**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

Washington, D.C. 20549

 

 

**FORM 10-Q**

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

**the Securities Exchange Act of 1934**

 

**For the Quarter Ended June30, 2001                             CommissionFile No. 1-14501**

**PENNZOIL-QUAKER STATE 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, July 31, 2001:

Common Stock, par value $0.10 per share,79,347,463 shares.

 

 

 

 

 

| PART I. FINANCIAL INFORMATION                                                  |
|--------------------------------------------------------------------------------|
| Item        1. Financial Statements                                            |   |   |   |   |   |   |   |
| PENNZOIL-QUAKER STATE COMPANY                                                  |
| CONDENSED CONSOLIDATED        STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME |
| (UNAUDITED)                                                                    |
|                                                                           |   | Three Months Ended |   | Six Months Ended |
|                                                                           |   | June 30 |   | June 30 |
|                                                                           |   | 2001 |   | 2000 |   | 2001 |   | 2000 |
|                                                                           |   | (Expressed in thousands        except per share amounts) |
| REVENUES                                                                       | $ 604,092 |   | $ 640,637 |   | $ 1,173,036 |   | $ 1,226,224 |
| COSTS AND EXPENSES                                                             |   |   |   |   |   |   |   |
|                                                                           | Cost        of sales | 426,840 |   | 420,431 |   | 816,713 |   | 802,951 |
|                                                                           | Selling,        general and administrative | 126,813 |   | 126,680 |   | 237,482 |   | 285,202 |
|                                                                           | Acquisition        related expenses | - |   | 3,844 |   | - |   | 7,799 |
|                                                                           | Depreciation        and amortization | 30,938 |   | 23,363 |   | 55,634 |   | 48,332 |
|                                                                           | Taxes,        other than income | 3,919 |   | 3,207 |   | 7,113 |   | 6,682 |
|                                                                           | Interest        charges, net | 24,165  |   | 23,601 |   | 48,877  |   | 45,242 |
| INCOME (LOSS) FROM CONTINUING OPERATIONS                                       |   |   |   |   |   |   |   |
|                                                                           | BEFORE        INCOME TAX | (8,583) |   | 39,511 |   | 7,217 |   | 30,016 |
| Income tax provision (benefit)                                                 | (5,837) |   | 19,968 |   | 1,258 |   | 11,639 |
| INCOME (LOSS) FROM CONTINUING OPERATIONS                                       | (2,746) |   | 19,543 |   | 5,959 |   | 18,377 |
| LOSS FROM DISCONTINUED OPERATIONS, net of tax                                  | (2,465) |   | (2,637)  |   | (2,465) |   | (9,271) |
| NET INCOME (LOSS)                                                              | $ (5,211)  |   | $ 16,906  |   | $ 3,494 |   | $ 9,106 |
| BASIC AND DILUTED EARNINGS (LOSS) PER SHARE                                    |   |   |   |   |   |   |   |
|                                                                           | Continuing        operations | $ (0.04) |   | $ 0.25 |   | $ 0.07 |   | $ 0.23 |
|                                                                           | Discontinued        operations | (0.03) |   | (0.03) |   | (0.03) |   | (0.11) |
|                                                                           |   | $ (0.07) |   | $ 0.22  |   | $ 0.04 |   | $ 0.12 |
| DIVIDENDS PER COMMON SHARE                                                     | $ 0.1875 |   | $ 0.1875 |   | $ 0.3750 |   | $ 0.3750 |
| AVERAGE SHARES OUTSTANDING:                                                    |   |   |   |   |   |   |   |
|                                                                           | BASIC | 79,107 |   | 78,403 |   | 78,971 |   | 78,308 |
|                                                                           | DILUTED | 79,107 |   | 79,641 |   | 79,693 |   | 78,927 |
| END OF PERIOD SHARES OUTSTANDING                                               | 79,261 |   | 78,496 |   | 79,261 |   | 78,496 |
| NET INCOME (LOSS)                                                              | $ (5,211) |   | $ 16,906 |   | $ 3,494 |   | $ 9,106 |
| Other comprehensive income (loss) net of tax:                                  |   |   |   |   |   |   |   |
|                                                                           | Foreign        currency translation adjustment | 315 |   | (2,509) |   | (2,161) |   | (2,572) |
|                                                                           | Unrealized        loss on investment in securities and other | (175)  |   | (494) |   | (144) |   | (123) |
|                                                                           | Total        other comprehensive income (loss) | 140 |   | (3,003) |   | (2,305) |   | (2,695) |
| COMPREHENSIVE INCOME (LOSS)                                                    | $ (5,071) |   | $ 13,903  |   | $ 1,189 |   | $ 6,411 |
| See Notes to Condensed Consolidated Financial        Statements.               |   |   |   |   |   |   |   |

