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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 MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from__________to__________
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 April 30, 2001.
Number of
Shares
Title of Class Outstanding
-------------- -----------
Common Stock, $.01 Par Value 61,248,620
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2001 and December 31, 2000.................................... 3
Consolidated Statements of Income - for the Three Months Ended
March 31, 2001 and 2000........................................................................... 4
Consolidated Statements of Cash Flows - for the Three Months Ended
March 31, 2001 and 2000........................................................................... 5
Notes to Consolidated Financial Statements............................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................................. 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 27
PART II. OTHER INFORMATION................................................................................. 30
Item 1. Legal Proceedings................................................................................ 30
Item 6. Exhibits and Reports on Form 8-K................................................................. 30
SIGNATURE................................................................................................... 31
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
March 31,
2001 December 31,
(Unaudited) 2000
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments .......................................... $ 125,739 $ 14,596
Receivables, less allowance for doubtful accounts of
$5,588 (2001) and $5,612 (2000) ............................................ 586,647 585,892
Inventories .................................................................. 581,411 539,882
Current deferred income tax assets ........................................... 92,136 105,817
Prepaid expenses and other ................................................... 41,320 38,880
------------ ------------
1,427,253 1,285,067
------------ ------------
PROPERTY, PLANT AND EQUIPMENT - including
construction in progress of $210,046 (2001)
and $158,445 (2000), at cost ................................................. 3,549,783 3,481,117
Less: Accumulated depreciation ............................................ 836,236 804,437
------------ ------------
2,713,547 2,676,680
------------ ------------
DEFERRED CHARGES AND OTHER ASSETS .............................................. 418,822 345,957
------------ ------------
$ 4,559,622 $ 4,307,704
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt .............................................................. $ -- $ 27,000
Accounts payable ............................................................. 867,624 806,879
Accrued expenses ............................................................. 206,118 205,113
------------ ------------
1,073,742 1,038,992
------------ ------------
LONG-TERM DEBT ................................................................. 1,042,124 1,042,417
------------ ------------
DEFERRED INCOME TAXES .......................................................... 468,627 406,634
------------ ------------
DEFERRED CREDITS AND OTHER LIABILITIES ......................................... 97,915 120,106
------------ ------------
VALERO-OBLIGATED MANDATORILY REDEEMABLE
PREFERRED CAPITAL TRUST SECURITIES OF SUBSIDIARY
TRUST HOLDING SOLELY VALERO SENIOR NOTES ..................................... 172,500 172,500
------------ ------------
COMMON STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 150,000,000 shares authorized;
issued 62,311,166 (2001 and 2000) shares ................................... 623 623
Additional paid-in capital ................................................... 1,249,445 1,249,127
Retained earnings ............................................................ 452,763 321,566
Accumulated other comprehensive income - net gains on
cash flow hedges ........................................................... 42,665 --
Treasury stock, 1,295,001 (2001) and 1,472,698 (2000) shares, at cost ........ (40,782) (44,261)
------------ ------------
1,704,714 1,527,055
------------ ------------
$ 4,559,622 $ 4,307,704
============ ============
See Notes to Consolidated Financial Statements.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended
March 31,
-------------------------------
2001 2000
------------ ------------
OPERATING REVENUES ................................................... $ 3,769,288 $ 2,928,617
------------ ------------
COSTS AND EXPENSES:
Cost of sales and operating expenses ............................... 3,464,060 2,826,855
Selling and administrative expenses ................................ 36,370 20,155
Depreciation expense ............................................... 31,799 23,840
------------ ------------
Total ............................................................ 3,532,229 2,870,850
------------ ------------
OPERATING INCOME ..................................................... 237,059 57,767
OTHER INCOME (EXPENSE), NET .......................................... (318) 1,932
INTEREST AND DEBT EXPENSE:
Incurred ........................................................... (21,197) (14,147)
Capitalized ........................................................ 2,480 1,387
DISTRIBUTIONS ON PREFERRED SECURITIES OF
SUBSIDIARY TRUST ................................................... (3,342) --
------------ ------------
INCOME BEFORE INCOME TAXES ........................................... 214,682 46,939
INCOME TAX EXPENSE ................................................... 78,600 16,200
------------ ------------
NET INCOME ........................................................... $ 136,082 $ 30,739
============ ============
EARNINGS PER SHARE OF COMMON STOCK ................................... $ 2.23 $ .55
Weighted average common shares outstanding (in thousands) ........ 61,065 55,874
EARNINGS PER SHARE OF COMMON STOCK - ASSUMING DILUTION ............... $ 2.13 $ .54
Weighted average common shares outstanding (in thousands) ........ 63,861 57,234
DIVIDENDS PER SHARE OF COMMON STOCK .................................. $ .08 $ .08
See Notes to Consolidated Financial Statements.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
Three Months Ended
March 31,
-------------------------------
2001 2000
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................... $ 136,082 $ 30,739
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense ..................................................... 31,799 23,840
Amortization of deferred charges and other, net .......................... 23,396 8,758
Changes in current assets and current liabilities ........................ 29,297 (63,089)
Deferred income tax expense .............................................. 52,700 11,200
Changes in deferred items and other, net ................................. 3,559 (271)
------------ ------------
Net cash provided by operating activities .............................. 276,833 11,177
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ......................................................... (68,771) (25,229)
Deferred turnaround and catalyst costs ....................................... (67,544) (15,088)
Investment in joint ventures and other, net .................................. 198 (1,649)
------------ ------------
Net cash used in investing activities ...................................... (136,117) (41,966)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in short-term debt, net .................................. (27,000) 126,500
Long-term borrowings ......................................................... 18,311 60,000
Long-term debt reduction ..................................................... (18,500) (200,000)
Issuance of common stock in connection with employee benefit plans ........... 13,861 5,912
Common stock dividends ....................................................... (4,885) (4,469)
Purchase of treasury stock ................................................... (11,360) (8,732)
------------ ------------
Net cash used in financing activities ...................................... (29,573) (20,789)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY
CASH INVESTMENTS ............................................................. 111,143 (51,578)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD .......................................................... 14,596 60,087
------------ ------------
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD ................................................................ $ 125,739 $ 8,509
============ ============
See Notes to Consolidated Financial Statements.
