**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

Washington, D.C. 20549

 

 

**FORM 10-Q/A**

**Quarterly Report Pursuant to Section 13 or15(d) of**

**the Securities Exchange Act of 1934**

 

**For the Quarter EndedSeptember 30, 2001                             CommissionFile No. 1-14501**

**PENNZOIL-QUAKERSTATE COMPANY**

**(Exact name of registrant asspecified in its charter)**

**Delaware                                                                            76-0200625**

**(State or other jurisdictionof incorporation ororganization)                (I.R.S.Employer Identification No.)**

**Pennzoil Place, P.O. Box 2967**

**Houston, Texas 77252-2967**

**(Address of principalexecutive offices)**

 

 

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

 

            Indicateby check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes X . No . 

Number of shares of stock were outstanding, asof latest practicable date, October 31, 2001:

Common Stock, par value $0.10 per share,79,515,317 shares.

 

| PART I. FINANCIAL INFORMATION                                                         |
|---------------------------------------------------------------------------------------|
| Item        1. Financial Statements                                                   |   |   |   |   |   |   |   |
| PENNZOIL-QUAKER STATE COMPANY                                                         |
| CONDENSED        CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE        INCOME |
| (UNAUDITED)                                                                           |
|                                                                                  |   | Restated |   | Restated |
|                                                                                  |   | Three Months Ended |   | Nine Months Ended |
|                                                                                  |   | September 30 |   | September 30 |
|                                                                                  |   | 2001 |   | 2000 |   | 2001 |   | 2000 |
|                                                                                  |   | (Expressed in thousands        except per share amounts) |
| REVENUES                                                                              | $ 595,822 |   | $ 616,973 |   | $ 1,767,356 |   | $ 1,841,800 |
| COSTS AND EXPENSES                                                                    |   |   |   |   |   |   |   |
|                                                                                  | Cost        of sales | 404,177 |   | 412,452 |   | 1,220,890 |   | 1,215,403 |
|                                                                                  | Selling,        general and administrative | 115,394 |   | 119,996 |   | 352,876 |   | 405,198 |
|                                                                                  | Acquisition        related expenses | - |   | 4,558 |   | - |   | 12,357 |
|                                                                                  | Depreciation        and amortization | 24,970 |   | 24,111 |   | 80,604 |   | 72,443 |
|                                                                                  | Taxes,        other than income | 3,541 |   | 3,321 |   | 10,654 |   | 10,003 |
|                                                                                  | Interest        charges, net | 22,659 |   | 24,334 |   | 71,536 |   | 69,576 |
| INCOME FROM CONTINUING OPERATIONS                                                     |   |   |   |   |   |   |   |
|                                                                                  | BEFORE        INCOME TAX | 25,081 |   | 28,201 |   | 30,796 |   | 56,820 |
| Income tax provision                                                                  | 21,018 |   | 21,196 |   | 21,326 |   | 32,283 |
| INCOME FROM CONTINUING OPERATIONS                                                     | 4,063 |   | 7,005 |   | 9,470 |   | 24,537 |
| LOSS FROM DISCONTINUED OPERATIONS, net of tax                                         | (3,782) |   | (1,457) |   | (6,247) |   | (10,728) |
| NET INCOME                                                                            | $ 281 |   | $ 5,548 |   | $ 3,223 |   | $ 13,809 |
| BASIC AND DILUTED EARNINGS (LOSS) PER SHARE                                           |   |   |   |   |   |   |   |
|                                                                                  | Continuing        operations | $ 0.05 |   | $ 0.09 |   | $ 0.12 |   | $ 0.31 |
|                                                                                  | Discontinued        operations | (0.05) |   | (0.02) |   | (0.08) |   | (0.13) |
|                                                                                  |   | $ - |   | $ 0.07 |   | $ 0.04 |   | $ 0.18 |
| DIVIDENDS PER COMMON SHARE                                                            | $ 0.0250 |   | $ 0.1875 |   | $ 0.4000 |   | $ 0.5625 |
| AVERAGE SHARES OUTSTANDING:                                                           |   |   |   |   |   |   |   |
|                                                                                  | BASIC | 79,365 |   | 78,573 |   | 79,100 |   | 78,395 |
|                                                                                  | DILUTED | 81,175 |   | 79,910 |   | 80,184 |   | 79,254 |
| END OF PERIOD SHARES OUTSTANDING                                                      | 79,449 |   | 78,663 |   | 79,449 |   | 78,663 |
| NET INCOME                                                                            | $ 281 |   | $ 5,548 |   | $ 3,223 |   | $ 13,809 |
| Other comprehensive income (loss) net of tax:                                         |   |   |   |   |   |   |   |
|                                                                                  | Foreign        currency translation adjustment | 889 |   | 2,275 |   | (1,272) |   | (297) |
|                                                                                  | Unrealized        gain (loss) on investment in securities and other | 95 |   | (247) |   | (49) |   | (370) |
|                                                                                  | Total        other comprehensive income (loss) | 984 |   | 2,028 |   | (1,321) |   | (667) |
| COMPREHENSIVE INCOME                                                                  | $ 1,265 |   | $ 7,576 |   | $ 1,902 |   | $ 13,142 |
| See Notes to Condensed Consolidated Financial        Statements.                      |   |   |   |   |   |   |   |

 

| PART I. FINANCIAL INFORMATION - continued                        |
|------------------------------------------------------------------|
| PENNZOIL-QUAKER STATE COMPANY                                    |
| CONDENSED CONSOLIDATED        BALANCE SHEET                      |
|                                                             |   | Restated |
|                                                             |   | September 30 |   | December 31 |
|                                                             |   | 2001 |   | 2000 |
|                                                             |   | (Unaudited) |   |   |
|                                                             |   | (Expressed in thousands) |
| ASSETS                                                           |   |   |   |
| Current assets                                                   |   |   |   |
|                                                             | Cash        and cash equivalents | $ 582 |   | $ 38,263 |
|                                                             | Receivables | 349,222 |   | 315,710 |
|                                                             | Inventories | 224,872 |   | 186,999 |
|                                                             | Other        current assets | 78,904 |   | 52,775 |
| Total current assets                                             | 653,580 |   | 593,747 |
| Property, plant and equipment, net                               | 453,299 |   | 476,134 |
| Deferred income taxes                                            | 266,574 |   | 282,198 |
| Goodwill and other intangibles                                   | 1,110,251 |   | 1,139,413 |
| Other assets                                                     | 222,348 |   | 212,316 |
| Net assets of discontinued operations                            | - |   | 97,259 |
| TOTAL ASSETS                                                     | $ 2,706,052 |   | $ 2,801,067 |
| LIABILITIES AND SHAREHOLDERS' EQUITY                             |   |   |   |
| Current liabilities                                              |   |   |   |
|                                                             | Current        maturities of long-term debt | $ 170,632 |   | $ 13,786 |
|                                                             | Accounts        payable | 154,147 |   | 166,056 |
|                                                             | Payroll        accrued | 15,222 |   | 17,215 |
|                                                             | Other        current liabilities | 143,600 |   | 121,515 |
| Total current liabilities                                        | 483,601 |   | 318,572 |
| Total long-term debt, less current maturities                    | 978,083 |   | 1,194,426 |
| Capital lease obligations, less current        maturities        | 57,014 |   | 61,861 |
| Net liabilities of discontinued operations                       | 5,090 |   | - |
| Other liabilities                                                | 382,998 |   | 405,229 |
| TOTAL LIABILITIES                                                | 1,906,786 |   | 1,980,088 |
| COMMITMENTS AND CONTINGENCIES                                    |   |   |   |
| SHAREHOLDERS' EQUITY                                             | 799,266 |   | 820,979 |
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                       | $ 2,706,052 |   | $ 2,801,067 |
| See Notes to Condensed Consolidated Financial        Statements. |   |   |   |

