Annual Report (Form 10-K), fiscal year 1994

ITEM 1. BUSINESS AND ITEM 2.




ITEM 3. LEGAL PROCEEDINGS.
(A) CURTAILMENT DAMAGE ACTIONS. Reference is made to Note 8 of Notes to Consolidated Financial Statements for information regarding a lawsuit in which Pennzoil has been joined as a defendant for damages allegedly caused by curtailment of deliveries of gas by United Gas Pipe Line Company in 1974, a former Pennzoil subsidiary, to its customers.
(B) ENVIRONMENTAL MATTERS. In June 1994, Pennzoil received an Administrative Complaint from the EPA alleging violation of the Superfund Amendments and Reauthorization Act in connection with reporting requirements under this statute, and the EPA regulations relating thereto, with respect to Pennzoil's refinery in Roosevelt, Utah. The complaint seeks civil penalties of $329,000. Pennzoil intends to vigorously contest both the alleged liability and the amount of the proposed penalty. In July 1994, the West Virginia Division of Environmental Protection opened negotiations with Pennzoil and Pennzoil's indirect subsidiary Eureka Pipe Line Company ("Eureka") for a consent order addressing numerous environmental matters relating to operations of Pennzoil and Eureka. As currently proposed by the state agency, the consent order would require Eureka to undertake environmental remediation at several locations and would impose civil penalties of approximately $1.5 million. Pennzoil and Eureka are investigating the state's position, but currently intend to vigorously contest many of the state's claims and the amount of any civil penalty assessed.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted during the fourth quarter of 1994 to a vote of security holders.
ITEM S-K 401(B). EXECUTIVE OFFICERS OF THE REGISTRANT.
(a) Set forth below are the names and ages of the executive officers of Pennzoil (at February 21, 1995). Positions, unless otherwise specified, are with Pennzoil.
DAVID P. ALDERSON, II (45) Group Vice President -- Finance and Treasurer
CLYDE W. BEAHM (57) Group Vice President -- Franchise Operations
LINDA F. CONDIT (47) Corporate Secretary
THOMAS M. HAMILTON (51) Group Vice President -- Oil and Gas
TERRY HEMEYER (56) Group Vice President -- Administration
MARK A. MALINSKI (39) Group Vice President -- Accounting and Controller
JAMES L. PATE (59)(1) Chairman of the Board, President and Chief Executive Officer
WILLIAM M. ROBB (50) Group Vice President -- Products Manufacturing
JAMES W. SHADDIX (48) General Counsel
WILLIAM E. WELCHER (62) Group Vice President -- Products Marketing
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(1) Director of Pennzoil and member of Executive Committee.
(b) Officers are appointed annually to serve for the ensuing year or until their successors have been appointed. Officers listed above have held their present offices for at least the past five years except for those named below, who have had the business experience indicated during that period. Positions, unless specified otherwise, are with Pennzoil.
DAVID P. ALDERSON, II -- Group Vice President -- Finance since February 1992 and Treasurer since August 1989. Senior Vice President -- Finance from March 1990 to February 1992. Assistant Treasurer prior thereto.
CLYDE W. BEAHM -- Group Vice President -- Franchise Operations since July 1992. Executive Vice President -- Franchise Operations from February 1992 to July 1992. Senior Vice President -- Franchise Operations from May 1991 to February 1992. Vice President -- Quick Lube Operations prior thereto.
LINDA F. CONDIT -- Corporate Secretary since March 1990. Director -- Treasury Operations prior thereto.
THOMAS M. HAMILTON -- Group Vice President -- Oil and Gas since December 1991. Chief Executive -- Frontier and International Operating Company of BP Exploration prior thereto.
TERRY HEMEYER -- Group Vice President -- Administration since February 1992. Senior Vice President -- Administration from March 1990 to February 1992. Vice President -- Public Affairs prior thereto.
MARK A. MALINSKI -- Group Vice President -- Accounting since February 1992 and Controller since March 1990. Senior Vice President -- Accounting from March 1990 to February 1992. Corporate Secretary prior thereto.
JAMES L. PATE -- Chairman of the Board since May 1994 and President and Chief Executive Officer since March 1990. Chief Operating Officer from February to March 1990 and Executive Vice President prior thereto.
WILLIAM M. ROBB -- Group Vice President -- Products Manufacturing since October 1992. Executive Vice President -- Manufacturing of Pennzoil Products Company prior thereto.
JAMES W. SHADDIX -- General Counsel since March 1990. Assistant General Counsel prior thereto.
WILLIAM E. WELCHER -- Group Vice President -- Products Marketing since October 1992. Executive Vice President -- Marketing of Pennzoil Products Company prior thereto.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The following table shows high and low sales prices for the common stock of Pennzoil as reported on the New York Stock Exchange (consolidated transactions reporting system), the principal market in which the common stock is traded, and dividends paid per share for the calendar quarters indicated. The common stock is also listed for trading on the Pacific Stock Exchange, as well as the Toronto, London and Swiss stock exchanges.
Pennzoil has paid quarterly dividends for 71 consecutive years.
As of December 31, 1994, Pennzoil had 20,025 record holders of its common stock.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA.
The following table contains selected financial data for the five years indicated.
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(1) Reference is made to Note 8 of Notes to Consolidated Financial Statements.
(2) Represents results of Purolator Products Company, which was sold in 1992. Reference is made to Note 11 of Notes to Consolidated Financial Statements.
(3) In 1993 and 1992, Pennzoil redeemed amounts outstanding under several debt facilities using proceeds from various sources. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in extraordinary charges of $18.4 million ($28.3 million before tax), or $.44 per share, in 1993 and $16.6 million ($25.2 million before tax), or $.41 per share, in 1992.
(4) Reference is made to Notes 2 and 6 of Notes to Consolidated Financial Statements for discussion of 1994 and 1992 events, respectively. In December 1991, Pennzoil announced its decision to change its method of accounting for postretirement benefit costs other than pensions by adopting the new requirements of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," effective as of January 1, 1991. Pennzoil recorded a charge of $49.0 million ($74.2 million before tax), or $1.21 per share, in 1991 to reflect the cumulative effect of the change in accounting principle for periods prior to 1991.
(5) Reference is made to Note 1 of Notes to Consolidated Financial Statements.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Reference is made to Industry Segment Financial Information included in Item 1, Business and Item 2, Properties and the Consolidated Financial Statements beginning on page for additional information.
RESULTS OF OPERATIONS
A net loss of $288.7 million, or $6.27 per share, was recorded for 1994 compared with net income of $141.9 million, or $3.36 per share, for 1993 and $128.2 million, or $3.16 per share, for 1992. Results for 1994 include net charges of $210.4 million ($388.2 million before tax), or $4.57 per share, associated with the
settlement of a dispute with the Internal Revenue Service ("IRS") relating to a proposed tax deficiency based on an audit of Pennzoil's 1988 federal income tax return. Reference is made to "-- Capital Resources and Liquidity" and Note 8 of Notes to Consolidated Financial Statements for additional information.
Results of operations for 1994 also include a $21.1 million ($32.5 million before tax), or $.46 per share, charge associated with the cessation of crude oil processing at Pennzoil's Roosevelt, Utah refinery, a $32.6 million ($50.2 million before tax), or $.71 per share, charge in connection with the agreement providing for the sale by Pennzoil to Freeport-McMoRan Resource Partners, Limited Partnership ("Freeport-McMoRan") of substantially all the domestic assets of Pennzoil's sulphur segment, and a $9.9 million ($15.2 million before tax), or $.22 per share, charge to reflect adjustments of recorded values of certain real estate properties. Reference is made to "-- Motor Oil & Refined Products", "-- Sulphur" and "-- Other", respectively, for additional information.
Effective January 1, 1994, Pennzoil changed its method of accounting for postemployment benefit costs by adopting the new requirements of Statement of Financial Accounting Standards ("SFAS") No. 112, "Employers' Accounting for Postemployment Benefits." As a result, Pennzoil recorded a charge of $4.9 million ($7.6 million before tax), or $.11 per share, as of January 1, 1994, to reflect the cumulative effect of change in accounting principle for the periods prior to 1994.
In November 1993, Pennzoil sold 8,158,582 shares of Chevron Corporation ("Chevron") common stock in a block trade on the New York Stock Exchange ("NYSE") for a net price of $88.38 per share. The sale resulted in a net realized gain of $137.0 million ($171.6 million before tax), or $3.25 per share. Reference is made to "-- Capital Resources and Liquidity" for additional information.
In September 1993, Pennzoil called for redemption an aggregate of $292.5 million principal amount of indebtedness. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $13.7 million ($21.1 million before tax), or $.32 per share, in 1993. In June 1993, Pennzoil called for redemption $96.1 million principal amount of indebtedness (which redemption occurred in July 1993). The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in an extraordinary charge of $4.7 million ($7.2 million before tax), or $.11 per share, in 1993.
In August 1993, the Omnibus Budget Reconciliation Act of 1993 was enacted, establishing a new 35% corporate income tax rate effective January 1, 1993. As a result of the increase in the marginal income tax rate and other tax law changes, Pennzoil recorded a one-time, non-cash charge of $16.0 million, or $.38 per share, in 1993 to adjust its deferred income tax liabilities and assets for the effect of the change in income tax rates.
In December 1992, Pennzoil announced its decision to change its method of accounting for income taxes by adopting the new requirements of SFAS No. 109, "Accounting for Income Taxes," effective as of January 1, 1992. As a result, Pennzoil recognized an increase to net income of $119.1 million in 1992. Of this amount, $115.7 million, or $2.85 per share, was reported as the one-time cumulative effect on prior year results. The remaining $3.4 million, or $.08 per share, reflected the impact of adoption of this standard on 1992 income from continuing operations. Reference is made to Note 2 of Notes to Consolidated Financial Statements for additional information.
In December 1992, Pennzoil sold in initial public offerings all its shares of capital stock of Purolator Products Company ("Purolator"). Pennzoil recorded a net gain on the disposition of Purolator of $1.5 million, or $.04 per share, in 1992. Reference is made to "-- Discontinued Operations" and Note 11 of Notes to Consolidated Financial Statements for additional information.
In December 1992, Pennzoil called for redemption $272.9 million principal amount of indebtedness (which redemption occurred in February 1993). As of December 31, 1992, this indebtedness was defeased by placing funds required for the redemption with the trustee for the indebtedness. As a result, the funds deposited with the trustee for the redemption of the debentures and the principal amount of the indebtedness were not reflected in Pennzoil's consolidated balance sheet at December 31, 1992. The premiums and related unamortized discount and debt issue costs relating to this redemption resulted in an extraordinary charge of $16.6 million ($25.2 million before tax), or $.41 per share, in 1992.
Investment and other income, net, for 1994 and 1992 primarily represents dividend income from Pennzoil's investment in Chevron common stock. Investment and other income, net, for 1993 primarily represents a pretax gain of $171.6 million from Pennzoil's sale of 8,158,582 shares of Chevron common stock and dividend income from Pennzoil's investment in Chevron common stock. Pennzoil beneficially owned 18,071,036 shares of Chevron common stock as of December 31, 1994, after giving effect to a "two-for-one" split of Chevron common stock in June 1994. The shares of Chevron common stock beneficially owned by Pennzoil are classified as non-current marketable securities and other investments in the accompanying consolidated balance sheet. Reference is made to "-- Capital Resources and Liquidity" for additional information.
OIL AND GAS
The oil and gas segment recorded an operating loss of $4.9 million in 1994, compared with operating income of $159.2 million in 1993 and $134.7 million in 1992. The reduction in operating income was attributable to weak oil and gas prices, increased depreciation, depletion and amortization of $93.9 million related to the settlement of a tax dispute with the IRS, and other nonrecurring net charges totaling $36.8 million.
In October 1992, Pennzoil completed a tax-free transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock beneficially owned by Pennzoil for all the capital stock of Pennzoil Petroleum Company ("Pennzoil Petroleum"), which owned Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. The exchange of stock was accounted for using the purchase method of accounting, and the results of operations of Pennzoil Petroleum subsequent to October 30, 1992 have been included in Pennzoil's oil and gas segment results. Included in the assets of Pennzoil Petroleum at the time of the transfer to Pennzoil was $57.4 million in cash contributed by Chevron to Pennzoil Petroleum immediately prior to closing, representing the net cash flow from Pennzoil Petroleum's operations during the four-month period between the "effective date" and the closing date of the transaction, after reduction as a result of nonrecurring closing adjustments of approximately $11 million. As a result of an audit completed during 1993, Chevron contributed an additional $9.9 million in cash to Pennzoil Petroleum in 1993, representing an adjustment to the initial $57.4 million cash contribution made by Chevron to Pennzoil Petroleum prior to closing. This additional contribution from Chevron was accounted for as an adjustment to the original purchase price of Pennzoil Petroleum. As a result of an audit conducted during 1994, Chevron contributed an additional $6.8 million in cash to Pennzoil Petroleum in 1994, representing post-closing adjustments related to the acquisition. Reference is made to Note 10 of Notes to Consolidated Financial Statements for additional information.
