1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-13175
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VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 74-1828067
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Valero Place
San Antonio, Texas
(Address of principal executive offices)
78212
(Zip Code)
(210) 370-2000
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
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Indicated below is the number of shares outstanding of the registrant's
only class of common stock, as of November 1, 2000.
Number of
Shares
Title of Class Outstanding
-------------- -----------
Common Stock, $.01 Par Value 60,853,263
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2
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 2000 and December 31, 1999 .... 3
Consolidated Statements of Income - for the Three Months Ended and
Nine Months Ended September 30, 2000 and 1999 ......................... 4
Consolidated Statements of Cash Flows - for the Nine Months Ended
September 30, 2000 and 1999 ........................................... 5
Notes to Consolidated Financial Statements ................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ................................................. 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........... 32
PART II. OTHER INFORMATION ..................................................... 35
Item 1. Legal Proceedings .................................................... 35
Item 6. Exhibits and Reports on Form 8-K ..................................... 36
SIGNATURE ....................................................................... 37
2
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
September 30,
2000 December 31,
(Unaudited) 1999
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments .................................... $ 12,985 $ 60,087
Receivables, less allowance for doubtful accounts of
$3,382 (2000) and $3,038 (1999) ...................................... 651,583 372,542
Inventories ............................................................ 495,992 303,388
Current deferred income tax assets ..................................... 49,995 79,307
Prepaid expenses and other ............................................. 38,393 13,534
----------- -----------
1,248,948 828,858
----------- -----------
PROPERTY, PLANT AND EQUIPMENT - including
construction in progress of $166,659 (2000)
and $114,747 (1999), at cost ........................................... 3,417,886 2,607,204
Less: Accumulated depreciation ...................................... 773,650 692,497
----------- -----------
2,644,236 1,914,707
----------- -----------
DEFERRED CHARGES AND OTHER ASSETS ........................................ 318,003 235,707
----------- -----------
$ 4,211,187 $ 2,979,272
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt ........................................................ $ 93,000 $ --
Accounts payable ....................................................... 765,946 616,895
Accrued expenses ....................................................... 179,325 102,087
----------- -----------
1,038,271 718,982
----------- -----------
LONG-TERM DEBT ........................................................... 1,092,711 785,472
----------- -----------
DEFERRED INCOME TAXES .................................................... 342,027 275,521
----------- -----------
DEFERRED CREDITS AND OTHER LIABILITIES ................................... 120,391 114,528
----------- -----------
VALERO-OBLIGATED MANDATORILY REDEEMABLE
PREFERRED CAPITAL TRUST SECURITIES OF SUBSIDIARY
TRUST HOLDING SOLELY VALERO SENIOR NOTES ............................... 172,500 --
----------- -----------
COMMON STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 150,000,000 shares authorized;
issued 62,311,166 (2000) and 56,331,166 (1999) shares ................ 623 563
Additional paid-in capital ............................................. 1,249,706 1,092,348
Retained earnings (accumulated deficit) ................................ 233,088 (3,331)
Treasury stock, 1,378,941 (2000) and 264,464 (1999) shares, at cost .... (38,130) (4,811)
----------- -----------
1,445,287 1,084,769
----------- -----------
$ 4,211,187 $ 2,979,272
=========== ===========
See Notes to Consolidated Financial Statements.
3
4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
OPERATING REVENUES ............................................ $ 4,248,831 $ 2,161,938 $ 10,549,950 $ 5,323,491
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales and operating expenses ........................ 3,951,733 2,074,784 9,942,073 5,170,784
Selling and administrative expenses ......................... 42,901 16,395 86,653 49,123
Depreciation expense ........................................ 30,287 22,606 81,155 66,213
------------ ------------ ------------ ------------
Total ..................................................... 4,024,921 2,113,785 10,109,881 5,286,120
------------ ------------ ------------ ------------
OPERATING INCOME .............................................. 223,910 48,153 440,069 37,371
OTHER INCOME (EXPENSE), NET ................................... (357) 1,781 1,846 1,337
INTEREST AND DEBT EXPENSE:
Incurred .................................................... (23,894) (16,292) (62,551) (46,593)
Capitalized ................................................. 2,141 1,170 5,565 4,496
DISTRIBUTIONS ON PREFERRED SECURITIES OF
SUBSIDIARY TRUST ............................................ (3,344) -- (3,454) --
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES ............................. 198,456 34,812 381,475 (3,389)
INCOME TAX EXPENSE (BENEFIT) .................................. 71,100 12,200 135,700 (1,200)
------------ ------------ ------------ ------------
NET INCOME (LOSS) ............................................. $ 127,356 $ 22,612 $ 245,775 $ (2,189)
============ ============ ============ ============
EARNINGS (LOSS) PER SHARE OF COMMON STOCK ..................... $ 2.08 $ .40 $ 4.26 $ (.04)
Weighted average common shares outstanding (in thousands) ... 61,186 56,266 57,745 56,161
EARNINGS (LOSS) PER SHARE OF COMMON STOCK -
ASSUMING DILUTION ........................................... $ 2.01 $ .40 $ 4.12 $ (.04)
Weighted average common shares outstanding (in thousands) ... 63,242 56,953 59,621 56,161
DIVIDENDS PER SHARE OF COMMON STOCK ........................... $ .08 $ .08 $ .24 $ .24
See Notes to Consolidated Financial Statements.
4
5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
Nine Months Ended
September 30,
--------------------------
2000 1999
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .......................................................... $ 245,775 $ (2,189)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation expense ................................................... 81,155 66,213
Amortization of deferred charges and other, net ........................ 38,565 39,989
Changes in current assets and current liabilities ...................... (86,158) 167,208
Deferred income tax expense (benefit) .................................. 99,200 (8,100)
Changes in deferred items and other, net ............................... (8,592) 2,057
----------- -----------
Net cash provided by operating activities ............................ 369,945 265,178
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ....................................................... (131,478) (76,717)
Deferred turnaround and catalyst costs ..................................... (72,515) (58,626)
Benicia Acquisition ........................................................ (889,730) --
Investment in joint ventures and other, net ................................ (1,877) 487
----------- -----------
Net cash used in investing activities .................................... (1,095,600) (134,856)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in short-term debt, net ................................ 93,000 (148,000)
Long-term borrowings, including proceeds from senior notes offering ........ 1,899,367 722,794
Long-term debt reduction ................................................... (1,597,000) (701,000)
Proceeds from common stock offering, net ................................... 166,763 --
Issuance of common stock in connection with employee benefit plans ......... 13,328 6,638
Proceeds from offering of preferred securities of subsidiary trust, net .... 166,729 --
Common stock dividends ..................................................... (13,825) (13,479)
Purchase of treasury stock ................................................. (49,809) (655)
----------- -----------
Net cash provided by (used in) financing activities ...................... 678,553 (133,702)
----------- -----------
NET DECREASE IN CASH AND TEMPORARY CASH INVESTMENTS .......................... (47,102) (3,380)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD ........................................................ 60,087 11,199
----------- -----------
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD .............................................................. $ 12,985 $ 7,819
=========== ===========
See Notes to Consolidated Financial Statements.
5
6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
As used in this report, the term "Valero" may refer, depending upon the
context, to Valero Energy Corporation, one or more of its consolidated
subsidiaries, or all of them taken as a whole.
The consolidated financial statements included in this report have been
prepared by Valero without audit, in accordance with the rules and regulations
of the Securities and Exchange Commission, or SEC. However, all adjustments have
been made to these financial statements which are, in the opinion of Valero's
management, necessary for a fair presentation of Valero's results of operations
for the periods covered. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted as permitted under the
SEC's rules and regulations, although Valero believes that the disclosures are
adequate to make the information presented not misleading. Certain prior period
amounts have been reclassified for comparative purposes. See Note 7.
2. ACQUISITION OF CALIFORNIA REFINING AND MARKETING ASSETS
During the second quarter of 2000, Valero completed the acquisition of
Exxon Mobil Corporation's Benicia, California refinery (the "Benicia Refinery")
and Exxon-branded California retail assets, which consisted of approximately 80
service stations (the "Service Station Assets") and branded supplier
relationships with approximately 260 Exxon-branded service stations (the
"Distribution Assets") (collectively, the "Benicia Acquisition"). ExxonMobil
agreed to sell these assets as a result of consent decrees issued by the Federal
Trade Commission and the State of California requiring certain assets to be
divested by ExxonMobil to satisfy anticompetitive issues in connection with the
1999 fourth quarter merger of Exxon Corporation and Mobil Corporation. The
purchase price for the Benicia Refinery, the Distribution Assets and the Service
Station Assets was $895 million, plus approximately $150 million for (i)
refinery inventories acquired in the transaction (based on market-related prices
at the time of closing) and (ii) certain costs incurred in connection with the
acquisition. As described further below, $155 million of the total purchase
price was funded through a structured lease arrangement for the Service Station
Assets and the Benicia Refinery's dock facility. The acquisition of the Benicia
Refinery and the Distribution Assets closed on May 15, 2000, and the structured
lease transaction closed on June 15, 2000.
In connection with the Benicia Acquisition, Valero assumed all
liabilities, including environmental liabilities, of ExxonMobil related to the
acquired California assets with certain exceptions, including those exceptions
enumerated below. ExxonMobil retained liability for (i) pending penalties
assessed for violations relating to the Benicia Refinery, (ii) pending lawsuits,
(iii) personal injury or exposure, including asbestos
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7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
exposure, suffered by ExxonMobil employees, contractors or subcontractors prior
to closing, (iv) all costs associated with compliance with a variance issued in
connection with control of nitrogen oxides, (v) claims in connection with
offsite transportation and disposal of wastes prior to closing asserted within
three years of closing or asserted with respect to abandoned disposal sites,
(vi) the capital costs incurred within five years of closing for specified
corrective action of groundwater and soil contamination, (vii) all covered
contamination at the Service Station Assets caused by ExxonMobil or its lessees
that is reflected in baseline reports prepared prior to closing, (viii) the
repair or replacement of any underground storage tanks at the Service Station
Assets found to be leaking prior to closing and (ix) fines and penalties imposed
within five years of closing arising out of a request for information from the
Environmental Protection Agency relating to certain provisions of the Clean Air
Act that are attributable to actions taken prior to closing or untimely or
unresponsive responses to the request. ExxonMobil agreed to indemnify Valero for
all losses related to these retained liabilities, provided that ExxonMobil will
indemnify Valero for losses related to covered contamination at the Service
Station Assets for a period of five years from the date of closing. In addition,
ExxonMobil will indemnify Valero for breaches of its representations and
warranties to the extent that the aggregate amount of Valero's losses resulting
from such breaches exceeds $1 million and ExxonMobil receives notice of such
losses within one year after the closing date.