 

| PART I. FINANCIAL INFORMATION - continued                        |
|------------------------------------------------------------------|
| PENNZOIL-QUAKER STATE COMPANY                                    |
| CONDENSED CONSOLIDATED        STATEMENT OF CASH FLOWS            |
| (UNAUDITED)                                                      |
|                                                             |   |   |   | Restated |
|                                                             |   |   |   | Nine Months Ended |
|                                                             |   |   |   | September 30 |
|                                                             |   |   |   | 2001 |   | 2000 |
|                                                             |   |   |   | (Expressed in thousands) |
| CASH FLOWS FROM OPERATING ACTIVITIES                             |   |   |   |
|                                                             | Net income | $ 3,223 |   | $ 13,809 |
|                                                             | Adjustments to reconcile net income to net cash |   |   |   |
|                                                             |   | provided by (used in) operating activities: |   |   |   |
|                                                             |   |   | Depreciation        and amortization | 80,604 |   | 72,443 |
|                                                             |   |   | Deferred        income tax | 15,503 |   | 22,570 |
|                                                             |   |   | Earnings        in excess of distributions from |   |   |   |
|                                                             |   |   | equity        investees | (6,413) |   | (206) |
|                                                             |   |   | Other        non-cash items | 22,248 |   | 12,440 |
|                                                             |   |   | Loss        from discontinued operations | 10,326 |   | 17,731 |
|                                                             |   |   | Changes        in accounts receivable | (60,561) |   | (42,223) |
|                                                             |   |   | Changes        in inventories | (42,174) |   | (48,782) |
|                                                             |   |   | Changes        in accounts payable | (20,360) |   | (20,876) |
|                                                             |   |   | Changes        in other operating assets and liabilities | (20,339) |   | 10,268 |
|                                                             |   |   |   |   |   |   |
|                                                             | Net cash provided by (used in) operating        activities | (17,943) |   | 37,174 |
|                                                             |   |   |   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                             |   |   |   |
|                                                             | Capital expenditures | (38,437) |   | (49,646) |
|                                                             | Acquisitions, net of cash acquired | (700) |   | (76,282) |
|                                                             | Proceeds from sales of assets | 12,454 |   | 21,485 |
|                                                             | Other investing activities | 4,634 |   | 4,260 |
|                                                             |   |   |   |   |   |   |
|                                                             | Net cash used in investing activities | (22,049) |   | (100,183) |
|                                                             |   |   |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                             |   |   |   |
|                                                             | Net proceeds from (repayments of) debt | (67,400) |   | 171,307 |
|                                                             | Dividends paid | (31,613) |   | (44,020) |
|                                                             |   |   |   |   |   |   |
|                                                             | Net cash provided by (used in) financing        activities | (99,013) |   | 127,287 |
|                                                             |   |   |   |   |   |   |
| NET CASH PROVIDED BY (USED IN)                                   |   |   |   |
|                                                             | DISCONTINUED OPERATIONS | 101,324 |   | (62,108) |
|                                                             |   |   |   |   |   |   |
| NET INCREASE (DECREASE) IN CASH                                  |   |   |   |
|                                                             | AND CASH EQUIVALENTS | (37,681) |   | 2,170 |
|                                                             |   |   |   |   |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                   | 38,263 |   | 20,155 |
|                                                             |   |   |   |   |   |   |
| CASH AND CASH EQUIVALENTS, end of period                         | $ 582 |   | $ 22,325 |
|                                                             |   |   |   |   |   |   |
| See Notes to Condensed Consolidated Financial        Statements. |   |   |   |

PENNZOIL-QUAKER STATE COMPANY

NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS

(UNAUDITED)

**(1)       General -**

            Thecondensed consolidated financial statements included herein havebeen prepared by Pennzoil-Quaker State Company("Pennzoil-Quaker State" or the "Company")without audit and should be read in conjunction with thefinancial statements and the notes thereto included inPennzoil-Quaker State's latest annual report. The foregoingfinancial statements include only normal recurring accruals andall adjustments which Pennzoil-Quaker State considers necessaryfor a fair presentation. Certain prior period items have beenreclassified in the condensed consolidated financial statementsin order to conform with the current year presentation.    

           TheCompany is restating its financial results for the quarters andnine months ended September 30, 2001 and 2000. The restatementresults from an error in the consolidated financial statements ofExcel Paralubes, in which the Company and Conoco Inc.("Conoco") are equal partners. Details surrounding therestatement are included in Note 4.

**(2)       New AccountingStandards -**

            InJune 2001, the Financial Accounting Standards Board("FASB") issued Statement of Financial AccountingStandards ("SFAS") No. 141, "BusinessCombinations". SFAS No. 141 eliminates the use of thepooling-of-interests method of accounting for businesscombinations and establishes the purchase method of accounting asthe only acceptable method on all business combinations initiatedafter June 30, 2001.  

          InJune 2001, the FASB issued SFAS No. 142, "Goodwill and OtherIntangible Assets." This statement modifies existinggenerally accepted accounting principles related to theamortization and impairment of goodwill and other intangibleassets. Upon adoption of the new standard, goodwill, includinggoodwill associated with equity method investments, will nolonger be amortized. For the nine months ended September 30,2001, goodwill amortization was $26.5 million. In addition,goodwill, other than goodwill associated with equity methodinvestments, must be assessed at least annually for impairmentusing a fair-value based approach. The provisions of thisstatement are required to be adopted as of the beginning of thefirst fiscal year after December 15, 2001. Impairment losses thatarise due to the initial application of this statement are to bereported as a cumulative effect of change in accountingprinciple. Pennzoil-Quaker State has not completed an analysis ofthe impact of implementing the provisions of thisstatement. 

          InJuly 2001, the FASB issued SFAS No. 143, "Accounting forAsset Retirement Obligations." SFAS No. 143 requiresentities to record the fair value of a liability for legalobligations associated with the retirement obligations oftangible long-lived assets in the period in which it is incurredand the corresponding cost capitalized by increasing the carryingamount of the related asset. The liability is accreted to thefair value at the time of settlement over the useful life of theasset, and the capitalized cost is depreciated over the usefullife of the related asset. If the liability is settled for anamount other than the recorded amount, a gain or loss isrecognized. The standard is effective for fiscal years beginningafter June 15, 2002, with earlier application encouraged. TheCompany is currently evaluating the impact of adopting SFAS No.143 on its financial position and results of operations and hasnot determined its timing ofadoption.      

