ITEM 1. BUSINESS AND ITEM 2.
ITEM 3. LEGAL PROCEEDINGS.
(a) TAX DISPUTE. Reference is made to "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources and Liquidity -- Tax Dispute" and Note 8 of Notes to Consolidated Financial Statements for information regarding a letter and examination report received from the District Director of the Internal Revenue Service in January 1994 that proposes a tax deficiency based on an audit of Pennzoil's 1988 federal income tax return.
(b) CURTAILMENT DAMAGE ACTIONS. Reference is made to Note 8 of Notes to Consolidated Financial Statements for information regarding a lawsuit in which Pennzoil has been joined as a defendant for damages allegedly caused by curtailment of deliveries of gas by United Gas Pipe Line Company, a former Pennzoil subsidiary, to its customers.
(c) EATON V. PENNZOIL COMPANY. In December 1992, two former employees of Pennzoil filed a purported class action suit in the United States District Court for the Southern District of Texas, Galveston Division. The suit alleges that one of Pennzoil's deferred compensation plans had been improperly administered because of the absence of an adjustment under the plan for a significant event occurring in 1988 in determining the value of awards under the plan maturing in 1988 and 1990. The plaintiffs allege breach of contract, common law fraud and breach of fiduciary duty and seek compensatory and consequential damages of $40.0 million and punitive damages of $400.0 million. Pennzoil believes that the plan was administered properly and that the lawsuit is without merit. In October 1993, the court granted Pennzoil's motion for summary judgment. The plaintiffs have appealed.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted during the fourth quarter of 1993 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 (at March 4, 1994). Positions, unless otherwise specified, are with Pennzoil.
DAVID P. ALDERSON, II (44) Group Vice President -- Finance and Treasurer
CLYDE W. BEAHM (56) Group Vice President -- Franchise Operations
LINDA F. CONDIT (46) Corporate Secretary
JOHN L. DAVIS (46) Group Vice President -- Sulphur
THOMAS M. HAMILTON (50) Group Vice President -- Oil and Gas
TERRY HEMEYER (55) Group Vice President -- Administration J. HUGH LIEDTKE (72)(1) Chairman of the Board
MARK A. MALINSKI (38) Group Vice President -- Accounting and Controller
JAMES L. PATE (58)(1) President and Chief Executive Officer
WILLIAM M. ROBB (49) Group Vice President -- Products Manufacturing
JAMES W. SHADDIX (47) General Counsel
WILLIAM E. WELCHER (61) Group Vice President -- Products Marketing
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(1) Director of Pennzoil 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.
DAVID P. ALDERSON, II -- Group Vice President -- Finance since February 1992 and Treasurer since August 1989. Senior Vice President -- Finance from March 1990 to February 1992. Assistant Treasurer prior thereto.
CLYDE W. BEAHM -- Group Vice President -- Franchise Operations since July 1992. Executive Vice President -- Franchise Operations from February 1992 to July 1992. Senior Vice President -- Franchise Operations from May 1991 to February 1992. Vice President -- Quick Lube Operations from November 1989 to May 1991. Assistant Vice President -- Wholesale Market Development of Western Auto Supply Company's wholesale supply division prior thereto.
LINDA F. CONDIT -- Corporate Secretary since March 1990. Director -- Treasury Operations prior thereto.
JOHN L. DAVIS -- Group Vice President -- Sulphur since June 1991. Senior Vice President -- Pennzoil Sulphur Company from June 1990 to June 1991. Vice President -- Legal of Pennzoil Sulphur Company prior thereto.
THOMAS M. HAMILTON -- Group Vice President -- Oil and Gas since December 1991. Chief Executive -- Frontier and International Operating Company of BP Exploration from September 1989 to June 1991. General Manager -- East Asia, Australia and Latin America of BP Exploration prior thereto.
TERRY HEMEYER -- Group Vice President -- Administration since February 1992. Senior Vice President -- Administration from March 1990 to February 1992. Vice President -- Public Affairs prior thereto.
MARK A. MALINSKI -- Group Vice President -- Accounting since February 1992 and Controller since March 1990. Senior Vice President -- Accounting from March 1990 to February 1992. Corporate Secretary prior thereto.
JAMES L. PATE -- President and Chief Executive Officer since March 1990. Chief Operating Officer from February to March 1990 and Executive Vice President from July 1989 to March 1990. Senior Vice President -- Finance and Treasurer prior thereto.
WILLIAM M. ROBB -- Group Vice President -- Products Manufacturing since October 1992. Executive Vice President -- Manufacturing of Pennzoil Products Company prior thereto.
JAMES W. SHADDIX -- General Counsel since March 1990. Assistant General Counsel prior thereto.
WILLIAM E. WELCHER -- Group Vice President -- Products Marketing since October 1992. Executive Vice President -- Marketing of Pennzoil Products Company prior thereto.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The following table shows high and low sales prices for the common stock of Pennzoil as reported on the New York Stock Exchange (consolidated transactions reporting system), the principal market in which the common stock is traded and dividends paid per share for the calendar quarters indicated. The common stock is also listed for trading on the Pacific Stock Exchange, as well as the Toronto, London and Swiss stock exchanges.
Pennzoil has paid quarterly dividends for 70 consecutive years.
As of December 31, 1993, Pennzoil had 20,590 record holders of its common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table contains selected financial data for the five years indicated.
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(1) Reference is made to Note 11 of Notes to Consolidated Financial Statements.
(2) Reference is made to Note 3 of Notes to Consolidated Financial Statements.
(3) Reference is made to Notes 2 and 6 of Notes to Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Reference is made to Industry Segment Financial Information included in Item 1, Business and Item 2, Properties and the Consolidated Financial Statements beginning on page for additional information.
RESULTS OF OPERATIONS
Net income for 1993 was $141.9 million, or $3.36 per share, compared with net income of $128.2 million, or $3.16 per share, for 1992 and $21.0 million, or $.52 per share, for 1991. In November 1993, Pennzoil sold 8,158,582 shares of Chevron Corporation ("Chevron") common stock in a block trade on the New York Stock Exchange ("NYSE") for a net price of $88.38 per share. The sale resulted in a net realized gain of $137.0 million ($171.6 million before tax), or $3.25 per share. Reference is made to "-- Capital Resources and Liquidity" for additional information.
In September 1993, Pennzoil called for redemption an aggregate of $292.5 million principal amount of indebtedness. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $13.7 million ($21.1 million before tax), or $.33 per share, in the third quarter of 1993. Reference is made to "-- Capital Resources and Liquidity" for additional information.
In August 1993, the Omnibus Budget Reconciliation Act of 1993 was enacted, establishing a new 35% corporate income tax rate effective January 1, 1993. As a result of the increase in the marginal income tax rate and other tax law changes, Pennzoil recorded a one-time, non-cash charge of approximately $16 million, or $.38 per share, in the third quarter of 1993 to adjust its deferred income tax liabilities and assets for the effect of the change in income tax rates.
In June 1993, Pennzoil called for redemption $96.1 million principal amount of indebtedness (which redemption occurred in July 1993). The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $4.7 million ($7.2 million before tax), or $.12 per share, in the second quarter of 1993. Reference is made to "-- Capital Resources and Liquidity" for additional information.
In December 1992, Pennzoil announced its decision to change its method of accounting for income taxes by adopting the new requirements of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," effective as of January 1, 1992. As a result, Pennzoil recognized an increase to net income of $119.1 million in 1992. Of this amount, $115.7 million, or $2.85 per share, is reported as the one-time cumulative effect on prior year results. The remaining $3.4 million, or $.08 per share, reflects the impact of adoption of this standard on 1992 income from continuing operations.
In December 1992, Pennzoil sold in initial public offerings all its shares of capital stock of Purolator Products Company ("Purolator"). Pennzoil recorded a net gain on the disposition of Purolator of $1.5 million, or $.04 per share, in the fourth quarter of 1992. Reference is made to "-- Discontinued Operations" and Note 11 of Notes to Consolidated Financial Statements for additional information.
In December 1992, Pennzoil called for redemption $272.9 million principal amount of indebtedness (which redemption occurred in February 1993). As of December 31, 1992, this indebtedness was defeased by placing funds required for the redemption with the trustee for the indebtedness. As a result, the funds deposited with the trustee for the redemption of the debentures and the principal amount of the indebtedness are not reflected in Pennzoil's consolidated balance sheet at December 31, 1992. The premiums and related unamortized discount and debt issue costs relating to this redemption resulted in an extraordinary charge of $16.6 million ($25.2 million before tax), or $.41 per share, in the fourth quarter of 1992. Reference is made to "-- Capital Resources and Liquidity" for additional information.
In December 1991, Pennzoil announced its decision to change its method of accounting for postretirement benefit costs other than pensions by adopting the new requirements of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," effective as of January 1, 1991. As a result, Pennzoil recorded a charge of $49.0 million (including $11.4 million related to Purolator), or $1.21 per share, in the first quarter of 1991 to reflect the cumulative effect of the change in accounting principle for periods prior to 1991. In addition to the cumulative effect, Pennzoil's 1991 postretirement health care and life insurance costs increased $1.7 million, or $.04 per share, as a result of adopting the new standard.
Net income for 1991 was increased by adjustments of approximately $27.6 million, or $.68 per share, required to reclassify Purolator from a discontinued operation to a continuing operation as a result of Pennzoil's 1991 decision to retain Purolator. Reference is made to Note 11 of Notes to Consolidated Financial Statements for additional information.
Investment and other income for 1993 primarily represents a gain on the sale of 8,158,582 shares of Chevron common stock and dividend income from Pennzoil's investment in Chevron common stock. Investment and other income for 1992 and 1991 primarily represents dividend income from Pennzoil's investment in Chevron common stock. From 1989 through 1991, Pennzoil acquired 32,944,100 shares of common stock of Chevron. As of December 31, 1993, Pennzoil beneficially owned 9,035,518 shares of Chevron common stock, which is classified as non-current marketable securities and other investments in the accompanying consolidated balance sheet. Reference is made to "-- Capital Resources and Liquidity" for additional information.
OIL AND GAS
Operating income for the oil and gas segment was $159.2 million, compared with operating income of $134.7 million in 1992 and $48.6 million in 1991, reflecting the inclusion of a full year of results of Pennzoil Petroleum Company ("Pennzoil Petroleum"). Gas and liquids volume increases along with higher gas prices and gains on asset sales were primarily responsible for the increase in operating income. These increases were partially offset by lower crude oil prices, generally higher expenses associated with the higher level of activity within the oil and gas segment and higher exploration expenses described below.
In October 1992, Pennzoil completed a transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock held by Pennzoil for all the capital stock of Pennzoil Petroleum, which owns Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. The exchange of stock has been accounted for using the purchase method of accounting, and Pennzoil Petroleum's results of operations subsequent to October 30, 1992 have been included in Pennzoil's oil and gas segment results. Reference is made to Note 10 of Notes to Consolidated Financial Statements for additional information.
During the four-month period between the "effective date" and the closing date of the transaction, Chevron continued operation of the Pennzoil Petroleum oil and gas properties and, immediately prior to closing, contributed $57.4 million in cash to Pennzoil Petroleum (for the benefit of Pennzoil), representing the cash flow from Pennzoil Petroleum's operations during this four-month period, less production costs, provisions for taxes and approximately $11 million of nonrecurring closing adjustments. As a result of an audit completed during 1993, Chevron contributed an additional $9.9 million in cash to Pennzoil Petroleum, representing an adjustment to the initial $57.4 million cash contribution made by Chevron to Pennzoil Petroleum prior to closing. This additional contribution from Chevron was accounted for as an adjustment to the original purchase price of Pennzoil Petroleum.
Natural gas produced for sale in 1993 was 649,399 Mcf per day, compared with 447,561 Mcf per day and 400,960 Mcf per day in 1992 and 1991, respectively. Natural gas prices averaged $2.04 per Mcf in 1993 compared to $1.81 per Mcf in 1992 and $1.54 per Mcf in 1991. Liquids volumes in 1993 were 64,273 barrels per day, compared to 39,462 and 30,897 barrels per day in 1992 and 1991, respectively. The average liquids price received in 1993 dropped to $14.90 per barrel compared with $16.95 per barrel in 1992 and $18.30 per barrel in 1991.
The results of operations from Pennzoil's oil and gas segment are subject to volatility resulting from changes in crude oil and natural gas prices. Pennzoil has used in the past, and may use in the future, a limited price risk management strategy to provide protection against temporary declines in domestic natural gas prices. To date, these price risk management activities have encompassed no more than 3% of Pennzoil's total annual natural gas production.
During 1993, Pennzoil recorded $34.9 million in gains on sales of assets, primarily oil and gas producing properties. Proceeds from these asset sales were $87.5 million. These properties were categorized as noncore properties as a part of Pennzoil's continuing assessment of its domestic oil and gas properties, which commenced early in 1992. These properties, while constituting a significant number of fields, were, as a whole, immaterial to Pennzoil. Management estimates that Pennzoil's proved reserves at December 31, 1993 were reduced by approximately 13.7 million barrels of proved oil equivalents, or less than 3% of Pennzoil's proved reserves, as a result of these sales. Pennzoil intends to continue disposal of noncore properties during 1994, with the proceeds from these sales intended for reinvestment in or reallocation to Pennzoil's core properties.
Expenses associated with exploration activities in 1993 increased to $70.7 million compared with $11.7 million in 1992 and $47.3 million in 1991. This increase was due to a $46.9 million charge for impairments of unproved offshore property costs, primarily in the Mobile Bay area, and an increase in geological and geophysical expenses of $12.9 million over 1992 associated with an increase in Pennzoil's domestic exploration and development activity and the continuing assessment of its domestic oil and gas properties. In the early stages of this assessment, Pennzoil curtailed domestic exploration activity and, as a result, reduced its 1992 capital budget related to both exploration and development activity and geological and
geophysical expenses. As this assessment has progressed, more exploration and development activity has occurred in and around core areas. As a result, both domestic capital expenditures and geological and geophysical expenses for 1993 have more than doubled from the previous year as new opportunities were evaluated and exploration and development programs were implemented.