As a result of the IRS settlement in October 1994, Pennzoil increased the balance of its investment in Pennzoil Petroleum capital stock for financial reporting purposes and, therefore, the carrying value of Pennzoil Petroleum's oil and gas properties by $390.3 million, and such increased investment resulted in a $93.9 million increase in depreciation, depletion and amortization expense recognized in October 1994 relating to Pennzoil Petroleum's oil and gas properties from the date of the acquisition of Pennzoil Petroleum to the date of the IRS settlement. These adjustments resulted in a net increase in property, plant and equipment of $296.4 million as of September 30, 1994, while interest charges and depreciation, depletion and amortization expense adjustments related to the IRS settlement reduced Pennzoil's 1994 pretax income by $388.2 million. In addition, oil and gas segment earnings will be reduced in future periods by comparably higher depreciation, depletion and amortization expense as a result of the increase in the investment in Pennzoil Petroleum's oil and gas properties. Reference is made to Note 8 of Notes to Consolidated Financial Statements for additional information.
Oil and gas production volumes increased approximately 10% for 1994 compared to 1993, despite a reduction in production associated with the 1993 sale of a net 60 Bcf of proved natural gas reserves and a net 3 million barrels of proved oil reserves. The increase in production volumes was primarily as a result of accelerated Gulf of Mexico drilling and the addition of the oil and gas properties of Co-enerco Resources Ltd. ("Co-enerco"). Natural gas produced for sale in 1994 was 716,962 Mcf per day, compared with 649,399 Mcf per day and 447,561 Mcf per day in 1993 and 1992, respectively. Natural gas prices averaged $1.79 per Mcf in
1994 compared to $2.04 per Mcf in 1993 and $1.81 per Mcf in 1992. Liquids volumes in 1994 were 68,709 barrels per day, compared to 64,273 and 39,462 barrels per day in 1993 and 1992, respectively. The average liquids price received in 1994 dropped to $13.74 per barrel, compared with $14.90 per barrel in 1993 and $16.95 per barrel in 1992.
The results of operations from Pennzoil's oil and gas segment are subject to volatility resulting from changes in crude oil and natural gas prices. Pennzoil has used in the past, and may use in the future, a limited price-risk management strategy to provide protection against temporary declines in domestic natural gas prices. To date, these price-risk management activities have encompassed no more than 3% of Pennzoil's total annual natural gas production.
In February 1995, Pennzoil and Brooklyn Union Gas Co. announced that their subsidiaries, Pennzoil Gas Marketing Company and BRING Gas Services Corp., would form a 50-50 gas marketing joint venture. Pennzoil currently expects to contribute approximately $3 million in cash to the venture and to commit substantially all of its natural gas production from the continental U.S. to be marketed through the venture.
Pennzoil disposed of approximately 90 producing oil and gas fields in 1994, continuing its asset highgrading program begun in 1992, and decreasing the number of producing fields in which Pennzoil had an interest from approximately 800 in early 1993 to approximately 400 at the end of 1994. Reference is made to "-- Capital Resources and Liquidity -- Assessment of Oil and Gas Properties" for additional information.
Expenses associated with exploration activities in 1994 were $61.0 million compared with $70.7 million in 1993 and $11.7 million in 1992. Exploration expenses in 1994 included a $9.6 million charge for impairments of unproved property costs and an increase in geological and geophysical expenses of $7.2 million over 1993 associated with an increase in Pennzoil's domestic exploration and development activity and the continuing assessment of its domestic oil and gas properties. In the early stages of this assessment, Pennzoil curtailed domestic exploration activity and, as a result, reduced its 1992 capital budget related to both exploration and development activity and geological and geophysical expenses. As this assessment has progressed, more exploration and development activity has occurred in and around core areas.
Operating results for 1994 included a charge of $24.3 million for the write-down of an investment in a Siberian drilling partnership and $13.8 million in charges associated with the impending disposition of other various non-core assets.
Depreciation, depletion and amortization expense in 1994 and 1993 include charges of $29.8 and $17.7 million, respectively, to increase an impairment reserve originally established in 1988 related to Pennzoil's net investment in offshore California producing properties. Generally lower offshore California oil prices, a reassessment of remaining reserves and revisions to other projected economic parameters led Pennzoil to determine that additional impairments were necessary.
In June 1994, Pennzoil Canada, Inc. ("Pennzoil Canada"), an indirect wholly owned subsidiary of Pennzoil, acquired Co-enerco, a Canadian oil and gas exploration and production company operating in Alberta, northeastern British Columbia and southeastern Saskatchewan. Pennzoil Canada paid $230.9 million in cash in connection with the acquisition of Co-enerco and the repayment of Co-enerco's outstanding bank debt, which was financed primarily through two credit facilities. The acquisition of Co-enerco was accounted for using the purchase method of accounting, and the results of operations of Co-enerco subsequent to June 30, 1994 have been included in Pennzoil's oil and gas segment results. Reference is made to Notes 3 and 10 of Notes to Consolidated Financial Statements for additional information.
In July 1994, Pennzoil Qatar, Inc. ("Pennzoil Qatar"), an indirect wholly owned subsidiary of Pennzoil, was awarded the rights to explore acreage of Block 8 offshore Qatar. The block is located 50 miles from shore in the Arabian Gulf and is adjacent to three large producing oil fields. Under the production sharing agreement, Pennzoil Qatar has committed to a seismic acquisition and drilling program over the next four years. Seismic acquisition is planned for the second quarter of 1995; drilling will begin late this year or early in 1996, with four wells planned over the next several years.
In September 1994, the State Oil Company of the Azerbaijan Republic ("SOCAR") and a consortium of foreign oil companies, which includes Pennzoil, signed an oil production sharing contract for development of the Azeri, Chirag and a deep-water portion of the Guneshli fields in the Caspian Sea. The contract was ratified by the National Parliament of the Republic of Azerbaijan in November 1994 and was made effective in December 1994. Aggregate capital investment for all the participants in the consortium is estimated to be between $7 and $8 billion over the 30-year life of this project to develop an estimated 4 billion barrels of recoverable reserves. Pennzoil's 9.82% share has the potential to add net reserves estimated in the range of 300 million barrels once the area is developed. The contract includes a $300 million bonus to be paid by the consortium to the government of Azerbaijan in a phased manner over the life of the project. The bonus payment is payable in three installments. The first bonus payment made by the consortium was equal to 50% of the total bonus. Pennzoil's proportionate share was $17.8 million, of which $11.9 million was paid in cash and $5.9 million was credited toward Pennzoil's prior investment in a gas utilization project in Azerbaijan. The second bonus payment, equal to 25% of the total bonus, will be due 30 days from the date when production in the contract area reaches an average rate of 40,000 barrels of crude oil per day and is sustained for a period of 60 days. The remaining bonus payment will be due within 30 days from the date when crude oil has been exported from the main export pipeline for a sustained period of 60 days.
In November 1994, Pennzoil Egypt, Inc., an indirect wholly owned subsidiary of Pennzoil, and its Spanish partner, Repsol Exploracion Egypto S.A., were selected to explore the Southeast Gulf of Suez Block offshore Egypt. The block, which is approximately the size of 44 Gulf of Mexico blocks, surrounds the Shoab Ali oil field, which has significant oil reserves in place. The agreement requires approval by the Egyptian Oil Ministry, cabinet and parliament. The agreement calls for acquisition of 3-D seismic data and the drilling of one well over the next two years following final approval of the agreement.
Capital expenditures for the oil and gas segment in 1994 were $399.5 million, excluding expenditures related to Pennzoil's acquisition of Co-enerco, compared to $360.5 million in 1993, and $93.8 million in 1992, excluding expenditures related to Pennzoil's acquisition of Pennzoil Petroleum. Total capital expenditures for this segment in 1995 are estimated to be $334.2 million. Reference is made to "-- Capital Resources and Liquidity" for additional information.
MOTOR OIL & REFINED PRODUCTS
Operating income in 1994 for this segment was $41.8 million, compared with $90.0 million in 1993 and $77.9 million in 1992. Lower earnings in the manufacturing division in 1994 resulted primarily from a third quarter charge of approximately $32.5 million associated with the cessation of crude oil processing at Pennzoil's Roosevelt, Utah refinery. Total processed volume at the refineries of 58,703 barrels per day in 1994 was 519 barrels per day lower than 1993 but 248 barrels per day higher than 1992. Also contributing to lower earnings in the manufacturing division were expenses incurred related to the start-up of a joint venture project with Conoco, Inc. ("Conoco") described below. Lower earnings in the domestic marketing division primarily resulted from lower GUMOUT(R) sales volumes and margins and higher advertising expense, partially offset by higher revenues from all other products. Domestic motor oil volumes were about 1% higher than 1993 and 1992. Domestic motor oil margins increased approximately 2% over 1993 margins and approximately 8% over 1992 margins. These margin increases were primarily the result of lower average crude oil prices in 1994 versus 1993 and 1992. Higher earnings in the international marketing division resulted primarily from increased revenues partially offset by higher advertising and selling expenditures. Total international motor oil and other lubricating product sales volumes, including those sold through licensees and joint ventures, increased 36% when compared to 1993 and 70% when compared to 1992.
In June 1994, Conoco and Pennzoil agreed to carry out a joint venture project at Conoco's refinery in Lake Charles, Louisiana. Operating through a 50-50 joint venture, the companies will construct a new, state-of-the-art lube oil hydrocracker facility estimated to cost approximately $500 million, which is expected to be funded with project financing. The facility will produce more than 16,000 barrels per day of high-quality base oils, the base ingredient in finished lubricants. Site preparation began in the third quarter of 1994, and the facility is expected to be completed in early 1997. Conoco is acting as construction manager and operator of the plant with support positions staffed by both companies.
In September 1994, Pennzoil and the Polymers Division of Petrolite Corporation ("Petrolite") agreed in principle to form the BARECO(R) Products Company, a 50-50 partnership aimed at providing a broad line of wax products to domestic and international purchasers of paraffin, microcrystalline and related synthetic waxes. Pennzoil will transport partially refined feedstock from Utah to its Rouseville refinery, which will produce paraffinic waxes and related products. The new wax products, along with certain waxes from Petrolite and existing wax products from Pennzoil's Atlas and Rouseville refineries, will be sold through the partnership. More than $23 million will be invested by Pennzoil at its Rouseville refinery and its packaging plant in nearby Reno, Pennsylvania in connection with this venture. Marketing will begin in April 1995.
Capital expenditures for the motor oil and refined products segment were $40.4 million in 1994, $71.5 million in 1993 and $35.8 million in 1992. The 1993 expenditures included $26.6 million for a diesel desulphurization and dewaxing project at the Atlas refinery in Shreveport, Louisiana, which was required to meet requirements promulgated under the 1990 Amendments to the federal Clean Air Act. Also included were expenditures of $6.3 million for a feasibility study for the base oil plant joint venture with Conoco and $4.8 million for the acquisition of property, plant and equipment of a blending plant in Spain (acquired in the first quarter of 1993). Capital expenditures for 1994 were primarily at a level to maintain operations. Total capital expenditures for this segment in 1995 are estimated to be $120.7 million. The 1995 capital budget includes $41.3 million to begin construction of a refinery complex designed to convert the Atlas refinery's lube oil by-products into clean burning gasoline and diesel fuels. This upgrade project will allow Atlas to significantly diversify its production capabilities and to realize higher profits from by-products, which are currently sold at low values. The 1995 capital budget also includes $20.5 million to provide for manufacturing facilities at the Rouseville refinery and the Reno packaging plant to enable production of additional waxes in connection with the Petrolite joint venture.
FRANCHISE OPERATIONS
The franchise operations segment, operating through Pennzoil's wholly owned subsidiary Jiffy Lube International, Inc. ("Jiffy Lube"), recorded operating income of $2.8 million during 1994, compared to operating losses of $17.6 million in 1993 and $13.4 million in 1992. Operating income in 1994 improved significantly as a result of improvements in company center revenues and reduced operating costs. Excluding legal settlement charges, selling, general and administrative costs were down approximately $1.3 million. Operating results for 1994 include charges of $8.2 million for reserves for identified self-insured claims, estimated environmental remediation costs, various litigation settlement charges and other miscellaneous items. As of December 31, 1994, Jiffy Lube operated 426 company-owned service centers.
Operating results for 1993 included a charge of $10.0 million for estimated costs associated with centers that Jiffy Lube had decided to eliminate. Jiffy Lube had determined that these centers were not viable as company-operated centers and had been unsuccessful in subleasing many of these centers for alternative uses. This provision for estimated costs takes into consideration the present value of future lease obligations related to operating leases (less estimated sublease rental revenue of existing subleases) and the estimated fair value of land, buildings, leaseholds and leasehold improvements. Additionally, 1993 results included approximately $12.7 million for the settlement of certain litigation, estimated environmental costs and write-downs of other individually insignificant investments to reflect Jiffy Lube's estimate of the net realizability of those investments. Operating results in 1992 included increased selling and administrative expenses of $6.8 million incurred in connection with the settlement of certain litigation and increased start-up expenses of $2.6 million incurred in association with the development and installation of a new point-of-sale system.