          InOctober 2001, the FASB issued SFAS No. 144, "Accounting forthe Impairment or Disposal of Long-Lived Assets." SFAS No.144 supersedes SFAS No. 121, "Accounting for the Impairmentof Long-Lived Assets and for Long-Lived Assets to Be DisposedOf," and replaces the accounting and reporting provisionsfor segments of a business to be disposed of AccountingPrinciples Board ("APB") Opinion No. 30,"Reporting Results of Operations--Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusualand Infrequently Occurring Events and Transactions." SFASNo. 144 maintains the requirement that an impairment loss berecognized for a long-lived asset to be held and used if itscarrying value is not recoverable from its undiscounted cashflows. SFAS No. 144 requires that long-lived assets to bedisposed of other than by sales be considered held and used untilit is actually disposed of and requires that its depreciable lifebe revised in accordance with APB Opinion No. 20,"Accounting Changes." SFAS No. 144 also requires thatlong-lived assets to be disposed of by sale be measured at thelower of its carrying amount or fair value less selling costs,but retains the requirement to report discontinued operationsseparately from continuing operations and extends that reportingto a component of an entity that has either been disposed of oris classified as held for sale. The standard is effective forfiscal years beginning after December 15, 2001 and early adoptionis encouraged. The Company has not yet determined its timing ofadoption.

**(3)       DerivativeInstruments -**

           Attimes, the Companyhas utilized swaps andforward contracts to manage certain risks resulting fromfluctuations in interest rates and foreign currency exchangerates.  On January 1, 2001, the Company adopted SFAS No.133, "Accounting for Derivative Instruments and HedgingActivities", as amended, which established accounting andreporting standards requiring that every derivative instrument berecorded on the balance sheet as either an asset or liabilitymeasured at its fair value. The statement requires that changesin the derivative instrument's fair value be recognized currentlyin earnings unless specific hedge accounting criteria are met.The adoption of this standard did not impact the Company'sresults of operations or financial position.   

          Inconnection with the issuance of $150.0 million of two-year fixedrate notes in December 2000, Pennzoil-Quaker State entered into afixed-to-floating interest rate swap to maintain its mix ofvariable rate versus fixed rate debt. The Company designated theswap as a fair value hedge. Under SFAS No. 133, changes in thefair value of the swap are recognized currently in earnings alongwith the offsetting changes in the fair value of the associateddebt. At September 30, 2001, the fair market value of the swap of$5.0 million was recorded in other current assets. During thenine months ended September 30, 2001, the Company repurchasednotes and unwound the corresponding swap in the amount of $24.5million. Pretax gains of $0.4 million were recognized on thesetransactions as of September 30,2001.                                     

           Duringthe nine months ended September 30, 2001, the Company's Canadiansubsidiary entered into Canadian dollar foreign currency forwardcontracts to reduce the cash flow variability of U.S. dollarspurchases of inventory. The Company designated these forwardcontracts as cash flow hedges. Under SFAS No. 133, gains andlosses on the forward contracts are recorded in othercomprehensive income and then reclassified to earnings as theinventory is sold. The fair market value of the forward contractswas not material. As of September 30, 2001, the Company had $3.5million of foreign currency forward contracts. The remainingcontracts totaling $3.5 million were settled on October 30, 2001and there are no remaining contracts outstanding.

 

 

**(4)       SummarizedFinancial Data of Excel Paralubes and Correction of an Error -**

**            **TheCompany and Conoco are equal partners in Excel Paralubes, whichoperates a base oil processing facility located adjacent toConoco's refinery in Lake Charles, Louisiana. The facility iscapable of producing approximately 21,000 barrels per day ofhigh-quality base oils, the base ingredient in finishedlubricants. Conoco operates the plant with support positionsstaffed primarily by Conoco.      

**           **Undera co-products sale and purchase agreement, certain co-productsproduced at an adjacent Conoco facility are allocated betweenExcel Paralubes and Conoco based upon Excel Paralubes' feedstream flow rates and compositions. Excel Paralubes recentlydetermined that the measurements of the allocation of co-productsbetween Excel Paralubes and Conoco had been in error since thecommencement of Excel Paralubes' operations in 1997. As a resultof this error, pretax income of Excel Paralubes for the quartersended September 30, 2001 and 2000 was overstated by $0.2 millionand $0.8 million, respectively. This requires a restatement ofthe Company's previously filed financial statements to reduce netincome of the Company for the quarters ended September 30, 2001and 2000 by $0.6 million ($0.01 per share) and $0.5 million($0.01 per share), respectively. As a result of this error,pretax income of Excel Paralubes for the nine months endedSeptember 30, 2001 and 2000 was overstated by $1.7 million and$2.2 million, respectively. This requires a restatement of theCompany's previously filed financial statements to reduce netincome of the Company for the nine months ended September 30,2001 and 2000 by $1.1 million ($0.01 per share) and $1.3 million($0.02 per share), respectively. There was no impact on cash flowor cash flows from operations. Under the co-products sale andpurchase agreement, no adjustment is required for periods priorto 1999.       

           Pennzoil-QuakerState's net investment in Excel Paralubes, accounted for usingthe equity method and carried as a credit balance of $68.8million and $75.2 million at September 30, 2001 and December 31,2000, respectively, is included in other liabilities on thecondensed consolidated balance sheet. Pennzoil-Quaker State'sequity in Excel Paralubes' restated pretax income for the threemonths ended September 30, 2001 and 2000 of $10.1 million and$7.0 million, respectively, and for the nine months endedSeptember 30, 2001 and 2000 of $21.3 million and $17.4 million,respectively, is included in revenues in the condensedconsolidated statement of operations and comprehensiveincome.    

           Summarizedfinancial information for Excel Paralubes for the three and ninemonths ended September 30, 2001 and 2000 on a 100% basis follows:

|                      | Restated                        |   | Restated                       |
|---------------------------|---------------------------------|--------|--------------------------------|
|                      | Three months ended September 30 |   | Nine months ended September 30 |
|                      | 2001                            |   | 2000                           |   | 2001 |   | 2000 |
|                      | (Expressed in thousands)        |
|                      | (Unaudited)                     |
| Revenues                  | $        122,542                |   | $        134,052               |   | $        344,811 |   | $        374,767 |
| Operating        earnings | 29,918                          |   | 24,093                         |   | 72,720 |   | 65,067 |
| Net income                | 20,188                          |   | 14,025                         |   | 42,618 |   | 34,708 |

**(5)       SegmentReporting -**

            Duringthe first quarter of 2001, the Company realigned its businesssegments to report five separate operating segments. Results forthe three and nine months ended September 30, 2000 have beenrestated to conform with the new presentation. Information withrespect to revenues, operating income and other data is presentedin the following tables (expressed in thousands).