| PART I. FINANCIAL INFORMATION - continued                        |
|------------------------------------------------------------------|
| PENNZOIL-QUAKER STATE COMPANY                                    |
| CONDENSED CONSOLIDATED        BALANCE SHEET                      |
|                                                             |   | June 30 |   | December 31 |
|                                                             |   | 2001 |   | 2000 |
|                                                             |   | (Unaudited) |   |   |
|                                                             |   | (Expressed in thousands) |
| ASSETS                                                           |   |   |   |
| Current assets                                                   |   |   |   |
|                                                             | Cash        and cash equivalents | $ 3,683 |   | $ 38,263 |
|                                                             | Receivables | 362,567 |   | 315,710 |
|                                                             | Inventories | 214,753 |   | 186,999 |
|                                                             | Other        current assets | 72,265 |   | 52,775 |
| Total current assets                                             | 653,268 |   | 593,747 |
| Property, plant and equipment, net                               | 458,426 |   | 476,134 |
| Deferred income taxes                                            | 281,141 |   | 280,813 |
| Goodwill and other intangibles                                   | 1,116,801 |   | 1,139,413 |
| Other assets                                                     | 218,099 |   | 212,316 |
| Net assets of discontinued operations                            | - |   | 97,259 |
| TOTAL ASSETS                                                     | $ 2,727,735 |   | $ 2,799,682 |
| LIABILITIES AND SHAREHOLDERS' EQUITY                             |   |   |   |
| Current liabilities                                              |   |   |   |
|                                                             | Current        maturities of long-term debt | $ 12,777 |   | $ 13,786 |
|                                                             | Accounts        payable | 152,441 |   | 166,056 |
|                                                             | Payroll        accrued | 14,538 |   | 17,215 |
|                                                             | Other        current liabilities | 128,023 |   | 121,515 |
| Total current liabilities                                        | 307,779 |   | 318,572 |
| Total long-term debt, less current maturities                    | 1,163,246 |   | 1,194,426 |
| Capital lease obligations, less current        maturities        | 58,702 |   | 61,861 |
| Net liabilities of discontinued operations                       | 12,281 |   | - |
| Other liabilities                                                | 387,062 |   | 401,632 |
| TOTAL LIABILITIES                                                | 1,929,070 |   | 1,976,491 |
| COMMITMENTS AND CONTINGENCIES                                    |   |   |   |
| SHAREHOLDERS' EQUITY                                             | 798,665 |   | 823,191 |
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                       | $ 2,727,735 |   | $ 2,799,682 |
| See Notes to Condensed Consolidated Financial        Statements. |   |   |   |

 

| PART I. FINANCIAL INFORMATION - continued                        |                                                       |
|------------------------------------------------------------------|------------------------------------------------------------|
|                                                             |                                                       |   |   |   |   |   |   |
| PENNZOIL-QUAKER STATE COMPANY                                    |                                                       |
| CONDENSED CONSOLIDATED        STATEMENT OF CASH FLOWS            |                                                       |
| (UNAUDITED)                                                      |                                                       |
|                                                             |                                                       |   |   |   |   |   |   |
|                                                             |                                                       |   |   | Six Months Ended |   |
|                                                             |                                                       |   |   | June 30 |   |
|                                                             |                                                       |   |   | 2001 |   | 2000 |   |
|                                                             |                                                       |   |   | (Expressed in thousands) |   |
|                                                             |                                                       |   |   |   |   |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                             |                                                       |   |   |   |
|                                                             | Net income                                                 | $ 3,494 |   | $ 9,106 |   |
|                                                             | Adjustments to reconcile net income to net cash            |   |   |   |   |
|                                                             |                                                       | used in operating activities: |   |   |   |   |
|                                                             |                                                       |   | Depreciation        and amortization | 55,634 |   | 48,332 |   |
|                                                             |                                                       |   | Deferred        income tax | (342) |   | 4,916 |   |
|                                                             |                                                       |   | Earnings        in excess of distributions from |   |   |   |   |
|                                                             |                                                       |   | equity        investees | (5,321) |   | (6,991) |   |
|                                                             |                                                       |   | Other        non-cash items | 17,770 |   | 13,947 |   |
|                                                             |                                                       |   | Loss        from discontinued operations | 4,074 |   | 15,322 |   |
|                                                             |                                                       |   | Changes        in accounts receivable | (63,995) |   | (74,484) |   |
|                                                             |                                                       |   | Changes        in inventories | (32,055) |   | (49,567) |   |
|                                                             |                                                       |   | Changes        in accounts payable | (23,381) |   | (5,971) |   |
|                                                             |                                                       |   | Changes        in other operating assets and liabilities | (34,782) |   | 3,118 |   |
|                                                             | Net cash used in operating activities                      | (78,904) |   | (42,272) |   |
|                                                             |                                                       |   |   |   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                             |                                                       |   |   |   |
|                                                             | Capital expenditures                                       | (24,963) |   | (28,152) |   |
|                                                             | Acquisitions, net of cash acquired                         | (700) |   | (76,421) |   |
|                                                             | Proceeds from sales of assets                              | 9,592 |   | 12,828 |   |
|                                                             | Other investing activities                                 | 14,382 |   | 2,487 |   |
|                                                             | Net cash used in investing activities                      | (1,689) |   | (89,258) |   |
|                                                             |                                                       |   |   |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                             |                                                       |   |   |   |
|                                                             | Net proceeds from (repayments of) debt                     | (38,629) |   | 176,910 |   |
|                                                             | Dividends paid                                             | (29,628) |   | (29,285) |   |
|                                                             | Net cash provided by (used in) financing        activities | (68,257) |   | 147,625 |   |
|                                                             |                                                       |   |   |   |   |   |   |
| NET CASH PROVIDED BY (USED IN)                                   |                                                       |   |   |   |
|                                                             | DISCONTINUED OPERATIONS                                    | 114,270 |   | (15,275) |   |
|                                                             |                                                       |   |   |   |   |   |   |
| NET INCREASE (DECREASE) IN CASH                                  |                                                       |   |   |   |
|                                                             | AND CASH EQUIVALENTS                                       | (34,580) |   | 820 |   |
|                                                             |                                                       |   |   |   |   |   |   |
| CASH AND CASH EQUIVALENTS, beginning of period                   | 38,263                                                     |   | 20,155 |   |
|                                                             |                                                       |   |   |   |   |   |   |
| CASH AND CASH EQUIVALENTS, end of period                         | $ 3,683                                                    |   | $ 20,975 |   |
|                                                             |                                                       |   |   |   |   |   |   |
| 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.