Systemwide service center sales reported to Jiffy Lube for the year ended December 31, 1994 increased $68.1 million, or approximately 12.6%, to $607.5 million, compared with the prior year, and increased $106.9 million, or approximately 21.4%, compared with 1992. Average ticket prices increased to $34.09 for the year ended December 31, 1994, compared with $33.60 and $33.23 for the years ended December 31, 1993 and 1992, respectively.
During the year ended December 31, 1994, Jiffy Lube acquired 22 centers with estimated values of $5.2 million and real estate with estimated values of $1.1 million, in exchange for cash of $5.2 million,
forgiveness of amounts due Jiffy Lube of $1.1 million, liabilities and debt assumed of $.6 million and 4 centers with a net book value of $.3 million. During the year ended December 31, 1993, Jiffy Lube acquired 70 centers with estimated values of $15.8 million and real estate with estimated values of $.9 million in exchange for cash of $12.2 million, forgiveness of amounts due Jiffy Lube of $.9 million, liabilities assumed of $.5 million, debt assumed of $.4 million and real estate valued at $1.6 million. During the year ended December 31, 1992, Jiffy Lube acquired 104 service centers with estimated values of $29.7 million in exchange for cash of $16.7 million, forgiveness of amounts due Jiffy Lube of $2.8 million, liabilities assumed of $8.7 million and debt issued of $1.5 million.
Capital expenditures for the franchise operations segment were $18.9 million in 1994, compared to $21.7 million and $25.8 million in 1993 and 1992, respectively. Capital expenditures for 1995 are estimated to be approximately $48.8 million.
SULPHUR
In October 1994, Pennzoil entered into an agreement with Freeport-McMoRan providing for the sale by Pennzoil to Freeport-McMoRan of substantially all the domestic assets of Pennzoil's sulphur segment. The transaction was completed in January 1995. Pennzoil continues to own and operate its Antwerp, Belgium sulphur terminal and the related international sulphur business. As consideration under the agreement, Freeport-McMoRan assumed certain liabilities of Pennzoil relating to or arising out of the business of Pennzoil's sulphur segment, and Pennzoil will be entitled to receive a series of quarterly installment payments from Freeport-McMoRan for periods through December 31, 2014, subject to the prevailing market price of sulphur. The installment payments, recorded at their estimated fair value of $22.5 million as of September 30, 1994, may be terminated earlier by Freeport-McMoRan (through the exercise of a call option providing for a $65 million payment to Pennzoil), or by Pennzoil (through the exercise of a put option providing for a $10 million payment to Pennzoil). Neither the call option nor the put option may be exercised prior to January 1999. In connection with this transaction, Pennzoil's sulphur segment recorded a charge to depreciation, depletion and amortization expense of $50.2 million in September 1994.
Excluding the $50.2 million pretax charge, the sulphur segment recorded an operating loss of $7.2 million in 1994 compared to a loss of $20.8 million in 1993 and operating income of $1.0 million in 1992. The average Green Markets Tampa Recovered Contract Price range for sulphur in 1994 had a mid-point of $57.00 per long ton in 1994 compared to a 1993 mid-point of $64.00 per long ton and a 1992 mid-point of $86.50 per long ton. Intense competition in the domestic market has pushed sulphur prices down, primarily because of aggressive marketing by U.S. producers. Partially offsetting these lower sulphur prices in 1994 were lower unit costs due to reduced workforce expenses and reduced gas and water treatment costs at the Culberson mine.
During 1994, sulphur sales volumes were 1.2 million long tons compared to 1.1 million long tons in 1993 and 1.7 million long tons in 1992. The lower level of sales volumes in 1994 and 1993 were primarily due to reduced market share resulting from lower priced imports from Canada and increased recovered production domestically.
OTHER
Other operating income in 1994 was $55.6 million, compared to $253.7 million in 1993 and $88.2 million in 1992. Other operating income for 1994 includes a $15.2 million charge to reflect adjustment of recorded values of certain real estate properties. The higher level of other income in 1993 was primarily due to the gains of $171.6 million on the sale of shares of Chevron common stock and $10.5 million on the sale of shares of Pogo Producing Company common stock. Dividend income on the Chevron common stock was $33.4 million for 1994, $60.2 million for 1993 and $95.7 million for 1992.
Other revenues, net of related expenses, are included in the consolidated statement of income under "Investment and Other Income, Net" which consists of the following:
Substantially all interest and dividend income is from marketable securities and other cash investments.
INTEREST CHARGES, NET
Net interest expense for 1994 included interest charges of $294.3 million associated with the IRS settlement. Reference is made to Note 8 of Notes to Consolidated Financial Statements for additional information.
Excluding the interest expense associated with the IRS settlement, interest charges, net of interest capitalized for 1994, increased $2.8 million over 1993 levels and decreased $42.3 million from 1992 levels. The increase in interest expense for 1994 was primarily due to increased borrowings at higher average interest rates. The decrease in interest expense from 1992 levels is primarily due to lower average interest rates.
DISCONTINUED OPERATIONS
In October 1992, as a result of Pennzoil's conclusion that disposal of Purolator's filtration products operations would enhance Pennzoil's efforts to focus on its strategic businesses and to reduce indebtedness, Purolator filed a registration statement pursuant to which Pennzoil offered to the public all shares of Purolator stock held by Pennzoil. Accordingly, Purolator's net assets and results of operations for all periods have been reclassified as discontinued operations for financial reporting purposes. In December 1992, Pennzoil sold in initial public offerings all its shares of capital stock of Purolator. The total amount received by Pennzoil, prior to the payment of expenses, from the net proceeds of the offerings and the repayment of indebtedness by Purolator was $206.0 million. Pennzoil recorded a net gain on the disposition of Purolator stock of $1.5 million ($20.0 million before tax loss), or $.04 per share, in 1992.
Reference is made to "-- Capital Resources and Liquidity -- Environmental Matters" and Note 8 of Notes to Consolidated Financial Statements for information concerning an environmental indemnification agreement between Pennzoil and Purolator entered into in connection with Pennzoil's disposition of Purolator.
CAPITAL RESOURCES AND LIQUIDITY
CASH FLOW. Pennzoil had cash and cash equivalents of $24.9 million and $262.3 million at December 31, 1994 and 1993, respectively. Pennzoil's cash flow from operating activities, excluding the cash payment made to the IRS for taxes and interest in settlement of a dispute relating to a proposed tax deficiency based on an
audit of Pennzoil's 1988 federal income tax return, was $322.7 million for the twelve months ended December 31, 1994. Reference is made to Note 8 of Notes to Consolidated Financial Statements for additional information. Cash flow from operating activities was $286.9 million for the twelve months ended December 31, 1993. Pennzoil used cash from operating activities, net proceeds from the sales of marketable securities and proceeds from the sales of assets primarily for payments relating to the IRS settlement ($556.0 million), capital expenditures ($473.3 million) and the payment of cash dividends ($138.1 million).
INVESTMENT IN CHEVRON CORPORATION. Pennzoil beneficially owned 18,071,036 shares of Chevron common stock as of December 31, 1994, after giving effect to a "two-for-one" stock split declared by Chevron in June 1994. None of the share or per-share information related to Pennzoil's investment in Chevron common stock prior to June 1994 has been adjusted to reflect the "two-for-one" stock split. The current quarterly dividend rate on Chevron common stock is $.4625 per share. At the current dividend rate, Pennzoil receives $33.4 million annually in dividends on the 18,071,036 Chevron shares. All 18,071,036 shares of Chevron common stock beneficially owned by Pennzoil have been deposited with exchange agents for possible exchange for Pennzoil exchangeable debentures. See "-- Exchangeable Debentures."
In November 1993, Pennzoil sold 8,158,582 shares of Chevron common stock in a block trade on the NYSE for a price of $89.00 per share before commissions ($88.38 per share net of commissions). The sale resulted in a net realized gain of $137.0 million ($171.6 million before tax), or $3.25 per share. Reference is made to Note 2 of Notes to Consolidated Financial Statements for additional information.
In October 1992, Pennzoil completed a tax-free transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock beneficially owned by Pennzoil for all the capital stock of Pennzoil Petroleum, which owned Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. The exchange of stock was accounted for using the purchase method of accounting, and the results of operations of Pennzoil Petroleum subsequent to October 30, 1992 have been included in Pennzoil's oil and gas segment results.
EXCHANGEABLE DEBENTURES. In 1993, Pennzoil completed public offerings of $402.5 million principal amount of its 6 1/2% Exchangeable Senior Debentures due January 15, 2003 (the "6 1/2% Debentures") and $500.0 million principal amount of its 4 3/4% Exchangeable Senior Debentures due October 1, 2003 (the "4 3/4% Debentures"). The 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable at the option of the holders thereof at any time prior to maturity, unless previously redeemed, for shares of Chevron common stock beneficially owned by Pennzoil at exchange rates of 23.774 shares and 17.004 shares, respectively, per $1,000 principal amount of the 6 1/2% Debentures and the 4 3/4% Debentures (the equivalent of $42 1/16 per share and $58 13/16 per share, respectively), subject to adjustment in certain events. In lieu of delivering certificates representing shares of Chevron common stock in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may, at its option, pay to any holder surrendering the 6 1/2% Debentures and the 4 3/4% Debentures an amount in cash equal to the market price of the shares for which the 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable. Pennzoil has deposited all 18,071,036 shares of Chevron common stock beneficially owned by Pennzoil with exchange agents for possible exchange for the 6 1/2% Debentures and the 4 3/4% Debentures.
Under the instruments governing the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may not pledge, mortgage, hypothecate or grant a security interest in, or permit any mortgage, pledge, security interest or other lien upon, the shares of Chevron common stock deposited with exchange agents and deliverable in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures. Pennzoil may at any time obtain from the exchange agents or otherwise authorize or direct the exchange agents to release all or part of the 18,071,036 shares of Chevron common stock deposited with the exchange agents. However, in the event Pennzoil obtains or otherwise releases any shares of Chevron common stock subject to exchange, each holder of a 6 1/2% Debenture or a 4 3/4% Debenture will generally have the right, at such holder's option, to require Pennzoil to repurchase all or a portion of such holder's debentures at a premium.
ASSESSMENT OF OIL AND GAS PROPERTIES. Pennzoil is continuing its assessment of its domestic oil and gas properties and its related asset highgrading program commenced in early 1992. The assessment has resulted in, and is expected to continue to result in, the categorization of Pennzoil's oil and gas properties into core and
noncore producing areas and core and noncore producing fields within core areas. In the early stages of the assessment, Pennzoil curtailed domestic exploration and development activity and, as a result, reduced its 1992 capital expenditures for domestic exploration and development by approximately one-half, excluding expenditures related to Pennzoil's acquisition of Pennzoil Petroleum. The ongoing assessment now includes the properties added in October 1992 as a result of the acquisition of Pennzoil Petroleum and the properties added in July 1994 as a result of the acquisition of Co-enerco, which have created additional core areas and enhanced other core areas. As part of its asset highgrading program, Pennzoil disposed of approximately $35 million of noncore properties and fields during 1992. No significant gain or loss was realized as a result of these dispositions. Pennzoil began 1993 with interests in approximately 800 producing fields, owning small working interests and/or insignificant reserves in the majority of these fields. In 1993, the asset highgrading program resulted in the disposal of approximately 300 fields, representing less than 3% of the total value of Pennzoil's proved oil and gas reserves. Pennzoil realized gains in 1993 of $34.9 million from these asset dispositions on total proceeds of $87.5 million. In addition, four asset exchanges were finalized during 1993 to increase working interests in core Gulf of Mexico fields.
Pennzoil disposed of approximately 90 producing oil and gas fields in 1994, continuing its asset highgrading program begun in 1992, and decreasing the number of producing fields in which Pennzoil had an interest to approximately 400 at the end of 1994. The fields disposed of in 1994 primarily consisted of noncore properties in the Gulf of Mexico, Permian Basin, Mid-Continent and Gulf Coast. Pennzoil realized gains in 1994 of $36.0 million from these asset dispositions on total proceeds of $81.3 million. The 1994 asset dispositions in the aggregate represented approximately 5% of Pennzoil's total oil and gas production and approximately 3% of the total value of Pennzoil's proved oil and gas reserves. If market conditions are favorable, Pennzoil intends to continue the disposal of noncore properties during 1995 with the goal of retaining about 100 core fields in the United States by late 1995. These 100 core fields are estimated to generate approximately 90% of Pennzoil's current cash flow and contain most of Pennzoil's future reserve potential. In addition to dispositions of producing fields, Pennzoil completed five exchanges of producing fields in 1994, representing approximately $26 million in assets, primarily in the Gulf of Mexico and Permian Basin. After netting asset dispositions against acquisitions and including the impact of the acquisition of Co-enerco and exchanges, Pennzoil's asset highgrading program in 1994 added approximately 32 million barrels of oil equivalent ("BOE") at a net cost of $149.7 million, for a reserve replacement cost of $4.68 per BOE.
CREDIT FACILITIES. In August 1994, Pennzoil entered into an amended and restated credit facility with a group of banks that provides for up to $600 million of unsecured revolving credit borrowings through August 16, 1995, with any outstanding borrowings on such date being converted into a term credit facility terminating on September 1, 1996. Pennzoil has the option, subject to the extension of additional credit by new or existing banks, of increasing the size of the facility by $100 million. This amended and restated credit facility replaces and supersedes the previous revolving credit facilities of Pennzoil. Borrowings under the facility totaled $205.0 million at December 31, 1994.