Depreciation, depletion and amortization expense in 1993 included a charge of $17.7 million to increase an impairment reserve originally established in 1988 related to Pennzoil's net investment in offshore California producing properties. Generally lower offshore California oil price forecasts in the fourth quarter, led management to determine that an additional impairment was necessary.
Internationally, Pennzoil in 1992 announced agreements for the exclusive right to negotiate with the Azerbaijan Republic and the State Oil Company of the Azerbaijan Republic ("SOCAR") to develop the Guneshli Field offshore Azerbaijan in the southern portion of the Caspian Sea. In May 1993, the Azeri government announced its intention to jointly develop, under a unified development plan, three fields (the Guneshli, Chirag and Azeri Fields) then under negotiation with western oil companies. In October 1993, the group of eight western oil companies, including Pennzoil, entered into an Area of Mutual Interest ("AMI") agreement that reaffirmed the equity distribution among the companies set out in a Declaration of Unitization previously signed by the western oil companies and SOCAR and established the basis for the companies' development of the three-field unit. Subsequently, during October 1993, the Azeri government elected to withdraw the Guneshli Field from the unit to be developed by the western oil companies and develop the Guneshli Field on its own. Under the terms of the AMI agreement, Pennzoil and Ramco Energy Ltd. of Scotland will have a 17% working interest in any development of the three fields by the western oil companies party to the AMI agreement, including the current two-field unit composed of the Chirag and Azeri Fields.
Also in Azerbaijan, Pennzoil continued work on a comprehensive gas gathering and compression system during 1993. This project is designed to capture, compress and transport to shore approximately 150 million cubic feet per day of gas presently being vented from the Guneshli Field. The gas utilization project accounted for approximately $98 million of the $361 million in capital expenditures for the oil and gas segment in 1993. Pennzoil has signed a gas utilization agreement with SOCAR that provides for recovery of Pennzoil's costs incurred in connection with the gas utilization project by payment in hard currency or oil or petroleum products or by a credit against a signature bonus for the first exploration, exploitation and/or development contract entered into between Pennzoil and SOCAR in Azerbaijan. The gas utilization project should be completed during the first quarter of 1994. Pennzoil's total investment related to its Azerbaijan activities, including the gas utilization project, was $116 million as of December 31, 1993.
Capital expenditures for the oil and gas segment in 1993 were $360.5 million compared to $93.8 million in 1992, excluding expenditures related to Pennzoil's acquisition of Pennzoil Petroleum, and $177.9 million in 1991. Total capital expenditures for this segment in 1994 are estimated to be $223.9 million, net of expected recoveries from the gas utilization project in Azerbaijan. Reference is made to "-- Capital Resources and Liquidity" for additional information.
MOTOR OIL & AUTOMOTIVE PRODUCTS
Operating income in 1993 for this segment was $90.0 million, compared with $77.9 million in 1992 and $108.3 million in 1991. Higher income in the marketing division in 1993 resulted primarily from higher domestic motor oil margins, which increased by approximately 6% due to lower crude oil prices in 1993. Domestic motor oil volumes were about even with 1992 but 4% higher than 1991 (lower 1991 volumes were the result of a recessionary decrease in total market demand). Domestic motor oil margin gains in 1993 were partially offset by higher advertising and selling expenditures. International motor oil and other lubricating product volumes increased 25% when compared to 1992 and 51% when compared to 1991. The revenue increases resulting from the higher international motor oil volumes were partially offset by higher selling and depreciation expenses. Higher income in the manufacturing division in 1993 was the result of higher refining and specialty product margins. Higher refining margins were due to higher fuels and other light product margins and higher base oil margins, all resulting from lower crude prices. Total processed volume at the refineries of 59,222 barrels per day was 767 barrels per day higher than 1992 but 2,683 barrels per day lower
than 1991. The lower volumes in 1993 and 1992 were primarily due to major maintenance turnarounds. Higher refinery operating and maintenance expenses slightly offset the increased margin. Income from the specialty products Penreco division was up 47% in 1993 due to higher volumes and margins coupled with a division-wide focus on reducing operating expenses.
The profitability of Pennzoil's refineries is directly affected by the supply and price of the grade and quality of crude oil purchased or otherwise obtained for refinery throughput. Because of shortages in the supply of crude oil meeting the unique grade and quality requirements for each of Pennzoil's refineries, and possible declining refinery margins resulting from such shortages, Pennzoil continually considers and evaluates crude oil supply arrangements for each of its refineries and the corresponding impact on the operating profitability of the affected refineries. In response to these crude oil supply shortages, Pennzoil is evaluating, among other things, the feasibility of increasing production from nearby fields and the possible reduction or consolidation of refinery operations. The magnitude and timing of crude oil supply shortages, and the resultant impact on Pennzoil's operating results and business operations, cannot be predicted with accuracy.
Capital expenditures for the motor oil and automotive products segment were $71.5 million in 1993, $35.8 million in 1992 and $32.3 million in 1991. The 1993 expenditures included $26.6 million for a diesel desulphurization and dewaxing project at the Atlas Processing Company ("Atlas") refinery in Shreveport, Louisiana, required to meet the new standards of the Clean Air Act. Also included were expenditures of $6.3 million for a feasibility study for a state-of-the-art base oil plant to be built as a joint venture and $4.8 million for the acquisition of property, plant and equipment of a blending plant in Spain (acquired in the first quarter of 1993). Total capital expenditures for this segment in 1994 are estimated to be $59.1 million.
FRANCHISE OPERATIONS
The operating loss from franchise operations during 1993 was $17.6 million, compared with an operating loss of $13.4 million in 1992 and an operating loss of $7.8 million in 1991. Operating results for 1993 include a charge of $10.0 million for estimated costs associated with centers that Jiffy Lube International, Inc. ("Jiffy Lube") has decided to eliminate. Jiffy Lube has determined that these centers are not viable as company-operated centers and has been unsuccessful in subleasing many of these centers for alternative uses. This provision for estimated costs takes into consideration the present value of future lease obligations related to operating leases (less estimated sublease rental revenue of existing subleases) and the estimated fair value of land, buildings, leaseholds and leasehold improvements. Additionally, 1993 results include approximately $12.7 million for the settlement of certain litigation, estimated environmental costs and write-downs of other individually insignificant investments to reflect Jiffy Lube's estimate of the net realizability of those investments. The decline in operating results in 1992 as compared to 1991 was due in part to increased selling, general and administrative expenses incurred in connection with the settlement of certain litigation ($6.8 million in 1992 compared to $1.1 million in 1991) and increased start-up expenses incurred in association with the development and installation of a new point-of-sale system ($2.6 million in 1992 compared to $1.1 million in 1991). As of December 31, 1993, Jiffy Lube operated 410 service centers, of which 19 are currently held for resale.
Systemwide service center sales reported to Jiffy Lube for the year ended December 31, 1993 increased $39 million, or approximately 8%, to $539 million, compared with the prior year and increased $64 million, or approximately 13%, compared with 1991. Average ticket prices increased to $33.60 for the year ended December 31, 1993, compared with $33.23 and $32.15 for the years ended December 31, 1992 and 1991, respectively.
During the year ended December 31, 1993, Jiffy Lube acquired 70 centers with estimated values of $15.8 million and real estate with estimated values of $.9 million in exchange for cash of $12.2 million, forgiveness of amounts due Jiffy Lube of $.9 million, liabilities assumed of $.5 million, debt assumed of $.4 million and real estate valued at $1.6 million. During the year ended December 31, 1992, Jiffy Lube acquired 104 service centers with estimated values of $29.7 million in exchange for cash of $16.7 million, forgiveness of amounts due Jiffy Lube of $2.8 million, liabilities assumed of $8.7 million and debt issued of $1.5 million. During the year ended December 31, 1991, Jiffy Lube acquired 106 service centers with estimated values of $31.9 million
in exchange for cash of $13.3 million, forgiveness of amounts due Jiffy Lube of $6.3 million, liabilities assumed of $11.5 million and debt issued of $6.5 million.
Capital expenditures for the franchise operations segment were $21.7 million in 1993, compared to $25.8 million and $4.9 million in 1992 and 1991, respectively. Capital expenditures for 1994 are estimated to be approximately $14.5 million.
SULPHUR
The operating loss from this segment was $20.8 million in 1993, down from $1.0 million of operating income earned in 1992 and from $42.7 million of operating income reported in 1991. The decrease in operating income in the sulphur segment during 1993 was primarily attributable to reduced sales volumes and sharply lower prices received for sulphur during 1993. The average Green Markets Tampa Recovered Contract Price range for sulphur in 1993 had a mid-point of $64.00 per long ton, which was approximately 26% below the 1992 mid-point and 44% below the mid-point in 1991. A downturn related to aggressive pricing by Canadian and U.S. recovered sulphur producers began in mid-1991, with average mid-point prices falling by $77.00 per ton from a weekly high of $131.00 in June 1991 to a weekly low of $54.00 in December 1993.
During 1993, sulphur sales volumes were 1.1 million long tons, a decrease of approximately 37% and 46% from 1992 and 1991 levels, respectively, due to reduced market share resulting from lower priced imports from Canada and increased recovered production domestically. Consumption of sulphur in North America was also estimated to be down one million tons due to lower phosphate exports. Sales volume commitments from certain Pennzoil customers have also been reduced or eliminated, including the elimination of commitments in the second half of 1992 from a customer accounting for approximately 10% of annual sulphur sales.
In October 1993, Pennzoil announced intended capital expenditures of approximately $7.4 million to modify the process of heating recycled mine water for reinjection into the production zone at the Culberson mine and the replacement of inefficient steam turbines with a gas-fired turbine. The modification resulted in a one-time charge of approximately $3.6 million for the write-off of obsolete property, plant and equipment. In addition, Pennzoil Sulphur Company began a work force reduction program in 1993, which resulted in a fourth quarter charge of $3.2 million. Annual expense savings at current production rates as a result of these actions are estimated at $12 million.
Pennzoil announced a voluntary workforce reduction for the sulphur segment effective in September 1992 and an involuntary workforce reduction program at two locations in October 1992. These measures resulted in one-time charges of $1.3 million and $1.1 million, respectively, and estimated cost reductions of $2.2 million and $3.2 million annually.
So long as sulphur prices and volumes remain at current levels, operating results in the sulphur segment will continue to be adversely affected, and the sulphur segment will likely generate an operating loss. The magnitude and timing of the actual effect on operating results of any future sulphur price fluctuation cannot be accurately predicted.
A significant portion of Pennzoil's sulphur sales is made to United States phosphate fertilizer producers who sell in both domestic and foreign agricultural markets. Domestic agricultural markets typically peak during spring and fall planting seasons, which are in the first and third quarters of the year. Foreign markets are also cyclical, but seasonal variations among individual foreign countries tend to offset each other.
Capital expenditures for the sulphur segment were $2.3 million in 1993, compared with $2.9 million and $7.0 million in 1992 and 1991, respectively. Total capital expenditures for this segment in 1994 have been budgeted at $6.2 million.
OTHER
Other operating income for 1993 was $253.7 million, compared to $88.2 million in 1992 and $127.8 million in 1991. The higher level of other income in 1993 was primarily due to the gains on the sales of shares of Chevron common stock of $171.6 million and Pogo Producing Company common stock of $10.5 million. Dividend income on the Chevron common stock was $60.2 million for 1993, $95.7 million for 1992 and $107.0 million for 1991.
Other revenues, net of related expenses, are included in the consolidated statement of income under "Investment and Other Income, Net" which consists of the following:
Substantially all interest and dividend income is from marketable securities and other cash investments.
INTEREST CHARGES, NET
During 1993, Pennzoil's interest charges, net of interest capitalized, decreased $45.1 million over 1992 levels. This decrease is primarily due to a decrease in the average amount of debt outstanding and lower average interest rates during 1993 compared to 1992. In addition, interest expense for 1991 includes $3.7 million in interest payments related to federal income tax paid on a portion of the $3.0 billion settlement received by Pennzoil from Texaco, Inc. ("Texaco") in 1988 in settlement of certain litigation. Reference is made to "-- Capital Resources and Liquidity -- Investment in Chevron Corporation" for additional information.
DISCONTINUED OPERATIONS
In early 1990, Pennzoil decided to sell or otherwise dispose of Purolator. In connection with this decision, Pennzoil recorded a 1989 fourth quarter write-down of $125.0 million to reflect the estimated loss to be incurred from the then anticipated sale or other disposition of Purolator's filtration products operations, including estimated future costs and operating results from the segment until the date of disposition.
In August 1991, Pennzoil concluded that, because of Purolator's improved performance, the intrinsic value of Purolator could be more effectively realized by retaining Purolator. Accordingly, Pennzoil reclassified Purolator's net assets and results of operations for all periods as part of continuing operations. As a result of Pennzoil's decision to retain Purolator, the remaining reserve of $115.7 million for the estimated loss on the disposition of Purolator originally established in the fourth quarter of 1989 was reversed. Concurrent with the reversal of the reserve, Pennzoil recorded, during the third quarter of 1991, a provision of $108.0 million ($88.0 million after tax) to reflect losses due to asset impairment and other identified liabilities related to Purolator.