The Benicia Refinery is located on the Carquinez Straits of the San
Francisco Bay. It is considered a highly complex refinery and has a total
throughput capacity of 160,000 barrels per day, or "BPD." The Benicia Refinery
produces a high percentage of light products, with limited production of other
products. Approximately 95% of the gasoline produced by the Benicia Refinery
meets the California Air Resources Board ("CARB") specifications for CARB II
gasoline sold in California. The refinery has significant liquid storage
capacity, including storage for crude oil and other feedstocks. The refinery
assets also include a deepwater dock located offsite on the Carquinez Straits
that is capable of berthing large crude carriers, petroleum coke storage silos
located on an adjacent dock, a 20-inch crude pipeline connecting the refinery to
a southern California crude delivery system, and an adjacent truck terminal for
regional truck rack sales. Under the consent decrees, ExxonMobil was required to
offer the buyer of the divested assets a crude oil supply contract. As a
consequence, in connection with the closing of the Benicia Acquisition, Valero
entered into a ten-year term contract providing for ExxonMobil to supply and for
Valero to purchase 100,000 BPD of Alaska North Slope ("ANS") crude oil at
market-related prices, to be reduced to 65,000 BPD on January 1, 2001. After
January 1, 2001, Valero will have an option to reduce the required volumes by an
additional 20,000 BPD once per year.
The Service Station Assets included 10 company-operated service
stations and approximately 70 lessee-dealer service stations, 75 of which are
in the San Francisco Bay area. In connection with the consent decrees issued by
the Federal Trade Commission and the State of California, ExxonMobil was
required to withdraw
7
8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
the "Exxon" brand name from the San Francisco Bay area. As a result, ExxonMobil
notified the dealers in this market area that their franchise right to market
"Exxon" branded products was being terminated effective June 15, 2000. Valero is
introducing its own brand of retail petroleum products in the San Francisco Bay
area and the dealers at these locations have entered into a franchise agreement
with Valero to market products under the new Valero brand. In July 2000, these
dealers were offered an option to purchase the stations that they were leasing.
If exercised, the purchase option requires that the dealers enter into a fuels
purchase agreement with Valero for a term of 15 years. Any purchases of stations
by these dealers resulting from the exercise of their purchase options are
expected to be completed during the first quarter of 2001.
The Distribution Assets included approximately 260 independently-owned
and operated distributor facilities which are located outside of the San
Francisco Bay area. These distributor locations retained the right to use the
Exxon brand and continue to receive Exxon brand support, while Valero received
the exclusive rights to offer the Exxon brand throughout the state of California
(except for the San Francisco Bay area) for a ten-year period. In connection
with the Benicia Acquisition, ExxonMobil assigned to Valero all of the existing
Exxon California distributor contracts under which the distributors now purchase
Exxon-branded products from Valero.
The Benicia Acquisition was funded through a common stock offering, an
offering of premium equity participating security units ("PEPS Units"), a senior
notes offering and borrowings under Valero's existing bank credit facilities.
See Note 3 for details regarding the common stock, PEPS and senior note
offerings. In addition, Valero entered into a $155 million structured lease
arrangement for the Service Station Assets and the Benicia Refinery's dock
facility. This structured lease is being accounted for as an operating lease and
has a remaining primary term of approximately five years.
The Benicia Acquisition was accounted for under the purchase method of
accounting. In accordance with the purchase method, the accompanying
Consolidated Balance Sheet as of September 30, 2000 includes the assets acquired
and liabilities assumed based on a preliminary purchase price allocation, which
will be finalized upon the completion of independent appraisals and other
evaluations. The accompanying Consolidated Statement of Income for the three
months ended September 30, 2000 includes the results of operations related to
the Benicia Acquisition for the entire period, while the Consolidated Statement
of Income for the nine months ended September 30, 2000 includes the results of
operations related to the Benicia Refinery and the Distribution Assets beginning
May 16, 2000 and the results of operations related to the Service Station Assets
beginning June 16, 2000.
8
9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The preliminary purchase price allocation, including transaction costs
incurred in the acquisition, is as follows (in thousands):
Inventories (including certain base inventories and supplies inventories
included in the $895 million base purchase price) ...................... $ 171,471
Prepaid expenses and other ................................................. 15,000
Property, plant and equipment .............................................. 679,303
Deferred charges and other assets .......................................... 37,424
Accrued expenses ........................................................... (2,500)
Deferred credits and other liabilities ..................................... (10,968)
---------
$ 889,730
=========
The following unaudited pro forma financial information of Valero for
the nine months ended September 30, 2000 and 1999 assumes that the Benicia
Acquisition and the securities offerings discussed in Note 3 below occurred at
the beginning of each period. This pro forma information is not necessarily
indicative of the results of future operations. (Dollars in thousands, except
per-share amounts.)
Nine Months Ended
September 30,
-------------------------
2000 1999
----------- -----------
Operating revenues .............................. $11,272,234 $ 6,277,666
Operating income ................................ 490,074 177,448
Net income ...................................... 263,827 56,850
Earnings per common share ....................... 4.28 .91
Earnings per common share - assuming dilution ... 4.15 .91
3. SECURITIES OFFERINGS
As described in Note 2, in late June 2000, Valero completed three
securities offerings, the proceeds from which were used to repay interim bank
borrowings incurred in connection with the Benicia Acquisition. These securities
were issued under Valero's $1.3 billion universal shelf registration statement
on Form S-3 which was filed with the SEC on March 31, 2000. These securities
offerings are further described below.
9
10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Common Stock
On June 28, 2000, Valero issued to the public 5,980,000 shares of its
common stock at $29.125 per share. The net proceeds received by Valero from this
offering were approximately $167 million.
Premium Equity Participating Security Units
On June 28, 2000, Valero issued to the public 6,900,000 7 3/4% PEPS
Units at $25.00 per unit. The net proceeds received by Valero from this offering
were approximately $167 million. Each PEPS Unit consists of (i) a purchase
contract for shares of Valero common stock and (ii) a trust preferred security.
Each purchase contract obligates the holder to purchase from Valero on
August 18, 2003, for a price of $25, the following number of shares of Valero
common stock based on the average closing price of Valero's common stock over
the 20-day trading period ending on the third trading day prior to August 18,
2003: (i) .71531 shares if the average closing price equals or exceeds $34.95;
(ii) a number of shares having a value equal to $25 if the average closing price
is less than $34.95 but greater than $29.125; and (iii) .85837 shares if the
average closing price is less than or equal to $29.125. The holder has the
option to settle a purchase contract early for a price of $25 in exchange for
.71531 shares of Valero common stock.
Each trust preferred security represents an undivided interest in the
assets of VEC Trust I (a wholly owned subsidiary trust of Valero), has a stated
liquidation amount of $25 and matures on August 18, 2005. The trust preferred
security is pledged as collateral to secure the PEPS Unit holder's obligation to
purchase Valero common stock under the related purchase contract. VEC Trust I
will pay a cash distribution on each trust preferred security of $1.9375 per
year (equal to 7.75% of the $25 stated liquidation amount) prior to August 18,
2003, and from August 18, 2003 until August 18, 2005, at a reset rate that may
be less than, equal to or greater than this amount. The cash distribution
payments will be made quarterly on February 18, May 18, August 18 and November
18 of each year, beginning August 18, 2000.
The assets of VEC Trust I consist solely of Valero senior deferrable
notes maturing on August 18, 2005. VEC Trust I's sole source of funds for
distributions on the trust preferred securities is the interest payments it
receives from Valero on the senior deferrable notes. Valero has the right to
defer interest on the senior deferrable notes until August 18, 2003, in which
case distributions on the trust preferred securities would also be deferred. Any
deferred distributions will accumulate and compound quarterly at the rate of
7.75% per year. Valero guarantees the payment of distributions on the trust
preferred securities to the extent interest is paid on the senior deferrable
notes.
10
11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The financial statements of VEC Trust I are included in the
accompanying consolidated financial statements of Valero, with the trust
preferred securities shown on the accompanying Consolidated Balance Sheet as of
September 30, 2000 as "Valero-obligated mandatorily redeemable preferred capital
trust securities of subsidiary trust holding solely Valero senior notes."
Distributions on the trust preferred securities, whether paid or accumulated,
are reflected as a charge to income and are shown on the accompanying
Consolidated Statements of Income for the three months ended and nine months
ended September 30, 2000 as "distributions on preferred securities of subsidiary
trust."
Prior to the issuance of shares of Valero common stock upon settlement
of the purchase contracts, the PEPS Units are reflected in Valero's earnings per
share calculations using the treasury stock method. Consequently, the PEPS Units
will only have a dilutive effect on earnings per share during reporting periods
when the average market price per share of Valero common stock during the
reporting period is above the average closing price for the 20-day trading
period ending on the third trading day prior to the end of the reporting period.
Senior Notes
On June 29, 2000, Valero issued to the public $200 million aggregate
principal amount of 8 3/8% senior notes which are due on June 15, 2005, and $200
million aggregate principal amount of 8 3/4% senior notes which are due on June
15, 2030. The net proceeds received by Valero from this offering were
approximately $394 million, including an aggregate discount of approximately
$1.8 million related to the two issuances. Interest payments on the notes will
be made semi-annually on June 15 and December 15 of each year, beginning
December 15, 2000. These notes do not have any sinking fund requirements and are
redeemable at any time, in whole or in part, at Valero's option.