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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 8 under "EITF
00-1."
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 Stations") and branded supplier relationships
with over 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 Stations was $895 million,
plus approximately $150 million for refinery inventories acquired in the
transaction and 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 Stations 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.
The Service Stations included 10 company-operated service stations and
approximately 70 lessee-dealer service stations, all of which are in the greater
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 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 has introduced its own brand of retail petroleum products in the San
Francisco Bay area and the dealers at these locations have entered into a
franchise
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 and enter into a fuels purchase agreement with Valero for a term of
15 years. Currently, dealers leasing 52 stations have elected to exercise their
purchase options.
The Benicia Acquisition was funded through a $400 million senior notes
offering, a $172.5 million offering of premium equity participating security
units ("PEPS Units"), a common stock offering totaling approximately $174.2
million and borrowings under Valero's existing bank credit facilities. In
addition, Valero entered into a $155 million, five-year structured lease
arrangement for the Service Stations and the Benicia Refinery's dock facility
which is being accounted for as an operating lease.
The acquisition of the Benicia Refinery and Distribution Assets was
accounted for under the purchase method of accounting. In accordance with the
purchase method, the accompanying Consolidated Balance Sheets as of March 31,
2001 and December 31, 2000 include 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 March 31, 2000 does
not include the results of operations related to the Benicia Acquisition.
The following unaudited pro forma financial information of Valero for
the three months ended March 31, 2000 assumes that the Benicia Acquisition and
the senior notes, PEPS Units and common stock offerings discussed above occurred
at the beginning of such period. This pro forma information is not necessarily
indicative of the results of future operations. (Dollars in thousands, except
per share amounts.)
Operating revenues............................................................. $3,243,416
Operating income .............................................................. 100,971
Net income .................................................................... 47,654
Earnings per common share...................................................... .77
Earnings per common share - assuming dilution.................................. .75
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. HUNTWAY ACQUISITION
On March 20, 2001, Valero and Huntway Refining Company executed a
definitive agreement under which Valero would acquire Huntway, a leading
supplier of asphalt in California, for a total cost of approximately $78
million. Under the terms of the definitive agreement, holders of Huntway common
stock would receive $1.90 per share in cash and Valero would
retire Huntway's outstanding debt and cash out outstanding stock options. The
transaction has been approved by the boards of directors of both companies.
Completion of the transaction is subject to the satisfaction of several
conditions, including obtaining approvals from Huntway's lenders whose debt is
to be retired and from Huntway's stockholders. Huntway will hold a special
meeting of stockholders on May 30, 2001 to vote on a proposal to approve the
transaction with closing anticipated to occur shortly thereafter.
Huntway owns and operates two California refineries at Benicia and
Wilmington, which primarily process California crude oil to produce liquid
asphalt for use in road construction and repair, primarily in California and
Nevada, as well as smaller amounts of gas oil, naphtha, kerosene distillate and
bunker fuels. The Huntway Benicia refinery, which is located adjacent to
Valero's Benicia refinery, has a throughput capacity of approximately 13,000
barrels per day. The Wilmington facility, which is located near Los Angeles,
has a throughput capacity of approximately 6,000 barrels per day. The Huntway
Benicia refinery has waterborne access, while both Huntway refineries have the
ability to receive crude or ship product via pipeline, truck rack, rail rack or
barge.
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 March 31, 2001, the
replacement cost of Valero's LIFO inventories exceeded their LIFO carrying
values by approximately $265 million. The cost of materials and supplies is
determined principally under the weighted average cost method. Inventories as of
March 31, 2001 and December 31, 2000 were as follows (in thousands):
March 31, December 31,
2001 2000
----------- -----------
Refinery feedstocks.......................................... $ 186,490 $ 142,522
Refined products and blendstocks............................. 329,763 332,653
Materials and supplies....................................... 65,158 64,707
----------- -----------
$ 581,411 $ 539,882
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
5. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net
income 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."
Three Months Ended
March 31,
------------------------
2001 2000
---------- -----------
Receivables, net......................................... $ 10,318 $ (31,015)
Inventories.............................................. (41,529) (132,809)
Prepaid expenses and other............................... (2,001) (9,057)
Accounts payable......................................... 60,402 115,666
Accrued expenses......................................... 2,107 (5,874)
---------- -----------
Total................................................ $ 29,297 $ (63,089)
========== ===========
Cash flows related to interest and income taxes were as follows (in
thousands):
Three Months Ended
March 31,
-----------------------
2001 2000
---------- ----------
Interest paid (net of amount capitalized)................ $ 9,315 $ 13,621
Income taxes paid........................................ 29,685 3,051
Income tax refunds received.............................. 24 --
6. LONG-TERM DEBT
In March 2001, Valero refinanced its $18.5 million of Series 1998
taxable, variable-rate Waste Disposal Revenue Bonds with tax-exempt, fixed-rate
bonds. These Series 2001 tax-exempt bonds have a fixed interest rate of 6.65%
and mature on April 1, 2032.