In October 1992, as a result of Pennzoil's conclusion that disposal of Purolator's filtration products operations would enhance Pennzoil's efforts to focus on its strategic businesses and to reduce indebtedness, Purolator filed a registration statement pursuant to which Pennzoil offered to the public all shares of Purolator stock held by Pennzoil. Accordingly, Purolator's net assets and results of operations for all periods have been reclassified as discontinued operations for financial reporting purposes. In December 1992, Pennzoil sold in initial public offerings all its shares of capital stock of Purolator. The total amount received by Pennzoil, prior
to the payment of expenses, from the net proceeds of the offerings and the repayment of indebtedness by Purolator was $206.0 million. Pennzoil also expects to receive a tax refund of approximately $23 million as a result of the transaction. Pennzoil recorded a net gain on the disposition of Purolator stock of $1.5 million, or $.04 per share, in the fourth quarter of 1992.
Reference is made to "-- Capital Resources and Liquidity -- Environmental Matters" and Note 8 of Notes to Consolidated Financial Statements for information concerning an environmental indemnification agreement between Pennzoil and Purolator entered into in connection with Pennzoil's disposition of Purolator.
CAPITAL RESOURCES AND LIQUIDITY
CASH FLOW. Pennzoil had cash and cash equivalents and current marketable securities and other investments of $946.6 million and $20.7 million at December 31, 1993 and 1992, respectively. Cash flow generated from operations, net proceeds from the sale of 8.2 million shares of Chevron common stock and proceeds from the sale of assets totaled approximately $1.1 billion. These funds were primarily used for the payment of cash dividends ($126.2 million) and for capital expenditures ($475.0 million).
INVESTMENT IN CHEVRON CORPORATION. As of December 31, 1993, Pennzoil beneficially owned 9,035,518 shares of Chevron common stock. From 1989 through 1991, Pennzoil acquired 32,944,100 shares of Chevron common stock at an average cost of $67.36 per share with approximately $2.2 billion of the net proceeds from the Texaco settlement. In anticipation of not reinvesting in excess of $2.2 billion of the original $3.0 billion of proceeds from the Texaco settlement in property that is similar or related in service or use to the property involuntarily converted by Texaco, Pennzoil paid $13.2 million in federal income tax and $3.7 million in related interest in 1991 in addition to payments of $120.4 million in federal income tax and $17.6 million in related interest made during 1990. The interest payments are included in interest expense for 1991 and 1990, respectively. Provision for the income tax was previously made when the proceeds from the Texaco settlement were received in 1988. Reference is made to Note 8 of Notes to Consolidated Financial Statements for additional information.
In April 1991, Chevron increased the amount of quarterly dividends paid to holders of its common stock from $.775 per share to $.825 per share, and, in January 1993, Chevron announced an increase in the amount of quarterly dividends paid to holders of its common stock from $.825 per share to $.875 per share. In January 1994, Chevron announced an increase in the amount of quarterly dividends paid to holders of its common stock from $.875 per share to $.925 per share. At March 4, 1994, the closing price for Chevron common stock on the NYSE was $88.25 per share.
In October 1992, Pennzoil completed a transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock held by Pennzoil for all capital stock of Pennzoil Petroleum, which owns Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. The exchange of stock has been accounted for using the purchase method of accounting, and Pennzoil Petroleum's results subsequent to October 30, 1992 are included in Pennzoil's oil and gas segment results.
In November 1993, Pennzoil sold 8,158,582 shares of Chevron common stock in a block trade on the NYSE for a price of $89.00 per share before commissions ($88.38 per share net of commissions). The sale resulted in a net gain of $137.0 million ($171.6 million before tax), or $3.25 per share. The tax liability resulting from the sale of shares of Chevron common stock has been reduced by $25.5 million as a result of the utilization of a net operating loss carryforward. Realization of the net operating loss carryforward resulted in the reversal of a valuation allowance related to the deferred tax asset. Reference is made to Note 2 of Notes to Consolidated Financial Statements for additional information.
EXCHANGEABLE DEBENTURES. In 1993, Pennzoil completed public offerings of $402.5 million principal amount of its 6 1/2% Exchangeable Senior Debentures due January 15, 2003 (the "6 1/2% Debentures") and $500.0 million principal amount of its 4 3/4% Exchangeable Senior Debentures due October 1, 2003 (the "4 3/4% Debentures"). The 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable at the option of the holders thereof at any time prior to maturity, unless previously redeemed, for shares of Chevron common stock owned by Pennzoil at exchange rates of 11.887 shares and 8.502 shares, respectively, per $1,000 principal amount of
the 6 1/2% Debentures and the 4 3/4% Debentures (the equivalent of $84 1/8 per share and $117 5/8 per share, respectively), subject to adjustment in certain events. In lieu of delivering certificates representing shares of Chevron common stock in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may, at its option, pay to any holder surrendering the 6 1/2% Debentures and the 4 3/4% Debentures an amount in cash equal to the market price of the shares for which the 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable. Pennzoil has deposited 9,035,518 shares of Chevron common stock deliverable in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures with exchange agents.
Under the instruments governing the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may not pledge, mortgage, hypothecate or grant a security interest in, or permit any mortgage, pledge, security interest or other lien upon, the shares of Chevron common stock deposited with exchange agents and deliverable in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures. Pennzoil may at any time obtain from the exchange agents or otherwise authorize or direct the exchange agents to release all or part of the 9,035,518 shares of Chevron common stock deposited with the exchange agents. However, in the event Pennzoil obtains or otherwise releases any shares of Chevron common stock subject to exchange, each holder of a 6 1/2% Debenture or a 4 3/4% Debenture will generally have the right, at such holder's option, to require Pennzoil to repurchase all or a portion of such holder's debentures at a premium.
From the proceeds from the sale in January 1993 of the 6 1/2% Debentures, Pennzoil in March 1993 redeemed $223.4 million principal amount of indebtedness (including $80.1 million of Pennzoil's 12 1/8% and 12 1/4% debentures due 2007, $100.0 million of Pennzoil's 9 1/8% notes due 1996 and $43.3 million of Pennzoil's 9% debentures due 2001). The call premiums and related unamortized net premiums and debt issue costs relating to the redemption of these series of indebtedness resulted in a charge of $1.4 million, net of tax, or $.02 per share, for the first quarter of 1993. Also with such proceeds, approximately $23.3 million of additional indebtedness has been retired, repaid or repurchased in 1993 and $100.0 million principal amount of Pennzoil's 9% notes was retired upon maturity in May 1993. From the proceeds from the sale of the 4 3/4% Debentures, Pennzoil in October 1993 reduced its borrowings outstanding under its unsecured revolving credit facility.
ASSESSMENT OF OIL AND GAS PROPERTIES. Pennzoil is continuing its assessment of its domestic oil and gas properties commenced in early 1992. This assessment has resulted in, and is expected to continue to result in, the categorization of Pennzoil's oil and gas properties into core and noncore producing areas and core and noncore producing fields within core areas. In the early stages of this assessment, Pennzoil curtailed domestic exploration and development activity and, as a result, reduced its 1992 capital expenditures for domestic exploration and development by approximately one-half, excluding expenditures related to Pennzoil's acquisition of Pennzoil Petroleum. This ongoing assessment now includes the properties added in October 1992 as a result of the acquisition of Pennzoil Petroleum, which has created additional core areas and enhanced other core areas. With respect to properties to date categorized as noncore, Pennzoil sought to dispose of certain of these properties during 1992, and Pennzoil responded to inquiries from third parties with respect to other of these properties. As a result, Pennzoil disposed of approximately $35 million of these noncore properties and fields during 1992. No significant gain or loss was realized as a result of these dispositions. Pennzoil began 1993 with interests in approximately 800 producing fields owning small working interests and/or insignificant reserves in the majority of these fields. The successful first step in an asset highgrading program resulted in the disposal of approximately 300 of these fields representing less than 3% of the total value of Pennzoil's proved oil and gas reserves. Pennzoil realized gains of $34.9 million from these asset sales on total proceeds of $87.5 million. In addition, four asset swaps were finalized during 1993 to increase working interests in core Gulf of Mexico fields. Pennzoil intends to continue disposal of noncore properties during 1994 with the proceeds from these sales intended for reinvestment in or reallocation to Pennzoil's core properties.
CREDIT FACILITIES. In August 1993, Pennzoil entered into an amended and restated credit facility with a group of banks that provides for up to $600.0 million of unsecured revolving credit borrowings through August 19, 1994, with any outstanding borrowings on such date being converted into a term credit facility terminating on September 1, 1995. A facility fee of .15% per annum is payable on the aggregate amount of the banks' commitments. This amended and restated credit facility replaces and supersedes the previous revolving
credit facilities of Pennzoil and Pennzoil Exploration and Production Company. Borrowings under the facility totaled $195.0 million and $200.0 million at December 31, 1993 and March 1, 1994, respectively.
During 1993, Pennzoil's Board of Directors increased the limit on the aggregate amount of commercial paper that Pennzoil may issue under its domestic commercial paper program and/or its Euro-commercial paper program from $150.0 million to $250.0 million. Borrowings under Pennzoil's commercial paper facilities totaled $249.4 million and $247.1 million at December 31, 1993 and March 1, 1994, respectively.
Pennzoil has several short-term variable-rate credit arrangements with certain banks. Pennzoil's Board of Directors has limited borrowings under these credit arrangements to $200.0 million. Outstanding borrowings totaled $183.6 million at December 31, 1993 and $193.9 million at March 1, 1994. None of the banks has any obligation to continue to extend credit after the maturities of outstanding borrowings or to extend the maturities of any borrowings under these credit arrangements.
OTHER REDEMPTIONS OF INDEBTEDNESS. In December 1992, Pennzoil called for redemption $272.9 million principal amount of indebtedness (including $250.0 million of Pennzoil's 10 5/8% debentures due 2018 and $22.9 million of Pennzoil's 10% debentures due 2011), using proceeds from the disposition of Purolator, from the disposition of certain oil and gas properties and from cash contributed by Chevron to Pennzoil Petroleum for the benefit of Pennzoil. The redemptions were completed in February 1993. As of December 31, 1992, this indebtedness was defeased by placing funds required for the redemption with the trustee for the indebtedness. As a result, the funds deposited with the trustee for the redemption of the debentures and the principal amount of the indebtedness are not reflected in Pennzoil's consolidated balance sheet at December 31, 1992. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $16.6 million ($25.2 million before tax), or $.41 per share, in the fourth quarter of 1992.
In June 1993, Pennzoil called for redemption $96.1 million principal amount of indebtedness (including $66.1 million of Pennzoil's 10% debentures due 2011 and $30.0 million of Pennzoil's 10 1/8% debentures due 2011). The redemptions were completed in July 1993. The funds used for these redemptions were obtained from (i) the cash proceeds from the completed sale of a subsidiary holding Pennzoil's Indonesian gold properties in January 1993, (ii) the cash proceeds from the sale in March 1993 of common stock of Pogo Producing Company held by Pennzoil and (iii) the cash payments received from Chevron from and as a result of the net cash flows from operations of the oil and gas properties of Pennzoil Petroleum through March 31, 1993. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $4.7 million, net of tax, or $.12 per share, in the second quarter of 1993.
In September 1993, Pennzoil called for redemption $292.5 million principal amount of indebtedness (including $120.0 million of Pennzoil's 10 1/8% debentures due 2011, $111.0 million of Pennzoil's 10% debentures due 2011 and $61.5 million of Pennzoil's 9% debentures due 2017). The redemptions were completed in November 1993. The funds used for these redemptions were primarily obtained from the net proceeds from the sale in September 1993 of 5,000,000 shares of Pennzoil common stock. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $13.7 million, net of tax, or $.33 per share, in the third quarter of 1993.
In November 1993, Pennzoil redeemed $24.0 million principal amount of indebtedness (including $21.3 million of Pennzoil's 8 3/8% and 8 5/8% debentures due 1996 and $2.7 million of Pennzoil's 8 3/4% debentures due 2001). No significant gain or loss resulted from these early retirements.
TAX DISPUTE. In January 1994, Pennzoil received a letter and examination report from the District Director of the Internal Revenue Service ("IRS") that proposes a tax deficiency based on an audit of Pennzoil's 1988 federal income tax return. The examination report proposes two principal adjustments with which Pennzoil disagrees.
The first adjustment challenges Pennzoil's position under Section 1033 of the Internal Revenue Code that (i) at least $2.2 billion of the $3.0 billion cash payment received from Texaco in 1988 in settlement of certain litigation was realized as a result of the involuntary conversion of property and (ii) the shares of Chevron common stock purchased with $2.2 billion of the net Texaco settlement proceeds were similar or related in
service or use to the property converted by Texaco. Although these issues have not been resolved, Pennzoil believes that its position is sound, and it intends to contest the proposed adjustment in court unless an acceptable settlement is reached. The proposed tax deficiency relating to this proposed adjustment is $550.9 million, net of available offsets. Pennzoil estimates that the additional after-tax interest on this proposed deficiency would be approximately $234.3 million as of December 31, 1993. If Pennzoil's position is not sustained by the courts, Pennzoil would be required to pay the assessed taxes, plus the accrued interest. Pennzoil's consolidated financial statements do not include an accrual for the interest that would be due in such event.
The second adjustment proposed by the IRS would permanently capitalize, rather than allow Pennzoil to deduct, approximately $366 million incurred by Pennzoil in 1988 and earlier years for litigation and related expenses in connection with the Texaco settlement, even if it were determined that the entire $3.0 billion is includable in Pennzoil's 1988 taxable income. Pennzoil believes that this proposed adjustment is irrational and capricious and will not be sustained in court. The proposed tax deficiency relating to the disallowance of deductions is $124.6 million, and the estimated additional after-tax interest on this proposed deficiency would be approximately $46.7 million as of December 31, 1993. If the deductions for legal and related expenses were ultimately disallowed, Pennzoil would be required to pay the assessed taxes, plus the accrued interest. Pennzoil's consolidated financial statements do not include an accrual for the taxes that would be assessed as a result of the proposed disallowance of deductions or the related interest that would be due in such event.