4. INVENTORIES
Inventories are carried at the lower of cost or market. The cost of
refinery feedstocks purchased for processing and produced products are
determined primarily under the last-in, first-out ("LIFO") method of inventory
pricing, and the cost of feedstocks and products purchased for resale are
determined under the weighted average cost method. At September 30, 2000, the
replacement cost of Valero's LIFO inventories exceeded their LIFO carrying
values by approximately $285 million. The cost of materials and supplies is
determined principally under the weighted average cost method. Inventories as of
September 30, 2000 and December 31, 1999 were as follows (in thousands):
11
12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
September 30, December 31,
2000 1999
------------- ------------
Refinery feedstocks .................. $103,939 $ 61,649
Refined products and blendstocks ..... 323,878 183,519
Materials and supplies ............... 68,175 58,220
-------- --------
$495,992 $303,388
======== ========
5. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net
income (loss) has been adjusted by, among other things, changes in current
assets and current liabilities. The changes in Valero's current assets and
current liabilities are shown in the following table as an (increase)/decrease
in current assets and an increase/(decrease) in current liabilities (in
thousands). These amounts exclude changes in "cash and temporary cash
investments," "current deferred income tax assets" and "short-term debt." Also
excluded from the amounts for the nine months ended September 30, 2000 are the
current assets and current liabilities acquired in connection with the Benicia
Acquisition which are reflected separately in the Statement of Cash Flows.
Nine Months Ended
September 30,
----------------------
2000 1999
--------- ---------
Receivables, net .............. $(279,041) $ (68,770)
Inventories ................... (21,133) (103,412)
Prepaid expenses and other .... (9,859) 4,156
Accounts payable .............. 149,137 320,484
Accrued expenses .............. 74,738 14,750
--------- ---------
Total ..................... $ (86,158) $ 167,208
========= =========
Cash flows related to interest and income taxes were as follows (in
thousands):
Nine Months Ended
September 30,
-----------------
2000 1999
------- -------
Interest paid (net of amount capitalized) .... $46,382 $36,086
Income tax refunds received .................. 384 7,505
Income taxes paid ............................ 23,995 581
12
13
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. EARNINGS PER SHARE
The computation of basic and diluted per-share amounts, as required by
the Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards No. 128, is as follows (dollars and shares in thousands,
except per-share amounts):
Three Months Ended September 30,
----------------------------------------------------------------
2000 1999
------------------------------- ------------------------------
Per- Per-
Net Share Net Share
Income Shares Amt. Income Shares Amt.
-------- -------- -------- -------- -------- --------
Net income ........................ $127,356 $ 22,612
======== ========
BASIC EARNINGS PER SHARE:
Net income available to
common stockholders ............. $127,356 61,186 $ 2.08 $ 22,612 56,266 $ .40
======== ========
EFFECT OF DILUTIVE SECURITIES:
Stock options ..................... -- 1,360 -- 370
Performance awards ................ -- 696 -- 317
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE:
Net income available to
common stockholders
plus assumed conversions ........ $127,356 63,242 $ 2.01 $ 22,612 56,953 $ .40
======== ======== ======== ======== ======== ========
Nine Months Ended September 30,
----------------------------------------------------------------
2000 1999
------------------------------- ------------------------------
Per- Per-
Net Share Net Share
Income Shares Amt. (Loss) Shares Amt.
-------- -------- -------- -------- -------- --------
Net income (loss) ................. $245,775 $ (2,189)
======== ========
BASIC EARNINGS PER SHARE:
Net income (loss) available to
common stockholders ............. $245,775 57,745 $ 4.26 $ (2,189) 56,161 $ (.04)
======== ========
EFFECT OF DILUTIVE SECURITIES:
Stock options ..................... -- 1,188 -- --
Performance awards ................ -- 688 -- --
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE:
Net income (loss) available to
common stockholders
plus assumed conversions ........ $245,775 59,621 $ 4.12 $ (2,189) 56,161 $ (.04)
======== ======== ======== ======== ======== ========
13
14
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Because Valero reported a net loss for the nine months ended September
30, 1999, various stock options and performance awards which were granted to
employees in connection with Valero's stock compensation plans and were
outstanding during such period were not included in the computation of diluted
earnings per share because the effect would have been antidilutive. At September
30, 1999, options to purchase approximately 6.4 million common shares and
performance awards totaling approximately 317,000 common shares were
outstanding.
7. NEW ACCOUNTING PRONOUNCEMENTS
In September 2000, the FASB issued Statement No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This statement replaces Statement 125 with the same name. Statement 140 revises
the standards for accounting for securitizations and other transfers of
financial assets and collateral and requires certain disclosures, but carries
over most of Statement 125's provisions without reconsideration. Statement 140
is effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring after March 31, 2001. However, certain provisions
regarding the recognition and reclassification of collateral and certain
disclosures relating to securitization transactions and collateral are effective
for Valero's financial statements for the year ended December 31, 2000. Valero
has not yet determined the impact on its financial statements of adopting this
statement.
In December 1999, the SEC staff issued Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition," to provide guidance on the recognition,
presentation and disclosure of revenue in financial statements. SAB 101 reflects
the basic principles of revenue recognition in existing generally accepted
accounting principles and does not supercede any existing authoritative
literature. In March 2000, the SEC staff issued SAB 101A which delayed the
required adoption date for SAB 101 to the second quarter of 2000 for calendar
year-end companies. In June 2000, the SEC staff issued SAB 101B which further
delayed the required adoption date for calendar year-end companies to the fourth
quarter of 2000. Valero believes that its revenue recognition policies are
consistent with those described in SAB 101 and that the adoption of this SAB
will not have a material effect on its consolidated financial statements.
In the third quarter of 2000, the FASB's Emerging Issues Task Force
("EITF") finalized various consensuses in connection with its Issue No. 00-10,
"Accounting for Shipping and Handling Fees and Costs." The EITF concluded that
(i) all amounts billed to a customer in a sale transaction related to shipping
and handling, if any, represent revenues earned for the goods provided and
should be classified as revenues in the income statement, (ii) costs incurred
for shipping and handling should not be deducted from revenues (i.e., netted
against shipping and handling revenues) in the income statement and (iii) the
classification in the
14
15
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
income statement of costs incurred for shipping and handling is an accounting
policy decision that should be disclosed under the requirements of Accounting
Principles Board Opinion No. 22, "Disclosure of Accounting Policies," and if
shipping or handling costs are significant and are not included in cost of
sales, both the amount(s) of these costs and the line item(s) on the income
statement that includes them should be disclosed. The guidance in these
consensuses is required to be adopted beginning in the fourth quarter of 2000,
consistent with the required adoption date for SEC Staff Accounting Bulletin No.
101 as described above. Valero believes that its accounting policies are
consistent with the guidance in these consensuses and that the adoption of these
consensuses will have an insignificant effect on its consolidated financial
statements.
In May 2000, the EITF reached a consensus in connection with its Issue
No. 00-1, "Investor Balance Sheet and Income Statement Display under the Equity
Method for Investments in Certain Partnerships and Other Ventures." This
consensus concluded that a proportionate gross financial statement presentation
is not appropriate for an investment in an unincorporated legal entity accounted
for by the equity method unless the investee is in either the construction
industry or an extractive industry (such as oil and gas exploration and
production but not related activities such as refining, marketing or
transporting extracted mineral resources) where there is a longstanding practice
of its use. In connection with adopting this consensus, Valero changed the
financial statement presentation of its interest in the Clear Lake, Texas
methanol plant (owned by a joint venture between a Valero subsidiary and Hoechst
Celanese Chemical Group) from a proportionate gross presentation to a
single-amount equity method presentation. This change was effective with
Valero's Form 10-Q for the quarter ended June 30, 2000 at which time comparative
financial statements were restated to conform with the consensus. The
comparative financial statements included in this Form 10-Q have also been
restated to conform with the consensus. This single-amount presentation related
to Valero's investment in the Clear Lake methanol plant is included in the
accompanying Consolidated Balance Sheets under "Deferred charges and other
assets" and is included in the accompanying Consolidated Income Statements under
"Other income (expense), net."
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation." This interpretation
clarifies the application of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," for certain issues including, among
other things, (i) the definition of employee for purposes of applying Opinion
25, (ii) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (iii) the accounting consequence of various modifications
to the terms of a previously fixed stock option or award, and (iv) the
accounting for an exchange of stock compensation awards in a business
combination. This interpretation became effective for Valero's financial
statements beginning July 1, 2000, including the effects of applying this
interpretation to certain specific events that occurred prior to July 1, 2000.
The adoption of this interpretation did not have a material effect on Valero's
consolidated financial statements.
15
16
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In June 1999, the FASB issued
Statement No. 137 which delayed the effective date of Statement 133 for one year
to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued
Statement No. 138 which amended various provisions of Statement 133. Statement
133, as amended, establishes accounting and reporting standards requiring that
every derivative instrument (including certain derivative instruments embedded
in hybrid instruments) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes in a
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. Statement 133 will become effective for Valero's financial
statements beginning January 1, 2001 and is not allowed to be applied
retroactively to financial statements of prior periods. With respect to hybrid
instruments, Valero plans to apply Statement 133, as allowed by the statement,
to only those hybrid instruments that were issued, acquired or substantively
modified on or after January 1, 1999. Valero is currently in the process of
implementing Statement 133 with respect to its hedging and trading activities as
described in this report under Item 3. Quantitative and Qualitative Disclosures
About Market Risk and in Valero's Form 10-K for the year ended December 31,
1999. Valero currently anticipates that the adoption of this statement will not
result in any significant changes in its business practices; however, various
systems modifications have been required and are being implemented. Because
these systems changes were not in place during the current reporting periods,
Valero is unable to quantify the effects of adopting Statement 133 on its
financial statements, including the effect on Valero's earnings and other
comprehensive income.