7. EARNINGS PER SHARE
The computation of basic and diluted per share amounts, as required by
the Financial Accounting Standards Board's ("FASB") Statement No. 128, is as
follows (dollars and shares in thousands, except per share amounts):
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Three Months Ended March 31,
--------------------------------------------------------------------
2001 2000
-------------------------------- --------------------------------
Per Per
Net Share Net Share
Income Shares Amount Income Shares Amount
-------- -------- -------- -------- -------- --------
Net income ....................................... $136,082 $ 30,739
======== ========
BASIC EARNINGS PER SHARE:
Net income available to
common stockholders ............................ $136,082 61,065 $ 2.23 $ 30,739 55,874 $ .55
======== ========
EFFECT OF DILUTIVE SECURITIES:
Stock options .................................... -- 1,714 -- 838
Performance and other benefit plan awards ........ -- 918 -- 522
PEPS units ....................................... -- 164 -- --
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE:
Net income available to
common stockholders
plus assumed conversions ....................... $136,082 63,861 $ 2.13 $ 30,739 57,234 $ .54
======== ======== ======== ======== ======== ========
8. NEW ACCOUNTING PRONOUNCEMENTS
FASB 140
In September 2000, the FASB issued Statement No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This statement replaced FASB 125 with the same name. FASB 140 revised the
standards for accounting for securitizations and other transfers of financial
assets and collateral and requires certain disclosures, but carried over most of
FASB 125's provisions without reconsideration. FASB 140 is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. In addition, certain provisions regarding the
recognition and reclassification of collateral and certain disclosures relating
to securitization transactions and collateral became effective for Valero's
financial statements for the year ended December 31, 2000. The adoption of this
statement with regard to the provisions for the recognition and reclassification
of collateral did not affect Valero's accompanying consolidated financial
statements. In addition, Valero believes that the adoption of this statement
with regard to the revised accounting standards effective for transactions
occurring after March 31, 2001 will not have a material effect on its
consolidated financial statements in the future.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
EITF 00-1
In May 2000, the FASB's Emerging Issues Task Force ("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 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 for the three months ended March 31, 2000
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 Statements of Income under "Other income (expense),
net."
FASB 133
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 FASB 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 FASB 133. FASB 133, as
amended, became effective for Valero's consolidated financial statements
beginning January 1, 2001. See Note 9 below for a detailed discussion of FASB
133 and its effect on Valero's accounting for its price risk management
activities.
9. PRICE RISK MANAGEMENT ACTIVITIES
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 its refining operations. In order to reduce the impact of this price
volatility, Valero enters into fair value hedges (see below under New Accounting
Pronouncement) using derivative commodity instruments to hedge its exposure to
changes in the fair value of a portion of its refinery feedstock and refined
product inventories and a portion of its unrecognized firm commitments to
purchase these inventories. In order to reduce the impact of price volatility on
certain forecasted transactions such as forecasted feedstock and natural gas
purchases and product sales, Valero enters into cash flow hedges (see below
under New Accounting Pronouncement)
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
using derivative commodity instruments to hedge its exposure to changes in the
cash flows of these forecasted transactions. Valero also uses derivative
commodity instruments to manage its exposure to price volatility on a portion of
its refined product inventories and on certain forecasted feedstock and refined
product purchases for which the changes in their fair value are reported
currently in earnings. Although these derivative instruments do not receive
hedge accounting treatment under FASB 133 (see below under New Accounting
Pronouncement), they are considered economic hedges as the impact on earnings is
the same as if hedge accounting had been applied. Finally, Valero uses
derivative commodity instruments for trading purposes using its fundamental and
technical analysis of market conditions to earn additional income.
The types of derivative commodity instruments used in Valero's hedging
and trading activities described above include futures 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.
NEW ACCOUNTING PRONOUNCEMENT
As discussed in Note 8, effective January 1, 2001, Valero adopted FASB
133 which 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 also requires that changes
in a derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met.
FASB 133 allows special hedge accounting for derivative instruments
designated and qualifying as a fair value hedge or a cash flow hedge. A fair
value hedge is a hedge of the exposure to changes in the fair value of a
recognized asset or liability, or of an unrecognized firm commitment,
attributable to a particular risk. A cash flow hedge is a hedge of the exposure
to variability in the cash flows of a recognized asset or liability, or of a
forecasted transaction, attributable to a particular risk. FASB 133 provides
that the gain or loss on a derivative instrument designated and qualifying as a
fair value hedge, as well as the offsetting loss or gain on the hedged item
attributable to the hedged risk, be recognized currently in earnings in the same
accounting period. FASB 133 also provides that the effective portion of the gain
or loss on a derivative instrument designated and qualifying as a cash flow
hedge be reported outside earnings as a component of other comprehensive income
and be reclassified into earnings in the same period or periods during which the
hedged forecasted transaction affects earnings. The remaining ineffective
portion of the gain or loss on the derivative instrument, if any, must be
recognized currently in earnings. FASB 133 requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting.
FASB 133 is not allowed to be applied retroactively to financial
statements of prior periods. The adoption of this statement has not resulted in
any significant changes in Valero's business practices,
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including its hedging and trading activities as described above; however,
various systems modifications have been required.
ACCOUNTING POLICIES
The accounting policies described below reflect the policies followed
by Valero with respect to its price risk management activities subsequent to the
adoption, effective January 1, 2001, of FASB 133.