**(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. This statement is effective beginningJune 30, 2001. The Company does not believe that this standardwill have a material impact on its financial position or resultsof operations. 

            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. In addition, goodwill, other than goodwillassociated with equity method investments, must be assessed atleast annually for impairment using a fair-value based approach.The provisions of this statement are required to be adopted as ofthe beginning of the first fiscal year after December 15, 2001.Companies that have a December 31 fiscal year-end, such asPennzoil-Quaker State, may not early adopt the provisions of thestatement. Impairment losses that arise due to the initialapplication of this statement are to be reported as a cumulativeeffect of change in accounting principle. Pennzoil-Quaker Statehas not completed an analysis of the impact of implementing theprovisions of this statement. On an annual basis, the Companyexpects the adoption of SFAS No. 142 to generate an additional$.32 to $.36 basic earnings per share. For the six months endedJune 30, 2001, goodwill amortization was $17.8 million. 

            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 periods in which it isincurred. When the liability is initially recorded, the entityincreases the carrying amount of the related long-lived asset.The liability is accreted to the fair value at the time ofsettlement over the useful life of the asset, and the capitalizedcost is depreciated over the useful life of the related asset.The standard is effective for fiscal years beginning after June15, 2002, with earlier application encouraged. The Company iscurrently evaluating the effect of adopting SFAS No. 143 on itsfinancial statements and has not 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 in 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 June 30, 2001, the fair market value of the swap of $3.3million was recorded in other current assets. During the sixmonths ended June 30, 2001, the Company repurchased notes andunwound the corresponding swap in the amount of $17.8 million. Nomaterial gain or loss was recognized on these transactions.

            Duringthe second quarter of 2001, the Company's Canadian subsidiaryentered into Canadian dollar foreign currency forward contractsto reduce the cash flow variability of U.S. dollars purchases ofinventory. The Company designated these forward contracts as cashflow hedges. Under SFAS No. 133, gains and losses on the forwardcontracts are recorded in other comprehensive income and thenreclassified to earnings as the inventory is sold. The fairmarket value of the forward contracts was not material. At June30, 2001, the Company had $5.0 million of foreign currencyforward contracts and no material gains or losses wererecognized.

**(4)       SummarizedFinancial Data of Excel Paralubes -**

            Pennzoil-QuakerState's net investment in Excel Paralubes, accounted for usingthe equity method and carried as a credit balance of $66.3million and $71.6 million at June 30, 2001 and December 31, 2000,respectively, is included in other liabilities on the condensedconsolidated balance sheet. Pennzoil-Quaker State's equity inExcel Paralubes' pretax income for the three months ended June30, 2001 and 2000 of $5.8 million and $9.6 million, respectively,is included in revenues in the condensed consolidated statementof operations and comprehensive income. Pennzoil-Quaker State'sequity in Excel Paralubes' pretax income for the six months endedJune 30, 2001 and 2000 of $12.7 million and $11.7 million,respectively, is included in revenues in the condensedconsolidated statement of operations and comprehensive income.

Summarized financial information for Excel Paralubes for thethree and six months ended June 30, 2001 and 2000 on a 100% basisfollows:

|                      | Three months ended June 30 |   | Six months ended June 30 |
|---------------------------|----------------------------|--------|--------------------------|
|                      | 2001                       |   | 2000                     |   | 2001 |   | 2000 |
|                      | (Expressed in thousands)   |
|                      | (Unaudited)                |
| Revenues                  | $ 101,578                  |   | $ 128,646                |   | $ 225,274 |   | $ 243,510 |
| Operating        earnings | 21,614                     |   | 29,299                   |   | 45,807 |   | 43,769 |
| Net        income         | 11,545                     |   | 19,105                   |   | 25,435 |   | 23,478 |

**(5)       SegmentReporting -**

            Duringthe first quarter of 2001, the Company realigned its businesssegments to report five separate operating segments. Results forthe three and six months ended June 30, 2000 have been restatedto conform with the new presentation. Information with respect torevenues, operating income and other data is presented in thefollowing tables (expressed in thousands).