8. LITIGATION AND CONTINGENCIES
Prior to July 31, 1997, Valero was a wholly owned subsidiary of a
separate corporation named at that time Valero Energy Corporation, or Old
Valero. Old Valero was engaged in both the refining and marketing business and
the natural gas related services business. On July 31, 1997, Old Valero spun off
Valero to Old Valero's stockholders and, with its remaining natural gas related
services business, merged with a wholly owned subsidiary of PG&E Corporation
(the "Restructuring"). Old Valero, together with certain of its natural gas
related subsidiaries, and Valero have been sued by Teco Pipeline Company
regarding the operation of a 340-mile pipeline in West Texas in which a
subsidiary of Old Valero holds a 50% undivided interest. The case was filed
April 24, 1996. In 1985, a subsidiary of Old Valero sold a 50% undivided
interest in the pipeline and entered into a joint venture through an ownership
agreement and an operating agreement, with the purchaser of the interest. In
1988, Teco succeeded to that purchaser's 50% interest. A subsidiary of Old
Valero has at
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17
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
all times been the operator of the pipeline. Despite the written ownership and
operating agreements, the plaintiff contends that a separate, unwritten
partnership agreement exists, and that the defendants have exercised improper
control over this alleged partnership's affairs. The plaintiff also contends
that the defendants acted in bad faith and negatively affected the economics of
the joint venture in order to provide financial advantages to facilities or
entities owned by the defendants, and by allegedly taking for the defendants'
own benefit certain opportunities available to the joint venture. The plaintiff
asserts causes of action for breach of fiduciary duty, fraud, tortious
interference with business relationships, professional malpractice and other
claims, and seeks unquantified actual and punitive damages. Old Valero's motion
to require arbitration of the case as required in the written agreements was
denied by the trial court, but Old Valero appealed, and in August 1999, the
court of appeals ruled in Old Valero's favor and ordered arbitration of the
entire dispute. Teco has since waived efforts to further appeal this ruling, and
an arbitration panel has been selected. Valero has been formally added to this
proceeding. The arbitration panel has scheduled the arbitration hearing for
February 2001. Although PG&E previously acquired Teco and now owns both Teco and
Old Valero, PG&E's agreement for the acquisition of Teco purports to assign the
benefit or detriment of this lawsuit to the former shareholders of Teco. In
connection with the Restructuring, Valero has agreed to indemnify Old Valero
with respect to this lawsuit for 50% of any final judgment or settlement amount
up to $30 million, and 100% of that part of any final judgment or settlement
amount over $30 million.
In 1986, Valero filed suit against M.W. Kellogg Company for damages
arising from certain alleged design and construction defects in connection with
a major construction project at the Corpus Christi Refinery. Ingersoll-Rand
Company was added as a defendant in 1989. In 1991, the trial court granted
summary judgment against Valero based in part on certain exculpatory provisions
in various agreements connected with the project. In 1993, the court of appeals
affirmed the summary judgment and the Texas Supreme Court denied review.
Subsequent to the summary judgment, Kellogg and Ingersoll-Rand brought indemnity
claims against Valero for attorneys' fees and expenses incurred in defending the
original action. In 1996, the trial court rendered summary judgment against
Kellogg and Ingersoll-Rand based on procedural grounds, and the court of appeals
affirmed that ruling in 1997. However, in 1999, the Texas Supreme Court reversed
the court of appeals and remanded Kellogg's and Ingersoll-Rand's claims for
attorneys' fees and expenses to the trial court. The case went to trial in
August 2000. During trial, the claims of Ingersoll-Rand were settled for an
immaterial amount. The jury returned a verdict on Kellogg's claims that would
result in a judgment between $4.5 and $6.25 million, depending on the
calculation of prejudgment interest by the court. To date, no judgment has been
rendered. Any judgment will be appealed by Valero.
Valero had previously received notice of, but was not served with, a
complaint filed April 28, 2000 in federal court by Texas City Railway Company
alleging that several companies, including Valero, are liable
17
18
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
under the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA), other environmental laws and tort law theories for alleged
contamination of the plaintiff's marine loading and tankering facilities. On
September 6, 2000, the complaint was dismissed pursuant to a tolling agreement.
The parties are presently seeking to resolve the matter through mediation which
is expected to conclude in the first quarter of 2001.
On May 24, 2000, Valero was served with a complaint seeking to certify
a class action which alleges that numerous gasoline suppliers, including Valero,
contaminated groundwater in the State of New York with methyl tertiary butyl
ether (MTBE). Valero has filed a motion to dismiss the complaint based upon a
failure to state a claim and based upon federal preemption under the Clean Air
Act. Early discovery has been allowed by the judge and is proceeding. The
Judicial Panel on Multidistrict Litigation has consolidated this matter with two
other related cases for pretrial purposes. The cases are consolidated in the
existing court in New York.
Earlier this year, the United States Environmental Protection Agency
("EPA") issued a series of information requests to U.S. refiners pursuant to
Section 114 of the Clean Air Act as part of an enforcement initiative. Like
other refiners, Valero received a Section 114 information request pertaining to
all of its refineries owned at that time. Valero has completed its response to
the request and has provided additional clarification requested by the EPA.
Valero has not been named in any proceeding. However, based in part upon
recently announced settlements and evaluation of its relative position, Valero
expects total penalties and related expenses of less than $5 million in
connection with this enforcement initiative. Valero's estimate of expenses to be
incurred related to this issue, which has been provided for in the accompanying
consolidated financial statements, is immaterial to its financial position and
results of operations.
Valero is also a party to additional claims and legal proceedings
arising in the ordinary course of business. Valero believes it is unlikely that
the final outcome of any of the claims or proceedings to which it is a party
would have a material adverse effect on its financial statements; however, due
to the inherent uncertainty of litigation, the range of possible loss, if any,
cannot be estimated with a reasonable degree of precision and there can be no
assurance that the resolution of any particular claim or proceeding would not
have an adverse effect on Valero's results of operations, financial position or
liquidity.
9. SUBSEQUENT EVENTS
On October 19, 2000, Valero's Board of Directors declared a regular
quarterly cash dividend of $.08 per common share payable December 13, 2000, to
holders of record at the close of business on November 15, 2000.
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19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains certain estimates, predictions, projections and
other "forward-looking statements" (as defined in Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve
various risks and uncertainties. While these forward-looking statements, and any
assumptions upon which they are based, are made in good faith and reflect
Valero's current judgment regarding the direction of its business, actual
results will almost always vary, sometimes materially, from any estimates,
predictions, projections, assumptions, or other future performance suggested
herein. These forward- looking statements can generally be identified by the
words "anticipate," "believe," "expect," "plan," "intend," "estimate,"
"project," "budget," "forecast," "will," "could," "should," "may" and similar
expressions. These forward-looking statements include, among other things,
statements regarding:
o future refining margins, including gasoline and heating oil margins;
o expectations regarding feedstock costs, including crude oil discounts, and
operating costs;
o anticipated levels of crude oil and refined product inventories;
o Valero's anticipated level of capital investments, including deferred
turnaround and catalyst costs and capital expenditures for environmental
and other purposes, and the effect of these capital investments on Valero's
results of operations;
o anticipated trends in the supply and demand for crude oil feedstocks and
refined products in the United States and elsewhere;
o expectations regarding environmental and other regulatory initiatives; and
o the effect of general economic and other conditions on refining industry
fundamentals.
Valero's forward-looking statements are based on its beliefs and
assumptions derived from information available at the time the statements are
made. Differences between actual results and any future performance suggested in
these forward-looking statements could result from a variety of factors,
including the following:
o the domestic and foreign supplies of refined products such as gasoline,
diesel, heating oil and petrochemicals;
o the domestic and foreign supplies of crude oil and other feedstocks;
o the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil price and production controls;
o the level of consumer demand, including seasonal fluctuations;
o refinery overcapacity or undercapacity;
o the actions taken by competitors, including both pricing and the expansion
and retirement of refining capacity in response to market conditions;
o environmental and other regulations at both the state and federal levels
and in foreign countries;
o political conditions in oil producing regions, including the Middle East;
19
20
o the level of foreign imports;
o accidents or other unscheduled shutdowns affecting Valero's plants,
machinery, pipelines or equipment, or those of Valero's suppliers or
customers;
o changes in the cost or availability of transportation for feedstocks and
refined products;
o the price, availability and acceptance of alternative fuels and
alternative-fuel vehicles;
o cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such projects;
o irregular weather, which can unforeseeably affect the price or availability
of feedstocks and refined products;
o rulings, judgments, or settlements in litigation or other legal or
regulatory matters, including unexpected environmental remediation costs in
excess of any reserves;
o the introduction or enactment of federal or state legislation which may
adversely affect Valero's business or operations;
o changes in the credit ratings assigned to Valero's debt securities and
trade credit; and
o overall economic conditions.
Any one of these factors, or a combination of these factors, could
materially affect Valero's future results of operations and whether any
forward-looking statements ultimately prove to be accurate. Valero's
forward-looking statements are not guarantees of future performance, and actual
results and future performance may differ materially from those suggested in any
forward-looking statement. Valero does not intend to update these statements
unless it is required by the securities laws to do so.
All subsequent written and oral forward-looking statements attributable
to Valero or persons acting on its behalf are expressly qualified in their
entirety by the foregoing. Valero undertakes no obligation to publicly release
the result of any revisions to any such forward-looking statements that may be
made to reflect events or circumstances after the date of this report or to
reflect the occurrence of unanticipated events.