At the time Valero enters into a derivative commodity instrument, the
derivative is designated as either a fair value hedge, a cash flow hedge, an
economic hedge or a trading instrument. For those derivatives designated as fair
value or cash flow hedges, Valero formally documents the hedging relationship
and its risk management objective and strategy for undertaking the hedge. This
documentation includes specific identification of the hedging instrument, the
hedged asset, liability, firm commitment, or forecasted transaction, the nature
of the risk being hedged, and the method Valero will use to assess the hedging
instrument's effectiveness in offsetting changes in fair value or cash flows
attributable to the hedged risk. Valero formally measures the effectiveness of
its fair value and cash flow hedging relationships both at the inception of the
hedge and on an ongoing basis using a method that is consistent with the risk
management strategy documented for each particular hedging relationship.
Valero accounts for its hedging relationships designated and qualifying
as fair value hedges or cash flow hedges in accordance with the requirements of
FASB 133 as discussed above. For Valero's economic hedging relationships, the
derivative commodity instrument is recorded at fair value, the gain or loss on
the derivative is recognized currently in earnings, and the gain or loss (i.e.,
change in fair value) on the hedged item attributable to the hedged risk is also
recognized currently in earnings as it was prior to the adoption of FASB 133.
For derivative commodity instruments entered into by Valero for trading
purposes, the derivative is recorded at fair value and the gain or loss on the
derivative is recognized currently in earnings.
Valero discontinues hedge accounting prospectively if (i) it is
determined that the derivative is no longer highly effective in offsetting
changes in fair value or cash flows attributable to the hedged risk, (ii) the
derivative expires or is sold, terminated, or exercised, or (iii) the derivative
is no longer designated as a hedging instrument. In any of these circumstances,
Valero may designate prospectively a new hedging relationship with a new hedging
instrument or, in the case of (i) or (iii), a different hedged item or hedged
transaction.
When a cash flow hedge is discontinued, Valero continues to report the
related net derivative gain or loss in accumulated other comprehensive income
until the hedged forecasted transaction affects earnings, at which time the net
derivative gain or loss is reclassified into earnings. However, if it is
probable that the forecasted transaction will not occur either by the end of the
originally specified time
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
period or within two months thereafter, Valero reclassifies the related
derivative gain or loss from accumulated other comprehensive income into
earnings immediately.
CURRENT PERIOD DISCLOSURES
The transition adjustments recorded by Valero in connection with its
adoption of FASB 133 had the following effect on its financial statements as of
January 1, 2001 (in thousands):
Amount
Balance sheet Debit (Credit)
- ------------- ------------
Inventories ...................................................... $ 3,215
Deferred charges, deferred credits and other ..................... 42,865
Accounts payable ................................................. (2,536)
Deferred income taxes ............................................ (15,240)
Other comprehensive income ....................................... (28,304)
During the three months ended March 31, 2001, the net loss recognized
in earnings representing the amount of hedge ineffectiveness was $3.4 million
for fair value hedges and $8.3 million for cash flow hedges. These amounts are
included in "Cost of sales and operating expenses" in the accompanying
Consolidated Statement of Income. Valero did not exclude any component of the
derivative instruments' gain or loss from the assessment of hedge effectiveness.
No amounts were recognized in earnings for hedged firm commitments no longer
qualifying as fair value hedges.
For cash flow hedges, gains and losses currently reported in
accumulated other comprehensive income will be reclassified into earnings when
the forecasted feedstock or natural gas purchase or product sale affects
earnings. The estimated amount of existing net gains included in accumulated
other comprehensive income as of March 31, 2001 that is expected to be
reclassified into earnings within the next 12 months is $7.5 million. As of
March 31, 2001, the maximum length of time over which Valero was hedging its
exposure to the variability in future cash flows for forecasted transactions was
17 months. During the three months ended March 31, 2001, no amounts were
reclassified from accumulated other comprehensive income into earnings as a
result of the discontinuance of cash flow hedge accounting.
10. COMPREHENSIVE INCOME
Comprehensive income consists of net income and other gains and losses
affecting stockholders' equity that, under generally accepted accounting
principles, are excluded from net income, such as foreign currency translation
adjustments, minimum pension liability adjustments, unrealized gains and
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15
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
losses on certain investments in debt and equity securities, and gains and
losses related to certain derivative instruments.
The following is a summary of Valero's comprehensive income for the
three months ended March 31, 2001 and 2000 (in thousands):
Three Months Ended
March 31,
------------------------
2001 2000
---------- ----------
Net income ..................................................................... $ 136,082 $ 30,739
---------- ----------
Other comprehensive income, net of tax:
Net gain on derivative instruments designated and qualifying as cash flow
hedging instruments:
FASB transition adjustment (net of tax expense of $15,240) .............. 28,304 --
Net gain arising during the period (net of tax expense of $5,119) ....... 9,506 --
Net amount of reclassifications into earnings (net of tax benefit
of $2,614) ............................................................ 4,855 --
---------- ----------
Total net gains on cash flow hedges ......................................... 42,665 --
---------- ----------
Other comprehensive income ..................................................... 42,665 --
---------- ----------
Comprehensive income ........................................................... $ 178,747 $ 30,739
========== ==========
11. 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 were 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 all times been the operator of the pipeline. The plaintiff
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. 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 was formally added to this proceeding. In January 2001, the
panel dismissed the plaintiff's legal malpractice claims. The arbitration
hearing began on
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
February 5, 2001 and is proceeding intermittently, with a conclusion expected in
this fiscal year. On February 5, 2001, Teco dismissed its claims against Valero,
but Valero continues to participate in the hearing. Although PG&E previously
acquired Teco and owned both Teco and Old Valero (prior to El Paso Corporation's
acquisition of Old Valero in December 2000), 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. El Paso Corporation
has assumed Old Valero's liability in this matter.