Pennzoil has formally protested the IRS' proposed tax deficiency in writing within the required 30-day time period. The issue has been forwarded to the IRS Appeals Office, which is empowered to settle disputes with taxpayers, taking into account the hazards of litigation. If Pennzoil and the IRS Appeals Office are unable to reach a negotiated resolution of these tax issues, the IRS would forward a letter requiring Pennzoil to pay the assessed taxes, plus the accrued interest, within 90 days, unless Pennzoil files a petition with the United States Tax Court. If Pennzoil were to choose to file suit in the Tax Court, Pennzoil would not pay any taxes unless and until the Tax Court rendered a judgment against Pennzoil, but interest would continue to accrue on any taxes ultimately determined to be due. Alternatively, Pennzoil would be entitled to choose to pay the assessed taxes, plus the accrued interest, and file a claim for a refund in either the United States Court of Claims or the United States District Court for the Southern District of Texas. Paying the assessed taxes would halt the accrual of interest on any taxes finally determined to be owing by Pennzoil. In such event, any refund to Pennzoil would include a refund by the IRS of the prior interest paid by Pennzoil, as well as a payment by the IRS of additional interest accrued on the assessed taxes previously paid by Pennzoil. If litigation is necessary, a case of this kind would normally take several years in the absence of a settlement, which could occur at any stage in the process.
Pennzoil had cash and cash equivalents and current marketable securities and other investments of $946.6 million at December 31, 1993 and approximately $850 million at March 1, 1994. As a result of these available liquid assets and Pennzoil's available credit facilities, Pennzoil believes that it has the financial flexibility to deal with any eventuality that may occur in connection with the dispute with the IRS, including the possibility of paying the taxes assessed, plus the accrued interest, and suing for a refund if Pennzoil is not able to resolve the disputed matters through discussions with the IRS.
Deferred income taxes originally resulted from the timing difference in the recognition of the settlement income for tax and financial reporting purposes under the deferred method of accounting for income taxes and not from the accrual of a contingency reserve for taxes due in the event Pennzoil's tax reporting position ultimately were determined to be incorrect. Under the liability method of accounting for income taxes adopted by Pennzoil in December 1992, since the excess of the financial reporting basis over the tax basis of Pennzoil's investment in Pennzoil Petroleum is not expected to result in a future income tax liability, deferred income taxes attributable to the 15,750,000 shares of Chevron common stock exchanged for the stock of Pennzoil Petroleum have been reflected as a reduction of the cost of Pennzoil's investment in Pennzoil Petroleum. Deferred income taxes remain related to the 9,035,518 shares of Chevron common stock currently owned by Pennzoil. Resolution of the tax dispute could result in an increase in the carrying cost of Pennzoil's investment in Pennzoil Petroleum and, therefore, an increase in future depreciation, depletion and amortization expense.
CAPITAL EXPENDITURES. Total capital expenditures for 1993 were $485.1 million, including $11.4 million of interest capitalized, representing an increase of $322.5 million from comparable 1992 capital expenditure levels.
The table below summarizes the current 1994 capital budget by segment compared with 1993 and 1992 capital expenditures, excluding expenditures related to Pennzoil's acquisition of Pennzoil Petroleum in 1992. The capital budget is reassessed from time to time, and could, for example, be adjusted to reflect changes in oil and gas prices and other economic factors.
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(1) The 1994 capital expenditures for this segment are net of expected recoveries from the gas utilization project in Azerbaijan.
Pennzoil currently expects to generate funds for its budgeted 1994 capital expenditures from cash flows from operations, borrowings under its revolving credit facility, available cash, proceeds from future debt issuances or a combination of some or all of the foregoing.
ENVIRONMENTAL MATTERS. Pennzoil continues to make capital and operating expenditures relating to the environment, including expenditures associated with the compliance with increasing federal, state and local environmental regulations. As they continue to evolve, environmental protection laws are expected to have an increasing impact on Pennzoil's operations. In connection with pollution abatement efforts related to current operations, Pennzoil made capital expenditures of approximately $35 million in 1993. The 1993 expenditures included $26.6 million for a diesel desulphurization and dewaxing project at the Atlas refinery in Shreveport, Louisiana, which was required to meet the new regulations promulgated under the federal Clean Air Act. Capital expenditures in connection with pollution abatement are expected to be approximately $18 million in 1994. Pennzoil's recurring operating expenditures relating to environmental compliance activities are not material.
Pennzoil 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. Pennzoil 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's consolidated financial statements. Pennzoil 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.
Pennzoil's assessment of the potential impact of these environmental laws is subject to uncertainty due to the difficult process of estimating and refining 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 to 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 finally the
actual implementation of the remediation plan. This process occurs over relatively long periods of time and is sequential, highly influenced by regulatory and community approval processes and subject to ongoing development of remediation technologies. Pennzoil's assessment analysis takes into account the state of the process each site is in at the time of estimation, the degree of uncertainty surrounding the estimates for each phase of remediation and other site specific factors.
In connection with Pennzoil's disposition of Purolator, Pennzoil and Purolator entered into an indemnification agreement pursuant to which Pennzoil has agreed to reimburse Purolator for costs and expenses of certain environmental remediation relating to a plant operated by Purolator in Elmira Heights, New York, and certain environmental remediation, if any, relating to one other site located near the Elmira facility and a landfill site located in Metamora, Michigan. The indemnification provided by Pennzoil applies to all remediation required by Purolator under CERCLA that has been identified at the Elmira facility in the Environmental Protection Agency's September 1992 Record of Decision with respect to the Elmira facility, but does not extend to certain additional environmental expenditures relating to the Elmira facility or other sites for which Purolator is or may be held responsible. Pennzoil had a reserve of $16.3 million and $17.7 million recorded with respect to its obligations under its indemnification agreement with Purolator as of December 31, 1993 and 1992, respectively.
Certain of Pennzoil'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'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, 1993 and 1992, Pennzoil's consolidated balance sheet included accrued liabilities for environmental remediation of $33.1 million and $34.2 million, respectively, which amounts include reserves with respect to Pennzoil's obligations under its indemnification agreement with Purolator referred to in the previous paragraph. Of these reserves, $4.8 million and $4.9 million is reflected on the consolidated balance sheet as other current liabilities as of December 31, 1993 and 1992, respectively, and $28.3 million and $29.3 million is reflected as other liabilities as of December 31, 1993 and 1992, respectively. Pennzoil does not currently believe there is a reasonable possibility of incurring additional material amounts in excess of the current accruals recognized for such environmental remediation activities. With respect to the sites in which Pennzoil subsidiaries are PRPs, Pennzoil'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's current belief that its share of wastes at a particular site is or will be less than the threshold deemed by the Environmental Protection Agency or recognized by the relevant group of PRPs as being de minimis (and as a result Pennzoil's monetary exposure is not expected to be material).
OTHER MATTERS. Pennzoil does not currently consider the impact of inflation to be significant in the businesses in which Pennzoil operates.
Reference is made to Notes 1 and 6 of Notes to Consolidated Financial Statements for a discussion of the impact that recently issued accounting standards are expected to have on Pennzoil's consolidated financial statements, when adopted.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements of Pennzoil, together with the report thereon of Arthur Andersen & Co. dated March 4, 1994 and the supplementary financial data specified by Item 302 of Regulation S-K, are set forth on pages through hereof. (See Item 14 for Index.)
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information appearing under the captions "Nominees," "Directors with Terms Expiring in 1995 and 1996" and "Compliance with Section 16(a) of the Exchange Act" set forth within the section entitled "Election of Directors" in Pennzoil'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.
ITEM 11. EXECUTIVE COMPENSATION.
The information appearing under the captions "Director Remuneration," "Executive Compensation" and "Compensation Committee Interlocks and Insider Participation" set forth within the section entitled "Election of Directors" in Pennzoil'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.
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 Pennzoil'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.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information appearing under the captions "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions Concerning Continuing Directors" and "Certain Transactions Concerning Retiring Directors" 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 Pennzoil'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.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A)(1) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The supplementary financial data specified by Item 302 of Regulation S-K are included in the Supplemental Financial and Statistical Information -- Unaudited beginning on page.
(A)(2) FINANCIAL STATEMENT SCHEDULES.
Other schedules of Pennzoil 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.
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* Incorporated by reference.
+ 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.
During the fourth quarter of 1993, Pennzoil filed a Current Report on Form 8-K with the SEC dated as of November 26, 1993 to report the completion of the sale of 8,158,582 shares of the common stock of Chevron.
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 COMPANY
By: JAMES L. PATE ---------------------------------- (JAMES L. PATE, PRESIDENT AND CHIEF EXECUTIVE OFFICER)
Date: March 11, 1994
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.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Pennzoil Company:
We have audited the accompanying consolidated balance sheet of Pennzoil Company (a Delaware corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
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 provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pennzoil Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.
As discussed in Note 8 to the Consolidated Financial Statements, in January 1994, the Company received a letter and examination report from the District Director of the Internal Revenue Service ("IRS") that proposes a tax deficiency based on an audit of the Company's 1988 federal income tax return. The proposed tax deficiency relates primarily to the Company's tax reporting position with regard to the receipt of $3.0 billion in 1988 in settlement of certain litigation. Deferred income taxes were provided in the Consolidated Financial Statements in 1988 in connection with the Company's receipt of the $3.0 billion settlement; however, no accrual has been made for interest on the proposed tax deficiency. The Company has filed a protest with the IRS asserting the Company's disagreement with the examination report; however, the ultimate outcome of this matter is not presently determinable.
As discussed in Note 2 to the Consolidated Financial Statements, as of January 1, 1992, the Company changed its method of accounting for income taxes. Also, as discussed in Note 6 to the Consolidated Financial Statements, as of January 1, 1991, the Company changed its method of accounting for postretirement benefit costs other than pensions.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedules listed in Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. The financial statement schedules have been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN & CO.
Houston, Texas March 4, 1994
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PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
LIABILITIES AND SHAREHOLDERS' EQUITY
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --
Principles of Consolidation --
The accompanying consolidated financial statements include all majority-owned subsidiaries of Pennzoil Company ("Pennzoil"). All significant intercompany accounts and transactions have been eliminated. Certain prior period items have been reclassified in the Consolidated Financial Statements in order to conform with the current year presentation. The results of operations of Pennzoil Petroleum Company ("Pennzoil Petroleum") have been included in Pennzoil's consolidated financial statements subsequent to October 30, 1992 (see Note 10).
Marketable Securities and Other Investments --
At December 31, 1993, marketable securities and other investments included in current assets were comprised of domestic commercial paper, Federal National Mortgage Association notes, a certificate of deposit and treasury bills.
Marketable securities and other investments are carried at the lower of aggregate cost or market value, as shown below.
As of December 31, 1993 and 1992, Pennzoil beneficially owned 9,035,518 shares and 17,194,100 shares, respectively, of the common stock of Chevron Corporation ("Chevron"). At March 4, 1994, the closing price for Chevron common stock on the New York Stock Exchange was $88.25 per share. Realized gains on Pennzoil's remaining investment in Chevron common stock could be limited as a result of the issuance of Pennzoil's 6 1/2% Exchangeable Senior Debentures due January 15, 2003 (the "6 1/2% Debentures") and 4 3/4% Exchangeable Senior Debentures due October 1, 2003 (the "4 3/4% Debentures"), all of which are exchangeable at the option of the holders thereof for shares of Chevron common stock owned by Pennzoil. Reference is made to Note 3 for additional information.
In November 1993, Pennzoil sold 8,158,582 shares of Chevron common stock in a block trade on the New York Stock Exchange for a price of $89.00 per share before commissions ($88.38 per share net of commissions). The sale resulted in a net realized gain of $137.0 million ($171.6 million before tax), or $3.25 per share.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The cost of the securities sold is based on the average cost of each security held at the time of sale.
Other income effects from marketable securities and other investments are discussed under the caption "Investment and Other Income, Net" below.
In May 1993, the Financial Accounting Standards Board ("FASB") issued a new standard on accounting for certain investments in debt and equity securities. This standard requires that, except for debt securities classified as "held-to-maturity securities," investments in debt and equity securities must be reported at fair value. As a result of the standard, Pennzoil's remaining investment in Chevron common stock will be reported at fair value, with unrealized gains or losses excluded from earnings and reported as a separate component of shareholders' equity. Adoption of the standard by Pennzoil is required effective January 1, 1994. Based on December 31, 1993 fair values, adoption of the standard would increase shareholders' equity by approximately $107 million.
Investment and Other Income, Net --
Other revenues, net of related expenses, are included in investment and other income, net, and consist of the following:
Substantially all interest and dividend income is from marketable securities and other cash investments.
Receivables --
Current receivables include trade accounts and notes receivable and are net of allowances for doubtful accounts of $10.0 million in 1993 and $10.1 million in 1992. Long-term receivables consist of notes receivable and are net of allowances for doubtful accounts of $4.2 million in 1993 and $8.2 million in 1992.
At December 31, 1993 and 1992, current receivables included notes receivable of $12.6 million and $13.0 million, respectively. Other assets included long-term notes receivable of $44.7 million and $31.8 million at December 31, 1993 and 1992, respectively.
In May 1993, the FASB issued a new standard on accounting by creditors for impairment of loans. This standard requires certain impaired loans to be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Adoption of the standard by Pennzoil is required no later than the first quarter of 1995, although earlier implementation is permitted. Pennzoil currently expects to adopt the standard effective January 1, 1995. Based on a preliminary review, Pennzoil does not expect that adoption of the standard will have a material effect on its financial condition or results of operations.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Inventories --
A majority of inventories are 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 $131.2 million at December 31, 1993 and $134.3 million at December 31, 1992. The current cost of LIFO inventories was approximately $178.8 million and $207.9 million at December 31, 1993 and 1992, respectively.