In June 1994, in connection with its acquisition of Co-enerco, Pennzoil Canada established a Cdn. $260 million credit facility with a syndicate of Canadian banks, the borrowings of which are guaranteed by Pennzoil. Also in June 1994, Pennzoil Canada established an additional Cdn. $40 million credit facility with a Canadian bank, the borrowings of which are guaranteed by Pennzoil. These facilities provide for borrowings through May 30, 1995, with any outstanding borrowings on such date being converted into term credit facilities terminating on May 30, 1996. Borrowings under these facilities can be made in any combination of U.S. or Canadian dollars and totaled U.S. $185.0 million and U.S. $10.0 million, respectively, as of December 31, 1994.
In February 1995, Pennzoil's Board of Directors increased the limit on the aggregate amount of commercial paper that Pennzoil may issue under its domestic commercial paper program and/or its Euro-commercial paper program from $250.0 million to $500.0 million. Borrowings under Pennzoil's commercial paper facilities totaled $243.9 million and $249.4 million at December 31, 1994 and 1993, respectively.
Pennzoil has several short-term variable-rate credit arrangements with certain banks. Pennzoil's Board of Directors has limited borrowings under these credit arrangements to $200.0 million. Outstanding borrowings
totaled $93.3 million and $183.6 million at December 31, 1994 and 1993, respectively. None of the banks under these credit arrangements has any obligation to continue to extend credit after the maturities of outstanding borrowings or to extend the maturities of any borrowings.
SETTLEMENT OF IRS DISPUTE. Reference is made to Note 8 of Notes to Consolidated Financial Statements for information concerning Pennzoil's settlement in October 1994 of a dispute with the IRS relating to a proposed tax deficiency based on an audit of Pennzoil's 1988 federal income tax return.
CAPITAL EXPENDITURES. Total capital expenditures for 1994, excluding expenditures related to Pennzoil's acquisition of Co-enerco, were $474.6 million, including $9.0 million of interest capitalized, representing a decrease of $10.5 million from comparable 1993 capital expenditure levels.
The table below summarizes the current 1995 capital budget by segment compared with 1994 and 1993 capital expenditures, excluding expenditures related to Pennzoil's acquisition of Co-enerco in 1994. The capital budget is reassessed from time to time, and could, for example, be adjusted to reflect changes in oil and gas prices and other economic factors.
Pennzoil currently expects to generate funds for its budgeted 1995 capital expenditures from a combination of some, or all, of the following: cash flows from operations, the sale of noncore properties, borrowings under its credit facilities and arrangements, available cash and proceeds from future debt issuances.
ENVIRONMENTAL MATTERS. Pennzoil continues to make capital and operating expenditures relating to the environment, including expenditures associated with its compliance with federal, state and local environmental regulations. As they continue to evolve, environmental protection laws are expected to have an increasing impact on Pennzoil's operations. In connection with pollution abatement efforts related to current operations, Pennzoil made capital expenditures of approximately $37 million in 1994 and $35 million in 1993. The 1993 expenditures included $26.6 million for a diesel desulphurization and dewaxing project at the Atlas refinery in Shreveport, Louisiana, which was required to meet requirements promulgated under the 1990 Amendments to the federal Clean Air Act. Capital expenditures for environmental control facilities are currently expected to be approximately $33 million in 1995. Pennzoil's recurring operating expenditures relating to environmental compliance activities are not material.
Pennzoil is subject to certain laws and regulations relating to environmental remediation activities associated with past operations, such as the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"), the Resource Conservation and Recovery Act and similar state statutes. In response to liabilities associated with these activities, accruals have been established when reasonable estimates are possible. Such accruals primarily include estimated costs associated with remediation. Pennzoil has not used discounting in determining its accrued liabilities for environmental remediation, and no claims for possible recovery from third party insurers or other parties related to environmental costs have been recognized in Pennzoil's consolidated financial statements. Pennzoil adjusts the accruals when new remediation responsibilities are discovered and probable costs become estimable, or when current remediation estimates must be adjusted to reflect new information.
Pennzoil's assessment of the potential impact of these environmental laws is subject to uncertainty due to the difficult process of estimating and refining remediation costs that are subject to ongoing and evolving
change. Initial estimates of remediation costs reflect a broad-based analysis of site conditions and potential environmental and human health impacts derived from preliminary site investigations (including soil and water analysis, migration pathways and potential risk). Later changes in these initial estimates may be based on additional site investigations, completion of feasibility studies (comparing and selecting from among various remediation methods and technologies) and risk assessments (determining the degree of current and future risk to the environment and human health, based on current scientific and regulatory criteria) and finally the actual implementation of the remediation plan. This process occurs over relatively long periods of time and is influenced by regulatory and community approval processes and subject to the ongoing development of remediation technologies. Pennzoil's assessment analysis takes into account the state of the process each site is in at the time of estimation, the degree of uncertainty surrounding the estimates for each phase of remediation and other site specific factors.
In connection with Pennzoil's disposition of Purolator, Pennzoil and Purolator entered into an indemnification agreement, pursuant to which Pennzoil agreed to reimburse Purolator for the costs and expenses of certain environmental remediation activities at a plant operated by Purolator in Elmira Heights, New York, and certain environmental remediation activities, if any, required at one other site located near the Elmira facility and a landfill site located in Metamora, Michigan. Pennzoil had a reserve of $16.2 million and $16.3 million recorded with respect to its obligations under its indemnification agreement with Purolator as of December 31, 1994 and 1993, respectively. Reference is made to Notes 8 and 11 of Notes to Consolidated Financial Statements for additional information.
Certain of Pennzoil's subsidiaries are involved in matters in which it has been alleged that such subsidiaries are potentially responsible parties ("PRPs") under CERCLA or similar state legislation with respect to various waste disposal areas owned or operated by third parties. In addition, certain of Pennzoil's subsidiaries are involved in other environmental remediation activities, including the removal, inspection and replacement, as necessary, of underground storage tanks. As of December 31, 1994 and 1993, Pennzoil's consolidated balance sheet included accrued liabilities for environmental remediation of $44.9 million and $33.1 million, respectively, which amounts include reserves with respect to Pennzoil's obligations under its indemnification agreement with Purolator referred to in the previous paragraph. Of these reserves, $8.8 million and $4.8 million are reflected in the consolidated balance sheet as current liabilities as of December 31, 1994 and 1993, respectively, and $36.1 million and $28.3 million are reflected as other liabilities as of December 31, 1994 and 1993, respectively. Pennzoil does not currently believe there is a reasonable possibility of incurring additional material costs in excess of the current accruals recognized for such environmental remediation activities. With respect to the sites in which Pennzoil subsidiaries are PRPs, Pennzoil's conclusion is based in large part on (i) the availability of defenses to liability, including the availability of the "petroleum exclusion" under CERCLA and similar state laws, and/or (ii) Pennzoil's current belief that its share of wastes at a particular site is or will be viewed by the Environmental Protection Agency or other PRPs as being de minimis. As a result, Pennzoil's monetary exposure is not expected to be material.
OTHER MATTERS. Pennzoil does not currently consider the impact of inflation to be significant in the businesses in which Pennzoil operates.
Reference is made to Note 1 of Notes to Consolidated Financial Statements for a discussion of the impact that a recently issued accounting standard is expected to have on Pennzoil's consolidated financial statements, when adopted.
ITEM 8.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements of Pennzoil, together with the report thereon of Arthur Andersen LLP dated February 24, 1995 and the supplementary financial data specified by Item 302 of Regulation S-K, are set forth on pages through hereof. (See Item 14 for Index.)
ITEM 9.

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEM 10.



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information appearing under the captions "Nominees," "Directors with Terms Expiring in 1996 and 1997" and "Compliance with Section 16(a) of the Exchange Act" set forth within the section entitled "Election of Directors" in Pennzoil's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 is incorporated herein by reference. See also Item S-K 401(b) appearing in Part I of this Annual Report on Form 10-K.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION.
The information appearing under the captions "Director Remuneration," "Executive Compensation" and "Compensation Committee Interlocks and Insider Participation" set forth within the section entitled "Election of Directors" in Pennzoil's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 is incorporated herein by reference.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information appearing under the caption "Security Ownership of Directors and Officers" set forth within the section entitled "Election of Directors" and under the caption "Security Ownership of Certain Shareholders" set forth within the section entitled "Additional Information" in Pennzoil's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 is incorporated herein by reference.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information appearing under the captions "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions" set forth within the section entitled "Election of Directors" and under the caption "Security Ownership of Certain Shareholders" set forth within the section entitled "Additional Information" in Pennzoil's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 is incorporated herein by reference.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A)(1) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The supplementary financial data specified by Item 302 of Regulation S-K are included in the Supplemental Financial and Statistical Information -- Unaudited beginning on page.
(A)(2) FINANCIAL STATEMENT SCHEDULES.
Schedules of Pennzoil and its subsidiaries are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or notes thereto.
(A)(3) EXHIBITS.
- ---------------
* Incorporated by reference.
+ Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.
(B) REPORTS ON FORM 8-K.
During the fourth quarter of 1994, Pennzoil filed a Current Report on Form 8-K with the SEC dated as of October 28, 1994 to report the declaration of a dividend of one right to purchase preferred stock for each outstanding share of Pennzoil's common stock.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
PENNZOIL COMPANY
By: JAMES L. PATE ------------------------------------ (JAMES L. PATE, CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER)
Date: February 27, 1995
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Pennzoil Company:
We have audited the accompanying consolidated balance sheet of Pennzoil Company (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pennzoil Company and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.
As discussed in Notes 1 and 6 to the Consolidated Financial Statements, the Company changed its method of accounting for certain investments in debt and equity securities and postemployment benefits as of January 1, 1994. Also, as discussed in Note 2 to the Consolidated Financial Statements, as of January 1, 1992, the Company changed its method of accounting for income taxes.
ARTHUR ANDERSEN LLP
Houston, Texas February 24, 1995
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PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
LIABILITIES AND SHAREHOLDERS' EQUITY
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
See Notes to Consolidated Financial Statements.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --
Principles of Consolidation --
The accompanying consolidated financial statements include all majority-owned subsidiaries of Pennzoil Company ("Pennzoil"). All significant intercompany accounts and transactions have been eliminated.
Marketable Securities and Other Investments --
Effective January 1, 1994, Pennzoil changed its method of accounting for certain investments in debt and equity securities by adopting the requirements of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This standard requires that, except for debt securities classified as "held-to-maturity," investments in debt and equity securities must be reported at fair value. As a result, Pennzoil's investment in Chevron Corporation ("Chevron") common stock, which shares are classified as "available for sale," is reported at fair value, with the unrealized gain excluded from earnings and reported as a separate component of shareholders' equity. As of January 1, 1994, Pennzoil beneficially owned 9,035,518 shares of Chevron common stock that were acquired at an average cost of $67.36 per share. The fair market value for the shares of Chevron common stock held by Pennzoil as of January 1, 1994 was $87.125 per share based on the closing transaction price for Chevron shares reported on the New York Stock Exchange ("NYSE") on December 31, 1993.
After giving effect to a "two-for-one" split of Chevron common stock in June 1994, Pennzoil beneficially owned 18,071,036 shares of Chevron common stock as of December 31, 1994, acquired at an average cost of $33.68 per share.
Realized gains on Pennzoil's remaining investment in Chevron common stock are subject to the exchange rights of holders of Pennzoil's $402.5 million outstanding principal amount of 6 1/2% Exchangeable Senior Debentures due January 15, 2003 (the "6 1/2% Debentures") and $500.0 million outstanding principal amount of 4 3/4% Exchangeable Senior Debentures due October 1, 2003 (the "4 3/4% Debentures"), all of which are exchangeable at the option of the holders thereof for shares of Chevron common stock owned by Pennzoil. Reference is made to Note 3 for additional information. The fair market value of the shares of Chevron common stock held by Pennzoil as of December 31, 1994 was $43.27 per share, based on the closing transaction price for Chevron common stock reported on the NYSE on December 30, 1994 of $44.625 per share, reduced by a $1.355 per share reserve for exchange rights relating to Pennzoil's outstanding 6 1/2% Debentures and 4 3/4% Debentures.
Adoption of SFAS No. 115 resulted in an increase in shareholders' equity of $106.8 million as of January 1, 1994, representing the net unrealized gain related to Pennzoil's investment in Chevron common stock. Prior year financial statements have not been restated to reflect the new accounting method. As of December 31, 1994, the net unrealized after-tax gain included in shareholders' equity related to Pennzoil's investment in Chevron common stock was $112.7 million.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The cost, market value and unrealized gains related to Pennzoil's marketable securities are as follows:
In November 1993, Pennzoil sold 8,158,582 shares of Chevron common stock in a block trade on the NYSE for a price of $89.00 per share before commissions ($88.38 per share net of commissions). The sale resulted in a net realized gain of $137.0 million ($171.6 million before tax), or $3.25 per share. The cost of the securities sold is based on the average cost of each security held at the time of sale.