|                      |                                                                     | Three months ended        September 30, 2001 (Restated) |
|---------------------------|--------------------------------------------------------------------------|---------------------------------------------------------|
|                      |                                                                     |                                                    |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |
|                      |                                                                     | Lubricants                                              |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 311,799                                                                |                                                    | $ 80,972 |   | $ 63,421 |   | $ 88,210 |   | $ 53,025 |   | $ (1,605) |   | $ 595,822 |
| Intersegment revenues     | 15,497                                                                   |                                                    | 3,994 |   | - |   | - |   | 39,173 |   | (58,664) |   | - |
|                      | Total        revenues                                                    | $ 327,296                                               |   | $ 84,966 |   | $ 63,421 |   | $ 88,210 |   | $ 92,198 |   | $ (60,269) |   | $ 595,822 |
| Income (loss) before      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |
|                      | interest        and income taxes                                         | $ 31,982                                                |   | $ 6,086 |   | $ 5,144 |   | $ 6,416 |   | $ 15,360 |   | $ (17,248) |   | $ 47,740 |
|                      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |
|                      |                                                                     | Three months ended        September 30, 2000 (Restated) |
|                      |                                                                     |                                                    |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                      |                                                                     | Lubricants                                              |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 349,954                                                                |                                                    | $ 76,115 |   | $ 66,189 |   | $ 87,317 |   | $ 33,354 |   | $ 4,044 |   | $ 616,973 |
| Intersegment revenues     | 15,125                                                                   |                                                    | 3,278 |   | - |   | - |   | 49,744 |   | (68,147) |   | - |
|                      | Total        revenues                                                    | $ 365,079                                               |   | $ 79,393 |   | $ 66,189 |   | $ 87,317 |   | $ 83,098 |   | $ (64,103) |   | $ 616,973 |
| Income (loss) before      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |
|                      | interest        and income taxes                                         | $ 39,722                                                |   | $ 4,736 |   | $ 2,254 |   | $ 7,921 |   | $ 11,028 |   | $ (13,125) |   | $ 52,536 |
|                      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |
|                      |                                                                     | Nine months ended September        30, 2001 (Restated)  |
|                      |                                                                     |                                                    |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                      |                                                                     | Lubricants                                              |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 935,815                                                                |                                                    | $ 257,036 |   | $ 192,123 |   | $ 260,432 |   | $ 127,159 |   | $ (5,209) |   | $ 1,767,356 |
| Intersegment revenues     | 46,315                                                                   |                                                    | 15,282 |   | 709 |   | - |   | 116,258 |   | (178,564) |   | - |
|                      | Total        revenues                                                    | $ 982,130                                               |   | $ 272,318 |   | $ 192,832 |   | $ 260,432 |   | $ 243,417 |   | $ (183,773) |   | $ 1,767,356 |
| Income (loss) before      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |
|                      | interest        and income taxes                                         | $ 95,989                                                |   | $ 9,478 |   | $ (6,667) |   | $ 15,920 |   | $ 33,209 |   | $ (45,597) |   | $ 102,332 |
|                      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |
|                      |                                                                     | Nine months ended September        30, 2000 (Restated)  |
|                      |                                                                     |                                                    |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                      |                                                                     | Lubricants                                              |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 1,049,001                                                              |                                                    | $ 244,375 |   | $ 189,391 |   | $ 257,127 |   | $ 96,714 |   | $ 5,192 |   | $ 1,841,800 |
| Intersegment revenues     | 45,337                                                                   |                                                    | 14,646 |   | - |   | - |   | 142,210 |   | (202,193) |   | - |
|                      | Total        revenues                                                    | $ 1,094,338                                             |   | $ 259,021 |   | $ 189,391 |   | $ 257,127 |   | $ 238,924 |   | $ (197,001) |   | $ 1,841,800 |
| Income (loss) before      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |
|                      | interest        and income taxes                                         | $ 124,670                                               |   | $ 24,757 |   | $ 11,105 |   | $ 18,797 |   | $ 28,768 |   | $ (81,700) |   | $ 126,397 |
|                      |                                                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |   |
| (a)                       | Unaffiliated revenues include sales to        unconsolidated affiliates. |                                                    |   |   |   |   |   |   |   |   |   |
| (b)                       | Includes consolidating eliminations.                                     |                                                    |   |   |   |   |   |   |   |   |   |   |   |

 

**(6)       Debt -**

           Pennzoil-QuakerState entered into a new $348 million senior secured revolvingcredit facility on November 2, 2001. Under the facility, $325million is available on a revolving basis until November 2, 2004and $23 million is available on a revolving basis until November1, 2002. Outstanding revolving credit borrowings under theCompany's previous revolving credit facility were $218.0 millionat September 30, 2001 and were classified as long-term debt. Theaverage interest rate applicable to the company's revolvingcredit borrowings was 5.86% during the first nine months of2001.    

           OnNovember 2, 2001, the Company issued $250.0 million of 10% SeniorNotes due 2008. Net proceeds of $242.8 million were used to paydown all outstanding revolving credit borrowings under theCompany's previous revolving credit facility and increase cash onhand.

            Pennzoil-QuakerState's Canadian subsidiary also maintains a revolving creditfacility with Canadian banks, which provides for up to $17.8million of committed borrowings through November 9, 2001, withany outstanding borrowings on such date being converted into aterm credit facility due on October 28, 2002. The revolvingcredit facility is currently being renewed and amended. As ofSeptember 30, 2001 borrowings under the Company's Canadianfacility totaled $7.6 million and were classified as short-termdebt. 

           AU.K. subsidiary of the Company maintains a revolving creditfacility that provides for borrowings up to $20.6 million throughJuly 26, 2002. Outstanding borrowings under the facility totaled$19.9 million at September 30, 2001 and were classified asshort-term debt.

            InDecember 2000, Pennzoil-Quaker State issued $150.0 million of8.65% Notes due 2002. Net proceeds of $149.1 million were used toreduce the Company's commercial paper borrowings. The terms ofthe notes provide that, in the event a rating on Pennzoil-QuakerState's senior unsecured debt falls and remains below investmentgrade, the coupon on the notes increases 0.75% to 9.40% and eachnoteholder has the option, at any time on or after June 1, 2001,to require the Company to purchase its note at 100% of theprincipal amount thereof plus accrued and unpaid interest on orafter June 1, 2001. During the nine months ended September 30,2001 Standard and Poor's, Moody's and Fitch lowered the seniorunsecured debt rating for the Company's debt below investmentgrade. To date, amounts put to the Company for repurchase havebeen immaterial. The notes, which are carried at fair marketvalue due to the interest rate swaps discussed in Note 3, arecurrently trading above 100% face value plus accrued interest.During the nine months ended September 30, 2001, the Companychose to purchase and retire $24.5 million face amount of thesenotes and pretax gains of $0.4 million were recognized on thesetransactions. As of September 30, 2001, the carrying amount of$130.4 million of indebtedness under Pennzoil-Quaker State's9.40% Notes due in 2002 (formerly 8.65% Notes due in 2002) hasbeen classified as short-term debt.

            Debtoutstanding was as follows:

|                                                          |                        |   September 30 | December 31 |
|---------------------------------------------------------------|-----------------------------|--------------------------|-------------|
|                                                          |                        | 2001                     |        | 2000 |
|                                                          |                        | (Expressed in thousands) |
| 7.375% Debentures due 2029, net of discount                   | $ 398,156                   | $ 398,105                |
| 6.750% Notes due 2009, net of discount                        | 199,235                     |                     | 199,159     |
| 9.40% Notes due 2002, at market value, net of        discount | 130,377                     |                     | 151,017     |
| 6.625 % Notes due 2005, net of discount                       | 99,754                      |                     | 99,708      |
| Commercial paper                                              | -                           |                     | 57,709      |
| Revolving credit facility                                     | 218,000                     |                     | 195,000     |
| Pollution control bonds, net of discount                      | 50,559                      |                     | 50,522      |
| International debt facilities                                 | 45,056                      |                     | 51,808      |
| Other debt                                                    | 7,578                       |                     | 5,184       |
|                                                          | Total        debt           | 1,148,715                |        | 1,208,212 |
| Less amounts classified as current maturities                 | (170,632)                   |                     | (13,786)    |
|                                                          | Total        long-term debt | $ 978,083                |        | $ 1,194,426 |
|                                                          |                        |                     |        |   |

            