Oil and Gas Producing Activities and Depreciation, Depletion and Amortization --
Pennzoil follows the successful efforts method of accounting for oil and gas operations. Under the successful efforts method, lease acquisition costs are capitalized. Significant unproved properties are reviewed periodically on a property-by-property basis to determine if there has been impairment of the carrying value, with any such impairment charged currently to exploration expense. All other unproved properties are generally aggregated and a portion of such costs estimated to be nonproductive, based on historical experience, is amortized on an average holding period basis.
Exploratory drilling costs are capitalized pending determination of proved reserves. If proved reserves are not discovered, the exploratory drilling costs are expensed. Other exploration costs are also expensed. All development costs are capitalized. Provision for depreciation, depletion and amortization is determined on a field-by-field basis using the unit-of-production method. Estimated costs of future dismantlement and abandonment of wells and production platforms, net of salvage values, are accrued as part of depreciation, depletion and amortization expense using the unit-of-production method; actual costs are charged to accumulated depreciation, depletion and amortization. The carrying amounts of proven properties are reviewed periodically and an impairment reserve is provided as conditions warrant.
Pennzoil follows the sales method of accounting for natural gas imbalances. Under the sales method, revenue is recognized on all production delivered by Pennzoil to its purchasers, regardless of Pennzoil's ownership interest in the respective property. At December 31, 1993, Pennzoil's gas imbalance reflects a net underproduced position of 17 billion cubic feet of gas. The company expects to recover this imbalance from its co-owners through future production or alternative arrangements.
Sulphur properties are generally depreciated and depleted on the unit-of-production method, except assets having an estimated life less than the estimated life of the mineral deposits, which are depreciated on the straight-line method.
All other properties are depreciated on straight-line or accelerated methods in amounts calculated to allocate the cost of properties over their estimated useful lives.
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.
Intangible Assets --
Substantially all intangible assets, included in other assets in the accompanying consolidated balance sheet, relate to goodwill recognized in business combinations accounted for as purchases. Goodwill included in other assets in the accompanying consolidated balance sheet was $86.2 million at December 31, 1993 and $82.3 million at December 31, 1992, net of accumulated amortization of $17.2 million and $11.2 million, respectively. Goodwill is being amortized on a straight-line basis over periods ranging from 20 to 40 years. Amortization expense recorded during 1993 and 1992 was $8.1 million and $5.2 million, respectively.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Cash used in operating activities includes cash payments for interest (net of amounts capitalized) of $183.6 million, $228.9 million and $246.8 million in 1993, 1992 and 1991, respectively. Interest capitalized for 1993, 1992 and 1991 was $11.4 million, $8.7 million and $10.4 million, respectively. Income taxes paid, net of refunds, during 1993, 1992 and 1991 were $5.5 million, $2.2 million and $13.7 million, respectively.
Changes in operating assets and liabilities, net of effects from the purchases of equity interests in certain businesses acquired, consist of the following:
Earnings Per Share --
Earnings per share are computed based on the weighted average shares of common stock outstanding. The average shares used in earnings per share computations for the years 1993, 1992 and 1991 were 42,187,739, 40,582,451 and 40,346,652, respectively.
Foreign Operations --
Consolidated income (loss) from continuing operations before income tax includes losses from foreign operations of $17.3 million, $21.7 million and $10.0 million in 1993, 1992 and 1991, respectively.
(2) INCOME TAXES --
Accounting for Income Taxes --
In December 1992, Pennzoil announced its decision to change its method of accounting for income taxes by adopting the new requirements of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," effective as of January 1, 1992. Previous 1992 interim period results were restated as a result of the adoption. Prior year financial statements have not been restated to reflect the new accounting method. As a result of adopting SFAS No. 109, Pennzoil recognized a cumulative, one-time benefit from the change in accounting principle for periods prior to 1992 of $115.7 million, or $2.85 per share, as of the first quarter of 1992. In addition to the cumulative effect, income from continuing operations for the year ended December 31, 1992, increased $3.4 million ($4.5 million before tax), or $.08 per share, associated with adopting the new standard.
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 adoption of SFAS No. 109, deferred income taxes resulted from timing differences in the recognition of revenue and expense for tax and financial purposes.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Federal, State and Foreign --
Federal, state and foreign income tax expense (benefit) for continuing operations consists of the following:
Reference is made to Note 3 for information regarding the tax benefit applicable to the extraordinary loss on the early retirement of debt. In addition, reference is made to Note 6 for information regarding the deferred tax benefit applicable to the cumulative effect of the change in accounting for postretirement benefit costs other than pensions.
Pennzoil's net deferred tax liability is as follows:
Temporary differences and carryforwards which gave rise to significant portions of deferred tax assets and liabilities are as follows:
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Prior to adopting SFAS No. 109, the sources of timing differences resulting from the recognition of revenue and expense for tax and financial reporting purposes and the tax effect of each were as follows:
The principal items accounting for the difference in income taxes on income from continuing operations computed at the federal statutory rate and as recorded are as follows:
In August 1993, the Omnibus Budget Reconciliation Act of 1993 was enacted, establishing a new 35% corporate income tax rate effective January 1, 1993. As a result of the increase in the marginal income tax rate and other tax law changes, Pennzoil recorded a one-time, non-cash charge of approximately $16 million, or $.38 per share, in the third quarter of 1993 to adjust its deferred income tax liabilities and assets for the effect of the change in income tax rates.
The tax liability resulting from the November 1993 sale of 8,158,582 shares of Chevron common stock was reduced by $25.5 million as a result of the utilization of a net operating loss carryforward (see Note 1). Realization of the net operating loss carryforward resulted in the reversal of a valuation allowance related to the deferred tax asset.
As of December 31, 1993, Pennzoil had a United States net operating loss carryforward of approximately $133 million, which is available to reduce future regular income taxes payable. Additionally, for purposes of determining alternative minimum tax, an approximately $7 million net operating loss is available to offset future 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
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
income of the subsidiary, or its successor, generating the loss. If not used, these carryovers will expire in the years 1998 to 2004. In addition, Pennzoil has approximately $195 million of alternative minimum tax credits indefinitely available to reduce future 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.
Reference is made to Note 8 for information regarding a letter and examination report received from the District Director of the Internal Revenue Service ("IRS") in January 1994 that proposes a tax deficiency based on an audit of Pennzoil's 1988 federal income tax return.
(3) DEBT --
Long-term debt outstanding was as follows:
In August 1993, Pennzoil entered into an amended and restated credit facility with a group of banks that provides for up to $600.0 million of unsecured revolving credit borrowings through August 19, 1994, with any outstanding borrowings on such date being converted into a term credit facility terminating on September 1, 1995. A facility fee of .15% per annum is payable on the aggregate amount of the banks' commitments. This amended and restated credit facility replaces and supersedes the previous revolving credit facilities of Pennzoil and Pennzoil Exploration and Production Company ("PEPCO"), a wholly owned subsidiary of Pennzoil.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Borrowings under the facility totaled $195.0 million at December 31, 1993. The average interest rate applicable to amounts outstanding under this facility and the previous revolving credit facilities of Pennzoil and PEPCO was 3.59% during 1993.
Prior to August 1993, PEPCO had a revolving credit facility with a group of banks to provide for unsecured borrowings. A commitment fee of .20% per annum was payable on the average daily unborrowed amount under the facility. Outstanding borrowings under this facility totaled $72.1 million at December 31, 1992. The average interest rate applicable to amounts outstanding under this facility was 4.10% during 1992.
Also prior to August 1993, Pennzoil had a $500.0 million revolving credit facility with a group of banks to provide for unsecured revolving credit borrowings. A commitment fee of .15% per annum was payable on the average daily unborrowed amount under the facility. Outstanding borrowings under this facility totaled $207.7 million at December 31, 1992. The average interest rate applicable to amounts outstanding under this facility was 4.15% during 1992.
Pennzoil's Board of Directors has increased the limit on the aggregate amount of commercial paper that Pennzoil may issue under its domestic commercial paper program and/or its Euro-commercial paper program from $150.0 million to $250.0 million. Borrowings under Pennzoil's commercial paper facilities totaled $249.4 million and $147.3 million at December 31, 1993 and 1992, respectively, and are included in notes payable in the accompanying consolidated balance sheet. The average interest rates applicable to outstanding commercial paper were 3.26% and 3.81% during 1993 and 1992, respectively.
Pennzoil has several short-term variable-rate credit arrangements with certain banks. Pennzoil's Board of Directors has limited borrowings under these credit arrangements to $200.0 million. Outstanding borrowings totaled $183.6 million and $192.1 million at December 31, 1993 and 1992, respectively, and are included in notes payable in the accompanying consolidated balance sheet. The average interest rates applicable to amounts outstanding under these arrangements were 3.35% and 3.87% during 1993 and 1992, respectively. None of the banks has any obligation to continue to extend credit after the maturities of outstanding borrowings or to extend the maturities of any borrowings under these credit arrangements.
In December 1992, Pennzoil called for redemption $272.9 million principal amount of indebtedness (including $250.0 million of Pennzoil's 10 5/8% debentures due 2018 and $22.9 million of Pennzoil's 10% debentures due 2011), using proceeds from the disposition of Purolator Products Company ("Purolator"), from the disposition of certain oil and gas properties and from cash contributed by Chevron to Pennzoil Petroleum for the benefit of Pennzoil. The redemptions were completed in February 1993. As of December 31, 1992, this indebtedness was defeased by placing funds required for the redemption with the trustee for the indebtedness. As a result, the funds deposited with the trustee for the redemption of the debentures and the principal amount of the indebtedness are not reflected in Pennzoil's consolidated balance sheet at December 31, 1992. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $16.6 million ($25.2 million before tax), or $.41 per share, in the fourth quarter of 1992.
In 1993, Pennzoil completed public offerings of $402.5 million of the 6 1/2% Debentures and $500.0 million of the 4 3/4% Debentures. The 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable at the option of the holders thereof at any time prior to maturity, unless previously redeemed, for shares of Chevron common stock owned by Pennzoil at exchange rates of 11.887 shares and 8.502 shares, respectively, per $1,000 principal amount of the 6 1/2% Debentures and the 4 3/4% Debentures (the equivalent of $84 1/8 per share and $117 5/8 per share, respectively), subject to adjustment in certain events. In lieu of delivering certificates representing shares of Chevron common stock in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may, at its option, pay to any holder surrendering the 6 1/2% Debentures and the 4 3/4% Debentures an amount in cash equal to the market price of the shares for which the 6 1/2% Debentures and the 4 3/4% Debentures are
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
exchangeable. Pennzoil has deposited 9,035,518 shares of Chevron common stock deliverable in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures with exchange agents.
Under the instruments governing the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may not pledge, mortgage, hypothecate or grant a security interest in, or permit any mortgage, pledge, security interest or other lien upon, the shares of Chevron common stock deposited with exchange agents and deliverable in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures. Pennzoil may at any time obtain from the exchange agents or otherwise authorize or direct the exchange agents to release all or part of the 9,035,518 shares of Chevron common stock deposited with the exchange agents. However, in the event Pennzoil obtains or otherwise releases any shares of Chevron common stock subject to exchange, each holder of a 6 1/2% Debenture or a 4 3/4% Debenture will generally have the right, at such holder's option, to require Pennzoil to repurchase all or a portion of such holder's debentures at a premium.
In March 1993, using proceeds from the sale of the 6 1/2% Debentures, Pennzoil redeemed $223.4 million principal amount of indebtedness (including $80.1 million of Pennzoil's 12 1/8% and 12 1/4% debentures due 2007, $100.0 million of Pennzoil's 9 1/8% notes due 1996 and $43.3 million of Pennzoil's 9% debentures due 2001). The call premiums and related unamortized net premiums and debt issue costs relating to the redemption of these series of indebtedness resulted in a charge of $1.4 million, net of tax, or $.02 per share, for the first quarter of 1993. Also with such proceeds, approximately $23.3 million of additional indebtedness has been retired, repaid or repurchased in 1993 and $100.0 million principal amount of Pennzoil's 9% notes was retired upon maturity in May 1993.
In June 1993, Pennzoil called for redemption $96.1 million principal amount of indebtedness (including $66.1 million of Pennzoil's 10% debentures due 2011 and $30.0 million of Pennzoil's 10 1/8% debentures due 2011). The redemptions were completed in July 1993. The funds used for these redemptions were obtained from (i) the cash proceeds from the completed sale of a subsidiary holding Pennzoil's Indonesian gold properties in January 1993, (ii) the cash proceeds from the sale in March 1993 of common stock of Pogo Producing Company held by Pennzoil and (iii) the cash payments received from Chevron from and as a result of the net cash flows from operations of the oil and gas properties of Pennzoil Petroleum through March 31, 1993. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $4.7 million ($7.2 million before tax), or $.12 per share, in the second quarter of 1993.
In September 1993, Pennzoil called for redemption $292.5 million principal amount of indebtedness (including $120.0 million of Pennzoil's 10 1/8% debentures due 2011, $111.0 million of Pennzoil's 10% debentures due 2011 and $61.5 million of Pennzoil's 9% debentures due 2017). The redemptions were completed in November 1993. The funds used for these redemptions were obtained primarily from the net proceeds from the sale in September 1993 of 5,000,000 shares of Pennzoil common stock (see Note 7). The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $13.7 million ($21.1 million before tax), or $.33 per share, in the third quarter of 1993.