 

|                      |                    | Three months ended June 30,        2001 |
|---------------------------|-------------------------|-----------------------------------------|
|                      |                    |                                    |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                      |                    | Lubricants                              |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 318,868               |                                    | $ 96,391 |   | $ 66,139 |   | $ 88,458 |   | $ 36,245 |   | $ (2,009) |   | $ 604,092 |
| Intersegment revenues     | 14,835                  |                                    | 6,021 |   | - |   | - |   | 33,769 |   | (54,625) |   | - |
|                      | Total        revenues   | $ 333,703                               |   | $ 102,412 |   | $ 66,139 |   | $ 88,458 |   | $ 70,014 |   | $ (56,634) |   | $ 604,092 |
| Income before interest    |                    |                                    |   |   |   |   |   |   |   |   |   |   |   |
|                      | and        income taxes | $ 32,739                                |   | $ (1,498) |   | $ (12,969) |   | $ 4,531 |   | $ 8,937 |   | $ (16,158) |   | $ 15,582 |

|                      |                    | Three months ended June 30,        2000 |
|---------------------------|-------------------------|-----------------------------------------|
|                      |                    |                                    |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                      |                    | Lubricants                              |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 363,530               |                                    | $ 88,806 |   | $ 64,511 |   | $ 85,979 |   | $ 39,400 |   | $ (1,589) |   | $ 640,637 |
| Intersegment revenues     | 15,527                  |                                    | 6,735 |   | - |   | - |   | 49,958 |   | (72,220) |   | - |
|                      | Total        revenues   | $ 379,057                               |   | $ 95,541 |   | $ 64,511 |   | $ 85,979 |   | $ 89,358 |   | $ (73,809) |   | $ 640,637 |
| Income before interest    |                    |                                    |   |   |   |   |   |   |   |   |   |   |   |
|                      | and        income taxes | $ 50,363                                |   | $ 8,003 |   | $ 3,900 |   | $ 7,627 |   | $ 13,637 |   | $ (20,418) |   | $ 63,112 |

|                      |                    | Six months ended June 30,        2001 |
|---------------------------|-------------------------|---------------------------------------|
|                      |                    |                                  |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                      |                    | Lubricants                            |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a) | $ 624,016               |                                  | $ 176,063 |   | $ 128,702 |   | $172,222 |   | $ 75,637 |   | $ (3,604) |   | $1,173,036 |
| Intersegment revenues     | 30,818                  |                                  | 11,288 |   | 709 |   | - |   | 77,085 |   | (119,900) |   | - |
|                      | Total        revenues   | $ 654,834                             |   | $ 187,351 |   | $ 129,411 |   | $172,222 |   | $ 152,722 |   | $ (123,504) |   | $1,173,036 |
| Income before interest    |                    |                                  |   |   |   |   |   |   |   |   |   |   |   |
|                      | and        income taxes | $ 64,007                              |   | $ 3,392 |   | $ (11,811) |   | $ 9,504 |   | $ 19,351 |   | $ (28,349) |   | $ 56,094 |

|                                                              |                                                                     | Six months ended June 30,        2000 |
|-------------------------------------------------------------------|--------------------------------------------------------------------------|---------------------------------------|
|                                                              |                                                                     |                                  |   | Consumer |   |   |   |   |   | Supply Chain |   | Corporate |   |   |
|                                                              |                                                                     | Lubricants                            |   | Products |   | International |   | Jiffy Lube |   | Investments |   | and other (b) |   | Total |
| Unaffiliated revenues (a)                                         | $ 699,047                                                                |                                  | $ 168,260 |   | $ 123,202 |   | $169,810 |   | $ 64,757 |   | $ 1,148 |   | $1,226,224 |
| Intersegment revenues                                             | 30,212                                                                   |                                  | 11,368 |   | - |   | - |   | 92,466 |   | (134,046) |   | - |
|                                                              | Total        revenues                                                    | $ 729,259                             |   | $ 179,628 |   | $ 123,202 |   | $169,810 |   | $ 157,223 |   | $ (132,898) |   | $1,226,224 |
| Income before interest                                            |                                                                     |                                  |   |   |   |   |   |   |   |   |   |   |   |
|                                                              | and        income taxes                                                  | $ 84,948                              |   | $ 20,021 |   | $ 8,851 |   | $ 10,876 |   | $ 19,137 |   | $ (68,575) |   | $ 75,258 |
|                                                              |                                                                     |                                  |   |   |   |   |   |   |   |   |   |   |   |   |
| (a)                                                               | Unaffiliated revenues include sales to        unconsolidated affiliates. |
| (b)           Includes consolidating eliminations. |

**(6)       Debt -**

            Pennzoil-QuakerState has a revolving credit facility with a group of banks thatprovides for up to $450.0 million of committed unsecuredrevolving credit borrowings through December 13, 2001, with anyoutstanding borrowings on such date being converted into a termcredit facility due on December 13, 2002. The Company iscurrently negotiating a replacement multi-year revolving creditfacility. Outstanding borrowings were $236.0 million under therevolving credit facility at June 30, 2001 and were classified aslong-term debt. The average interest rate applicable toborrowings under the revolving credit facility was 6.26% duringthe first six months of 2001. 