**(7)       Earnings PerShare -**

            Computationsfor basic and diluted earnings per share for the three and ninemonths ended September 30, 2001 and 2000 consist of thefollowing:

|                                 |    | Restated                                                 |    | Restated                              |
|--------------------------------------|---------|----------------------------------------------------------|---------|---------------------------------------|
|                                 |    | Three months ended        September 30                   |    | Nine months ended September        30 |
|                                 |    | 2001                                                     |    | 2000                                  |   | 2001 |   | 2000 |
|                                 |    | (Expressed in thousands        except per share amounts) |
| Income from continuing operations    | $ 4,062 |                                                     | $ 7,005 |                                  | $ 9,469 |   | $ 24,537 |
| Basic weighted average shares        | 79,365  |                                                     | 78,573  |                                  | 79,100 |   | 78,395 |
| Effect of dilutive securities (a)    |    |                                                     |    |                                  |   |   |   |
|                                 | Options | 1,096                                                    |    | 772                                   |   | 677 |   | 474 |
|                                 | Awards  | 714                                                      |    | 565                                   |   | 407 |   | 385 |
| Diluted weighted average shares      | 81,175  |                                                     | 79,910  |                                  | 80,184 |   | 79,254 |
| Basic and diluted earnings per share | $ 0.05  |                                                     | $ 0.09  |                                  | $ 0.12 |   | $ 0.31 |

- A weighted average number of options to        purchase 5.9 million shares of common stock and 6.3        million shares of common stock were outstanding for the        three months ended September 30, 2001 and 2000, but were        not included in the computation of diluted earnings per        share because the options' exercise prices were greater        than the average market price of the common shares. A        weighted average number of options to purchase 5.5        million and 7.6 million shares of common stock were        outstanding for the nine months ended September 30, 2001        and 2000, but were not included in the computation of        diluted earnings per share because the options' exercise        prices were greater than the average market price of the        common shares. 

**(8)        CashFlow Information -**

            Cashpaid for interest during the nine months ended September 30, 2001and 2000 was $55.9 million and $60.8 million, respectively.Income tax payments (refunds) of $0.7 million and ($7.3) millionwere paid (received) during the nine months ended September 30,2001 and 2000, respectively. 

**(9)        DiscontinuedOperations -**

           During2000, the Company completed a strategic review of itsmanufacturing assets, including its refining assets and specialtybusiness. During the review, it evaluated the strategic andfinancial advantages and disadvantages it derives from thevertical integration of its manufacturing and marketingcapabilities. Based on the results of the review, the Companybegan to withdraw from the refining business and to dispose ofits refineries and related assets. In 2001 and 2000, the Companysold the wax processing facilities and related assets at theRouseville, Pennsylvania refinery and its interest in the Barecowax marketing partnership, its share of Penreco, a specialtyindustrial products partnership with Conoco and its Shreveportrefinery to Calumet, thus completing the Company's exit from therefinery business. Accordingly, the net assets and results ofoperations of the Company's refining assets and specialtyindustrial products businesses have been combined and reported asdiscontinued operations in the accompanying financial statements.

            Inthe third quarter the Company revised its estimate of loss fromdiscontinued operations and recorded an after-tax loss of $3.8million ($6.3 million pretax). After-tax loss from discontinuedoperations for the nine months ended September 30, 2001 was $6.3million ($10.3 million pretax). After-tax loss from discontinuedoperations for the quarter and nine months ended September 30,2000 was $1.5 million ($2.5 million pretax) and $10.7 million($17.7 million pretax), respectively. Operating revenues fordiscontinued operations for the quarter and nine months endedSeptember 30, 2001 were $6.1 million and $217.4 million comparedto $180.6 million and $592.3 million for the same periods lastyear. Included in net cash provided by discontinued operationsfor the 2001 period are proceeds of $70.0 million from the saleof Penreco and $25.2 million from the sale of the Shreveport,Louisiana, refinery.

            InApril 2001, Pennzoil-Quaker State completed the sale of itsShreveport, Louisiana, refinery to Calumet Lubricants Company,LP. The Company received $25.2 million from the sale, whichconsisted of $14.2 million in cash proceeds and a note for $11.0million. Results of the Shreveport refinery's operations,including the expected loss on its sale of $40.4 millionafter-tax that was accrued as of December 31, 2000, are includedin Pennzoil-Quaker State's discontinued operations.

**(10)       RestructuringCharges -**

            Inthe second quarter of 2001, the Company recorded a $28.5 millionpretax charge to accrue the costs associated with a restructuringprogram to reduce costs, streamline operations and position theCompany to continue its long-term growth plan. The charge relatedto two operating segments as follows: Consumer Products - $11.8million and International - $16.7 million. The Company isreducing the number of employees and closing and consolidatingwarehouses and office space. Second quarter charges primarilyincluded severance for approximately 362 administrative andoperational employees, the accrual for the closure andconsolidation of warehouses, consolidation of office space andinventory reductions and disposals related to changes inmarketing strategy. All of the 362 employees had been terminatedor notified of a termination date by June 30, 2001. Included inthe $16.7 million of International charges were charges of $6.5million associated with the impairment of goodwill. 

            Inthe third quarter of 2001, the Company recorded a $6.5 millionpretax charge to accrue additional costs associated with therestructuring program which related to two operating segments asfollows: Lubricants - $6.0 million and Consumer Products - $0.5million. Current period charges primarily included severance forapproximately 77 administrative and operational employees. All ofthe 77 employees had been terminated or notified of a terminationdate by September 30, 2001. The severance payments for the formeremployees are expected to be paid out over a minimum period oftwo months with a maximum period of up to two years. Theremaining total severance accrual at September 30, 2001 was $13.7million recorded in other current liabilities.

**(11)       EnvironmentalMatters -**

            Asa result of informal negotiations with the EnvironmentalProtection Agency and the Department of Justice, the Company hasreached an agreement to resolve disputed issues arising under theClean Air Act, the Clean Water Act, and the Resource Conservationand Recovery Act in connection with the Company’s formeroperation of a refinery in Shreveport, Louisiana by paying acivil penalty. No formal proceedings have been initiated againstthe Company with respect to the disputed issues. The Companybelieves the amount of the civil penalty will not have a materialeffect on its financial condition or results of operations.

            Separately,the EPA has initiated an administrative proceeding alleging thatcertain activities of a used oil collection and processingbusiness formerly operated by the Company and its predecessors inShreveport, Louisiana violated regulatory requirements under theResource Conservation and Recovery Act. Although the Companydisputes the issues raised by the EPA, it anticipates that thismatter will be settled by agreement of the parties, includingpayment by the Company of a civil penalty, the amount of whichwould not have a material adverse effect on its financialcondition or results of operations.

            TheCompany is engaged in informal settlement discussions with local,state, and federal authorities regarding allegations ofviolations of environmental laws at a fast-lube service center inAlexandria, Virginia owned and operated by its Jiffy Lubesubsidiary. No formal proceedings have been initiated regardingthese allegations, and the Company anticipates that this matterwill be settled by agreement of the parties, including payment ofa civil penalty, the amount of which would not have a materialadverse effect on its financial condition or results ofoperations.

**Item 2. Management's Discussion and Analysis ofFinancial Condition**

**            ****andResults of Operations**

            Pennzoil-QuakerState's operations are conducted primarily through the followingfive segments: (1) Lubricants, (2) Consumer Products, (3)International, (4) Jiffy Lube and (5) Supply Chain Investments.

           TheCompany and Conoco are equal partners in Excel Paralubes, whichoperates a base oil processing facility located adjacent toConoco's refinery in Lake Charles, Louisiana. Conoco operates theplant with support positions staffed primarily by Conoco.