20
21
RESULTS OF OPERATIONS
THIRD QUARTER 2000 COMPARED TO THIRD QUARTER 1999
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended September 30,
--------------------------------------------------------
Change
------------------------
2000 1999 Amount %
----------- ----------- ----------- -----------
Operating revenues ........................................... $ 4,248,831 $ 2,161,938 $ 2,086,893 97%
Cost of sales ................................................ (3,741,769) (1,943,146) (1,798,623) (93)
Operating costs:
Cash (fixed and variable) ................................ (194,065) (118,426) (75,639) (64)
Depreciation and amortization ............................ (44,620) (34,596) (10,024) (29)
Selling and administrative expenses (including related
depreciation expense) .................................... (44,467) (17,617) (26,850) -- (a)
----------- ----------- -----------
Total operating income ............................... $ 223,910 $ 48,153 $ 175,757 -- (a)
=========== =========== ===========
Other income (expense), net .................................. $ (357) $ 1,781 $ (2,138) -- (a)
Interest and debt expense, net ............................... $ (21,753) $ (15,122) $ (6,631) (44)
Distributions on preferred securities of subsidiary trust .... $ (3,344) $ -- $ (3,344) -- (a)
Income tax expense ........................................... $ (71,100) $ (12,200) $ (58,900) -- (a)
Net income ................................................... $ 127,356 $ 22,612 $ 104,744 -- (a)
Earnings per share of common stock - assuming
dilution ................................................. $ 2.01 $ .40 $ 1.61 -- (a)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") .............................. $ 271,444 (b) $ 85,832 $ 185,612 -- (a)
Ratio of EBITDA to interest incurred ......................... 10.0x (b) 5.3x 4.7x 89
- ----------------
(a) Percentage variance is greater than 100%.
(b) For purposes of this calculation, distributions on preferred securities of
subsidiary trust are included in interest incurred.
21
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OPERATING HIGHLIGHTS
Three Months Ended September 30,
-------------------------------------
Change
---------------
2000 1999 Amount %
------ ----- ------ -----
Sales volumes (Mbbls per day) .................... 1,235 967 268 28%
Throughput volumes (Mbbls per day) ............... 933 714 219 31
Average throughput margin per barrel ............. $ 5.91 $3.33 $2.58 77
Operating costs per barrel:
Cash (fixed and variable) .................... $ 2.26 $1.80 $ .46 26
Depreciation and amortization ................ .52 .53 (.01) (2)
------ ----- -----
Total operating costs per barrel ......... $ 2.78 $2.33 $ .45 19
====== ===== =====
Charges:
Crude oils:
Sour ..................................... 57% 50% 7% 14
Heavy sweet .............................. 8 12 (4) (33)
Light sweet .............................. 7 8 (1) (13)
------ ----- -----
Total crude oils ..................... 72 70 2 3
High-sulfur residual fuel oil, or "resid" .... 3 3 -- --
Low-sulfur resid ............................. 3 6 (3) (50)
Other feedstocks and blendstocks ............. 22 21 1 5
------ ----- -----
Total charges ............................ 100% 100% --% --
====== ===== =====
Yields:
Gasolines and blendstocks .................... 54% 50% 4% 8
Distillates .................................. 27 29 (2) (7)
Petrochemicals ............................... 3 5 (2) (40)
Lubes and asphalts ........................... 3 3 -- --
Other products ............................... 13 13 -- --
------ ----- -----
Total yields ............................. 100% 100% --% --
====== ===== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Three Months Ended September 30,
--------------------------------------
Change
---------------
2000 1999 Amount %
------ ----- ------ -----
Feedstocks (at U.S. Gulf Coast, except as noted):
West Texas Intermediate, or "WTI," crude oil ................ $31.69 $21.75 $ 9.94 46%
WTI less sour crude oil (a) (c) ............................. $ 3.87 $ 2.57 $ 1.30 51
WTI less ANS (U.S. West Coast) .............................. $ 1.93 $ 1.35 $ .58 43
WTI less sweet crude oil (b) (c) ............................ $ (.32) $ (.21) $ (.11) (52)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI ....................... $ 4.46 $ 3.65 $ .81 22
No. 2 fuel oil less WTI ................................. $ 4.74 $ .57 $ 4.17 -- (d)
Propylene less WTI................................. $ .92 $ 1.82 $ (.90) (49)
U.S. East Coast:
Conventional 87 gasoline less WTI ....................... $ 5.96 $ 4.97 $ .99 20
No. 2 fuel oil less WTI ................................. $ 5.50 $ 1.28 $ 4.22 -- (d)
Lube oils less WTI ...................................... $19.70 $ 8.92 $10.78 -- (d)
U.S. West Coast:
CARB less ANS ........................................... $20.48 $16.07 (e) $ 4.41 27
Low sulfur diesel less ANS .............................. $11.94 $ 8.31 (e) $ 3.63 44
- ------------
(a) The market reference differential for sour crude oil is based on posted
prices for 35% Arab medium, 30% Arab light, 20% Basrah and 15% Oriente.
(b) The market reference differential for sweet crude oil is based on posted
prices for 50% light Louisiana sweet, or "LLS," and 50% Cusiana, with LLS
adjusted for backwardation.
(c) The market reference differential for the 1999 period has been restated
from the amount reported in Valero's September 30, 1999 Form 10-Q to
conform to the components used in the 2000 period.
(d) Percentage variance is greater than 100%.
(e) The 1999 market reference differentials for the U.S. West Coast are
presented for information purposes only. The comparison is not relevant to
Valero since the Benicia Acquisition did not occur until the second quarter
of 2000.
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Valero reported net income for the third quarter of 2000 of $127.4
million, or $2.01 per share, compared to net income of $22.6 million, or $.40
per share, for the third quarter of 1999. The increase in third quarter results
was due primarily to the significant contribution from the Benicia Acquisition
($.90 per share) that was completed in May and June of 2000 and substantially
higher throughput margins for Valero's operations excluding Benicia resulting
from exceptionally strong refining industry fundamentals and higher throughput
volumes in the 2000 quarter. Partially offsetting the increase in throughput
margins for Valero's operations excluding Benicia were higher cash operating
costs and selling and administrative expenses and an increase in income tax
expense.
Operating revenues increased $2.1 billion, or 97%, to $4.2 billion
during the third quarter of 2000 compared to the same period in 1999 due to a
$12.92, or 53%, increase in the average sales price per barrel and a 28%
increase in average daily sales volumes. The increase in average sales prices
was due to (i) significantly higher refined product prices resulting from
reduced refined product inventories and (ii) the effect of higher-priced sales
of CARB gasoline and other products in the California market in connection with
the Benicia Acquisition. The decline in refined product inventory levels was
attributable primarily to (i) lower crude oil supplies resulting from the
continued impact of OPEC's decision in March 1999 to significantly reduce
production, (ii) lower refinery utilization rates in late 1999 and early 2000,
(iii) reduced refinery production due to more stringent fuel specifications in
the U.S. and Europe that became effective in 2000, (iv) improved product demand,
particularly for distillates, and (v) high market backwardation in the 2000
quarter. Average daily sales volumes increased due primarily to additional
volumes attributable to the Benicia Acquisition. Also contributing to the
increase in sales volumes was (i) an increase in throughput volumes at the
Corpus Christi Refinery resulting from various operational enhancements and the
nonrecurrence in 2000 of unplanned downtime experienced during the 1999 quarter
as a precaution against the effects of Hurricane Bret and (ii) an increase in
throughput volumes at the Paulsboro Refinery resulting from certain unit
expansions and improvements made during the second quarter of 2000.
Operating income increased $175.7 million to $223.9 million during the
third quarter of 2000 compared to the third quarter of 1999 due in large part to
the contribution from the Benicia Acquisition. Excluding the effect of the
Benicia Acquisition, operating income increased due to an approximate $121
million increase in total throughput margins (discussed below), partially offset
by an approximate $34 million increase in cash operating costs and an
approximate $20 million increase in selling and administrative expenses
(including related depreciation expense). Cash operating costs were higher due
primarily to an increase in employee salaries, benefits and variable
compensation, higher fuel and electricity costs attributable mainly to an
increase in natural gas prices, and higher maintenance costs related primarily
to certain minor unscheduled refinery downtime. Selling and administrative
expenses (including related depreciation expense) increased primarily as a
result of an increase in employee salaries, benefits, variable compensation and
other employee-related costs, and costs associated with litigation and other
matters described in Note 8 of Notes to Consolidated Financial Statements.
Total throughput margins (operating revenues less cost of sales),
excluding the effect of the Benicia Acquisition, increased due to (i)
significantly higher distillate margins resulting primarily from record demand
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and extremely low inventory levels, (ii) higher gasoline margins resulting
primarily from continued strong demand and low inventories, (iii) improved
feedstock discounts for sour crude oil resulting primarily from recent increases
in sour crude oil production by OPEC and increased demand for sweet crude oil
due to lower sulfur requirements for certain refined products, (iv) higher RFG
premiums and oxygenate margins due to improved demand and the tightening of fuel
specifications in the U.S. and Europe noted above, (v) higher throughput volumes
as described above, and (vi) significantly higher lube oil margins resulting
mainly from improved market conditions. Partially offsetting the increases in
total throughput margins resulting from these factors were (i) lower prices for
fuel oil and other heavy products relative to crude oil prices and (ii) a
decrease in sweet crude oil differentials attributable to an increase in
worldwide demand for sweet crude oils resulting from the new 2000 fuel
specifications and higher light product margins noted above.
Other income (expense), net, decreased by $2.1 million during the third
quarter of 2000 compared to the same period in 1999 due primarily to a full
quarter of costs in the 2000 period related to the agreement entered into by
Valero in September 1999 to sell a portion of its accounts receivable.
Net interest and debt expense increased $6.6 million, or 44%, to $21.8
million during the third quarter of 2000 compared to the same period in 1999 due
primarily to increased borrowings to fund the Benicia Acquisition, including the
issuance of the senior notes in June 2000 and borrowings under Valero's bank
credit facilities (the effects of which are included in the $.90 per-share
contribution from the Benicia Acquisition noted above), partially offset by a
paydown of bank borrowings during the 2000 period resulting from Valero's strong
earnings and cash flow.
Income tax expense increased $58.9 million to $71.1 million during the
third quarter of 2000 compared to the same period in 1999 due primarily to the
significant increase in pre-tax income.