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 resulted
in a judgment of $6.3 million. Valero has appealed the judgment.
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 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, and Valero is in the
process of evaluating certain settlement possibilities.
On May 24, 2000, Valero was served with a complaint seeking to certify
a class action that alleged that numerous gasoline suppliers, including Valero,
contaminated groundwater in New York with MTBE. As a result of certain
procedural changes, on January 8, 2001 certain of these plaintiffs filed a new
master complaint to certify a class action, and on February 28, 2001 two other
plaintiffs joined the litigation by filing a related claim for individual
damages. The complaints allege that the gasoline suppliers produced and/or
distributed gasoline that is alleged to be defective because it contained MTBE.
The class action plaintiffs have not claimed a specific amount of monetary
damages, but seek several equitable remedies, including the institution of a
court-mandated well-testing program and the enjoining
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17
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
of further distribution of MTBE in New York. No class has been certified. The
two individual plaintiffs seek unquantified compensatory and punitive damages
and attorneys' fees; one of these plaintiffs seeks certain of the same equitable
remedies as the class action plaintiffs. These cases have been consolidated by
the Judicial Panel on Multidistrict Litigation with certain other MTBE class
action lawsuits for pretrial purposes. Valero has filed a motion to dismiss the
consolidated complaints based upon failure to state a claim and based upon
federal preemption under the Clean Air Act. Discovery has been allowed and is
proceeding.
In 2000, the EPA issued to a majority of refiners operating in the
United States a series of information requests pursuant to Section 114 of the
Clean Air Act as part of an enforcement initiative. Valero received a Section
114 information request pertaining to its refineries. 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 believes that any settlement with the EPA in this
matter may require various capital improvements or changes in operating
parameters or both at some or all of its refineries.
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 consolidated 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In the discussions that follow, all "per share" amounts are on a
diluted basis.
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 on and to 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;
o the level of foreign imports;
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19
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.
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20
RESULTS OF OPERATIONS
FIRST QUARTER 2001 COMPARED TO FIRST QUARTER 2000
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended March 31,
-----------------------------------------------------------
Change
------------------------
2001 2000(a) Amount %
----------- ----------- ----------- -----------
Operating revenues ............................................. $ 3,769,288 $ 2,928,617 $ 840,671 29%
Cost of sales .................................................. (3,247,490) (2,685,123) (562,367) (21)
Operating costs:
Cash (fixed and variable) .................................. (196,910) (130,442) (66,468) (51)
Depreciation and amortization .............................. (49,506) (33,762) (15,744) (47)
Selling and administrative expenses (including related
depreciation expense) ...................................... (38,323) (21,523) (16,800) (78)
----------- ----------- -----------
Total operating income ................................. $ 237,059 $ 57,767 $ 179,292 --(b)
=========== =========== ===========
Other income (expense), net .................................... $ (318) $ 1,932 $ (2,250) --(b)
Interest and debt expense, net ................................. $ (18,717) $ (12,760) $ (5,957) (47)
Distributions on preferred securities of subsidiary trust ...... $ (3,342) $ -- $ (3,342) --(b)
Income tax expense ............................................. $ (78,600) $ (16,200) $ (62,400) --(b)
Net income ..................................................... $ 136,082 $ 30,739 $ 105,343 --(b)
Earnings per share of common stock - assuming dilution ......... $ 2.13 $ .54 $ 1.59 --(b)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") ................................ $ 289,572 (c) $ 95,235 $ 194,337 --(b)
Ratio of EBITDA to interest incurred ........................... 11.8x(c) 6.7x 5.1x 76
- --------------------------------------------------------------------------------
(a) Excludes the operations related to the Benicia Refinery and the
Distribution Assets which were acquired May 15, 2000 and the operations
related to the Service Stations which were acquired June 15, 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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21
OPERATING HIGHLIGHTS
Three Months Ended March 31,
------------------------------------------------
Change
----------------------
2001 2000(a) Amount %
-------- -------- -------- --------
Sales volumes (Mbbls per day) .................... 1,255 1,002 253 25%
Throughput volumes (Mbbls per day) ............... 877 744 133 18
Average throughput margin per barrel ............. $ 6.61 $ 3.60 $ 3.01 84
Operating costs per barrel:
Cash (fixed and variable) .................... $ 2.49 $ 1.93 $ .56 29
Depreciation and amortization ................ .63 .50 .13 26
-------- -------- --------
Total operating costs per barrel ......... $ 3.12 $ 2.43 $ .69 28
======== ======== ========
Charges:
Crude oils:
Sour ..................................... 60% 52% 8% 15
Heavy sweet .............................. 5 9 (4) (44)
Light sweet .............................. 8 9 (1) (11)
-------- -------- --------
Total crude oils ..................... 73 70 3 4
High-sulfur residual fuel oil, or "resid" .... 4 4 -- --
Low-sulfur resid ............................. 3 4 (1) (25)
Other feedstocks and blendstocks ............. 20 22 (2) (9)
-------- -------- --------
Total charges ............................ 100% 100% --% --
======== ======== ========
Yields:
Gasolines and blendstocks .................... 53% 50% 3% 6
Distillates .................................. 27 30 (3) (10)
Petrochemicals ............................... 3 5 (2) (40)
Lubes and asphalts ........................... 2 3 (1) (33)
Other products ............................... 15 12 3 25
-------- -------- --------
Total yields ............................. 100% 100% --% --
======== ======== ========
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Three Months Ended March 31,
----------------------------------------------
Change
---------------------
2001 2000 Amount %
-------- -------- -------- --------
Feedstocks (at U.S. Gulf Coast, except as noted):
West Texas Intermediate, or "WTI," crude oil ...... $ 28.78 $ 28.90 $ (.12) --%
WTI less sour crude oil (b) ....................... $ 5.33 $ 2.38 $ 2.95 --(f)
WTI less ANS (U.S. West Coast) (c) ................ $ 3.75 $ 1.71 $ 2.04 --(f)
WTI less sweet crude oil (d) (e) .................. $ 0.35 $ (.68) $ 1.03 --(f)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI ............. $ 5.76 $ 4.27 $ 1.49 35
No. 2 fuel oil less WTI ....................... $ 3.47 $ 1.84 $ 1.63 89
Propylene less WTI ............................ $ 2.67 $ 2.32 $ .35 15
U.S. East Coast:
Conventional 87 gasoline less WTI ............. $ 5.28 $ 4.78 $ .50 10
No. 2 fuel oil less WTI ....................... $ 4.32 $ 5.46 $ (1.14) (21)
Lube oils less WTI ............................ $ 26.24 $ 7.98 $ 18.26 --(f)
U.S. West Coast (c):
CARB 87 gasoline less ANS ..................... $ 19.47 $ 11.23 $ 8.24 73
Low-sulfur diesel less ANS .................... $ 9.38 $ 8.04 $ 1.34 17
- --------------------------------------------------------------------------------
(a) Excludes the operations related to the Benicia Refinery and the
Distribution Assets which were acquired May 15, 2000 and the operations
related to the Service Stations which were acquired June 15, 2000.