           Undera co-products sale and purchase agreement, certain co-productsproduced at an adjacent Conoco facility are allocated betweenExcel Paralubes and Conoco based upon Excel Paralubes' feedstream flow rates and compositions. Excel Paralubes recentlydetermined that the measurements of the allocation of co-productsbetween Excel Paralubes and Conoco had been in error since thecommencement of Excel Paralubes' operations in 1997. As a resultof this error, pretax income of Excel Paralubes for the quartersended September 30, 2001 and 2000 was overstated by $0.2 millionand $0.8 million, respectively. This requires a restatement ofthe Company's previously filed financial statements to reduce netincome of the Company for the quarters ended September 30, 2001and 2000 by $0.6 million ($0.01 per share) and $0.5 million($0.01 per share), respectively. As a result of this error,pretax income of Excel Paralubes for the nine months endedSeptember 30, 2001 and 2000 was overstated by $1.7 million and$2.2 million, respectively. This requires a restatement of theCompany's previously filed financial statements to reduce netincome of the Company for the nine months ended September 30,2001 and 2000 by $1.1 million ($0.01 per share) and $1.3 million($0.02 per share), respectively. There was no impact on cash flowor cash flows from operations. Under the co-products sales andpurchase agreement, no adjustment is required for periods priorto 1999.

**Results of Operations**

     **Third Quarter 2001 comparedwith Third Quarter 2000**

            Netsales for Pennzoil-Quaker State were $583.4 million for thequarter ended September 30, 2001, a decrease of $14.4 million, orapproximately 2.4% from the same period in 2000. The decrease innet sales was primarily a result of the disposition ofnon-strategic operating assets during 2000 along with the factorsdiscussed below.

            Incomefrom continuing operations for the quarter ended September 30,2001 was $4.1 million, or 6 cents per basic share. This compareswith income from continuing operations of $7.0 million, or 10cents per basic share for the quarter ended September 30, 2000.Results from continuing operations for the third quarter endedSeptember 30, 2001 included pretax charges of $6.8 millionprimarily associated with the restructuring program in theconsumer products and international segments. Results fromcontinuing operations for the third quarter ended September 30,2000 included pretax charges of $4.7 million related to theacquisition of Quaker State and other matters. Excluding pretaxcharges, net income from continuing operations for the thirdquarter ended September 30, 2001 and 2000 was $16.2 million and$15.4 million, respectively. 

**            Lubricants**.  Netsales for the Lubricants segment were $325.4 million for thequarter ended September 30, 2001, compared to $360.5 million forthe same period last year. The decrease in net sales is primarilya result of the disposition of non-strategic operating assetssold in 2000 and lower sales volumes from remaining assets as aresult of continued volume softness in the passenger car motoroil market. Operating income for this segment was $32.0 millionfor the quarter ended September 30, 2001, compared to $39.7million for the same period last year. The decrease in operatingincome for the quarter ended September 30, 2001 is primarily dueto lower sales volumes as a result of continued volume softnessin the passenger car motor oil market and the restructuringcharges of $6.0 million recorded in the third quarter. 

            **ConsumerProducts**. Net sales for the Consumer Products segment were$84.9 million for the quarter ended September 30, 2001, comparedto $79.4 million for the same period last year. The increase innet sales for the quarter ended September 30, 2001 is primarilydue to increased automotive seat cover and floor mat revenues asa result of the acquisition of Sagaz Industries in early March2000, partially offset by lower revenues from car wash and carcleaner products. Operating income for this segment was $6.1million for the quarter ended September 30, 2001, compared to$4.8 million for the same period last year. The increase inoperating income for the quarter ended September 30, 2001,compared to the same period in 2000, is primarily due to highermargins on sales of automotive chemical products and lower mediaexpense. 

**            International**.   Netsales for the International segment were $63.3 million for thequarter ended September 30, 2001, compared to $65.8 million forthe same period last year. The decrease in net sales for thequarter ended September 30, 2001, compared to the same period in2000, is primarily due to lower sales volumes in Europe. Thevolume decrease has been driven in part by the businessrestructuring currently under way in Europe which has includedminimum order amounts being established along with an intensiveproduct line rationalization in an effort to move away from lowmargin products. Operating income for this segment was $5.1million for the quarter ended September 30, 2001, compared to$2.3 million for the same period last year. The increase inoperating income was primarily due to lower selling, general andadministrative expense related to the restructuring programpartially offset by lower margins related to motor oil and otherlubricating products. 

**            JiffyLube.**   Net sales for this segment were $86.3million for the quarter ended September 30, 2001, compared to netsales of $84.0 million for the same period in 2000. Other incomefor this segment for the quarter ended September 30, 2001 was$1.9 million compared to $3.4 million for the same period in2000. Operating income from this segment for the quarter endedSeptember 30, 2001 was $6.4 million compared to $7.9 million forthe same period in 2000. The decrease in operating income for thequarter ended September 30, 2001 is primarily due to higher costof sales primarily related to higher insurance and oil costspartially offset by higher revenues primarily related to higherroyalties and higher average ticket prices attributable toincreased sales of additional products and services. 

            **SupplyChain Investments**.  Net sales for this segment,primarily intercompany sales to the Lubricants segment, were$82.0 million for the quarter ended September 30, 2001, comparedto net sales of $76.1 million for the same period in 2000. Otherincome for this segment for the quarter ended September 30, 2001,was $10.2 million compared to $7.0 million for the same period in2000. Other income is primarily the equity income from the 50/50Excel Paralubes partnership with Conoco Inc., which is recordedusing the equity method of accounting. The increase in equityincome for the quarter ended September 30, 2001 is primarily dueto higher base oil margins at Excel Paralubes. Operating incomefrom this segment for the quarter ended September 30, 2001 was$15.4 million compared to operating income of $11.0 million forthe same period in 2000. The increase in operating income for thequarter ended September 30, 2001 reflects higher margins.

**            CorporateAdministrative Expense**.  Corporate administrativedecreased $0.6 million to $16.1 million for the quarter endedSeptember 30, 2001, compared to the same period in 2000. 

**     Nine Months Ended September30, 2001 compared to Nine Months Ended 2000**

            Netsales for Pennzoil-Quaker State were $1,740.9 million for thenine months ended September 30, 2001, a decrease of $61.0million, or approximately 3.4% from the same period in 2000. Thedecrease in net sales was primarily a result of the dispositionof non-strategic operating assets during 2000 along with thefactors discussed below.

            Incomefrom continuing operations for the nine months ended September30, 2001 was $9.5 million, or 12 cents per basic share comparedwith income from continuing operations of $24.5 million, or 31cents per basic share for the same period in 2000. Results fromcontinuing operations for the nine months ended September 30,2001 included pretax charges of $38.5 million primarilyassociated with the restructuring program in the lubricants,consumer products and international segments. Results fromcontinuing operations for the nine months ended September 30,2000 included pretax charges of $41.5 million related to theacquisition of Quaker State and other matters. Excluding pretaxcharges, net income from continuing operations for the ninemonths ended September 30, 2001 and 2000 was $36.5 million and$52.0 million, respectively. The decrease in income fromcontinuing operations excluding pretax charges for the ninemonths ended September 30, 2001, is primarily due to lowerresults from the Lubricants segment due to lower sales volumesand margins, lower results from the International segment due tolower margins and higher labor and facility costs in the ConsumerProducts segment.