In October 1993, using $350.0 million of the proceeds from the sale of the 4 3/4% Debentures, Pennzoil reduced its borrowings outstanding under its unsecured revolving credit facility. Also from such proceeds, Pennzoil redeemed $24.0 million principal amount of indebtedness in November 1993 (including $21.3 million of Pennzoil's 8 3/8% and 8 5/8% debentures due 1996 and $2.7 million of Pennzoil's 8 3/4% debentures due 2001). No significant gain or loss resulted from these early retirements.
In May 1993, Jiffy Lube International, Inc. ("Jiffy Lube"), a wholly owned subsidiary of Pennzoil, repurchased at face value $20.0 million of its unsecured promissory notes which were originally issued in connection with Jiffy Lube's debt restructuring in January 1990 (see Note 10). Also issued in connection with Jiffy Lube's debt restructuring was a series of unsecured non-interest bearing promissory notes maturing over
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
seven years in the aggregate principal amount of approximately $15.1 million at December 31, 1993 (with a present value of approximately $11.5 million at December 31, 1993), the payment of which is contingent upon the future profitability of Jiffy Lube. Jiffy Lube also has $18.8 million in outstanding mortgages on certain real estate and buildings with interest rates ranging from 6.3% to 11.0% and maturing through 2012. The book value of the collateral securing these mortgages was $19.7 million at December 31, 1993.
At December 31, 1993, amounts due within one year for Jiffy Lube include $17.4 million of the long-term mortgage debt described above that is in default as a result of the violation of certain covenants and cross-default provisions applicable to such debt. As a result, the applicable lenders could declare these obligations to be in default and exercise certain rights and remedies, including accelerating the maturity of the obligations so that they become immediately due and payable subject, in some cases, to certain notice periods and provisions allowing the curing of the defaults. Although these obligations are in technical default, Jiffy Lube has paid all principal and interest on such obligations when due.
At December 31, 1993, sinking fund obligations and maturities of long-term debt for the years ending December 31, 1994 to 1998 were $19.6 million, $200.6 million, $5.4 million, $6.0 million and $1.7 million, respectively. Such maturities include $3.5 million, $3.5 million and $4.6 million for the years ending December 31, 1995 to 1997, respectively, related to Jiffy Lube's non-interest bearing promissory notes, the payment of which is contingent upon the future profitability of Jiffy Lube. These maturities of long-term debt include $17.4 million of Jiffy Lube's long-term debt in technical default classified as due within one year as discussed above.
(4) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK --
Financial Instruments with Off-Balance-Sheet Risk --
Pennzoil 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's consolidated balance sheet. In addition, in connection with Pennzoil's disposition of Purolator, Pennzoil entered into an agreement with certain banks to provide contingent credit support for a Purolator credit facility and an agreement with a government agency with respect to guarantees of benefits under certain of Purolator's employee benefit plans.
The financial guarantees primarily relate to debt and lease obligation guarantees with expiration dates of up to twenty 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. The largest of these commitments is to provide a guarantee for letters of credit issued by third parties to meet the reinsurance requirements of Pennzoil's captive insurance subsidiary. This commitment has no stated maturity and is expected to vary in amount from year to year to meet the reinsurance requirements. Reserves established for reported and incurred but not reported insurance losses in the amount of $32.3 million and $30.7 million have been recognized in Pennzoil's consolidated balance sheet as of December 31, 1993 and 1992, respectively. The credit risk to Pennzoil is mitigated by the insurance subsidiary's portfolio of high-quality short-term investments used to collateralize the letter of credit. At December 31, 1993, the collateral was valued at approximately 137% of the credit risk.
The credit support for the Purolator credit facility is contingent upon the occurrence of an acceleration of the debt under the facility after an event of default, but only if and to the extent Purolator has incurred certain
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
environmental expenses not covered by an indemnification agreement pursuant to which Pennzoil agreed to indemnify Purolator against necessary costs and expenses of certain environmental remediation activities currently required by the Environmental Protection Agency ("EPA") at specified Purolator sites (the indemnification is limited to remediation required solely as a result of contamination prior to the agreement) (see Note 8). In such event, Pennzoil would be required to pay to the banks an amount equal to the amount expended by Purolator for such unindemnified environmental expenses (in which case Purolator would become liable to Pennzoil for any such amount). The maximum amount of any such contingent payment is permanently reduced over time as the maximum amount available under the Purolator credit facility declines. As of December 31, 1993, the maximum amount of the contingent credit support was $23.1 million.
In connection with Pennzoil's disposition of Purolator in December 1992, Pennzoil entered into an agreement with the Pension Benefit Guaranty Corporation ("PBGC"), pursuant to which Pennzoil agreed that, for up to five years, in the event of the termination of any or all the employee benefit plans of Purolator that are subject to Title IV of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the inability of the PBGC in good faith to collect the amounts of any unfunded benefit liabilities under Purolator's plans from Purolator or any person controlling Purolator, Pennzoil would guarantee up to $7.0 million of such unfunded benefit liabilities.
Following are the amounts related to Pennzoil's financial guarantees and contractual commitments to extend financial guarantees, credit and other assistance as of December 31, 1993 and 1992.
Pennzoil's exposure to credit loss 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.
Concentrations of Credit Risk --
Pennzoil extends credit to various companies in the oil and gas, motor oil and automotive products, fast lube and sulphur industries 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's overall credit risk. However, management believes that consolidated receivables are well diversified, thereby reducing potential credit risk to Pennzoil, and that allowances for doubtful accounts are adequate to absorb estimated losses as of December 31, 1993. Pennzoil's policies concerning collateral requirements and the types of collateral obtained for on-balance-sheet financial
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
instruments are the same as those described above under "Financial Instruments with Off-Balance-Sheet Risk."
At December 31, 1993, receivables related to these group concentrations in the oil and gas, motor oil and automotive products, fast lube and sulphur industries were $182.8 million, $181.4 million, $36.9 million and $8.9 million, respectively, compared with $140.5 million, $184.5 million, $32.3 million and $20.3 million, respectively, at December 31, 1992.
(5) FAIR VALUE OF FINANCIAL INSTRUMENTS --
The carrying amounts of Pennzoil's short-term financial instruments, including cash equivalents, current marketable securities and other investments, trade accounts receivable, trade accounts payable and notes payable, approximate their fair values based on the short maturities of those instruments and on quoted market prices, where such prices are available.
The following table summarizes the carrying amounts and estimated fair values of Pennzoil's other financial instruments.
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.
Long-Term Investments --
The estimated fair value of long-term investments is based on quoted market prices at year end for those investments.
Long-Term Debt --
The estimated fair value of Pennzoil's 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 maturities and credit quality.
Off-Balance-Sheet Financial Instruments --
The estimated fair value of certain financial guarantees written and commitments to extend financial guarantees is based on the estimated cost to Pennzoil to obtain third party letters of credit to relieve Pennzoil
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Reference is made to Note 4 for further information regarding off-balance-sheet financial instruments.
(6) BENEFIT PLANS --
Retirement Plans --
Substantially all employees are covered by non-contributory retirement plans which provide benefits based on the participants' years of service and compensation or stated amounts for each year of service. Annual 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.
Net periodic pension cost for 1993, 1992 and 1991 included the following components:
Actual return on plans' assets was $2.6 million, $6.2 million and $30.4 million in 1993, 1992 and 1991, respectively.
Assumptions used were:
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table sets forth the plans' funded status and amounts recognized in the consolidated balance sheet:
The plans' assets include equity securities, common trust funds and various debt securities.
Unrecognized prior service cost is amortized on a straight-line basis over a period equal to the average of the expected future service of active employees expected to receive benefits under the respective plans.
Postretirement Health Care and Life Insurance Benefits --
Pennzoil sponsors several unfunded defined benefit postretirement plans covering most salaried and hourly 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's expressed intent to increase, where possible, contributions from future retirees to a minimum of 30% of the total annual cost. Furthermore, Pennzoil's future contributions for both current and future retirees have been limited, where possible, to 200% of the average 1992 benefit cost.
In December 1991, Pennzoil announced its decision to change its method of accounting for postretirement benefit costs other than pensions by adopting the new requirements of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," effective as of January 1, 1991. Previous 1991
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
interim period results were restated as a result of adopting the new standard. Pennzoil recorded a charge of $49.0 million ($74.2 million before tax), or $1.21 per share, as of the first quarter of 1991 to reflect the cumulative effect of the change in accounting principle for periods prior to 1991. The first quarter charge included $11.4 million ($17.3 million before tax) related to the cumulative effect of the change in accounting principle associated with Purolator. In addition to the cumulative effect, Pennzoil's 1991 postretirement health care and life insurance costs increased $1.7 million ($2.6 million before tax), or $.04 per share, as a result of adopting the new standard.
Net periodic postretirement benefit cost for 1993, 1992 and 1991 included the following components:
The following table sets forth the plans' combined status reconciled with the amount included in the consolidated balance sheet at December 31, 1993 and 1992:
For measurement purposes, an 11% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994; the rate was assumed to decrease gradually to 7% through the year 2001 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amount of the obligation and periodic cost reported. An increase in the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $3.4 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $.3 million.
The weighted-average discount rates used in determining the accumulated postretirement benefit obligation as of December 31, 1993 and 1992 were 7.5% and 8.25%, respectively.
Contribution Plans --
Pennzoil has defined contribution plans covering substantially all employees who have completed one year of service. Employee contributions of not less than 1% to not more than 6% of each covered employee's compensation are matched between 50% and 100% by Pennzoil. The cost of such company contributions totaled $9.4 million in 1993, $9.1 million in 1992 and $8.1 million in 1991.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Postemployment Benefits --
In November 1992, the FASB issued a new standard on accounting for postemployment benefits. This standard requires employers to recognize the obligation to provide postemployment benefits if the obligation is attributable to employees' services already rendered, employees' rights to those benefits accumulate or vest, payment of the benefits is probable and the amounts can be reasonably estimated. If those four conditions are not met, the employer should recognize the obligation to provide postemployment benefits when it is probable that a liability has been incurred and the amount can be reasonably estimated. Adoption of the standard by Pennzoil is required effective January 1, 1994. The standard does not represent a significant change from Pennzoil's current policy of recognizing postemployment benefit costs. As such, adoption of the standard will not have a material effect on Pennzoil's financial condition or results of operations.
(7) CAPITAL STOCK AND STOCK OPTIONS --
Pennzoil's Restated Certificate of Incorporation authorizes the issuance of up to 9,747,720 shares of preferred stock. None of these shares were issued or outstanding at December 31, 1993.
Pennzoil's Restated Certificate of Incorporation authorizes the issuance of up to 27,862,924 shares of preference common stock. None of these shares were issued or outstanding at December 31, 1993. Dividend rights on any preference common stock are junior to the rights of any preferred stock and senior to the rights of Pennzoil's common stock.
In September 1993, Pennzoil completed the sale, pursuant to underwritten public offerings, of 5,000,000 shares of its common stock at a price of $62.50 per share. As of December 31, 1993, 45,910,307 shares of Pennzoil common stock were issued and outstanding.
The net proceeds from the sale of the shares of Pennzoil common stock offered, prior to the payment of expenses, totaled approximately $303.3 million. Primarily utilizing funds from such offerings, Pennzoil redeemed an aggregate of $292.5 million principal amount of Pennzoil's debentures (see Note 3). Pro forma earnings per share for the year ended December 31, 1993, assuming the stock offering and redemption of debentures had occurred at the beginning of 1993, was $3.43 per share.
At December 31, 1993, Pennzoil had 2,694,418 shares of common stock reserved for issuance upon the exercise of stock options and the maturity of conditional stock awards.
At December 31, 1993, Pennzoil had nonqualified and incentive stock option plans covering a total of 2,620,565 shares of common stock (compared to 2,673,848 shares at December 31, 1992), of which 605,140 shares were available for granting of options. Options granted under the plans have a maximum term of ten years and are exercisable under the terms of the respective option agreements at the market price of the common stock at the date of grant, subject to antidilution adjustments in certain circumstances. At December 31, 1993, expiration dates for the outstanding options ranged from March 1994 to December 2003 and the average exercise price per share was $63.55. Payment of the exercise price may be made in cash or in shares of common stock previously owned by the optionee, valued at the then-current market value.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Additional information with respect to the stock option plans is as follows:
In 1993, 24,150 units of common stock were granted to selected employees under Pennzoil's conditional stock award programs. Awards under the programs are made in the form of units which entitle the recipient to receive, at the end of a specified period, subject to certain conditions of continued employment, a number of shares equal to the number of units granted. At December 31, 1993, units covering 73,853 shares were outstanding (compared to 50,033 shares at December 31, 1992). In 1992, 24,200 shares of common stock were distributed to selected employees upon maturity of awards granted under Pennzoil's conditional stock award programs.
(8) COMMITMENTS AND CONTINGENCIES --
Tax Dispute --
In 1988, Pennzoil received $3.0 billion from Texaco Inc. ("Texaco") in settlement of all litigation between Pennzoil and Texaco arising out of Texaco's tortious interference with Pennzoil's contractual rights to purchase a minority interest in Getty Oil Company. From 1989 through 1991, Pennzoil acquired 32,944,100 shares of Chevron common stock with approximately $2.2 billion of the net Texaco settlement proceeds.
For financial reporting purposes, Pennzoil reported an extraordinary gain of $1.656 billion (after expenses and estimated current and deferred taxes), or $42.62 per share, associated with the $3.0 billion in cash received from Texaco in April 1988.
For federal income tax purposes, Pennzoil originally reported that it recognized no gain upon receipt of the $3.0 billion and obtained no tax basis in the Chevron shares. Pennzoil's reporting position was based on its belief that, under Section 1033 of the Internal Revenue Code, the $3.0 billion received from Texaco was an amount realized as a result of the involuntary conversion of property and that the Chevron shares were similar or related in service or use to the property converted by Texaco. During 1990 and 1991, Pennzoil recalculated its 1988 federal income tax liability to recognize approximately $800 million of income, being the excess of the $3.0 billion received over the amount expended to acquire Chevron shares. As a result of these adjustments, current taxes were increased, and deferred taxes were decreased, by $120.4 million in 1990 and $13.2 million in 1991. In addition, Pennzoil paid interest on such taxes of $17.6 million during 1990 and $3.7 million in 1991.