(b) The market reference differential for sour crude oil is based on posted
prices for 50% Arab medium and 50% Arab light crude oils.
(c) The market reference differentials for the U.S. West Coast for the
three months ended March 31, 2000 are presented for informational
purposes only. The comparison is not relevant to Valero since the
Benicia Acquisition did not occur until the second quarter of 2000.
(d) The market reference differential for sweet crude oil is based on
posted prices for 50% light Louisiana sweet, or "LLS," and 50% Cusiana
crude oils, with LLS adjusted for backwardation.
(e) The market reference differential for the 2000 period has been restated
from the amount reported in Valero's March 31, 2000 Form 10-Q to
conform to the components used in the 2001 period.
(f) Percentage variance is greater than 100%.
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22
Valero reported net income for the first quarter of 2001 of $136.1
million, or $2.13 per share, compared to net income of $30.7 million, or $.54
per share, for the first quarter of 2000. The substantial increase in first
quarter results was due primarily to dramatically improved refining industry
fundamentals which resulted in a significant increase in throughput margins, and
an approximate $70 million contribution to operating income resulting from the
Benicia Acquisition completed in the second quarter of 2000. Partially
offsetting the increase in throughput margins for Valero's operations excluding
Benicia were the effects of refinery downtime related to scheduled turnarounds
at Valero's Texas City and Houston refineries, higher operating costs and
selling and administrative expenses, and an increase in income tax expense.
Operating revenues increased $840.7 million, or 29%, to $3.8 billion
during the first quarter of 2001 compared to the same period in 2000 due to a
25% increase in average daily sales volumes as well as a 4% increase in the
average sales price per barrel. The increase in average daily sales volumes was
due primarily to additional volumes attributable to the Benicia Acquisition and,
to a lesser extent, to an increase in the sale of feedstocks and products
purchased for resale. Average sales prices increased due to slightly higher
refined product prices and the effect of higher-priced sales of CARB gasoline
and other products in the California market in connection with the Benicia
Acquisition.
Operating income increased $179.3 million to $237.1 million during the
first quarter of 2001 compared to the first quarter of 2000 due in part to the
above-noted contribution from the Benicia Acquisition. Excluding the effect of
the Benicia Acquisition, operating income increased due to an approximate $145
million increase in total throughput margins (discussed below), partially offset
by an approximate $25 million increase in operating costs (including a $17
million increase in cash operating costs and an $8 million increase in
depreciation and amortization expense), and an approximate $10 million increase
in selling and administrative expenses (including related depreciation expense).
Cash operating costs were higher due primarily to higher fuel and electricity
costs attributable mainly to an increase in natural gas prices, an increase in
employee salaries, benefits and variable compensation, and higher maintenance
costs. Depreciation and amortization expense increased due primarily to an
increase in turnaround and catalyst amortization. Selling and administrative
expenses (including related depreciation expense) increased as a result of an
increase in employee salaries, benefits, variable compensation and other
employee-related costs, as well as an increase in professional and other fees.
Total throughput margins (operating revenues less cost of sales),
excluding the effect of the Benicia Acquisition, increased due to (i)
substantially higher feedstock discounts for sour crude oil resulting primarily
from increased supplies and lower demand as a result of significant
industry-wide refinery turnaround activity in the first quarter of 2001 as well
as the continuing industry-wide shift to sweet crude oils to meet lower sulfur
requirements for certain refined products, (ii) higher gasoline margins
resulting from continued strong demand, lower imports, and reduced gasoline
production due to the high level of first quarter 2001 turnarounds and lower
production of gasoline blending components derived from high-cost natural gas,
(iii) higher RFG premiums and oxygenate margins due to low inventories resulting
from reduced production and the tightening of fuel specifications in the U.S.
and Europe, (iv) significantly higher lube oil margins resulting mainly from
improved market conditions, (v) higher distillate margins resulting from
improved demand as a result of cooler weather and fuel switching due to higher
natural gas prices, combined with lower production due to refinery turnarounds,
and (vi) an increase in gains from trading activities. Partially offsetting the
increases in total throughput
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margins resulting from these factors were (i) the effect of higher natural gas,
hydrogen and methanol feedstock costs resulting from a significant increase in
natural gas prices, and (ii) the effect of lower throughput volumes resulting
primarily from the above-noted turnarounds at the Texas City and Houston
refineries in the first quarter of 2001.