Pennzoil's investments in debt securities are classified as "held-to-maturity" based on Pennzoil's ability and intent to hold those securities to maturity. Such securities are carried at cost, net of unamortized premium or discount, if any, and consist solely of domestic commercial paper. All of Pennzoil's "held-to-maturity" securities approximate their fair values based on the relatively short maturities of those investments and on quoted market prices, where such prices are available.
Other income effects from marketable securities and other investments are discussed under the caption "Investment and Other Income, Net" below.
Investment and Other Income, Net --
Other revenues, net of related expenses, are included in "Investment and Other Income, Net," which consists of the following:
Substantially all interest and dividend income is from marketable securities and other cash investments.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Receivables --
Current receivables include trade accounts and notes receivable and are net of allowances for doubtful accounts of $10.5 million in 1994 and $10.0 million in 1993. Long-term receivables consist of notes receivable and are net of allowances for doubtful accounts of $.9 million in 1994 and $4.2 million in 1993.
At December 31, 1994 and 1993, current receivables included notes receivable of $10.7 million and $12.6 million, respectively. Other assets included long-term notes receivable of $39.7 million and $44.7 million at December 31, 1994 and 1993, respectively.
In May 1993, the Financial Accounting Standards Board issued a new standard on accounting by creditors for impairment of loans. This standard requires certain impaired loans to be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Adoption of the standard by Pennzoil is required no later than the first quarter of 1995, although earlier implementation is permitted. Pennzoil currently expects to adopt the standard effective January 1, 1995. Based on a preliminary review, Pennzoil does not expect that adoption of the standard will have a material effect on its financial condition or results of operations.
Inventories --
A majority of inventories is reported at cost using the last-in, first-out ("LIFO") method, which is lower than market. Substantially all other inventories are reported at cost using the first-in, first-out method. Inventories valued on the LIFO method totaled $122.2 million at December 31, 1994 and $131.2 million at December 31, 1993. The current cost of LIFO inventories was approximately $182.5 million and $178.8 million at December 31, 1994 and 1993, respectively.
Oil and Gas Producing Activities and Depreciation, Depletion and Amortization --
Pennzoil follows the successful efforts method of accounting for oil and gas operations. Under the successful efforts method, lease acquisition costs are capitalized. Significant unproved properties are reviewed periodically on a property-by-property basis to determine if there has been impairment of the carrying value, with any such impairment charged currently to exploration expense. All other unproved properties are generally aggregated and a portion of such costs estimated to be nonproductive, based on historical experience, is amortized on an average holding period basis.
Exploratory drilling costs are capitalized pending determination of proved reserves. If proved reserves are not discovered, the exploratory drilling costs are expensed. Other exploration costs are also expensed. All development costs are capitalized. Provision for depreciation, depletion and amortization is determined on a field-by-field basis using the unit-of-production method. Estimated costs of future dismantlement and abandonment of wells and production platforms, net of salvage values, are accrued as part of depreciation, depletion and amortization expense using the unit-of-production method; actual costs are charged to accumulated depreciation, depletion and amortization. The carrying amounts of proven properties are reviewed periodically and an impairment reserve is provided as conditions warrant.
Pennzoil follows the sales method of accounting for natural gas imbalances. Under the sales method, revenue is recognized on all production delivered by Pennzoil to its purchasers, regardless of Pennzoil's ownership interest in the respective property. At December 31, 1994, Pennzoil's gas imbalance reflects a net underproduced position of 14.4 billion cubic feet of gas. The company expects to recover this imbalance from its co-owners through future production or alternative arrangements.
Sulphur properties were generally depreciated and depleted on the unit-of-production method, except assets having an estimated life less than the estimated life of the mineral deposits, which were depreciated on
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the straight-line method. In October 1994, Pennzoil entered into an agreement with Freeport-McMoRan Resource Partners, Limited Partnership ("Freeport-McMoRan") providing for the sale by Pennzoil to Freeport-McMoRan of substantially all the domestic assets of Pennzoil's sulphur segment. The transaction was completed in January 1995. Reference is made to Note 10 for additional information.
All other properties are depreciated on straight-line or accelerated methods in amounts calculated to allocate the cost of properties over their estimated useful lives.
Price Risk Management Activities --
Pennzoil has a formal price risk management program that permits periodic utilization of financial instruments to hedge a portion of the price risks associated with fluctuations in crude oil and natural gas prices. Through December 31, 1994, this program has been limited to the occasional use of swaps with financial institutions and industry partners, which hedge the sales price of natural gas. Gains and losses on these instruments are recognized in income when the associated hedged commodities are sold.
The results of Pennzoil's price risk management activities were not material to its results of operations during the three-year period ended December 31, 1994 or to its financial position as of that date.
Environmental Expenditures --
Environmental expenditures are expensed or capitalized in accordance with generally accepted accounting principles. Liabilities for these expenditures are recorded when it is probable that obligations have been incurred and the amounts can be reasonably estimated. Reference is made to Note 8 for a discussion of amounts recorded for these liabilities.
Intangible Assets --
Substantially all intangible assets, included in other assets in the accompanying consolidated balance sheet, relate to goodwill recognized in business combinations accounted for as purchases. Goodwill included in other assets in the accompanying consolidated balance sheet was $88.2 million at December 31, 1994 and $86.2 million at December 31, 1993, net of accumulated amortization of $19.9 million and $17.2 million, respectively. Goodwill is being amortized on a straight-line basis over periods ranging from 20 to 40 years. Amortization expense recorded during 1994 and 1993 was $7.1 million and $8.1 million, respectively.
Cash Flow Information --
For purposes of the consolidated statement of cash flows, all highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents. The effect of changes in foreign exchange rates on cash balances has been immaterial. Cash used in operating activities includes cash payments for interest (net of amounts capitalized) of $469.3 million, $183.6 million and $228.9 million in 1994, 1993 and 1992, respectively. Interest capitalized for 1994, 1993 and 1992 was $9.0 million, $11.4 million and $8.7 million, respectively. Income taxes paid, net of refunds, during 1994, 1993 and 1992 were $395.1 million, $5.5 million and $2.2 million, respectively. Cash payments for interest and income taxes in 1994 include $294.3 million and $261.7 million, respectively, paid to the Internal Revenue Service ("IRS") resulting from the settlement of a dispute relating to a proposed tax deficiency based on an audit of Pennzoil's 1988 federal income tax return. Reference is made to Note 8 for additional information.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Changes in operating assets and liabilities, net of effects from the purchases of equity interests in certain businesses acquired, consist of the following:
Earnings Per Share --
Earnings per share are computed based on the weighted average shares of common stock outstanding. The average shares used in earnings per share computations for the years 1994, 1993 and 1992 were 46,013,506, 42,187,739 and 40,582,451, respectively.
Foreign Operations --
Consolidated income (loss) from continuing operations before income tax includes losses from foreign operations of $53.4 million, $17.3 million and $21.7 million in 1994, 1993 and 1992, respectively.
(2) INCOME TAXES --
Accounting for Income Taxes --
In December 1992, Pennzoil announced its decision to change its method of accounting for income taxes by adopting the requirements of SFAS No. 109, "Accounting for Income Taxes," effective as of January 1, 1992. Previous 1992 interim period results were restated as a result of the adoption. Prior year financial statements were not restated to reflect the new accounting method. As a result of adopting SFAS No. 109, Pennzoil recognized a cumulative, one-time benefit from the change in accounting principle for periods prior to 1992 of $115.7 million, or $2.85 per share, as of the first quarter of 1992. In addition to the cumulative effect, income from continuing operations for the year ended December 31, 1992, increased $3.4 million ($4.5 million before tax), or $.08 per share, associated with adopting the new standard.
SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Federal, State and Foreign --
Federal, state and foreign income tax expense (benefit) for continuing operations consists of the following:
Reference is made to Note 3 for information regarding the tax benefit applicable to the extraordinary loss on the early retirement of debt. In addition, reference is made to Note 6 for information regarding the deferred tax benefits applicable to the cumulative effect of the change in accounting for postemployment benefit costs.
Pennzoil's net deferred tax liability is as follows:
Temporary differences and carryforwards which gave rise to significant portions of deferred tax assets and liabilities are as follows:
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The principal items accounting for the difference in income taxes on income (loss) from continuing operations computed at the federal statutory rate and as recorded are as follows:
Reference is made to Note 8 for information regarding a settlement agreement entered into with the IRS in October 1994 relating to a proposed tax deficiency based on an audit of Pennzoil's 1988 federal income tax return.
As a result of the IRS settlement, Pennzoil reduced its tax basis in the shares of Chevron common stock beneficially owned by Pennzoil. In January 1995, Pennzoil filed an amended 1993 federal income tax return to reflect the increase in taxable income for the 1993 sale of shares of Chevron common stock, which was substantially offset by the utilization of a net operating loss carryforward. Reference is made to Note 1 for additional information. Realization of the net operating loss carryforward resulted in the reversal of a valuation allowance of approximately $44 million. The valuation allowance had previously been reduced in 1993 by $25.5 million to reflect the net operating loss utilization resulting from the 1993 sale of shares of Chevron common stock on a pre-settlement basis.
In August 1993, the Omnibus Budget Reconciliation Act of 1993 was enacted, establishing a new 35% corporate income tax rate effective January 1, 1993. As a result of the increase in the marginal income tax rate and other tax law changes, Pennzoil recorded a one-time, non-cash charge of $16.0 million, or $.38 per share, in 1993 to adjust its deferred income tax liabilities and assets for the effect of the change in income tax rates.
As of December 31, 1994, Pennzoil had a United States net operating loss carryforward of approximately $8 million, which is available to reduce future regular federal income taxes payable. Additionally, for purposes of determining alternative minimum tax, an approximately $7 million net operating loss is available to offset future alternative minimum taxable income. Utilization of these regular and alternative minimum tax net operating losses, to the extent generated in separate return years, is limited based on the separate taxable income of the subsidiary, or its successor, generating the loss. If not used, these carryovers will expire in the years 2000 to 2006. In addition, Pennzoil has approximately $72 million of alternative minimum tax credits indefinitely available to reduce future regular tax liability to the extent it exceeds the related alternative minimum tax otherwise due. All net operating loss and credit carryover amounts are subject to examination by the tax authorities.
Pennzoil also has state net operating loss carryforwards, the tax effect of which was approximately $19 million as of December 31, 1994. A valuation allowance of approximately $13 million has been established to offset the portion of the deferred tax asset related to loss carryforwards expected to expire before their utilization.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) DEBT --
Long-term debt outstanding was as follows:
In August 1994, Pennzoil entered into an amended and restated revolving credit facility with a group of banks that provides for up to $600 million of unsecured revolving credit borrowings through August 16, 1995, with any outstanding borrowings on such date being converted into a term credit facility terminating on September 1, 1996. Pennzoil has the option, subject to the extension of additional credit by new or existing banks, of increasing the size of the facility by $100 million. This amended and restated credit facility replaces and supersedes the previous revolving credit facilities of Pennzoil. Borrowings under the facility totaled $205.0 million at December 31, 1994. The average interest rate applicable to amounts outstanding under this facility and the previous revolving credit facilities of Pennzoil was 4.69% and 3.59% during 1994 and 1993, respectively.
In June 1994, in connection with its acquisition of Co-enerco Resources, Ltd. ("Co-enerco"), Pennzoil Canada, Inc. ("Pennzoil Canada"), an indirect wholly owned subsidiary of Pennzoil, established a Cdn. $260 million credit facility with a syndicate of Canadian banks, the borrowings of which are guaranteed by Pennzoil. Also in June 1994, Pennzoil Canada established an additional Cdn. $40 million credit facility with a Canadian bank, the borrowings of which are guaranteed by Pennzoil. These facilities provide for borrowings through May 30, 1995, with any outstanding borrowings on such date being converted into term credit facilities terminating on May 30, 1996. Borrowings under these facilities can be made in any combination of U.S. or Canadian dollars and totaled U.S. $185.0 million and U.S. $10.0 million, respectively, as of December 31, 1994. The average interest rate applicable to amounts outstanding under this facility was 5.27% during 1994.
In February 1995, Pennzoil's Board of Directors increased the limit on the aggregate amount of commercial paper that Pennzoil may issue under its domestic commercial paper program and/or its Euro-commercial paper program from $250.0 million to $500.0 million. Borrowings under Pennzoil's commercial
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
paper facilities totaled $243.9 million and $249.4 million at December 31, 1994 and 1993, respectively, and are included in notes payable in the accompanying consolidated balance sheet. The average interest rates applicable to outstanding commercial paper were 4.43% and 3.26% during 1994 and 1993, respectively.
Pennzoil has several short-term variable-rate credit arrangements with certain banks. Pennzoil's Board of Directors has limited borrowings under these credit arrangements to $200.0 million. Outstanding borrowings totaled $93.3 million and $183.6 million at December 31, 1994 and 1993, respectively, and are included in notes payable in the accompanying consolidated balance sheet. The average interest rates applicable to amounts outstanding under these arrangements were 4.31% and 3.35% during 1994 and 1993, respectively. None of the banks under these credit arrangements has any obligation to continue to extend credit after the maturities of outstanding borrowings or to extend the maturities of any borrowings.