            **Lubricants.**Net sales for the Lubricants segment were $976.5 million for thenine months ended September 30, 2001, compared to $1,084.8million for the same period last year. The decrease in net salesis primarily a result of the disposition of non-strategicoperating assets sold in 2000 and lower sales volumes fromremaining assets as a result of continued volume softness in thepassenger car motor oil market. Operating income for this segmentwas $96.0 million for the nine months ended September 30, 2001,compared to $124.6 million for the same period last year. Thedecrease in operating income for the nine months ended September30, 2001 is primarily due to lower sales volumes and margins andthe $6.0 million of restructuring charges recorded in the thirdquarter.

**            ConsumerProducts**. Net sales for the Consumer Products segment were$272.3 million for the nine months ended September 30, 2001,compared to $258.8 million for the same period last year. Theincrease in net sales for the nine months ended September 30,2001 is primarily due to increased automotive seat cover andfloor mat revenues as a result of the acquisition of SagazIndustries in early March 2000, partially offset by lowerrevenues from car wash and car cleaner products. Operating incomefor this segment was $9.5 million for the nine months endedSeptember 30, 2001, compared to $24.8 million for the same periodlast year. Operating income for the nine months ended September30, 2001 included pretax restructuring charges of $12.3 millioncompared to $2.8 million of pretax nonrecurring charges in thesame period in 2000. Excluding these charges, operating incomewas $21.8 million for the nine months ended September 30, 2001,compared to $27.6 million for the same period in 2000. Marginswere negatively impacted by increased costs, a less profitableproduct mix and increased promotional activities.

            **International.**Net sales for the International segment were $192.6 million forthe nine months ended September 30, 2001, compared to $187.6million for the same period last year. The increase in net salesfor the nine months ended September 30, 2001, compared to thesame period in 2000, is primarily due to acquisitions completedin 2000 and higher lubricating product prices. Operating income(loss) for this segment was $(6.7) million compared to $11.1million for the same period last year. Operating loss for thenine months ended September 30, 2001 included pretaxrestructuring charges of $16.7 million. Excluding these charges,operating income for the nine months ended September 30, 2001 was$10.0 million. The decrease from the comparable period in 2000was primarily due to lower margins partially offset by lowerselling, general and administrative expenses. 

**            JiffyLube.** Net sales for Jiffy Lube segment were $255.8 millionfor the nine months ended September 30, 2001, compared to $250.8million for the same period in 2000. The 2.0% increase in netsales is primarily due to higher comparable store sales resultingfrom higher average ticket prices attributable to increased salesof additional products and services. Other income for thissegment for the nine months ended September 30, 2001 was $4.6million compared to $6.3 million for the same period in 2000.Operating income from this segment was $15.9 million compared to$18.8 million for the same period in 2000. The decrease wasprimarily due to higher operating costs in company-operatedcenters. 

**            SupplyChain Investments**. Net sales for the supply chain investmentssegment, primarily intercompany sales to Lubricants, were $222.0million for the nine months ended September 30, 2001, compared tonet sales of $221.6 million for the same period in 2000. Otherincome for this segment for the nine months ended September 30,2001 was $21.4 million compared to $17.3 million for the sameperiod in 2000. Other income is primarily the equity income fromthe 50/50 Excel Paralubes partnership with Conoco Inc., which isrecorded using the equity method of accounting. The increase inequity income for the nine months ended September 30, 2001 isprimarily due to higher base oil margins at Excel Paralubes.Operating income from this segment was $33.2 million for the ninemonths ended September 30, 2001, compared to $28.8 million forthe same period ended September 30, 2001. The increase inoperating income for the nine months ended September 30, 2001reflects higher margins.

**            Corporateadministrative expense**. Corporate administrative expensedecreased $36.8 million to $44.0 million for the nine monthsended September 30, 2001, compared to the same period in 2000.The decrease for the nine months ended September 30, 2001 isprimarily due to charges in 2000 related to a general andadministrative cost reduction project. 

**Discontinued Operations**

            Inthe third quarter the Company revised its estimate of loss fromdiscontinued operations and recorded an after-tax loss of $3.8million ($6.3 million pretax). After-tax loss from discontinuedoperations for the nine months ended September 30, 2001 was $6.3million ($10.3 million pretax). After-tax loss from discontinuedoperations for the quarter and nine months ended September 30,2000 was $1.5 million ($2.5 million pretax) and $10.7 million($17.7 million pretax). Operating revenues for discontinuedoperations for the quarter and nine months ended September 30,2001 were $6.1 million and $217.4 million compared to $180.6million and $592.3 million for the same periods last year.

**Capital Resources and Liquidity**

***            CashFlow*****.********As of September 30, 2001,Pennzoil-Quaker State had cash and cash equivalents of $0.6million. During the nine months ended September 30, 2001, cashand cash equivalents decreased $37.7 million as a result of therepayment of debt. The increase in cash used in operatingactivities is due to an increase in working capital as a resultof seasonality in the automotive sector and payments associatedwith severance and discontinued operations.

            ***Liquidity.***The Company's ability to satisfy its debt obligations andto pay principal and interest on its debt, fund working capitaland make capital expenditures will depend upon its futureperformance, which is subject to general economic conditions andother factors, some of which are beyond its control. Based oncurrent and anticipated levels of operations and conditions inour markets, the Company believes that cash flow from operationswill be adequate for the foreseeable future to make requiredpayments of principal and interest on debt, and fund workingcapital and capital expenditure requirements. The initiativesundertaken to reduce inventory and sell non-strategic assets willimprove cash flow over historical levels during 2001. Inaddition, the Company has sufficient availability under itscredit facilities to fund working capital needs and capitalexpenditures if necessary. In the event of cash flow constraints,capital expenditures could be postponed to fund other obligationsif required. Beginning in the third quarter of 2001, the Companyreduced its dividend to the equivalent of $0.10 per shareannually.

***            DebtInstruments and Repayments.***Pennzoil-Quaker State enteredinto a new $348 million senior secured revolving credit facilityon November 2, 2001. Under the facility, $325 million isavailable on a revolving basis until November 2, 2004 and $23million is available on a revolving basis until November 1, 2002.Outstanding revolving credit borrowings under the Company'sprevious revolving credit facility were $218.0 million atSeptember 30, 2001 and were classified as long-term debt. Theaverage interest rate applicable to the company's revolvingcredit borrowings was 5.86% during the first nine months of 2001.

           OnNovember 2, 2001, the Company issued $250.0 million of 10% SeniorNotes due 2008. Net proceeds of $242.8 million were used to paydown all outstanding revolving credit borrowings under theCompany's previous revolving credit facility and increase cash onhand.

            Pennzoil-QuakerState's Canadian subsidiary also maintains a revolving creditfacility with Canadian banks, which provides for up to $17.8million of committed borrowings through November 9, 2001, withany outstanding borrowings on such date being converted into aterm credit facility due on October 28, 2002. The revolvingcredit facility is currently being renewed and amended. As ofSeptember 30, 2001 borrowings under the Company's Canadianfacility totaled $7.6 million and were classified as short-termdebt.

            AU.K. subsidiary of the Company maintains a revolving creditfacility that provides for borrowings up to $20.6 million throughJuly 26, 2002. Outstanding borrowings under the facility totaled$19.9 million at September 30, 2001 and were classified asshort-term debt.