In January 1994, Pennzoil received a letter and examination report from the District Director of the IRS that proposes a tax deficiency based on an audit of Pennzoil's 1988 federal income tax return. The examination report proposes two principal adjustments with which Pennzoil disagrees.
The first adjustment challenges Pennzoil's position under Section 1033 of the Internal Revenue Code that (i) at least $2.2 billion of the $3.0 billion cash payment received from Texaco in 1988 in settlement of certain litigation was realized as a result of the involuntary conversion of property and (ii) the shares of Chevron common stock purchased with $2.2 billion of the net Texaco settlement proceeds were similar or related in service or use to the property converted by Texaco. Although these issues have not been resolved, Pennzoil
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
believes that its position is sound, and it intends to contest the proposed adjustment in court unless an acceptable settlement is reached. The proposed tax deficiency relating to this proposed adjustment is $550.9 million, net of available offsets. Pennzoil estimates that the additional after-tax interest on this proposed deficiency would be approximately $234.3 million as of December 31, 1993. If Pennzoil's position is not sustained by the courts, Pennzoil would be required to pay the assessed taxes, plus the accrued interest, and Pennzoil's tax basis in the shares of common stock of Chevron and Pennzoil Petroleum (see Note 10) would be Pennzoil's cost. Pennzoil's consolidated financial statements do not include an accrual for the interest that would be due in such event.
The second adjustment proposed by the IRS would permanently capitalize, rather than allow Pennzoil to deduct, approximately $366 million incurred by Pennzoil in 1988 and earlier years for litigation and related expenses in connection with the Texaco settlement, even if it were determined that the entire $3.0 billion is includable in Pennzoil's 1988 taxable income. Pennzoil believes that this proposed adjustment is irrational and capricious and will not be sustained in court. The proposed tax deficiency relating to the disallowance of deductions is $124.6 million, and the estimated additional after-tax interest on this proposed deficiency would be approximately $46.7 million as of December 31, 1993. If the deductions for legal and related expenses were ultimately disallowed, Pennzoil would be required to pay the assessed taxes, plus the accrued interest. Pennzoil's consolidated financial statements do not include an accrual for the taxes that would be assessed as a result of the proposed disallowance of deductions or the related interest that would be due in such event.
Pennzoil has formally protested the IRS' proposed tax deficiency in writing within the required 30-day time period. The issue has been forwarded to the IRS Appeals Office, which is empowered to settle disputes with taxpayers, taking into account the hazards of litigation. If Pennzoil and the IRS Appeals Office are unable to reach a negotiated resolution of these tax issues, the IRS would forward a letter requiring Pennzoil to pay the assessed taxes, plus the accrued interest, within 90 days, unless Pennzoil files a petition with the United States Tax Court. If Pennzoil were to choose to file suit in the Tax Court, Pennzoil would not pay any taxes unless and until the Tax Court rendered a judgment against Pennzoil, but interest would continue to accrue on any taxes ultimately determined to be due. Alternatively, Pennzoil would be entitled to choose to pay the assessed taxes, plus the accrued interest, and file a claim for a refund in either the United States Court of Claims or the United States District Court for the Southern District of Texas. Paying the assessed taxes would halt the accrual of interest on any taxes finally determined to be owing by Pennzoil. In such event, any refund to Pennzoil would include a refund by the IRS of the prior interest paid by Pennzoil, as well as a payment by the IRS of additional interest accrued on the assessed taxes previously paid by Pennzoil. If litigation is necessary, a case of this kind would normally take several years in the absence of a settlement, which could occur at any stage in the process.
Pennzoil had cash and cash equivalents and current marketable securities and other investments of $946.6 million at December 31, 1993 and approximately $850 million at March 1, 1994. As a result of these available liquid assets and Pennzoil's available credit facilities, Pennzoil believes that it has the financial flexibility to deal with any eventuality that may occur in connection with the dispute with the IRS, including the possibility of paying the taxes assessed, plus the accrued interest, and suing for a refund if Pennzoil is not able to resolve the disputed matters through discussions with the IRS.
Deferred income taxes originally resulted from the timing difference in the recognition of the settlement income for tax and financial reporting purposes under the deferred method of accounting for income taxes and not from the accrual of a contingency reserve for taxes due in the event Pennzoil's tax reporting position ultimately were determined to be incorrect. Under the liability method of accounting for income taxes adopted by Pennzoil in December 1992, since the excess of the financial reporting basis over the tax basis of Pennzoil's investment in Pennzoil Petroleum is not expected to result in a future income tax liability, deferred income taxes attributable to the 15,750,000 shares of Chevron common stock exchanged for the stock of Pennzoil
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Petroleum have been reflected as a reduction of the cost of Pennzoil's investment in Pennzoil Petroleum. Deferred income taxes remain related to the 9,035,518 shares of Chevron common stock currently owned by Pennzoil (see Note 10).
Curtailment Litigation --
United Gas Pipe Line Company ("United"), a former subsidiary of Pennzoil, curtailed deliveries of natural gas to its customers in accordance with priorities contained in its tariffs during the 1970s and early 1980s. Several lawsuits filed by industrial and power plant "direct sale" customers for damages allegedly caused by curtailments were brought against United, and Pennzoil was joined as a defendant in five of these suits. The only remaining suit against United involving Pennzoil is an action filed in the United States District Court for the Southern District of Mississippi on November 14, 1974 by Mississippi Power Co. ("MPCo"), which alleges damages of approximately $44.7 million and seeks to have such damages trebled pursuant to federal antitrust laws. In related proceedings before the Federal Energy Regulatory Commission ("FERC"), MPCo has introduced evidence indicating that its claimed damages (before trebling) have increased to approximately $88.2 million. The judge in the MPCo case has referred certain issues to the FERC and stayed all proceedings pending action by the FERC. No action has been taken to remove the stay. Pennzoil believes that it has no liability for any action it has taken or omitted to take, that it can successfully defend itself in the action and that the final outcome of the case will not have a material adverse effect on its financial condition or results of operations.
Eaton v. Pennzoil Company --
In December 1992, two former employees of Pennzoil filed a purported class action lawsuit in the United States District Court for the Southern District of Texas, Galveston Division. The suit alleges that one of Pennzoil's deferred compensation plans had been improperly administered because of the absence of an adjustment under the plan for a significant event occurring in 1988 in determining the value of awards under the plan maturing in 1988 and 1990. The plaintiffs allege breach of contract, common law fraud and breach of fiduciary duty and seek compensatory and consequential damages of $40.0 million and punitive damages of $400.0 million. Pennzoil believes that the plan was administered properly and the lawsuit is without merit. In October 1993, the court granted Pennzoil's motion for summary judgment. The plaintiffs have appealed. Pennzoil believes that the outcome of this suit will not have a material adverse effect on its financial condition or results of operations.
Environmental Matters --
Pennzoil 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. Pennzoil 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's consolidated financial statements. Pennzoil 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.
In connection with Pennzoil's disposition of Purolator, Pennzoil and Purolator entered into an indemnification agreement pursuant to which Pennzoil has agreed to reimburse Purolator for costs and expenses of certain environmental remediation relating to a plant operated by Purolator in Elmira Heights, New York, and certain environmental remediation, if any, relating to one other site located near the Elmira facility and a
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
landfill site located in Metamora, Michigan. The indemnification provided by Pennzoil applies to all remediation required by Purolator under CERCLA that has been identified at the Elmira facility in the EPA's September 1992 Record of Decision with respect to the Elmira facility, but does not extend to certain additional environmental expenditures relating to the Elmira facility or other sites for which Purolator is or may be held responsible. Pennzoil had a reserve of $16.3 million and a $17.7 million recorded with respect to its obligations under its indemnification agreement with Purolator as of December 31, 1993 and 1992, respectively. Reference is made to Note 11 for additional information.
Certain of Pennzoil'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'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, 1993 and 1992, Pennzoil's consolidated balance sheet included accrued liabilities for environmental remediation of $33.1 and $34.2 million, respectively, which amounts include reserves with respect to Pennzoil's obligations under its indemnification agreement with Purolator referred to in the previous paragraph. Of these reserves, $4.8 million and $4.9 million is reflected on the consolidated balance sheet as other current liabilities as of December 31, 1993 and 1992, respectively, and $28.3 million and $29.3 million is reflected as other liabilities as of December 31, 1993 and 1992, respectively. Pennzoil does not currently believe there is a reasonable possibility of incurring additional material amounts in excess of the current accruals recognized for such environmental remediation activities. With respect to the sites in which Pennzoil subsidiaries are PRPs, Pennzoil'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's current belief that its share of wastes at a particular site is or will be less than the threshold deemed by the EPA or recognized by the relevant group of PRPs as being de minimis (and as a result Pennzoil's monetary exposure is not expected to be material).
FTC Matters --
The Federal Trade Commission ("FTC") has inquired as to Pennzoil's reliance on the investment exemption of Section 7A(c)(9) and Rule 802.9 under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, in connection with Pennzoil's investment in common stock of other entities. Pennzoil has provided the requested information to the FTC and has cooperated with the FTC in response to the inquiry.
Franchisee Litigation --
Certain current and former Jiffy Lube franchisees have brought suit against Jiffy Lube to challenge various matters relating to the franchisor-franchisee relationship. Certain of the suits have included allegations against Pennzoil and/or Pennzoil Products Company ("PPC"), a wholly owned subsidiary of Pennzoil, as well. These franchisee lawsuits generally contain allegations of, among other things, certain misrepresentations by Jiffy Lube in connection with the execution of franchise and licensing agreements, certain breaches of these agreements by Jiffy Lube and/or certain breaches of fiduciary duty by Jiffy Lube. In some cases, conflicts of interest or conspiracy between Jiffy Lube and Pennzoil are also alleged. Pennzoil believes that the allegations in these lawsuits stem primarily from previous uncertainties surrounding Jiffy Lube's financial condition, financial difficulties experienced by certain franchisees and franchisees' concerns relating to the adequacy of services provided by Jiffy Lube prior to Pennzoil's initial acquisition of Jiffy Lube stock in January 1990 (see Note 10). Jiffy Lube, Pennzoil and/or PPC, as the case may be, have each denied the material allegations against them and intend to defend these actions vigorously. Pennzoil does not believe that the final outcome of these cases will have a material adverse effect on its financial condition or results of operations.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) LEASES --
As Lessee -- Pennzoil leases various assets and office space with lease periods of 1 to 20 years. Additionally, Pennzoil's wholly owned subsidiary Jiffy Lube 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 Jiffy Lube. 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.
Total operating lease rental expenses for Pennzoil (exclusive of oil and gas lease rentals) were $59.6 million, $56.2 million and $49.7 million for 1993, 1992 and 1991, respectively. Non-current capital lease obligations are classified as other liabilities in the accompanying consolidated balance sheet.
Future minimum commitments under noncancellable leasing arrangements as of December 31, 1993 are as follows:
Assets recorded under capital lease obligations of $65.3 million and $20.2 million at December 31, 1993 are classified as property, plant and equipment and other assets, respectively, in the accompanying consolidated balance sheet.
As Lessor -- Pennzoil, through its wholly owned subsidiary Jiffy Lube, 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.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future minimum lease payment receivables under noncancellable leasing arrangements as of December 31, 1993 are as follows:
(10) ACQUISITIONS --
Acquisition of Pennzoil Petroleum --
In October 1992, Pennzoil completed a transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock held by Pennzoil for all the capital stock of Pennzoil Petroleum, which owns Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. The exchange of stock has been accounted for using the purchase method of accounting, and Pennzoil Petroleum's results of operations subsequent to October 30, 1992 have been included in Pennzoil's consolidated financial statements. The fair market value of the 15,750,000 shares of Chevron common stock exchanged for the capital stock of Pennzoil Petroleum approximated Pennzoil's historical book value for such shares of $1.06 billion. Accordingly, Pennzoil used the net book value of the Chevron shares exchanged for purposes of purchase accounting.
Included in the assets of Pennzoil Petroleum at the time of the transfer to Pennzoil was $57.4 million in cash contributed by Chevron to Pennzoil Petroleum immediately prior to closing, representing the net cash flow from Pennzoil Petroleum's operations during the four-month period between the "effective date" and the closing date of the transaction, after reduction as a result of nonrecurring closing adjustments of approximately $11 million. As a result of an audit completed during 1993, Chevron contributed an additional $9.9 million in cash to Pennzoil Petroleum, representing an adjustment to the initial $57.4 million cash contribution made by Chevron to Pennzoil Petroleum prior to closing. This additional contribution from Chevron was accounted for as an adjustment to the original purchase price of Pennzoil Petroleum.
The following unaudited pro forma information has been prepared assuming that the acquisition of Pennzoil Petroleum had occurred at the beginning of the periods presented. Permitted pro forma adjustments include only the effects of events directly attributable to a transaction that are factually supportable and expected to have a continuing impact. Pro forma adjustments reflecting anticipated "efficiencies" in operations resulting from a transaction are, under most circumstances, not permitted. As a result of the limitations imposed with regard to the types of permitted pro forma adjustments, Pennzoil believes that this
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
unaudited pro forma information is not indicative of future results of operations, nor the results of historical operations had the acquisition of Pennzoil Petroleum been consummated as of the assumed dates.