The 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable at the option of the holders thereof at any time prior to maturity, unless previously redeemed, for shares of Chevron common stock beneficially owned by Pennzoil at exchange rates of 23.774 shares and 17.004 shares, respectively, per $1,000 principal amount of the 6 1/2% Debentures and the 4 3/4% Debentures (the equivalent of $42 1/16 per share and $58 13/16 per share, respectively), subject to adjustment in certain events. In lieu of delivering certificates representing shares of Chevron common stock in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may, at its option, pay to any holder surrendering the 6 1/2% Debentures and the 4 3/4% Debentures an amount in cash equal to the market price of the shares for which the 6 1/2% Debentures and the 4 3/4% Debentures are exchangeable. Pennzoil has deposited all 18,071,036 shares of Chevron common stock beneficially owned by Pennzoil with exchange agents for possible exchange for the 6 1/2% Debentures and the 4 3/4% Debentures.
Under the instruments governing the 6 1/2% Debentures and the 4 3/4% Debentures, Pennzoil may not pledge, mortgage, hypothecate or grant a security interest in, or permit any mortgage, pledge, security interest or other lien upon, the shares of Chevron common stock deposited with exchange agents and deliverable in exchange for the 6 1/2% Debentures and the 4 3/4% Debentures. Pennzoil may at any time obtain from the exchange agents or otherwise authorize or direct the exchange agents to release all or part of the 18,071,036 shares of Chevron common stock deposited with the exchange agents. However, in the event Pennzoil obtains or otherwise releases any shares of Chevron common stock subject to exchange, each holder of a 6 1/2% Debenture or a 4 3/4% Debenture will generally have the right, at such holder's option, to require Pennzoil to repurchase all or a portion of such holder's debentures at a premium.
In 1993 and 1992, Pennzoil redeemed amounts outstanding under several debt facilities using proceeds from various sources. The premiums and related unamortized discount and debt issue costs relating to these redemptions resulted in extraordinary charges of $18.4 million ($28.3 million before tax), or $.44 per share, in 1993 and $16.6 million ($25.2 million before tax), or $.41 share, in 1992.
At December 31, 1994, maturities of long-term debt for the years ending December 31, 1995 to 1999 were $1.8 million, $405.8 million, $6.7 million, $2.5 million and $200.4 million, respectively. These maturities include $400 million in 1996 related to the maturities of Pennzoil's revolving credit facilities. Such maturities also include $3.9 million and $5.2 million for the years ending December 31, 1996 and 1997, respectively, related to non-interest bearing promissory notes of Jiffy Lube International, Inc. ("Jiffy Lube"), a wholly owned subsidiary of Pennzoil, the payment of which is contingent upon the future profitability of Jiffy Lube.
(4) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK --
Financial Instruments with Off-Balance-Sheet Risk --
Pennzoil is a party to various financial instruments with off-balance-sheet risk as part of its normal course of business, including financial guarantees and contractual commitments to extend financial guarantees, credit and other assistance to customers, franchisees and other third parties. These financial instruments involve, to varying degrees, elements of credit risk which are not recognized in Pennzoil's consolidated balance sheet.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The financial guarantees primarily relate to debt and lease obligation guarantees with expiration dates of up to twenty years issued to third parties to guarantee the performance of customers and franchisees in the fast lube industry. Commitments to extend credit are also provided to fast lube industry participants to finance equipment purchases, working capital needs and, in some cases, the acquisition of land and construction of improvements. Contractual commitments to extend credit and other assistance are in effect as long as certain conditions established in the respective contracts are met. Contractual commitments to extend financial guarantees are conditioned on the occurrence of specified events. The largest of these commitments is to provide a guarantee for letters of credit issued by third parties to meet the reinsurance requirements of Pennzoil's captive insurance subsidiary. This commitment has no stated maturity and is expected to vary in amount from year to year to meet the reinsurance requirements. Reserves established for reported and incurred but not reported insurance losses in the amount of $35.4 million and $32.3 million have been recognized in Pennzoil's consolidated balance sheet as of December 31, 1994 and 1993, respectively. The credit risk to Pennzoil is mitigated by the insurance subsidiary's portfolio of high-quality, short-term investments used to collateralize the letters of credit. At December 31, 1994, the collateral was valued at approximately 141% of the credit risk.
In addition, in connection with Pennzoil's disposition of Purolator Products Company ("Purolator") in 1992, Pennzoil entered into an agreement with certain banks to provide contingent credit support for a Purolator credit facility. This obligation was terminated in November 1994 upon the payment in full of all obligations due under the facility by Purolator and the termination of the facility.
Also, in connection with Pennzoil's disposition of Purolator in 1992, Pennzoil entered into an agreement with the Pension Benefit Guaranty Corporation ("PBGC"), pursuant to which Pennzoil agreed that, for up to five years, in the event of the termination of any or all the employee benefit plans of Purolator that are subject to Title IV of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and the inability of the PBGC in good faith to collect the amounts of any unfunded benefit liabilities under Purolator's plans from Purolator or any person controlling Purolator, Pennzoil would guarantee up to $7.0 million of such unfunded benefit liabilities.
Following are the amounts related to Pennzoil's financial guarantees and contractual commitments to extend financial guarantees, credit and other assistance as of December 31, 1994 and 1993.
Pennzoil's exposure to credit losses in the event of nonperformance by the other parties to these financial instruments is represented by the contractual or notional amounts. Decisions to extend financial guarantees and commitments and the amount of remuneration and collateral required are based on management's credit evaluation of the counterparties on a case-by-case basis. The collateral held varies but may include accounts receivable, inventory, equipment, real property, securities and personal assets. Since many of the commit-
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
ments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Concentrations of Credit Risk --
Pennzoil extends credit to various companies in the oil and gas, motor oil and refined products, fast lube and sulphur industries in the normal course of business. Within these industries, certain concentrations of credit risk exist. These concentrations of credit risk may be similarly affected by changes in economic or other conditions and may, accordingly, impact Pennzoil's overall credit risk. However, management believes that consolidated receivables are well diversified, thereby reducing potential credit risk to Pennzoil, and that allowances for doubtful accounts are adequate to absorb estimated losses as of December 31, 1994. Pennzoil's policies concerning collateral requirements and the types of collateral obtained for on-balance-sheet financial instruments are the same as those described above under "Financial Instruments with Off-Balance-Sheet Risk."
At December 31, 1994, receivables related to these group concentrations in the oil and gas, motor oil and refined products, fast lube and sulphur industries were $128.1 million, $223.3 million, $31.8 million and $13.4 million, respectively, compared with $182.8 million, $181.4 million, $36.9 million and $8.9 million, respectively, at December 31, 1993.
(5) FAIR VALUE OF FINANCIAL INSTRUMENTS --
The carrying amounts of Pennzoil's short-term financial instruments, including cash equivalents, current marketable securities and other investments, trade accounts receivable, trade accounts payable and notes payable, approximate their fair values based on the short maturities of those instruments and on quoted market prices, where such prices are available.
The following table summarizes the carrying amounts and estimated fair values of Pennzoil's other financial instruments.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument included above:
Notes Receivable --
The estimated fair value of notes receivable is based on discounting future cash flows using estimated year-end interest rates at which similar loans have been made to borrowers with similar credit ratings for the same remaining maturities.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Long-Term Investments --
The estimated fair value of long-term investments is based on quoted market prices at year end for those investments, adjusted for any reserves for debenture exchange rights, where applicable. Reference is made to Note 1 for additional information.
Long-Term Debt --
The estimated fair value of Pennzoil's long-term debt is based on quoted market prices or, where such prices are not available, on estimated year-end interest rates of debt with the same remaining average maturities and credit quality.
Off-Balance-Sheet Financial Instruments --
The estimated fair value of certain financial guarantees written and commitments to extend financial guarantees is based on the estimated cost to Pennzoil to obtain third party letters of credit to relieve Pennzoil of its obligations under such guarantees or, in the case of certain lease guarantees related to Jiffy Lube franchisees, the present value of expected future cash flows using a discount rate commensurate with the risks involved. Reference is made to Note 4 for further information regarding off-balance-sheet financial instruments.
(6) BENEFIT PLANS --
Retirement Plans --
Substantially all employees are covered by non-contributory retirement plans which provide benefits based on the participants' years of service and compensation or stated amounts for each year of service. Annual contributions to the plans are made in accordance with the minimum funding provisions of ERISA where applicable, but not in excess of the maximum amount that can be deducted for federal income tax purposes.
Net periodic pension cost for 1994, 1993 and 1992 included the following components:
Actual return on plans' assets was $4.6 million, $2.6 million and $6.2 million in 1994, 1993 and 1992, respectively.
Assumptions used were:
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table sets forth the plans' funded status and amounts recognized in the consolidated balance sheet:
The plans' assets include equity securities, common trust funds and various debt securities.
Unrecognized prior service cost is amortized on a straight-line basis over a period equal to the average of the expected future service of active employees expected to receive benefits under the respective plans.
Postretirement Health Care and Life Insurance Benefits --
Pennzoil sponsors several unfunded defined benefit postretirement plans covering most salaried and hourly employees. The plans provide medical and life insurance benefits and are, depending on the type of plan, either contributory or non-contributory. The accounting for the health care plans anticipates future cost-sharing changes that are consistent with Pennzoil's expressed intent to increase, where possible, contributions from future retirees to a minimum of 30% of the total annual cost. Furthermore, Pennzoil's future contributions for both current and future retirees have been limited, where possible, to 200% of the average 1992 benefit cost.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net periodic postretirement benefit cost for 1994, 1993 and 1992 included the following components:
The following table sets forth the plans' combined status reconciled with the amount included in the consolidated balance sheet at December 31, 1994 and 1993:
For measurement purposes, a 10% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1995; the rate was assumed to decrease gradually to 6% through the year 2002 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amount of the obligation and periodic cost reported. An increase in the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $2.7 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $.3 million.
The weighted-average discount rates used in determining the accumulated postretirement benefit obligation as of December 31, 1994 and 1993 were 8.5% and 7.5%, respectively.
Contribution Plans --
Pennzoil has defined contribution plans covering substantially all employees who have completed one year of service. Employee contributions of not less than 1% to not more than 6% of each covered employee's compensation are matched between 50% and 100% by Pennzoil. The cost of such company contributions totaled $10.0 million in 1994, $9.4 million in 1993 and $9.1 million in 1992.
Postemployment Benefits --
Effective January 1, 1994, Pennzoil changed its method of accounting for postemployment benefit costs by adopting the new requirements of SFAS No. 112, "Employers' Accounting for Postemployment Benefits." This standard requires employers to recognize the obligation to provide postemployment benefits if the obligation is attributable to employees' services already rendered, employees' rights to those benefits accumulate or vest, payment of the benefits is probable and the amounts can be reasonably estimated. If those four conditions are not met, the employer should recognize the obligation to provide postemployment benefits
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
when it is probable that a liability has been incurred and the amount can be reasonably estimated. Pennzoil recorded a charge of $4.9 million ($7.6 million before tax), or $.11 per share, as of January 1, 1994 to reflect the cumulative effect of the change in accounting principle for periods prior to 1994.
(7) CAPITAL STOCK AND STOCK OPTIONS --
Pennzoil's Restated Certificate of Incorporation authorizes the issuance of up to 9,747,720 shares of preferred stock. None of these shares were issued or outstanding at December 31, 1994. Pursuant to its authority to divide the preferred stock into a series, the Board of Directors in October 1994 designated 750,000 shares of preferred stock as a series of "Series A Junior Participating Preferred Stock." The Series A Junior Participating Preferred Stock is issuable upon the exercise of certain rights to purchase the Series A Junior Participating Preferred Stock ("Rights"). One Right was distributed with respect to each share of Pennzoil common stock outstanding at the close of business on November 11, 1994, and Rights are issuable with all subsequently issued shares of Pennzoil common stock prior to the date the Rights become exercisable or expire. The Rights are not currently exercisable or transferable apart from the Pennzoil common stock. Each Right entitles the holder to purchase from Pennzoil a unit consisting of one one-hundredth of a share of Series A Junior Participating Preferred Stock at $140 per share upon the occurrence of certain specified events.
Pennzoil's Restated Certificate of Incorporation authorizes the issuance of up to 27,862,924 shares of preference common stock. None of these shares were issued or outstanding at December 31, 1994. Dividend rights on any preference common stock are junior to the rights of any Pennzoil preferred stock and senior to the rights of Pennzoil common stock.
In September 1993, Pennzoil completed the sale, pursuant to underwritten public offerings, of 5,000,000 shares of its common stock at a price of $62.50 per share. The net proceeds from the sale of the shares of Pennzoil common stock offered, prior to the payment of expenses, totaled approximately $303.3 million. Primarily utilizing funds from such offerings, Pennzoil redeemed an aggregate of $292.5 million principal amount of Pennzoil's debentures. Reference is made to Note 3 for additional information. Pro forma earnings per share for the year ended December 31, 1993, assuming the stock offering and redemption of debentures had occurred at the beginning of 1993, were $3.43 per share.