            Pennzoil-QuakerState's Canadian subsidiary also maintains a revolving creditfacility with Canadian banks, which provides for up to $17.8million of committed borrowings through October 28, 2001, withany outstanding borrowings on such date being converted into aterm credit facility due on October 28, 2002. As of June 30, 2001borrowings under the Company's Canadian facility totaled $11.2million and were classified as long-term debt. 

            AU.K. subsidiary of the Company maintains a revolving creditfacility that provides for borrowings up to $19.8 million throughJuly 26, 2002. Outstanding borrowings under the facility totaled$19.1 million at June 30, 2001 and were classified as long-termdebt.

            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 9.4% 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 six months ended June30, 2001 Standard and Poor's, Moody's and Fitch lowered thesenior unsecured debt rating for the Company's debt belowinvestment grade. The notes are currently trading above 100% facevalue plus accrued interest. During the six months ended June 30,2001, the Company chose to purchase and retire $17.8 million faceamount of these notes and no material gain or loss was recognizedon these transactions. 

            Asof June 30, 2001, the fair market value of $135.6 million ofindebtedness under Pennzoil-Quaker State's 8.65% Notes due in2002 has been classified as long-term debt. Such debtclassification is based upon the availability of committedlong-term credit facilities to refinance such short-termobligations and the Company's intent to maintain such commitmentsin excess of one year.

            Debtoutstanding was as follows:

|                                          |                        | June 30,                 |      | December 31, |
|-----------------------------------------------|-----------------------------|--------------------------|-----------|--------------|
|                                          |                        | 2001                     |      | 2000         |
|                                          |                        | (Expressed in thousands) |
| 7.375% Debentures due 2029, net of discount   | $ 398,139                   |                     | $ 398,105 |
| 6.750% Notes due 2009, net of discount        | 199,209                     |                     | 199,159   |
| 8.65% Notes due 2002, net of discount         | 135,437                     |                     | 151,017   |
| 6.625 % Notes due 2005, net of discount       | 99,739                      |                     | 99,708    |
| Commercial paper                              | -                           |                     | 57,709    |
| Revolving credit facility                     | 236,000                     |                     | 195,000   |
| Pollution control bonds, net of discount      | 50,558                      |                     | 50,522    |
| International debt facilities                 | 49,303                      |                     | 51,808    |
| Other debt                                    | 7,638                       |                     | 5,184     |
|                                          | Total        debt           | 1,176,023                |      | 1,208,212    |
| Less amounts classified as current maturities | (12,777)                    |                     | (13,786)  |
|                                          | Total        long-term debt | $ 1,163,246              |      | $ 1,194,426  |

**(7)       Earnings PerShare -**

            Computationsfor basic and diluted earnings (loss) per share for the three andsix months ended June 30, 2001 and 2000 consist of the following:

|                                        |      | Three months ended June 30                               |     | Six months ended June 30 |
|---------------------------------------------|-----------|----------------------------------------------------------|----------|--------------------------|
|                                        |      | 2001                                                     |     | 2000                     |   | 2001 |   | 2000 |
|                                        |      | (Expressed in thousands        except per share amounts) |
| Income (loss) from continuing operations    | $ (2,746) |                                                     | $ 19,543 |                     | $ 5,959 |   | $ 18,377 |
| Basic weighted average shares               | 79,107    |                                                     | 78,403   |                     | 78,971 |   | 78,308 |
| Effect of dilutive securities (a)           |      |                                                     |     |                     |   |   |   |
|                                        | Options   | -                                                        |     | 649                      |   | 468 |   | 325 |
|                                        | Awards    | -                                                        |     | 589                      |   | 254 |   | 294 |
| Diluted weighted average shares             | 79,107    |                                                     | 79,641   |                     | 79,693 |   | 78,927 |
| Basic and diluted earnings (loss) per share | $ (0.04)  |                                                     | $ 0.25   |                     | $ 0.07 |   | $ 0.23 |

- A weighted average number of options to        purchase 9.1 million shares of common stock and awards of        729.8 thousand shares of common stock were outstanding        for the three months ended June 30, 2001, but were not        included in the computation of diluted earnings per share        because these options and awards would have resulted in        an antidilutive per share amount. A weighted average        number of options to purchase 6.6 million shares of        common stock were outstanding for the three months ended        June 30, 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 6.9 million and 8.2 million shares of        common stock were outstanding for the six months ended        June 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 six months ended June 30, 2001 and2000 was $38.3 million and $49.5 million, respectively. Incometax payments (refunds) of $0.4 million and $(1.0) million werepaid (received) during the six months ended June 30, 2001 and2000, respectively. 