            InDecember 2000, Pennzoil-Quaker State issued $150.0 million of8.65% Notes due 2002. Net proceeds of $149.1 million were used toreduce the Company's commercial paper borrowings. The terms ofthe notes provide that, in the event a rating on Pennzoil-QuakerState's senior unsecured debt falls and remains below investmentgrade, the coupon on the notes increases 0.75% to 9.40% and eachnoteholder has the option, at any time on or after June 1, 2001,to require the Company to purchase its note at 100% of theprincipal amount thereof plus accrued and unpaid interest on orafter June 1, 2001. To date, amounts put to the Company forrepurchase have been immaterial. During the nine months endedSeptember 30, 2001 Standard and Poor's, Moody's and Fitch loweredthe senior unsecured debt rating for the Company's debt belowinvestment grade. The notes, which are carried at fair marketvalue due to the interest rate swaps discussed in Note 3, arecurrently trading above 100% face value plus accrued interest.During the first nine months ended September 30, 2001, theCompany chose to purchase and retire $24.5 million face amount ofthese notes. As of September 30, 2001, the carrying amount of$130.4 million of indebtedness under Pennzoil-Quaker State's9.40% Notes due in 2002 (formerly 8.65% Notes due in 2002) hasbeen classified as short-term debt. 

           ***AccountsReceivable***. Pennzoil-Quaker State, through its whollyowned subsidiary Pennzoil Receivables Company ("PRC"),sells certain of its accounts receivable to a third partypurchaser. PRC is a special limited purpose corporation and theassets of PRC are available solely to satisfy the claims of itsown creditors and not those of Pennzoil-Quaker State or itsaffiliates. The Company renewed the receivable sales facilityduring August 2001 to provide for ongoing sales of up to $110.0million through August 2002. The Company's net accountsreceivable sold under its receivable sales facility totaled$110.0 million and $149.1 million at September 30, 2001 andDecember 31, 2000, respectively.

            TheCompany maintains a lube center receivable purchase and saleagreement, which provides for the sale of certain notesreceivable up to $275.0 million, through a wholly ownedsubsidiary, Pennzoil Lube Center Acceptance Corporation("PLCAC"). The assets of PLCAC are available solely tosatisfy the claims of its own creditors and not those ofPennzoil-Quaker State or its affiliates. Through September 30,2001, the Company sold a total of $232.6 million of notesreceivable under this agreement, of which $147.9 million wereoutstanding to the third party purchaser at September 30, 2001.Through December 31, 2000, the Company sold a total of $212.5million of notes receivable under this agreement, of which $159.0million were outstanding to the third party purchaser at December31, 2000.

**Environmental Matters**

            Asa result of informal negotiations with the EnvironmentalProtection Agency and the Department of Justice, the Company hasreached an agreement to resolve disputed issues arising under theClean Air Act, the Clean Water Act, and the Resource Conservationand Recovery Act in connection with the Company’s formeroperation of a refinery in Shreveport, Louisiana by paying acivil penalty. No formal proceedings have been initiated againstthe Company with respect to the disputed issues. The Companybelieves the amount of the civil penalty will not have a materialeffect on its financial condition or results of operations.

            Separately,the EPA has initiated an administrative proceeding alleging thatcertain activities of a used oil collection and processingbusiness formerly operated by the Company and its predecessors inShreveport, Louisiana violated regulatory requirements under theResource Conservation and Recovery Act. Although the Companydisputes the issues raised by the EPA, it anticipates that thismatter will be settled by agreement of the parties, includingpayment by the Company of a civil penalty, the amount of whichwould not have a material adverse effect on its financialcondition or results of operations.

            TheCompany is engaged in informal settlement discussions with local,state, and federal authorities regarding allegations ofviolations of environmental laws at a fast-lube service center inAlexandria, Virginia owned and operated by its Jiffy Lubesubsidiary. No formal proceedings have been initiated regardingthese allegations, and the Company anticipates that this matterwill be settled by agreement of the parties, including payment ofa civil penalty, the amount of which would not have a materialadverse effect on its financial condition or results ofoperations.

**Disclosures about Market Risk**

            TheCompany's primary exposure to market risk includes changes ininterest rates and foreign currency exchange rates.

            Inconnection with the issuance of $150.0 million of two-year fixedrate notes in December 2000, Pennzoil-Quaker State entered into afixed-to-floating interest rate swap to maintain its mix ofvariable rate versus fixed rate debt. The Company designated theswap as a fair value hedge. Under SFAS No. 133, changes in thefair value of the swap are recognized currently in earnings alongwith the offsetting changes in the fair value of the associateddebt. During the nine months ended September 30, 2001, theCompany repurchased notes and unwound the corresponding swap inthe amount of $24.5 million. Pretax gains of $0.4 million wererecognized on these transactions as of September 30, 2001.

            Pennzoil-QuakerState enters into forward exchange contracts and options to hedgethe impact of foreign currency fluctuations on certain monetaryliabilities and commitments denominated in foreign currencies.The purpose of entering into these hedges is to minimize theimpact of foreign currency fluctuations on the results ofoperations. The unrealized gains and losses on these contractsare deferred and recognized in the results of operations in theperiod in which the hedged transaction is consummated. During thenine months ended September 30, 2001, the Company's Canadiansubsidiary entered into Canadian dollar foreign currency forwardcontracts to hedge the cash flow variability of U.S. dollarspurchases of inventory for a total amount of $23.5 million ofwhich $20.0 million of the foreign currency contracts weresettled during the period. At September 30, 2001, the Company had$3.5 million of foreign currency forward contracts. The remainingcontracts settled on October 30, 2001 and there are no remainingcontracts outstanding. The forward contracts are designated ascash flow hedges of forecasted transactions. The forwardcontracts are recorded at fair value as an asset or liability onthe Company's balance sheet with the effective portion of thegain or loss reported as a component of other comprehensiveincome and will be reclassified into earnings in the same periodduring which the transactions are settled. 

**Forward-Looking Statements - Safe Harbor Provisions**

            Thisquarterly report on Form 10-Q of Pennzoil-Quaker State for thequarter ended September 30, 2001 contains certain forward-lookingstatements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, which are intended to becovered by the safe harbors created thereby. To the extent thatsuch statements are not recitations of historical fact, suchstatements constitute forward-looking statements, which, bydefinition, involve risks and uncertainties. Where, in anyforward-looking statements, Pennzoil-Quaker State expresses anexpectation or belief as to future results or events, suchexpectation or belief is expressed in good faith and believed tohave a reasonable basis, but there can be no assurance that thestatement of expectation or belief will result or be achieved oraccomplished.

            Thefollowing are factors that could cause actual results or eventsto differ materially from those anticipated, and include but arenot limited to: general economic, financial and businessconditions; competition in the motor oil and marketing business;base oil margins and supply and demand in the base oil business;the success and cost of advertising and promotional efforts;mechanical failure in refining operations; unanticipatedenvironmental liabilities; changes in and compliance withgovernmental regulations; changes in tax laws; and the cost andeffects of legal proceedings.

Item 6. Exhibits and Reports on Form 8-K

(a)     Exhibits - 

                 12    Computationof Ratio of Earnings to Fixed Charges for the nine months ended 

                 September30, 2001 and 2000.

(b)    Reports -

                Noreports on Form 8-K were filed during the quarter for which thisreport was filed.

 

 

**SIGNATURE**

 

 

                    Pursuantto the requirements of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 

 

 

                                                                                   PENNZOIL-QUAKERSTATE COMPANY

                                                                                   Registrant

 

 

 

                                                                                    S/NMichael J. Maratea

                                                                                    MichaelJ. Maratea

                                                                                    VicePresident and Controller 

 

March 8, 2002