Other income (expense), net, decreased by $2.3 million during the first
quarter of 2001 compared to the same period in 2000 due to reduced results from
Valero's 20% equity interest in the Javelina off-gas processing plant in Corpus
Christi attributable primarily to significantly higher natural gas feedstock
costs. Partially offsetting the reduced results from the Javelina plant was an
increase in interest income earned on excess cash balances and lower costs
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 million, or 47%, to $18.7
million in the first quarter of 2001 compared to the same period in 2000 due
primarily to the issuance of the senior notes in June 2000 in connection with
funding the Benicia Acquisition, partially offset by a decrease in bank
borrowings resulting from Valero's strong earnings and cash flow.
Income tax expense increased $62.4 million to $78.6 million during the
first quarter of 2001 compared to the same period in 2000 due primarily to the
significant increase in pre-tax income.
OUTLOOK
Thus far in the second quarter of 2001, margins across Valero's
business continue to remain strong. Gasoline margins on average are
significantly higher than already favorable first quarter 2001 levels due to
extremely low inventories and increasing demand, and are considerably higher
than the exceptional margins experienced in the second quarter of 2000.
Distillate margins thus far in the second quarter of 2001 are comparable with
first quarter 2001 margins and are substantially in excess of second quarter
2000 margins due to continuing low inventories, as well as strong demand
resulting mainly from fuel switching attributable to high natural gas prices.
With regard to other products, average lube oil margins have increased slightly
from strong first quarter 2001 levels and are significantly higher than second
quarter 2000 margins. Average premiums for RFG thus far in the second quarter of
2001 have increased substantially from first quarter 2001 levels and are higher
than strong second quarter 2000 premiums. Propylene margins thus far in the
second quarter of 2001, however, have been under extreme pressure and are
significantly below second quarter 2000 levels due to lower worldwide demand for
petrochemical derivatives and excess capacity.
Average discounts for sour crude oil thus far in the second quarter of
2001 have improved from already favorable first quarter 2001 levels, and are
approximately double the second quarter 2000 discounts. This improvement in sour
crude oil discounts is due to increasing supplies of heavier crudes and
continuing higher demand for sweeter crudes to meet the lower sulfur
requirements of the new stringent fuel specifications implemented in 2000. Sweet
crude oil continues to trade at a premium to WTI due to increasing demand for
sweet crudes resulting from the lower sulfur requirements noted above as well as
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 continue to increase in the future.
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24
In the first quarter of 2001, Valero completed an upgrade of two of the
crude units at the Texas City Refinery, which substantially improved their
efficiency and yields and increased net throughput capacity by approximately
20,000 barrels per day. Valero also upgraded the hydrocracker and other units at
the Benicia Refinery. This upgrade significantly increased the CARB gasoline
capacity of the refinery to approximately 120,000 barrels per day. Finally,
Valero completed the first major plantwide turnaround at the Houston Refinery
since Valero acquired it in 1997. This refinery is now capable of processing
nearly 100% sour crude oils which should substantially improve its economics as
a result of the continuing wide differential between sweet and sour crude oils.
In the third quarter of 2001, Valero intends to upgrade the lubricants crude
unit and lubricants plant at the Paulsboro Refinery. As refining margins merit,
Valero expects to continue making capital improvements at its facilities to
increase, among other things, throughput capacity, resid conversion, operational
efficiency and feedstock flexibility and to improve mechanical reliability. The
majority of these capital improvements are planned to be performed during
scheduled maintenance turnarounds.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities increased $265.7 million to
$276.8 million during the first quarter of 2001 compared to the same period in
2000 due to the significant increase in earnings discussed above under "Results
of Operations," and to a $92.4 million decrease in the amount of cash utilized
for working capital purposes, as detailed in Note 5 of Notes to Consolidated
Financial Statements. During the first quarter of 2001, $29.3 million of cash
was generated by changes in working capital due primarily to an increase in
accounts payable which more than offset a related increase in feedstock
inventory levels resulting from scheduled and unscheduled downtime at Valero's
Benicia, Texas City and Houston refineries. During the first quarter of 2000,
amounts needed by Valero to finance feedstock and refined product inventories
increased significantly due to higher inventory levels as well as an increase in
commodity prices from December 31, 1999 to March 31, 2000. Although this
increase in inventories was somewhat offset by an increase in accounts payable
resulting from the higher volume of inventory purchases, Valero incurred a net
increase in cash utilized for working capital purposes in the 2000 period of
$63.1 million. During the first quarter of 2001, cash and temporary cash
investments increased $111.1 million as cash provided by operating activities
and issuances of common stock related to Valero's benefit plans exceeded amounts
required to (i) fund capital expenditures and deferred turnaround and catalyst
costs, (ii) reduce short-term bank borrowings, (iii) repurchase shares of Valero
common stock and (iv) 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, 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. As of March 31, 2001, there were no outstanding borrowings under
this committed facility, while letters of credit outstanding were approximately
$114 million. Valero also currently has various uncommitted short-term bank
credit facilities, along with various uncommitted bank letter of credit
facilities. As of March 31, 2001, there were no outstanding
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borrowings under the short-term bank credit facilities, while letters of credit
totaling approximately $143 million were outstanding under the uncommitted
letter of credit facilities.