**(9)        DiscontinuedOperations -**

**            **Basedon the results of a strategic review completed in 2000, theCompany began to withdraw from the refining business and todispose of its refineries and related assets. In February 2000,the Company ceased processing crude oil at its Rouseville,Pennsylvania refinery. In April 2000, the Company sold the waxprocessing facilities and related assets at the Rousevillerefinery and its interest in the Bareco wax marketingpartnership. In January 2001, the Company sold its share ofPenreco, a specialty industrial products partnership with Conoco.In April 2001, the Company completed its exit from the refiningbusiness with the sale of the Company's Shreveport, Louisianarefinery to Calumet Lubricants Company, LP. Accordingly, the netassets and results of operations of the Company's refining assetsand specialty industrial products businesses, including theShreveport and Rouseville refineries and the Penreco partnership,have been combined and reported as discontinued operations in theaccompanying financial statements.

            Inthe second quarter of 2001, the Company revised its estimate ofloss from discontinued operations and recorded an after-tax lossof $2.5 million ($4.1 million pretax). After-tax loss fromdiscontinued operations for the quarter and six months ended June30, 2000 was $2.6 million ($4.4 million pretax) and $9.3 million($15.3 million pretax). Operating revenues for discontinuedoperations for the quarter and six months ended June 30, 2001were $56.1 million and $211.2 million compared to $213.4 millionand $411.7 million for the same periods last year. Included innet cash provided by discontinued operations for the 2001 periodare proceeds of $70.0 million from the sale of Penreco and $25.2million 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. Included in the $16.7million of International charges were charges of $6.5 millionassociated with the impairment of goodwill. The Company isreducing the number of employees and closing and consolidatingwarehouses and office space. The restructuring is expected to becompleted by the first quarter of 2002. Current period chargesprimarily included severance for approximately 362 administrativeand operational 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 have been terminatedor notified of a termination date. The severance payments for theformer employees are expected to be paid out over a minimumperiod of two months with a maximum period of up to two years.The remaining accrual at June 30, 2001 was $9.6 million recordedin other current liabilities.

Item 2. Management's Discussion and Analysis of FinancialCondition

            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.

Results of Operations

            Netsales for Pennzoil-Quaker State were $596.7 million for thequarter ended June 30, 2001, a decrease of $31.1 million, orapproximately 4.9% from the same period in 2000. Net sales forPennzoil-Quaker State were $1,157.4 million for the six monthsended June 30, 2001, a decrease of $46.6 million, orapproximately 3.9% 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.

            Lossfrom continuing operations for the quarter ended June 30, 2001was $2.7 million, or 4 cents per basic share. This compares withincome from continuing operations of $19.5 million, or 25 centsper basic share for the quarter ended June 30, 2000. Income fromcontinuing operations for the six months ended June 30, 2001 was$6.0 million, or 7 cents per basic share. This compares withincome from continuing operations of $18.4 million, or 23 centsper basic share for the quarter ended June 30, 2000. The decreasein income from continuing operations for the quarter ended June30, 2001, compared to the same period in 2000, is primarily dueto charges associated with the Company's restructuring programrecorded in the second quarter of 2001, lower results from theLubricants segment due to lower sales volumes and margins andlower results from the Supply Chain Investments segment due tolower volumes produced at Excel Paralubes, as restricted hydrogensupply and operating issues caused unforeseen downtime. Thedecrease in income for the six months ended June 30, 2001,compared to the same period in 2000, is primarily due to loweroperating income from the Lubricants, Consumer Products andInternational segments and higher interest expense.

Lubricants

            Netsales for the Lubricants segment were $331.6 million and $651.1million for the quarter and six months ended June 30, 2001,compared to $376.4 million and $724.3 million for the sameperiods last year. The decrease in net sales is primarily aresult of the disposition of non-strategic operating assets soldin 2000 and lower sales volumes from remaining assets as a resultof continued softness in the automotive sector. Operating incomefor this segment was $32.7 million and $64.0 million for thequarter and six months ended June 30, 2001, compared to $50.4million and $84.9 million for the same periods last year. Thedecrease in operating income for the quarter and six months endedJune 30, 2001 is primarily due to lower sales volumes andmargins.

Consumer Products

            Netsales for the Consumer Products segment were $102.4 million and$187.3 million for the quarter and six months ended June 30,2001, compared to $95.5 million and $179.6 million for the sameperiods last year. The increase in net sales for the quarter andsix months ended June 30, 2001 is primarily due to increasedautomotive seat cover and floor mat revenues as a result of theacquisition of Sagaz Industries in early March 2000, partiallyoffset by lower revenues from car washes and cleaners. Operatingincome (loss) for this segment was $(1.5) million and $3.4million for the quarter and six months ended June 30, 2001,compared to $8.0 million and $20.0 million for the same periodslast year. The decrease in operating income for the quarter endedJune 30, 2001, compared to the same period in 2000, is primarilydue to restructuring charges recorded in selling, general andadministrative expense of $11.8 million. The decrease inoperating income for the six months ended June 30, 2001, comparedto the same period in 2000, is primarily due to restructuringcharges and increased cost of sales associated with automotivechemical products in the first quarter of 2001.