At December 31, 1994, Pennzoil had 2,774,187 shares of common stock reserved for issuance upon the grant and exercise of stock options and the grant and maturity of conditional stock awards. An additional 850,000 shares of Pennzoil common stock were reserved for issuance upon the grant and exercise of stock options in February 1995.
At December 31, 1994, Pennzoil had nonqualified and incentive stock option plans covering a total of 2,601,982 shares of Pennzoil common stock (compared to 2,620,565 shares at December 31, 1993), of which 621,633 shares were available for granting of options. Options granted under the plans have a maximum term of ten years and are exercisable under the terms of the respective option agreements at the market price of the common stock at the date of grant, subject to antidilution adjustments in certain circumstances. At December 31, 1994, expiration dates for the outstanding options ranged from December 1997 to August 2004 and the average exercise price per share was $63.75. Payment of the exercise price may be made in cash or in shares of Pennzoil common stock previously owned by the optionee, valued at the then-current market value.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Additional information with respect to the stock option plans is as follows:
In 1994, there were 20,620 units of common stock granted to selected employees under Pennzoil's conditional stock award programs. Awards under the programs are made in the form of units which entitle the recipient to receive, at the end of a specified period, subject to certain conditions of continued employment, a number of shares of Pennzoil common stock equal to the number of units granted. At December 31, 1994, units covering 79,778 shares of Pennzoil common stock were outstanding (compared to 73,853 shares at December 31, 1993). In 1994, 14,695 shares of Pennzoil common stock were distributed to selected employees upon maturity of awards granted under Pennzoil's conditional stock award programs.
(8) COMMITMENTS AND CONTINGENCIES --
Tax Dispute --
In 1988, Pennzoil received $3.0 billion from Texaco Inc. ("Texaco") in settlement of all litigation between Pennzoil and Texaco arising out of Texaco's tortious interference with Pennzoil's contractual rights to purchase a minority interest in Getty Oil Company. From 1989 through 1991, Pennzoil acquired 32,944,100 shares of Chevron common stock with approximately $2.2 billion of the net Texaco settlement proceeds. For financial reporting purposes, Pennzoil reported an extraordinary gain of $1.656 billion (after expenses and estimated current and deferred taxes), or $42.62 per share, associated with the $3.0 billion in cash received from Texaco in April 1988. For federal income tax purposes, Pennzoil originally reported that it recognized no gain upon receipt of the $3.0 billion and that $366 million in legal and other costs incurred in the Texaco litigation was fully deductible. Pennzoil's reporting position was based on its belief that, under Section 1033 of the Internal Revenue Code, the $3.0 billion received from Texaco was an amount realized as a result of the involuntary conversion of property and that the Chevron shares were similar or related in service or use to the property converted by Texaco. A corollary of this position is that Pennzoil would have no tax basis in the Chevron shares. During 1990 and 1991, Pennzoil recalculated its 1988 federal income tax liability to recognize approximately $800 million of income, representing the excess of the $3.0 billion received from Texaco over the amount expended to acquire Chevron shares. As a result of these adjustments, current taxes were increased, and deferred taxes were decreased, by $120.4 million in 1990 and $13.2 million in 1991. In addition, Pennzoil paid interest on such taxes of $17.6 million during 1990 and $3.7 million in 1991.
In January 1994, Pennzoil received a letter and examination report from the District Director of the IRS that proposed a tax deficiency based on an audit of Pennzoil's 1988 federal income tax return. The examination report proposed two principal adjustments with which Pennzoil disagreed.
The first adjustment challenged Pennzoil's position under Section 1033 of the Internal Revenue Code that (i) at least $2.2 billion of the $3.0 billion cash payment received from Texaco in 1988 in settlement of litigation was realized as a result of the involuntary conversion of property and (ii) the shares of Chevron common stock purchased with $2.2 billion of the net Texaco settlement proceeds were similar or related in service or use to the property converted by Texaco. The proposed tax deficiency relating to this proposed
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
adjustment was $550.9 million, net of available offsets. Pennzoil estimated that the additional after-tax interest on this proposed deficiency was approximately $234.3 million as of December 31, 1993.
The second adjustment proposed by the IRS would have permanently capitalized, rather than allow Pennzoil to deduct, approximately $366 million incurred by Pennzoil in 1988 and earlier years for litigation and related expenses in connection with the Texaco settlement, even if it were determined that the entire $3.0 billion was includable in Pennzoil's 1988 taxable income. The proposed tax deficiency relating to the disallowance of deductions was $124.6 million, and the estimated additional after-tax interest on this proposed deficiency was approximately $46.7 million as of December 31, 1993.
In October 1994, Pennzoil entered into a settlement agreement with the IRS to treat $618 million of the $2.2 billion as proceeds from an involuntary conversion; to reduce such amount by $72 million of litigation costs; to recognize the balance of the settlement proceeds as taxable income in 1988; and to allow the balance of the litigation costs as deductions in 1988. As a result, Pennzoil sustained a tax deficiency for 1988 of $261.7 million (net of available offsets), plus interest, and its tax basis in each Chevron share was its cost less $8.28 (after giving effect to a "two-for-one" stock split of Chevron common stock which occurred in June 1994). Total interest charges on the tax deficiency were $294.3 million, resulting in a total cash payment to the IRS of $556.0 million in October 1994.
In October 1992, Pennzoil completed a tax-free transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock beneficially owned by Pennzoil for all the capital stock of Pennzoil Petroleum Company ("Pennzoil Petroleum"), which owned Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. Reference is made to Note 10 for additional information. Under the liability method of accounting for income taxes adopted by Pennzoil in December 1992, the excess of the amount of Pennzoil's investment in Pennzoil Petroleum capital stock for financial reporting purposes over the tax basis of such investment was not expected to result in future income tax liability. Accordingly, deferred income taxes attributable to the Chevron common stock exchanged in 1992, which taxes were originally provided when the Texaco settlement proceeds were received in 1988, were reflected as a reduction of the cost of Pennzoil's investment in Pennzoil Petroleum. As a result of the IRS settlement, Pennzoil increased the balance of its investment in Pennzoil Petroleum capital stock for financial reporting purposes and, therefore, the carrying value of Pennzoil Petroleum's oil and gas properties by $390.3 million, and such increased investment resulted in a $93.9 million increase in depreciation, depletion and amortization expense recognized in October 1994 relating to Pennzoil Petroleum's oil and gas properties from the date of the acquisition of Pennzoil Petroleum to the date of the IRS settlement. These adjustments resulted in a net increase in property, plant and equipment of $296.4 million as of September 30, 1994, while interest charges and depreciation, depletion and amortization expense adjustments related to the IRS settlement reduced Pennzoil's 1994 pretax income by $388.2 million. After consideration of available tax offsets, the IRS settlement resulted in a 1994 after-tax charge of $210.4 million, or $4.57 per share.
Curtailment Litigation --
United Gas Pipe Line Company ("United"), a former subsidiary of Pennzoil, curtailed deliveries of natural gas to its customers in accordance with priorities contained in its tariffs during the 1970s and early 1980s. Several lawsuits filed by industrial and power plant "direct sale" customers for damages allegedly caused by curtailments were brought against United, and Pennzoil was joined as a defendant in five of these suits. The only remaining suit against United involving Pennzoil is an action filed in the United States District Court for the Southern District of Mississippi on November 14, 1974 by Mississippi Power Co. ("MPCo"), which alleges damages of approximately $44.7 million and seeks to have such damages trebled pursuant to federal antitrust laws. In related proceedings before the Federal Energy Regulatory Commission ("FERC"), MPCo has introduced evidence indicating that its claimed damages (before trebling) have increased to approximately $88.2 million. In 1977, the judge in the MPCo case referred certain issues to the FERC and
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
stayed all proceedings pending action by the FERC. No action has been taken since 1977 to remove the stay. Pennzoil believes that it has no liability for any action it has taken or omitted to take, that it can successfully defend itself in the action and that the final outcome of the case will not have a material adverse effect on its financial condition or results of operations.
Environmental Matters --
Pennzoil is subject to certain laws and regulations relating to environmental remediation activities associated with past operations, such as the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"), the Resource Conservation and Recovery Act and similar state statutes. In response to liabilities associated with these activities, accruals have been established when reasonable estimates are possible. Such accruals primarily include estimated costs associated with remediation. Pennzoil has not used discounting in determining its accrued liabilities for environmental remediation, and no claims for possible recovery from third party insurers or other parties related to environmental costs have been recognized in Pennzoil's consolidated financial statements. Pennzoil adjusts the accruals when new remediation responsibilities are discovered and probable costs become estimable, or when current remediation estimates must be adjusted to reflect new information.
In connection with Pennzoil's disposition of Purolator, Pennzoil and Purolator entered into an indemnification agreement pursuant to which Pennzoil agreed to reimburse Purolator for the costs and expenses of certain environmental remediation activities at a plant operated by Purolator in Elmira Heights, New York, and certain environmental remediation activities, if any, required at one other site located near the Elmira facility and a landfill site located in Metamora, Michigan. Pennzoil had a reserve of $16.2 million and $16.3 million recorded with respect to its obligations under its indemnification agreement with Purolator as of December 31, 1994 and 1993, respectively. Reference is made to Note 11 for additional information.
Certain of Pennzoil's subsidiaries are involved in matters in which it has been alleged that such subsidiaries are potentially responsible parties ("PRPs") under CERCLA or similar state legislation with respect to various waste disposal areas owned or operated by third parties. In addition, certain of Pennzoil's subsidiaries are involved in other environmental remediation activities, including the removal, inspection and replacement, as necessary, of underground storage tanks. As of December 31, 1994 and 1993, Pennzoil's consolidated balance sheet included accrued liabilities for environmental remediation of $44.9 million and $33.1 million, respectively, which amounts include reserves with respect to Pennzoil's obligations under its indemnification agreement with Purolator referred to in the previous paragraph. Of these reserves, $8.8 million and $4.8 million are reflected on the consolidated balance sheet as current liabilities as of December 31, 1994 and 1993, respectively, and $36.1 million and $28.3 million are reflected as other liabilities as of December 31, 1994 and 1993, respectively. Pennzoil does not currently believe there is a reasonable possibility of incurring additional material amounts in excess of the current accruals recognized for such environmental remediation activities. With respect to the sites in which Pennzoil subsidiaries are PRPs, Pennzoil's conclusion is based in large part on (i) the availability of defenses to liability, including the availability of the "petroleum exclusion" under CERCLA and similar state laws, and/or (ii) Pennzoil's current belief that its share of wastes at a particular site is or will be viewed by the Environmental Protection Agency or other PRPs as being de minimis. As a result, Pennzoil's monetary exposure is not expected to be material.
Franchisee Litigation --
Certain current and former franchisees of Jiffy Lube have brought suit against Jiffy Lube to challenge various matters relating to the franchisor-franchisee relationship. Certain of the suits have included allegations against Pennzoil and/or Pennzoil Products Company, a wholly owned subsidiary of Pennzoil, as well. Pennzoil does not believe that the final outcome of these cases will have a material adverse effect on its financial condition or results of operations.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) LEASES --
As Lessee --
Pennzoil leases various assets and office space with lease periods of 1 to 20 years. Additionally, Jiffy Lube leases sites and equipment which are subleased to franchisees or used in the operation of automotive fast lubrication and fluid maintenance service centers operated by Jiffy Lube. The typical lease period for the service centers is 20 years with escalation clauses generally increasing the lease payments by 9% every third year, with some leases containing renewal options generally for periods of five years. These leases, excluding leases for land that are classified as operating leases, are accounted for as capital leases and are capitalized using interest rates appropriate at the inception of each lease.
Certain operating and capital lease payments are contingent upon such factors as the consumer price index or the prime interest rate with any future changes reflected in income as accruable. The effects of these changes are not considered material.
Total operating lease rental expenses for Pennzoil (exclusive of oil and gas lease rentals) were $63.5 million, $59.6 million and $56.2 million for 1994, 1993 and 1992, respectively. Non-current capital lease obligations are classified as other liabilities in the accompanying consolidated balance sheet.
Future minimum commitments under noncancellable leasing arrangements as of December 31, 1994 are as follows:
Assets recorded under capital lease obligations of $62.4 million and $18.2 million at December 31, 1994 are classified as property, plant and equipment and other assets, respectively, in the accompanying consolidated balance sheet.
As Lessor --
Pennzoil, through Jiffy Lube, owns or leases numerous service center sites which are leased or subleased to franchisees. Buildings owned or leased that meet the criteria for direct financing leases are carried at the gross investment in the lease less unearned income. Unearned income is recognized in such a manner as to produce a constant periodic rate of return on the net investment in the direct financing lease. Any buildings leased or subleased that do not meet the criteria for a direct financing lease and any land leased or subleased are accounted for as operating leases. The typical lease period is 20 years and some leases contain renewal options. The franchisee is responsible for the payment of property taxes, insurance and maintenance costs related to the leased property. The net investment in direct financing leases is classified as other assets in the accompanying consolidated balance sheet.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future minimum lease payment receivables under noncancellable leasing arrangements as of December 31, 1994 are as follows:
(10) ACQUISITIONS AND DIVESTITURES --
Acquisition of Pennzoil Petroleum --
In October 1992, Pennzoil completed a tax-free transaction with Chevron, pursuant to which Pennzoil exchanged 15,750,000 shares of Chevron common stock beneficially owned by Pennzoil for all the capital stock of Pennzoil Petroleum, which owned Gulf of Mexico, Gulf Coast, Permian Basin and other domestic oil and gas producing properties. The exchange of stock was accounted for using the purchase method of accounting, and the results of operations of Pennzoil Petroleum subsequent to October 30, 1992 have been included in Pennzoil's oil and gas segment results. The fair market value of the 15,750,000 shares of Chevron common stock exchanged for the capital stock of Pennzoil Petroleum approximated Pennzoil's historical book value for such shares of $1.06 billion. Accordingly, Pennzoil used the net book value of the Chevron shares exchanged for purposes of purchase accounting.