24
25
YEAR-TO-DATE 2000 COMPARED TO YEAR-TO-DATE 1999
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Nine Months Ended September 30,
---------------------------------------------------------
Change
----------------------
2000(a) 1999 Amount %
------------ ----------- ----------- -------
Operating revenues............................................. $10,549,950 $ 5,323,491 $ 5,226,459 98%
Cost of sales ................................................. (9,423,003) (4,781,900) (4,641,103) (97)
Operating costs:
Cash (fixed and variable) ................................. (480,628) (350,060) (130,568) (37)
Depreciation and amortization ............................. (115,167) (102,030) (13,137) (13)
Selling and administrative expenses (including related
depreciation expense) ..................................... (91,083) (52,130) (38,953) (75)
----------- ---------- -----------
Total operating income ................................ $ 440,069 $ 37,371 $ 402,698 -- (b)
=========== ========== ===========
Other income, net ............................................. $ 1,846 $ 1,337 $ 509 38
Interest and debt expense, net ................................ $ (56,986) $ (42,097) $ (14,889) (35)
Distributions on preferred securities of subsidiary trust ..... $ (3,454) $ -- $ (3,454) -- (b)
Income tax (expense) benefit .................................. $ (135,700) $ 1,200 $ (136,900) -- (b)
Net income (loss) ............................................. $ 245,775 $ (2,189) $ 247,964 -- (b)
Earnings (loss) per share of common stock - assuming
dilution .................................................. $ 4.12 $ (.04) $ 4.16 -- (b)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") ............................... $ 564,384 (c) $ 144,641 $ 419,743 -- (b)
Ratio of EBITDA to interest incurred .......................... 8.6x (c) 3.1x 5.5x -- (b)
- -----------------
(a) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Station Assets beginning June 16, 2000.
(b) Percentage variance is greater than 100%.
(c) For purposes of this calculation, distributions on preferred securities of
subsidiary trust are included in interest incurred.
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OPERATING HIGHLIGHTS
Nine Months Ended September 30,
---------------------------------------
Change
-----------------
2000(a) 1999 Amount %
------- ------ ------ -------
Sales volumes (Mbbls per day)........................ 1,108 1,018 90 9%
Throughput volumes (Mbbls per day)................... 833 709 124 17
Average throughput margin per barrel................. $4.94 $ 2.80 $ 2.14 76
Operating costs per barrel:
Cash (fixed and variable)........................ $2.11 $ 1.81 $ .30 17
Depreciation and amortization.................... .50 .52 (.02) (4)
----- ------ ------
Total operating costs per barrel............. $2.61 $ 2.33 $ .28 12
===== ====== ======
Charges:
Crude oils:
Sour......................................... 53% 48% 5% 10
Heavy sweet.................................. 9 13 (4) (31)
Light sweet.................................. 8 9 (1) (11)
---- ----- -----
Total crude oils......................... 70 70 -- --
High-sulfur resid................................ 4 3 1 33
Low-sulfur resid................................. 4 6 (2) (33)
Other feedstocks and blendstocks................. 22 21 1 5
---- ----- -----
Total charges................................ 100% 100% --% --
==== ===== =====
Yields:
Gasolines and blendstocks........................ 52% 51% 1% 2
Distillates...................................... 28 30 (2) (7)
Petrochemicals................................... 4 4 -- --
Lubes and asphalts............................... 3 3 -- --
Other products................................... 13 12 1 8
---- ----- -----
Total yields................................. 100% 100% --% --
==== ===== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Nine Months Ended September 30,
--------------------------------------
Change
-----------------
2000 1999 Amount %
----- ------ ------ -------
Feedstocks (at U.S. Gulf Coast, except as noted):
WTI crude oil...................................... $29.82 $17.48 $12.34 71%
WTI less sour crude oil(b)(d)...................... $ 3.11 $ 2.53 $ .58 23
WTI less ANS (U.S. West Coast)..................... $ 1.90 $ 1.62 $ .28 17
WTI less sweet crude oil(c)(d)..................... $ (.48) $ .19 $ (.67) -- (e)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI.............. $ 5.39 $ 2.72 $ 2.67 98
No. 2 fuel oil less WTI........................ $ 2.71 $ .09 $ 2.62 -- (e)
Propylene less WTI............................. $ 5.91 $ (.13) $ 6.04 -- (e)
U.S. East Coast:
Conventional 87 gasoline less WTI.............. $ 6.03 $ 3.31 $ 2.72 82
No. 2 fuel oil less WTI........................ $ 4.57 $ .89 $ 3.68 -- (e)
Lube oils less WTI............................. $13.99 $12.54 $ 1.45 12
U.S. West Coast:
CARB less ANS.................................. $14.85 $13.66 (f) $ 1.19 9
Low sulfur diesel less ANS..................... $ 8.80 $ 7.11 (f) $ 1.69 24
- -------------
(a) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Station Assets beginning June 16, 2000.
(b) The market reference differential for sour crude oil is based on posted
prices for 35% Arab medium, 30% Arab light, 20% Basrah and 15% Oriente.
(c) The market reference differential for sweet crude oil is based on posted
prices for 50% LLS and 50% Cusiana, with LLS adjusted for backwardation.
(d) The market reference differential for the 1999 period has been restated
from the amount reported in Valero's September 30, 1999 Form 10-Q to
conform to the components used in the 2000 period.
(e) Percentage variance is greater than 100%.
(f) The 1999 market reference differentials for the U.S. West Coast are
presented for information purposes only. The comparison is not relevant to
Valero since the Benicia Acquisition did not occur until the second quarter
of 2000.
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27
Valero reported net income for the first nine months of 2000 of $245.8
million, or $4.12 per share, compared to a net loss of $2.2 million, or $.04 per
share, for the first nine months of 1999. The substantial increase in
year-to-date results was due primarily to dramatically improved refining
industry fundamentals which resulted in a significant increase in throughput
margins, and the contribution from the Benicia Acquisition ($1.09 per share)
completed in the 2000 period. Also contributing to higher year-to-date results
was the effect in the first quarter of 1999 of a major maintenance turnaround of
the heavy oil cracker and related units at the Corpus Christi Refinery, as well
as certain unit expansions implemented during that downtime, which both reduced
results for the 1999 period and increased results for the 2000 period. Partially
offsetting the increases in income resulting from these factors for Valero's
operations excluding Benicia were higher cash operating costs and selling and
administrative expenses, an increase in income tax expense, the effect of
certain scheduled and unscheduled refinery downtime experienced primarily during
the 2000 second quarter, and the nonrecurrence in 2000 of a benefit to income in
1999 related to a permanent reduction in LIFO inventories.
Operating revenues increased $5.2 billion, or 98%, to $10.5 billion
during the first nine months of 2000 compared to the same period in 1999 due to
a $15.51, or 81%, increase in the average sales price per barrel and a 9%
increase in average daily sales volumes. The increase in sales prices was due
primarily to the factors noted above in the quarter-to-quarter discussion, while
the increase in sales volumes was due primarily to additional volumes
attributable to the Benicia Acquisition.
Operating income increased $402.7 million, from $37.4 million during
the first nine months of 1999 to $440.1 million during the first nine months of
2000. Excluding the contribution from the Benicia Acquisition noted above, this
increase was primarily attributable to an approximate $370 million increase in
total throughput margins (discussed below), partially offset by an approximate
$68 million increase in cash operating costs and an approximate $32 million
increase in selling and administrative expenses (including related depreciation
expense). Cash operating costs increased primarily due to the factors noted
above in the quarter-to-quarter discussion, and to higher maintenance costs
related to unscheduled downtime experienced during the 2000 second quarter.
Selling and administrative expenses (including related depreciation expense)
increased mainly as a result of the factors noted above in the
quarter-to-quarter discussion.
Total throughput margins (excluding the effect of the Benicia
Acquisition) increased mainly due to significantly higher gasoline and
distillate margins resulting from the dramatic improvement in refining industry
fundamentals. Also contributing to the increase in total throughput margins were
(i) higher RFG premiums and oxygenate margins and improved feedstock discounts
for sour crude oil resulting primarily from the factors noted above in the
quarter-to-quarter discussion and (ii) higher petrochemical margins resulting
from improved worldwide demand, particularly in Asia. Partially offsetting these
increases in total throughput margins were (i) lower prices for fuel oil and
other heavy products relative to crude oil prices, (ii) an increase in sweet
crude oil costs to amounts in excess of WTI, (iii) the effect of scheduled and
unscheduled refinery downtime experienced primarily during the 2000 second
quarter, (iv) a decrease in gains from trading activities and (v) the
nonrecurrence in 2000 of a $10.5 million benefit in the first quarter of 1999
resulting from the liquidation of LIFO inventories.
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Other income, net, increased $.5 million during the first nine months
of 2000 compared to the same period in 1999 as improved results of $5.5 million
from Valero's 20% equity interest in the Javelina off-gas processing plant in
Corpus Christi were mostly offset by approximately $5 million of costs in 2000
related to the agreement entered into by Valero in September 1999 to sell a
portion of its accounts receivable. The increase in Javelina's results was
attributable primarily to significantly higher prices for natural gas liquids
and increases in prices for ethylene and other products, partially offset by
higher natural gas feedstock costs.
Net interest and debt expense increased $14.9 million, or 35%, to $57
million during the first nine months of 2000 compared to the same period in 1999
due primarily to increased borrowings to fund the Benicia Acquisition (the
effects of which are included in the $1.09 per-share contribution from the
Benicia Acquisition noted above), partially offset by a reduction in bank
borrowings during the 2000 period resulting from Valero's strong earnings and
cash flow.
Income taxes increased from an income tax benefit of $1.2 million in
the first nine months of 1999 to income tax expense of $135.7 million in the
first nine months of 2000 due primarily to the significant increase in pre-tax
income.
OUTLOOK
Thus far in the fourth quarter of 2000, margins across Valero's
business continue to remain strong. Heating oil margins on average are higher
than already favorable third quarter levels due to extremely low inventories and
increasing demand, and are significantly in excess of depressed fourth quarter
1999 margins. Average West Coast gasoline margins have remained strong due to
continued strong demand and the effect of substantial refinery turnaround
activity. Although Gulf Coast gasoline margins on average have declined somewhat
from the high levels achieved during the third quarter due to normal seasonal
patterns, they are still well above fourth quarter historical averages and
fourth quarter 1999 margins. With regard to other products, average lube oil
margins have increased from third quarter levels to more than double fourth
quarter 1999 margins. As a result of improved market conditions, combined with
an improved pricing structure related to Valero's lube oil contract with
ExxonMobil, Valero expects to see an increase in lube oil results in the fourth
quarter compared to the third quarter. Average premiums for RFG thus far in the
fourth quarter of 2000 have declined from high third quarter levels but are
still in excess of fourth quarter 1999 premiums. Propylene margins thus far in
the fourth quarter of 2000, however, have been under extreme pressure and are
significantly below fourth quarter 1999 levels due to higher crude oil prices.