International

            Netsales for the International segment were $66.2 million and $129.3million for the quarter and six months ended June 30, 2001,compared to $63.3 million and $121.8 million for the same periodslast year. The increase in net sales for the second quarter andsix months ended June 30, 2001 compared to the same periods lastyear is primarily due to acquisitions completed in March andApril of 2000 and higher lubricating product prices. Operatingincome (loss) for this segment was $(13.0) million and $(11.8)million for the quarter and six months ended June 30, 2001,compared to $3.9 million and $8.9 million for the same periodslast year. Included in the operating loss for the quarter and sixmonths ended June 30, 2001 are restructuring charges of $16.7million for severance, costs associated with vacating offices andwarehouses, cancellation of equipment and auto leases with otherfixed asset disposal costs. The restructuring charges recordedduring the three months ended June 30, 2001 included a $6.0million charge to cost of sales, a $4.2 million charge toselling, general and administrative expense and a $6.5 milliongoodwill impairment charge to depreciation and amortizationexpense.

            Excludingthe restructuring charges, operating income was down $0.2 millionfor the quarter ended June 30, 2001, compared to the same periodlast year. The decrease in operating income was primarily due tolower margins which were partially offset by higher volumes andlower selling, general and administrative expenses. Excluding therestructuring charges, operating income for the six months endedJune 30, 2001, was down $4.0 million compared to the same periodlast year. The decrease is primarily due to lower margins,partially offset by higher volumes and lower selling, general andadministrative expenses.

Jiffy Lube

            Netsales for this segment were $86.8 million and $169.5 million forthe quarter and six months ended June 30, 2001. This compares tonet sales of $84.8 million and $166.9 million for the sameperiods in 2000. Other income for this segment for the quarterand six months ended June 30, 2001, was $1.6 million and $2.7million compared to $1.2 million and $2.9 million for the sameperiods in 2000. Operating income from this segment for thequarter ended June 30, 2001 was $4.5 million and $9.5 millioncompared to $7.6 million and $10.9 million for the same periodsin 2000. The decrease in operating income for the quarter and sixmonths ended June 30, 2001 is primarily due to increased cost ofsales due to higher labor costs, motor oil costs and utilities. 

Supply Chain Investments 

            Netsales for this segment, primarily intercompany sales toLubricants, were $64.2 million and $140.0 million for the quarterand six months ended June 30, 2001. This compares to net sales of$79.8 million and $145.5 million for the same periods in 2000.Other income for this segment for the quarter and six monthsended June 30, 2001, was $5.8 million and $12.7 million comparedto $9.6 million and $11.7 million for the same periods in 2000.Other income represents the equity income from the 50/50 ExcelParalubes partnership with Conoco Inc., which is recorded usingthe equity method of accounting. The decrease in equity incomefor the quarter ended June 30, 2001 is primarily due to lowervolumes produced at Excel Paralubes, as restricted hydrogensupply and operating issues caused unforeseen downtime. Operatingincome from this segment for the quarter and six months endedJune 30, 2001 was $8.9 million and $19.3 million compared tooperating income of $13.6 million and $19.1 million for the sameperiods in 2000. The decrease in operating income for the quarterended June 30, 2001 reflects the lower volumes.

Discontinued Operations

            Inthe second quarter of 2001, the Company revised its estimate ofloss from discontinued operations and recorded an after-tax lossof $2.5 million ($4.1 million pretax). After-tax loss fromdiscontinued operations for the quarter and six months ended June30, 2000 was $2.6 million ($4.4 million pretax) and $9.3 million($15.3 million pretax). Operating revenues for discontinuedoperations for the quarter and six months ended June 30, 2001were $56.1 million and $211.2 million compared to $213.4 millionand $411.7 million for the same periods last year.

Corporate Administrative Expense

            Corporateadministrative expense decreased $3.7 million to $13.5 millionfor the quarter ended June 30, 2001, compared to the same periodin 2000. Corporate administrative expense decreased $36.1 millionto $27.9 million for the six months ended June 30, 2001, comparedto the same period in 2000. The decrease for the six months endedJune 30, 2001 is primarily due to charges in 2000 related to ageneral and administrative cost reduction project. 

Capital Resources and Liquidity

***            CashFlow*****.********As of June 30, 2001,Pennzoil-Quaker State had cash and cash equivalents of $3.7million. During the six months ended June 30, 2001, cash and cashequivalents decreased $34.6 million as a result of the repaymentof debt. The increase in cash used in operating activities is dueto an increase in working capital as a result of seasonality inthe automotive sector and payments associated with severance anddiscontinued operations.

            ***Liquidity.***The Company believes that it has sufficient availabilityunder its credit facilities to fund working capital needs andcapital expenditures if necessary. In the event of cash flowconstraints, capital expenditures could be postponed to fundother obligations if required.

