel) $ 21.72 $ 14.15 $ 17.47 $ 14.93
3-2-1 crack spread ($ per barrel) (D) $ 2.81 $ 2.30 $ 1.94 $ 2.92
Base oil gross margin ($ per barrel) (E) $ 14.49 $ 18.98 $ 16.67 $ 19.74
<FN>
<F1>
(A) Excludes Quaker State Corporation statistics.
<F2>
(B) Excludes Q Lube centers acquired from Quaker State Corporation.
<F3>
(C) Includes Pennzoil-Quaker State's 50% ownership in Excel Paralubes.
<F4>
(D) Regular unleaded gasoline and low sulphur diesel vs. WTI crude oil.
<F5>
(E) Exxon 100N posting vs. WTI crude oil.
</FN>
18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits -
12 Computation of Ratio of Earnings to Fixed Charges for
the nine months ended September 30, 1999 and 1998.
27 Financial Data Schedule
(b) Reports -
No reports on Form 8-K were filed during the quarter for
which this report was filed.
19
SIGNATURE
Pursuant to the requirements of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
PENNZOIL-QUAKER STATE COMPANY
Registrant
S/N Michael J. Maratea
Michael J. Maratea
Vice President and Controller
November 12, 1999