With regard to feedstocks, average discounts for sour crude oil have
improved from already favorable third quarter levels due to increasing OPEC
production of sour crude oil and continuing higher demand for sweeter crudes,
and are well in excess of fourth quarter 1999 discounts. Sweet crude oil
continues to trade at a premium to WTI due to increasing demand for sweet crudes
as a result of the new stringent fuel specifications implemented in 2000 and
higher margins for light products. Valero expects to continue to recognize
significant benefits from its ability to meet current fuel specifications using
predominantly sour crude oil feedstocks as the supply of sour crudes and the
demand for sweet crudes increase in the future.
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29
In the third quarter of 2000, Valero completed a 14-day turnaround and
expansion of a distillate hydrotreater at the Texas City Refinery which raised
its capacity by 20,000 barrels per day, or BPD. Combined with other operational
adjustments, Valero has increased its distillate production from approximately
250,000 BPD to almost 290,000 BPD to take advantage of the strong distillate
market. At the Corpus Christi Refinery, Valero completed a 14-day turnaround of
the MTBE plant in October 2000 and plans to undergo scheduled turnarounds of the
HDS unit, hydrocracker and reformer complex and sulfur plant in December 2000.
At the Paulsboro Refinery, turnarounds of the naphtha reformer and diesel
hydrotreater are currently underway and are expected to be completed by the end
of November 2000. A maintenance turnaround of the crude units at the Texas City
Refinery originally scheduled for October 2000 has been moved to January 2001.
Valero expects this turnaround will last approximately 30 days. As refining
margins merit, Valero expects to continue making capital improvements at its
refinery facilities to increase, among other things, throughput capacity,
conversion capability, operational efficiency and feedstock flexibility and to
improve mechanical reliability. The majority of these capital improvements are
expected to be performed during scheduled maintenance turnarounds.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities increased $104.8 million
during the first nine months of 2000 compared to the same period in 1999 due
primarily to the significant increase in earnings discussed above under "Results
of Operations," partially offset by a $253.4 million increase in the amount of
cash utilized for working capital purposes, as detailed in Note 5 of Notes to
Consolidated Financial Statements. In the first nine months of 2000,
approximately $118 million, $90 million and $35 million, respectively, of the
increases reflected in accounts receivable, accounts payable and accrued
expenses were attributable to balances at the end of September related to the
operations associated with the Benicia Acquisition which was completed in the
second quarter of 2000. However, while the Benicia Acquisition caused a
significant increase in individual components of the change in working capital
for the first nine months of 2000, it did not have a significant effect on the
total change in working capital for that period. This change was primarily
attributable to increased accounts receivable resulting from a significant
increase in commodity prices from December 31, 1999 to September 30, 2000. This
increase in accounts receivable was somewhat offset by an increase in accounts
payable, also resulting from higher commodity prices, and an increase in accrued
expenses resulting mainly from larger accruals for taxes, interest and variable
compensation. During the first nine months of 2000, cash provided by (i)
operating activities, (ii) existing cash balances, (iii) proceeds from the
common stock, PEPS Units and senior notes offerings described in Note 3 of Notes
to Consolidated Financial Statements, and (iv) issuances of common stock related
to Valero's benefit plans was utilized to (i) fund the Benicia Acquisition,
capital expenditures, deferred turnaround and catalyst costs and investments in
joint ventures, (ii) repurchase shares of Valero common stock and (iii) pay
common stock dividends.
Valero currently maintains an unsecured $835 million revolving bank
credit and letter of credit facility which matures in November 2002 and is
available for general corporate purposes including working capital needs and
letters of credit. Borrowings under this facility bear interest at either LIBOR
plus a margin, a base rate or a money market rate. Valero is also charged
various fees and expenses in connection with this facility,
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30
including a facility fee and various letter of credit fees. The interest rate
and fees under this credit facility are subject to adjustment based upon the
credit ratings assigned to Valero's long-term debt. The credit facility includes
certain restrictive covenants including a coverage ratio, a capitalization
ratio, and a minimum net worth test. In connection with Valero's interim
financing plan for the Benicia Acquisition, in April 2000, this credit facility
was amended to, among other things, increase the total debt-to-capitalization
limit from 50% to 65%. This ratio limit was subsequently decreased to 60% upon
the completion of the common stock and PEPS Units offerings described in Note 3,
and will further decrease to 55% on September 30, 2001. These amendments to the
credit facility became effective upon the closing of the acquisition of the
Benicia Refinery and the Distribution Assets. As of September 30, 2000,
outstanding borrowings under this committed facility totaled $50 million, while
letters of credit outstanding were approximately $148 million. Valero also
currently has various uncommitted short-term bank credit facilities, along with
various uncommitted bank letter of credit facilities. As of September 30, 2000,
$93 million was outstanding under the short-term bank credit facilities, and
letters of credit totaling approximately $32 million were outstanding under the
uncommitted letter of credit facilities. As of September 30, 2000, Valero's
debt-to-capitalization ratio was 43.5%, a decrease from 48.4% as of June 30,
2000 (with 20% of the aggregate liquidation amount of trust preferred securities
issued as part of the PEPS Units deemed to be debt for purposes of these
computations).
As discussed in Note 2 of Notes to Consolidated Financial Statements,
the Benicia Acquisition was completed in May and June of 2000 for a purchase
price of $895 million, plus approximately $150 million for refinery inventories
acquired in the transaction and certain other acquisition costs. Interim
financing for the acquisition was provided by a $600 million bank bridge loan
facility, borrowings under Valero's existing bank credit facilities, and an
interim lease arrangement for the Benicia Refinery's dock facility. The $600
million of borrowings under the bridge loan facility, which bore interest at
LIBOR plus an applicable margin, and approximately $128 million of the
borrowings under Valero's existing bank credit facilities were subsequently
repaid with the proceeds of the securities offerings described in Note 3. The
Service Station Assets were funded through, and the interim lease arrangement
for the dock facility was replaced with, a $155 million structured lease
arrangement. This structured lease, which is being accounted for as an operating
lease, has a remaining primary term of approximately five years.
During the first nine months of 2000, Valero expended approximately
$206 million for capital investments (excluding the cost of the Benicia
Acquisition), including capital expenditures of $131 million, deferred
turnaround and catalyst costs of $73 million and investments in joint ventures
of $2 million. The deferred turnaround and catalyst costs related primarily to
(i) a maintenance turnaround of the FCC unit and a crude unit at the Paulsboro
Refinery, (ii) a turnaround of the residfiner at the Texas City Refinery and
(iii) a turnaround of the hydrocracker and reformer units at the Corpus Christi
Refinery. For total year 2000, including amounts related to the Benicia Refinery
and the Service Station Assets, Valero currently expects to incur approximately
$200 million for capital expenditures and approximately $105 million for
deferred turnaround and catalyst costs. The capital expenditure estimate
includes approximately $15 million for projects related to environmental control
and protection (excluding costs related to a flue gas scrubber at the Texas City
Refinery which is being financed through a lease arrangement). Any major
upgrades in any of Valero's refineries would most likely require additional
expenditures to comply with environmental laws and regulations. However,
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31
because environmental laws and regulations are increasingly becoming more
stringent and new environmental laws and regulations are continuously being
enacted or proposed, Valero cannot predict with certainty the level of future
expenditures that will be required for environmental matters.
Under common stock repurchase programs approved by Valero's Board of
Directors, Valero repurchases shares of its common stock from time to time for
use in connection with its employee benefit plans and other general corporate
purposes. During the third quarter and first nine months of 2000, Valero
repurchased shares of its common stock under these programs at a cost of
approximately $31 million and $50 million, respectively. Thus far in the fourth
quarter of 2000 (through November 10), Valero has repurchased additional common
shares under these programs at a cost of approximately $10 million.
Valero believes it has sufficient funds from operations, and to the
extent necessary, from the public and private capital markets and bank markets,
to fund its ongoing operating requirements. Valero expects that, to the extent
necessary, it can raise additional funds from time to time through equity or
debt financings. However, there can be no assurances regarding the availability
of any future financings or whether such financings can be made available on
terms acceptable to Valero.
NEW ACCOUNTING PRONOUNCEMENTS
As discussed in Note 7 of Notes to Consolidated Financial Statements,
certain new financial accounting pronouncements have been issued by the FASB,
EITF and SEC which either have already been reflected in the accompanying
consolidated financial statements, or will become effective for Valero's
financial statements at various dates in the future. Except for FASB Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities," for
which the impact is still being quantified, and Statement No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," for which the impact has not yet been determined, the adoption of
these pronouncements has not had, or is not expected to have, a material effect
on Valero's consolidated financial statements.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COMMODITY PRICE RISK
Valero is exposed to market risks related to the volatility of crude
oil and refined product prices, as well as volatility in the price of natural
gas used in Valero's refining operations. In order to reduce the risks of these
price fluctuations, Valero uses derivative commodity instruments to hedge
certain refinery feedstock and refined product inventories. Valero also uses
derivative commodity instruments to hedge the price risk of anticipated
transactions such as anticipated feedstock, product and natural gas purchases,
product sales and refining operating margins. In addition, Valero uses
derivative commodity instruments for trading purposes using its fundamental and
technical analysis of market conditions to earn additional income.
The types of instruments used in Valero's hedging and trading
activities described above include futures, options, and swaps with third
parties. Valero's positions in derivative commodity instruments are monitored
and managed on a daily basis by a risk control group to ensure compliance with
Valero's stated risk management policy which has been approved by Valero's Board
of Directors.