Acquisition of Jiffy Lube --
On January 8, 1990, Jiffy Lube, Pennzoil and Jiffy Lube's senior unsecured creditors consummated a plan of debt restructuring for Jiffy Lube, which resulted in the restructuring and reduction of Jiffy Lube's senior unsecured debt and the acquisition by Pennzoil of 80% of the common stock of Jiffy Lube. In connection with the Jiffy Lube debt restructuring plan, Pennzoil paid $28.5 million in cash to or on behalf of Jiffy Lube and exchanged Pennzoil's $15.0 million principal amount of Jiffy Lube's 12% Convertible Subordinated Debenture (including accrued and unpaid interest) as consideration for the shares of Jiffy Lube common stock acquired.
The acquisition was accounted for using the purchase method of accounting, and the results of operations of Jiffy Lube have been included in Pennzoil's consolidated statement of income subsequent to January 8, 1990.
On August 5, 1991, a newly formed Pennzoil subsidiary commenced a tender offer to acquire all Jiffy Lube shares not already owned by Pennzoil at a price of $6.00 per share, or approximately $9.3 million in the aggregate. Pursuant to the tender offer, Pennzoil acquired additional Jiffy Lube common stock, as a result of which Pennzoil held directly or indirectly in excess of 93% of the outstanding Jiffy Lube common stock. A merger between Jiffy Lube and the newly formed Pennzoil subsidiary became effective as of October 17, 1991, pursuant to which each remaining Jiffy Lube share not owned by Pennzoil was converted into the right to receive $6.00 in cash. As a result of the merger, Jiffy Lube is now a wholly owned subsidiary of Pennzoil.
(11) DISCONTINUED OPERATIONS --
Filtration Products Segment --
In early 1990, Pennzoil decided to sell or otherwise dispose of Purolator. In connection with this decision, Pennzoil recorded a 1989 fourth quarter write-down of $125.0 million to reflect the estimated loss to be incurred from the then anticipated sale or other disposition of Purolator's filtration products operations, including estimated future costs and operating results from the segment until the date of disposition.
In August 1991, Pennzoil concluded that, because of Purolator's improved performance, the intrinsic value of Purolator could be more effectively realized by retaining Purolator. Accordingly, in the third quarter of 1991, Pennzoil reclassified Purolator's net assets and results of operations for all periods as part of continuing operations. As a result of Pennzoil's decision to retain Purolator, the remaining reserve of $115.7 million for the estimated loss on the disposition of Purolator originally established in the fourth quarter of 1989 was reversed. Concurrent with the reversal of the reserve, Pennzoil recorded a provision of $108.0 million ($88.0 million after tax) to reflect losses due to asset impairment and other identified liabilities
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
related to Purolator. The following is a summary of the write-downs and other charges provided during the three months ended September 30, 1991 (in millions):
(a) Write-Down of Goodwill --
In connection with the August 1991 decision not to dispose of Purolator, Pennzoil assessed the potential for loss recognition resulting from asset impairment and concluded that a portion of Purolator's goodwill was permanently impaired. Accordingly, a write-down of approximately $48.0 million was recorded.
(b) Reserve for Environmental Costs --
Purolator is involved in certain waste disposal areas in which it has been alleged that it is a potentially responsible party under CERCLA or similar state legislation. In connection therewith, charges totaling $30.0 million were recorded to reflect a reserve for estimated cleanup and compliance costs.
(c) Adjustment to Postretirement Benefit Liability Established at Acquisition - --
In connection with Pennzoil's 1988 acquisition of Purolator, a liability was established in the purchase price allocation for vested postretirement benefit obligations attributable to a specific group of Purolator retirees. Based on revised actuarial estimates, Pennzoil concluded that the remaining liability established for these retirees was understated and recorded a charge against earnings of $16.5 million. As of December 31, 1991, the net assets of discontinued operations have been reduced by a liability of $43.9 million attributable to these vested postretirement benefit obligations.
(d) Other Write-Downs and Charges --
Write-downs of other individually non-significant assets of approximately $10.0 million were recorded representing Pennzoil's estimate of the net realizability of those investments. In addition, other charges of approximately $3.5 million were recorded to reflect other identified liabilities.
Public Offerings --
In October 1992, as a result of Pennzoil's conclusion that disposal of Purolator's filtration products operations would enhance Pennzoil's efforts to focus on its strategic businesses and to reduce indebtedness, Purolator filed a registration statement pursuant to which Pennzoil offered to the public all shares of Purolator stock held by Pennzoil. Accordingly, Purolator's net assets and results of operations for all periods have been reclassified as discontinued operations for financial reporting purposes. In December 1992, Pennzoil sold in initial public offerings all its shares of capital stock of Purolator. The total amount received by Pennzoil, prior to the payment of expenses, from the net proceeds of the offerings and the repayment of indebtedness by Purolator was $206.0 million. Pennzoil also expects to receive a tax refund of approximately $23 million as a result of the transaction. Pennzoil recorded a net gain on the disposition of Purolator stock of $1.5 million ($20.0 million before tax loss), or $.04 per share, in the fourth quarter of 1992.
In connection with Pennzoil's disposition of Purolator, Pennzoil and Purolator entered into an indemnification agreement with respect to certain environmental matters (see Note 8). In addition, Pennzoil entered into an agreement with certain banks to provide contingent credit support for a Purolator credit facility and an
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
agreement with a government agency with respect to guarantees of benefits under certain of Purolator's employee benefit plans (see Note 4).
Income from discontinued operations is as follows:
(12) SEGMENT FINANCIAL INFORMATION --
Information with respect to revenues, operating income and other data by industry segment is presented in Item 1, Business and Item 2, Properties of this Annual Report on Form 10-K.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED
QUARTERLY RESULTS(1) --
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(1) Reference is made to Notes 1, 2, 3 and 10 of Notes to Consolidated Financial Statements for information on items affecting quarterly results.
(2) Operating income is defined as net revenues less costs and operating expenses.
(3) The total of the 1993 quarterly earnings (loss) per share amounts presented does not equal the annual 1993 earnings per share amount primarily due to the issuance of 5 million shares of Pennzoil's common stock during September 1993. Reference is made to Note 7 of Notes to Consolidated Financial Statements for additional information.
OIL AND GAS INFORMATION
Estimated Quantities of Proved Oil and Gas Reserves
Presented on the following page are Pennzoil's estimated net proved oil and gas reserves as of December 31, 1993, 1992 and 1991. Reserves in the United States are located onshore in all the main producing states (except Alaska) and offshore Alabama, California, Louisiana, Mississippi and Texas. Foreign reserves are located in Canada.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
The estimates of proved oil and gas reserves have been prepared by Ryder Scott Company Petroleum Engineers ("Ryder Scott") and are based on data supplied by Pennzoil. The reports of Ryder Scott, which include a description of the basis used in preparing the estimated reserves, are included as exhibits to Pennzoil's Annual Reports on Form 10-K for the respective years. Oil includes crude oil, condensate and natural gas liquids.
PROVED OIL RESERVES (MILLIONS OF BARRELS)
PROVED NATURAL GAS RESERVES (BILLIONS OF CUBIC FEET)
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(1) Purchases of minerals in place for 1992 include proved developed and undeveloped reserves attributable to Pennzoil Petroleum as of the date of acquisition (October 30, 1992).
(2) Purchases and sales of minerals in place for 1993 include 5 million barrels of oil and 91 billion cubic feet ("Bcf ") of natural gas and 4 million barrels of oil and 93 Bcf of natural gas, respectively, associated with asset swaps.
(3) United States natural gas reserves for 1993, 1992 and 1991 exclude 162 Bcf, 124 Bcf and 129 Bcf, respectively, of carbon dioxide gas for sale or use in company operations.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Capitalized Costs and Costs Incurred Relating to Oil and Gas Producing Activities
The following table shows the aggregate capitalized costs related to oil and gas producing activities and related accumulated depreciation, depletion and amortization and valuation allowances.
The following table shows costs incurred in oil and gas producing activities (whether charged to expense or capitalized).
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(1) Costs incurred for unproved property acquisition include approximately $98 million related to the gas utilization project in Azerbaijan. Pennzoil has signed a gas utilization agreement with the State Oil Company of the Azerbaijan Republic ("SOCAR") that provides for recovery of Pennzoil's costs incurred in connection with the gas utilization project by payment in hard currency or oil or petroleum products or as a credit against a signature bonus for the first exploration, exploitation and/or development contract entered into between Pennzoil and SOCAR in Azerbaijan. Total costs incurred during 1993 include $114 million related to Pennzoil's Azerbaijan activities.
(2) Costs incurred for property acquisitions in 1992 include $1,009 million attributable to the acquisition of Pennzoil Petroleum. See Note 10 of Notes to Consolidated Financial Statements for additional information.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Results of Operations From Oil and Gas Producing Activities
This information is similar to the disclosures set forth in the "Industry Segment Financial Information" set forth on pages 1 and 2 herein but differs in several respects as to the level of detail, geographic presentation and income taxes. Income taxes were determined by applying the applicable statutory rates to pretax income with adjustment for tax credits and other allowances. Income tax provisions involved certain allocations among geographic areas based on management's assessment of the principal factors giving rise to the tax obligation.
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(1) Foreign technical support and other during 1993 includes approximately $7 million related to Pennzoil's Azerbaijan activities.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves (Standardized Measure)
The Standardized Measure is determined on a basis which presumes that year-end economic and operating conditions will continue over the periods during which year-end proved reserves would be produced. Neither the effects of future inflation nor expected future changes in technology and operating practices have been considered.
The Standardized Measure is determined as the excess of future cash inflows from proved reserves less future costs of producing and developing the reserves, future income taxes and a discount factor. Future cash inflows represent the revenues that would be received from production of year-end proved reserve quantities assuming the future production would be sold at year-end prices plus any fixed and determinable future escalations (but not escalations based on inflation) of natural gas prices provided by existing contracts. As a result of the continued volatility in oil and natural gas markets, future prices received from oil, condensate and natural gas sales may be higher or lower than current levels.
Future production costs include the estimated expenditures related to production of the proved reserves plus any production taxes without consideration of inflation. Future development costs include the estimated costs of drilling development wells and installation of production facilities, plus the net costs associated with dismantlement and abandonment of wells and production platforms, assuming year-end costs continue without inflation. Future income taxes were determined by applying current legislated statutory rates to the excess of (a) future cash inflows, less future production and development costs, over (b) the tax basis in the properties involved plus existing net operating loss carryforwards. Tax credits are considered in the computation of future income tax expenses. The discount was determined by applying a discount rate of 10% per year to the annual future net cash flows.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
The Standardized Measure does not purport to be an estimate of the fair market value of Pennzoil's proved reserves. An estimate of fair market value would also take into account, among other things, the expected recovery of reserves in excess of proved reserves, anticipated changes in future prices and costs and a discount factor more representative of the time value of money and the risks inherent in producing oil and gas. In the opinion of Pennzoil's management, the estimated fair value of Pennzoil's oil and gas properties is in excess of the amounts set forth below.
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(1) Includes future dismantlement and abandonment costs, net of salvage values.
(2) Future income taxes before discount were $896 million (U.S.) and $35 million (foreign) and $1,004 million (U.S.) and $20 million (foreign) for 1993 and 1992, respectively.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Changes in the Standardized Measure
The following table sets forth the principal elements of the changes in the Standardized Measure for the years presented. All amounts are reflected on a discounted basis.
SULPHUR INFORMATION
Reference is made to Item 1, Business and Item 2, Properties under the caption "Sulphur -- Reserves, Production and Sales Information" for disclosures relative to sulphur reserves, production and sales information.
PENNZOIL COMPANY AND SUBSIDIARIES
SCHEDULE I -- MARKETABLE SECURITIES AND OTHER INVESTMENTS
AT DECEMBER 31, 1993
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(1) Maturities for the various securities and investments were as of the dates of the original investments.
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PENNZOIL COMPANY AND SUBSIDIARIES
SCHEDULE V -- CONSOLIDATED PROPERTY, PLANT AND EQUIPMENT
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(1) Retirements or Sales includes dry hole costs charged to exploration expense of $4,256,000, $2,404,000 and $30,849,000 for 1993, 1992 and 1991, respectively.
(2) During 1993, oil and gas property, plant and equipment has been reduced by $278,044,000 attributable to certain asset swap transactions. See Schedule VI for a corresponding reduction of oil and gas accumulated depreciation, depletion and amortization.
(3) Additions to the oil and gas segment include $1,009,410,000 allocated to the oil and gas properties attributable to the acquisition of Pennzoil Petroleum in October 1992.
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PENNZOIL COMPANY AND SUBSIDIARIES
SCHEDULE VI -- CONSOLIDATED ACCUMULATED DEPRECIATION, DEPLETION, AMORTIZATION AND VALUATION ALLOWANCES OF PROPERTY, PLANT AND EQUIPMENT
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(1) Additions charged to costs and expenses include impairments and abandonments charged to exploration expense. Impairments and abandonments for 1993, 1992 and 1991 were $46,884,000, $3,759,000 and $5,039,000, respectively.
(2) During 1993, oil and gas accumulated depreciation, depletion and amortization has been reduced by $278,044,000 attributable to certain asset swap transactions. See Schedule V for a corresponding reduction of oil and gas property, plant and equipment.
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PENNZOIL COMPANY AND SUBSIDIARIES
SCHEDULE IX -- SHORT-TERM BORROWINGS
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(1) Represents the weighted average interest rate in effect while the short-term borrowings were outstanding.
(2) None of the banks has any obligation to continue to extend credit after the maturities of outstanding borrowings or to extend the maturities of any borrowings under these credit arrangements.
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PENNZOIL COMPANY AND SUBSIDIARIES
SCHEDULE X -- SUPPLEMENTARY CONSOLIDATED INCOME STATEMENT INFORMATION
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EXHIBIT INDEX
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* Incorporated by reference.
+ 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.