***            DebtInstruments and Repayments***.   Pennzoil-QuakerState has a revolving credit facility with a group of banks thatprovides for up to $450.0 million of committed unsecuredrevolving credit borrowings through December 13, 2001, with anyoutstanding borrowings on such date being converted into a termcredit facility due on December 13, 2002. Outstanding borrowingswere $236.0 million under the revolving credit facility at June30, 2001 and were classified as long-term debt. The averageinterest rate applicable to borrowings under the revolving creditfacility was 6.26% during the first six months of 2001. 

            Pennzoil-QuakerState's Canadian subsidiary also maintains a revolving creditfacility with Canadian banks, which provides for up to $17.8million of committed borrowings through October 28, 2001, withany outstanding borrowings on such date being converted into aterm credit facility due on October 28, 2002. As of June 30, 2001borrowings under the Company's Canadian facility totaled $11.2million and were classified as long-term debt. 

            AU.K. subsidiary of the Company maintains a revolving creditfacility that provides for borrowings up to $19.8 million throughJuly 26, 2002. Outstanding borrowings under the facility totaled$19.1 million at June 30, 2001 and were classified as long-termdebt.

            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 9.4% 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 six months ended June30, 2001 Standard and Poor's, Moody's and Fitch lowered thesenior unsecured debt rating for the Company's debt belowinvestment grade. The notes are currently trading above 100% facevalue plus accrued interest. During the first six months endedJune 30, 2001, the Company chose to purchase and retire $17.8million face amount of these notes. 

            Asof June 30, 2001, the fair market value of $135.6 million ofindebtedness under Pennzoil-Quaker State's 8.65% Notes due in2002 has been classified as long-term debt. Such debtclassification is based upon the availability of committedlong-term credit facilities to refinance such short-termobligations and the Company's intent to maintain such commitmentsin excess of one year.

            ***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 and increased the receivablesales facility during August 2000. The renewed facility providesfor ongoing sales of up to $170.0 million through August 2001.The Company is in the process of renewing the facility. TheCompany's net accounts receivable sold under its receivable salesfacility totaled $125.6 million and $149.1 million at June 30,2001 and December 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 June 30, 2001,the Company sold a total of $217.1 million of notes receivableunder this agreement, of which $148.5 million were outstanding tothe third party purchaser at June 30, 2001. Through December 31,2000, the Company sold a total of $212.5 million of notesreceivable under this agreement, of which $159.0 million wereoutstanding to the third party purchaser at December 31, 2000.

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 six months ended June 30, 2001, the Companyrepurchased notes and unwound the corresponding swap in theamount of $17.8 million. No material gain or loss was recognizedon these transactions.

            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 thesecond quarter of 2001, the Company's Canadian subsidiary enteredinto Canadian dollar foreign currency forward contracts to hedgethe cash flow variability of U.S. dollars purchases of inventoryfor a total amount of $16.0 million of which $11.0 million of theforeign currency contracts were settled during the quarter. Theremaining contracts will settle over the next four months. Theforward contracts are designated as cash flow hedges offorecasted transactions. The forward contracts are recorded atfair value as an asset or liability on the Company's balancesheet with the effective portion of the gain or loss reported asa component of other comprehensive income and will bereclassified into earnings in the same period during which thetransactions are settled. At June 30, 2001, the Company had $5.0million of foreign currency forward contracts and no materialgains or losses were recognized.

Forward-Looking Statements - Safe Harbor Provisions

            Thisquarterly report on Form 10-Q of Pennzoil-Quaker State for thequarter ended June 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 4. Submission of Matters to a Vote of Security Holders

(a)     Annual Meeting ofShareholders

         May 3,2001

(b)                                                                                                                                Broker

         Proposals                                   For           Against      Withheld     Abstain     Non-Votes

         Electionof Directors

           W.L. Lyons Brown,Jr.         68,703,179      -          1,515,941           -                -  

           H.JohnGreeniaus                 68,713,056       -          1,506,064           -                 -  

           JamesJ.Postl                        68,707,187      -          1,511,933           -                 -

           TerryL.Savage                     68,680,986      -          1,538,134           -                 -

         Approvalof Appointment

            ofArthur Andersen LLP

            AsIndependent Public

            Accountants                         68,647,419     1,321,393           -        250,308          -

Approval of 2001 

            IncentivePlan                    46,618,569    23,147,908          -         451,248           -

Item 6. Exhibits and Reports on Form 8-K

(a)     Exhibits - 

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

                 June30, 2001 and 2000.

(b)    Reports -

               Duringthe second quarter of 2001, Pennzoil-Quaker State filed thefollowing Current Reports on Form 8-K with the Securities andExchange Commission:

Date of Report                                       ItemsReported

May 15,2001                                        Informationrelated to Pennzoil-Quaker State’s sale of its Shreveport,Louisiana                                                              refineryto Calumet Lubricants Company, LP.

 

 

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 

 

August 13, 2001