In the tables below detailing Valero's open derivative commodity
instruments as of September 30, 2000, the total gain or (loss) on swaps is the
net of the fixed price payor and receiver fair value amounts, while the total
gain or (loss) on futures and options is (i) the excess of the fair value amount
over the contract amount for fixed price payor positions, combined with (ii) the
excess of the contract amount over the fair value amount for fixed price
receiver positions. Gains and losses on hedging activities are deferred and
recognized when the hedged transaction occurs while gains and losses on trading
activities are recognized currently.
HEDGING ACTIVITIES
The following table provides information about Valero's derivative
commodity instruments held to hedge refining inventories as of September 30,
2000 (which mature in 2000) (dollars in thousands, except amounts per barrel,
or bbl).
Mature in 2000
---------------------
Fixed Price
---------------------
Payor Receiver
-------- --------
Futures:
Volumes (Mbbls) ............................ 5,283 8,412
Weighted average price (per bbl) ........... $ 35.19 $ 34.66
Contract amount ............................ $185,928 $291,554
Fair value ................................. $179,750 $284,588
Options:
Volumes (Mbbls) ............................ -- 4,500
Weighted average strike price (per bbl) .... -- $ 4.58
Contract amount ............................ -- $ 2,791
Fair value ................................. -- $ 7,713
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The following table provides information about Valero's derivative
commodity instruments held to hedge anticipated feedstock and product purchases,
product sales and refining margins as of September 30, 2000 (which mature in
2000 or 2001) (dollars in thousands, except amounts per barrel). Volumes shown
for swaps represent notional volumes which are used to calculate amounts due
under the agreements.
Mature in 2000 Mature in 2001
------------------- -------------------
Fixed Price Fixed Price
------------------- -------------------
Payor Receiver Payor Receiver
-------- -------- -------- --------
Swaps:
Notional volumes (Mbbls) .................... 1,500 7,725 300 2,700
Weighted average pay price (per bbl) ........ $ 1.83 $ 5.58 $ 2.00 $ 3.55
Weighted average receive price (per bbl) .... $ 2.74 $ 4.19 $ 3.55 $ 3.11
Fair value .................................. $ 1,357 $(10,698) $ 465 $ (1,201)
Futures:
Volumes (Mbbls) ............................. 1,122 1,046 280 102
Weighted average price (per bbl) ............ $ 32.02 $ 32.27 $ 32.45 $ 31.90
Contract amount ............................. $ 35,924 $ 33,750 $ 9,086 $ 3,254
Fair value .................................. $ 35,677 $ 33,386 $ 9,782 $ 3,720
In addition to the above, as of September 30, 2000, Valero was the
fixed price payor under certain swap contracts held to hedge anticipated
purchases of refinery feedstocks and refined products that mature in 2002, have
notional volumes totaling approximately 7.5 million barrels, and have a weighted
average pay price of $20.11 per barrel. As of September 30, 2000, these swaps
had a weighted average receive price of $25.52 per barrel and a net unrecognized
fair value of approximately $63.7 million.
TRADING ACTIVITIES
The following table provides information about Valero's derivative
commodity instruments held or issued for trading purposes as of September 30,
2000 (which mature in 2000 or 2001) (dollars in thousands, except amounts per
barrel or per million British thermal units, or MMBtus). Volumes shown for swaps
represent notional volumes which are used to calculate amounts due under the
agreements.
Mature in 2000 Mature in 2001
--------------------- ----------------------
Fixed Price Fixed Price
--------------------- ---------------------
Payor Receiver Payor Receiver
--------- --------- --------- ---------
Swaps:
Notional volumes (Mbbls) ...................... 6,200 6,250 3,450 4,050
Weighted average pay price (per bbl) .......... $ 3.32 $ 6.66 $ 3.86 $ 4.58
Weighted average receive price (per bbl) ...... $ 6.51 $ 3.44 $ 5.07 $ 3.51
Fair value .................................... $ 19,797 $ (20,126) $ 4,194 $ (4,319)
Notional volumes (billion Btus, or BBtus) ..... 25,950 25,050 17,085 16,485
Weighted average pay price (per MMBtu) ........ $ 3.70 $ 4.07 $ 3.48 $ 3.77
Weighted average receive price (per MMBtu) .... $ 3.93 $ 3.84 $ 3.65 $ 3.60
Fair value .................................... $ 6,100 $ (5,762) $ 2,829 $ (2,684)
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34
Futures:
Volumes (Mbbls) ............................... 11,599 12,116 3,975 3,733
Weighted average price (per bbl) .............. $ 23.94 $ 25.08 $ 20.26 $ 19.10
Contract amount ............................... $ 277,710 $ 303,819 $ 80,544 $ 71,292
Fair value .................................... $ 378,528 $ 396,140 $ 117,715 $ 110,733
Volumes (BBtus) ............................... 10,040 9,730 8,250 8,250
Weighted average price (per MMBtu) ............ $ 4.29 $ 4.43 $ 4.50 $ 4.26
Contract amount ............................... $ 43,092 $ 43,098 $ 37,126 $ 35,160
Fair value .................................... $ 52,353 $ 50,745 $ 41,465 $ 41,465
Options:
Volumes (Mbbls) ............................... -- 150 -- --
Weighted average strike price (per barrel) .... -- $ 7.00 -- --
Contract amount ............................... -- $ 128 -- --
Fair value .................................... -- $ 45 -- --
INTEREST RATE RISK
Valero's primary market risk exposure for changes in interest rates
relates to its long-term debt obligations. Valero manages its exposure to
changing interest rates principally through the use of a combination of fixed
and floating rate debt and currently does not use derivative financial
instruments to manage such risk.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Valero Energy Corporation, et al. v. M.W. Kellogg, et al., 117th
Judicial District Court, Nueces County, Texas (filed July 11, 1986). In 1986,
Valero filed suit against M.W. Kellogg Company for damages arising from certain
alleged design and construction defects in connection with a major construction
project at the Corpus Christi Refinery. Ingersoll-Rand Company was added as a
defendant in 1989. In 1991, the trial court granted summary judgment against
Valero based in part on certain exculpatory provisions in various agreements
connected with the project. In 1993, the court of appeals affirmed the summary
judgment and the Texas Supreme Court denied review. Subsequent to the summary
judgment, Kellogg and Ingersoll-Rand brought indemnity claims against Valero
for attorneys' fees and expenses incurred in defending the original action. In
1996, the trial court rendered summary judgment against Kellogg and
Ingersoll-Rand based on procedural grounds, and the court of appeals affirmed
that ruling in 1997. However, in 1999, the Texas Supreme Court reversed the
court of appeals and remanded Kellogg's and Ingersoll-Rand's claims for
attorneys' fees and expenses to the trial court. The case went to trial in
August 2000. During trial, the claims of Ingersoll-Rand were settled for an
immaterial amount. The jury returned a verdict on Kellogg's claims that would
result in a judgment between $4.5 and $6.25 million, depending on the
calculation of prejudgment interest by the court. To date, no judgment has been
rendered. Any judgment will be appealed by Valero.
Berisha, et al. v. Amerada Hess Corp., et al., Case No.
00-CIV-1898-[SAS], United States District Court for the Southern District of New
York. This case was initially reported in Part II of Valero's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000. On May 24, 2000, Valero was
served with a complaint seeking to certify a class action which alleges that
numerous gasoline suppliers, including Valero, contaminated groundwater in the
State of New York with methyl tertiary butyl ether (MTBE). Valero has filed a
motion to dismiss the complaint based upon a failure to state a claim and based
upon federal preemption under the Clean Air Act. Early discovery has been
allowed by the judge and is proceeding. The Judicial Panel on Multidistrict
Litigation has consolidated this matter with two other related cases for
pretrial purposes. The cases are consolidated in the United States District
Court for the Southern District of New York.
Texas City Terminal Railway Company d/b/a Port of Texas City v.
Marathon Ashland Petroleum, LLC, et al., Civil Action No. G-00-239, United
States District Court for the Southern District of Texas (Galveston Division).
This case was initially reported in Part II of Valero's Quarterly Report on Form
10-Q for the quarter ended June 30, 2000. The April 28, 2000 complaint filed in
federal court by Texas City Railway Company was dismissed on September 6, 2000
pursuant to a tolling agreement. Texas City Railway Company had filed a
complaint alleging that several companies, including Valero, are liable under
the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA), other environmental laws and tort law theories for alleged
contamination of the plaintiff's marine loading and tankering facilities. The
parties are presently seeking to resolve the matter through mediation which is
expected to conclude in the first quarter of 2001.
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Environmental Protection Agency - Section 114 Information Request.
Earlier this year, the United States Environmental Protection Agency ("EPA")
issued a series of information requests to U.S. refiners pursuant to Section 114
of the Clean Air Act as part of an enforcement initiative. Like other refiners,
Valero received a Section 114 information request pertaining to all of its
refineries owned at that time. Valero has completed its response to the request
and has provided additional clarification requested by the EPA. Valero has not
been named in any proceeding. However, based in part upon recently announced
settlements and evaluation of its relative position, Valero expects total
penalties and related expenses of less than $5 million in connection with this
enforcement initiative. Valero's estimate of expenses to be incurred related to
this issue, which has been provided for in the accompanying consolidated
financial statements, is immaterial to its financial position and results of
operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
27.1* Financial Data Schedule (reporting financial information as of
and for the nine months ended September 30, 2000).
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* The Financial Data Schedule shall not be deemed "filed" for purposes of
Section 11 of the Securities Act of 1933 or Section 18 of the Securities
Exchange Act of 1934, and is included as an exhibit only to the electronic
filing of this Form 10-Q in accordance with Item 601(c) of Regulation S-K
and Section 401 of Regulation S-T.
(b) Reports on Form 8-K.
None.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By: /s/ John D. Gibbons
----------------------------
John D. Gibbons
Chief Financial Officer,
Vice President - Finance
(Duly Authorized Officer
and Principal Financial
and Accounting Officer)
Date: November 13, 2000
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27.1 Financial Data Schedule