Included in the assets of Pennzoil Petroleum at the time of the transfer to Pennzoil was $57.4 million in cash contributed by Chevron to Pennzoil Petroleum immediately prior to closing, representing the net cash flow from Pennzoil Petroleum's operations during the four-month period between the "effective date" and the closing date of the transaction, after reduction as a result of nonrecurring closing adjustments of approximately $11 million. As a result of an audit completed during 1993, Chevron contributed an additional $9.9 million in cash to Pennzoil Petroleum in 1993, representing an adjustment to the initial $57.4 million cash contribution made by Chevron to Pennzoil Petroleum prior to closing. This additional contribution from Chevron was accounted for as an adjustment to the original purchase price of Pennzoil Petroleum. As a result of an audit conducted during 1994, Chevron contributed an additional $6.8 million in cash to Pennzoil Petroleum in 1994, representing post-closing adjustments related to the acquisition.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following unaudited pro forma information has been prepared assuming that the acquisition of Pennzoil Petroleum had occurred at the beginning of the period presented. Permitted pro forma adjustments include only the effects of events directly attributable to a transaction that are factually supportable and expected to have a continuing impact. Pro forma adjustments reflecting anticipated "efficiencies" in operations resulting from a transaction are, under most circumstances, not permitted. As a result of the limitations imposed with regard to the types of permitted pro forma adjustments, Pennzoil believes that this unaudited pro forma information is not indicative of future results of operations, nor the results of historical operations had the acquisition of Pennzoil Petroleum been consummated as of the assumed dates.
Acquisition of Co-enerco Resources Ltd. --
In June 1994, Pennzoil Canada acquired Co-enerco, a Canadian oil and gas exploration and production company operating in Alberta, northeastern British Columbia and southeastern Saskatchewan. Pennzoil Canada paid $230.9 million in cash in connection with the acquisition of Co-enerco and the repayment of Co- enerco's outstanding bank debt, which was financed primarily through two credit facilities. Reference is made to Note 3 for additional information. The acquisition of Co-enerco was accounted for using the purchase method of accounting, and the results of operations of Co-enerco subsequent to June 30, 1994 have been included in Pennzoil's oil and gas segment results.
Sale of Domestic Sulphur Assets --
In October 1994, Pennzoil entered into an agreement with Freeport-McMoRan providing for the sale by Pennzoil to Freeport-McMoRan of substantially all the domestic assets of Pennzoil's sulphur segment. The transaction was completed in January 1995. Pennzoil continues to own and operate its Antwerp, Belgium sulphur terminal and the related international sulphur business. As consideration under the agreement, Freeport-McMoRan assumed certain liabilities of Pennzoil relating to or arising out of the business of Pennzoil's sulphur segment, and Pennzoil will be entitled to receive a series of quarterly installment payments from Freeport-McMoRan for periods through December 31, 2014, subject to the prevailing market price of sulphur. The installment payments, recorded at their estimated fair value of $22.5 million as of September 30, 1994, may be terminated earlier by Freeport-McMoRan (through the exercise of a call option providing for a $65 million payment to Pennzoil), or by Pennzoil (through the exercise of a put option providing for a $10 million payment to Pennzoil). Neither the call option nor the put option may be exercised prior to January 1999. In connection with this transaction, Pennzoil's sulphur segment recorded a charge to depreciation, depletion and amortization expense of $50.2 million ($32.6 million after tax, or $.71 per share) in September 1994.
PENNZOIL COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) DISCONTINUED OPERATIONS --
Filtration Products Segment --
In October 1992, as a result of Pennzoil's conclusion that disposal of Purolator's filtration products operations would enhance Pennzoil's efforts to focus on its strategic businesses and to reduce indebtedness, Purolator filed a registration statement pursuant to which Pennzoil offered to the public all shares of Purolator stock held by Pennzoil. Accordingly, Purolator's net assets and results of operations for all periods have been reclassified as discontinued operations for financial reporting purposes. In December 1992, Pennzoil sold in initial public offerings all its shares of capital stock of Purolator. The total amount received by Pennzoil, prior to the payment of expenses, from the net proceeds of the offerings and the repayment of indebtedness by Purolator was $206.0 million. Pennzoil recorded a net gain on the disposition of Purolator stock of $1.5 million ($20.0 million before tax loss), or $.04 per share, in 1992.
In connection with Pennzoil's disposition of Purolator, Pennzoil and Purolator entered into an indemnification agreement with respect to certain environmental matters. Reference is made to Note 8 for additional information. In addition, Pennzoil entered into an agreement with certain banks to provide contingent credit support for a Purolator credit facility and an agreement with a government agency with respect to guarantees of benefits under certain of Purolator's employee benefit plans. Reference is made to Note 4 for additional information.
Income from discontinued operations is as follows:
(12) SEGMENT FINANCIAL INFORMATION --
Information with respect to revenues, operating income and other data by industry segment is presented in Item 1, Business and Item 2, Properties of this Annual Report on Form 10-K.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED
QUARTERLY RESULTS(1) --
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(1) Reference is made to Notes 1, 2, 3, 8 and 10 of Notes to Consolidated Financial Statements for information on items affecting quarterly results.
(2) Operating income (loss) is defined as net revenues less costs and operating expenses.
(3) The total of the 1993 quarterly earnings (loss) per share amounts presented does not equal the annual 1993 earnings per share amount primarily due to the issuance of 5 million shares of Pennzoil's common stock during September 1993. Reference is made to Note 7 of Notes to Consolidated Financial Statements for additional information.
OIL AND GAS INFORMATION
Estimated Quantities of Proved Oil and Gas Reserves
Presented on the following page are Pennzoil's estimated net proved oil and gas reserves as of December 31, 1994, 1993 and 1992. Reserves in the United States are located onshore in all the main producing states (except Alaska) and offshore Alabama, California, Louisiana, Mississippi and Texas. Foreign reserves are located in Canada.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
The estimates of proved oil and gas reserves have been prepared by Ryder Scott Company Petroleum Engineers ("Ryder Scott") and Outtrim Szabo Associates, Ltd. ("Outtrim Szabo") and are based on data supplied by Pennzoil. The reports of Ryder Scott and Outtrim Szabo, which include a description of the basis used in preparing the estimated reserves, are included as exhibits to Pennzoil's Annual Reports on Form 10-K for the respective years. Oil includes crude oil, condensate and natural gas liquids.
PROVED OIL RESERVES (MILLIONS OF BARRELS)
PROVED NATURAL GAS RESERVES (BILLIONS OF CUBIC FEET)
- --------------- (1) Purchases of minerals in place for 1994 include proved developed and undeveloped reserves attributable to Co-enerco as of the date of acquisition. Purchases of minerals in place for 1992 include proved developed and undeveloped reserves attributable to Pennzoil Petroleum as of the date of acquisition.
(2) Purchases and sales of minerals in place for 1994 include 8 million barrels of oil and 14 billion cubic feet ("Bcf") of natural gas and 2 million barrels of oil and 31 Bcf of natural gas, respectively, associated with asset exchanges. Purchases and sales of minerals in place for 1993 include 5 million barrels of oil and 91 Bcf of natural gas and 4 million barrels of oil and 93 Bcf of natural gas, respectively, associated with asset exchanges.
(3) United States natural gas reserves for 1994, 1993 and 1992 exclude 161 Bcf, 162 Bcf and 124 Bcf, respectively, of carbon dioxide gas for sale or use in company operations.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Capitalized Costs and Costs Incurred Relating to Oil and Gas Producing Activities
The following table shows the aggregate capitalized costs related to oil and gas producing activities and related accumulated depreciation, depletion and amortization and valuation allowances.
The following table shows costs incurred in oil and gas producing activities (whether charged to expense or capitalized).
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(1) Costs incurred for unproved property acquisition during 1994 and 1993 include approximately $48 million and $98 million, respectively, related to the gas utilization project in Azerbaijan. Total costs incurred during 1994 and 1993 include $50 million and $114 million, respectively, related to Pennzoil's Azerbaijan activities. Pennzoil's investment in the gas utilization project is being recovered through partial credit toward Pennzoil's portion of the first bonus payment made by members of the consortium of foreign oil companies to the government of Azerbaijan, direct hard currency payments by the Azerbaijan government during 1995 and an interest in another project. Any remaining balance due from the government of Azerbaijan with respect to the gas utilization project will be creditable against the remaining bonus payments to be made to the Azerbaijan government by the consortium. Total costs incurred for North America in 1994, including the acquisition of Co-enerco, were $602 million.
(2) Costs incurred for property acquisitions in 1994 include $231 million attributable to the acquisition of Co-enerco. Costs incurred for property acquisitions in 1992 include $1,009 million attributable to the acquisition of Pennzoil Petroleum. Reference is made to Note 10 of Notes to Consolidated Financial Statements for additional information.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Results of Operations From Oil and Gas Producing Activities
This information is similar to the disclosures set forth in the "Industry Segment Financial Information" set forth on pages 1 and 2 herein but differs in several respects as to the level of detail, geographic presentation and income taxes. Income taxes were determined by applying the applicable statutory rates to pretax income with adjustment for tax credits and other allowances. Income tax provisions involved certain allocations among geographic areas based on management's assessment of the principal factors giving rise to the tax obligation.
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(1) Foreign technical support and other during 1994 and 1993 includes approximately $9 million and $7 million, respectively, related to Pennzoil's Azerbaijan activities.
(2) In October 1994, Pennzoil settled a dispute with the IRS relating to a proposed tax deficiency based on an audit of Pennzoil's 1988 federal income tax return. As a result of the IRS settlement, Pennzoil increased the balance of its investment in Pennzoil Petroleum capital stock for financial reporting purposes and, therefore, the carrying value of Pennzoil Petroleum's oil and gas properties by $390.3 million, and such increased investment resulted in a $93.9 million increase in depreciation, depletion and amortization expense recognized in October 1994 relating to Pennzoil Petroleum's oil and gas properties from the date of the acquisition of Pennzoil Petroleum to the date of the IRS settlement. Reference is made to Notes 8 and 10 for additional information.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves (Standardized Measure)
The Standardized Measure is determined on a basis which presumes that year-end economic and operating conditions will continue over the periods during which year-end proved reserves would be produced. Neither the effects of future inflation nor expected future changes in technology and operating practices have been considered.
The Standardized Measure is determined as the excess of future cash inflows from proved reserves less future costs of producing and developing the reserves, future income taxes and a discount factor. Future cash inflows represent the revenues that would be received from production of year-end proved reserve quantities assuming the future production would be sold at year-end prices plus any fixed and determinable future escalations (but not escalations based on inflation) of natural gas prices provided by existing contracts. As a result of the continued volatility in oil and natural gas markets, future prices received from oil, condensate and natural gas sales may be higher or lower than current levels.
Future production costs include the estimated expenditures related to production of the proved reserves plus any production taxes without consideration of inflation. Future development costs include the estimated costs of drilling development wells and installation of production facilities, plus the net costs associated with dismantlement and abandonment of wells and production platforms, assuming year-end costs continue without inflation. Future income taxes were determined by applying current legislated statutory rates to the excess of (a) future cash inflows, less future production and development costs, over (b) the tax basis in the properties involved plus existing net operating loss carryforwards. Tax credits are considered in the computation of future income tax expenses. The discount was determined by applying a discount rate of 10% per year to the annual future net cash flows.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
The Standardized Measure does not purport to be an estimate of the fair market value of Pennzoil's proved reserves. An estimate of fair market value would also take into account, among other things, the expected recovery of reserves in excess of proved reserves, anticipated changes in future prices and costs and a discount factor more representative of the time value of money and the risks inherent in producing oil and gas. In the opinion of Pennzoil's management, the estimated fair value of Pennzoil's oil and gas properties is in excess of the amounts set forth below.
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(1) Includes future dismantlement and abandonment costs, net of salvage values.
(2) Future income taxes before discount were $670 million (U.S.) and $53 million (foreign) and $896 million (U.S.) and $35 million (foreign) for 1994 and 1993, respectively.
PENNZOIL COMPANY AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL AND STATISTICAL INFORMATION -- UNAUDITED (CONTINUED)
OIL AND GAS INFORMATION (CONTINUED)
Changes in the Standardized Measure
The following table sets forth the principal elements of the changes in the Standardized Measure for the years presented. All amounts are reflected on a discounted basis.
EXHIBIT INDEX
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* Incorporated by reference.
+ Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-K.