During the first quarter of 2001, Valero reduced its exposure to
increases in interest rates by refinancing its $18.5 million of taxable,
variable-rate industrial revenue bonds with tax-exempt fixed-rate bonds that
bear interest at 6.65%. See Note 6 of Notes to Consolidated Financial
Statements.
As of March 31, 2001, Valero's debt-to-capitalization ratio was 36.9%,
a decrease from 39.9% at December 31, 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).
During the first quarter of 2001, Valero expended approximately $136
million for capital investments, including capital expenditures of $69 million
and deferred turnaround and catalyst costs of $67 million. Capital expenditures
included approximately $7 million for projects related to environmental control
and protection (excluding approximately $4 million of costs related to a flue
gas scrubber at the Texas City Refinery which is being financed through a lease
arrangement). For total year 2001, Valero currently expects to incur
approximately $500 million for capital investments, including approximately $390
million for capital expenditures and approximately $110 million for deferred
turnaround and catalyst costs. The capital expenditure estimate includes
approximately $30 million for projects related to environmental control and
protection (excluding approximately $20 million of costs related to the Texas
City Refinery flue gas scrubber discussed above) and excludes the pending
acquisition of Huntway Refining Company discussed in Note 3 of Notes to
Consolidated Financial Statements. The total year 2001 capital expenditure
estimate also excludes anticipated payments related to earn-out contingency
agreements entered into in connection with (i) Valero's 1997 acquisition of
Basis Petroleum, Inc. from Salomon Inc and (ii) Valero's 1998 acquisition of the
Paulsboro Refinery from Mobil (now ExxonMobil), of $35 million and $20 million,
respectively. Any major upgrades in any of Valero's refineries would most likely
require additional expenditures to comply with environmental laws and
regulations. However, 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 first quarter of 2001, Valero repurchased shares of its
common stock under these programs at a cost of approximately $11 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.
On March 31, 2000, Valero filed a $1.3 billion universal shelf
registration statement on Form S-3, which was declared effective by the SEC on
May 30, 2000. Securities registered pursuant to this
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registration statement included common stock, preferred stock, debt securities
and warrants. The senior notes, PEPS Units and common stock offerings issued in
connection with funding the Benicia Acquisition were issued under this shelf
registration statement. Proceeds from any additional issuances under this shelf
registration statement, if any, are expected to be used for general corporate
purposes, including acquisitions, working capital requirements, capital
expenditures, repayment of debt or other business purposes.
NEW ACCOUNTING PRONOUNCEMENTS
As discussed in Note 8 of Notes to Consolidated Financial Statements,
certain new financial accounting pronouncements have been issued by the FASB and
EITF which either have already been reflected in the accompanying consolidated
financial statements, or will become effective for Valero's financial statements
in the future. Except for FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities," the effect of which is discussed in Note 9
of Notes to Consolidated Financial Statements, 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 its refining operations. In order to reduce the risks of these price
fluctuations, Valero uses derivative commodity instruments to hedge a portion of
its refinery feedstock and refined product inventories and a portion of its
unrecognized firm commitments to purchase these inventories (fair value hedges).
Valero also uses derivative commodity instruments to hedge the price risk of
forecasted transactions such as forecasted feedstock and natural gas purchases
and product sales (cash flow hedges). In addition, Valero uses derivative
commodity instruments to manage its exposure to price volatility on a portion of
its refined product inventories and on certain forecasted feedstock and refined
product purchases for which the changes in their fair value are reported
currently in earnings. Although these derivative instruments do not receive
hedge accounting treatment under FASB 133, they are considered economic hedges
as the impact on earnings is the same as if hedge accounting had been applied.
Finally, 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 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 March 31, 2001, 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 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. See Note 9 of Notes to Consolidated Financial Statements for a
discussion of Valero's accounting policies related to its derivative commodity
instrument transactions, including Valero's adoption of FASB Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities," effective
January 1, 2001.
HEDGING ACTIVITIES
The following table provides information about Valero's derivative
commodity instruments (i) designated and qualifying as fair value hedges and
held to hedge refining inventories and unrecognized firm commitments, and (ii)
used in economic hedging relationships and held to manage price volatility in
refined product inventories, as of March 31, 2001 (which mature in 2001)
(dollars in thousands, except amounts per barrel, or bbl).
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Mature in 2001
----------------------------
Fixed Price
----------------------------
Payor Receiver
------------ ------------
Futures:
Volumes (Mbbls) .......................... 11,475 16,254
Weighted average price (per bbl) ......... $ 27.61 $ 29.26
Contract amount .......................... $ 316,774 $ 475,667
Fair value ............................... $ 302,871 $ 459,693
The following table provides information about Valero's derivative
commodity instruments (i) designated and qualifying as cash flow hedges and held
to hedge forecasted feedstock purchases and product sales, and (ii) used in
economic hedging relationships and held to manage price volatility in forecasted
feedstock and refined product purchases, as of March 31, 2001 (which mature in
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 2001
----------------------------
Fixed Price
----------------------------
Payor Receiver
------------ ------------
Swaps:
Notional volumes (Mbbls) .......................... 600 9,825
Weighted average pay price (per bbl) .............. $ 1.33 $ 2.30
Weighted average receive price (per bbl) .......... $ 1.38 $ 3.42
Fair value (gain) ................................. $ 26 $ 11,046
Futures:
Volumes (Mbbls) ................................... 10,264 4,856
Weighted average price (per bbl) .................. $ 29.90 $ 28.40
Contract amount ................................... $ 306,919 $ 137,930
Fair value ........................................ $ 303,552 $ 135,807
In addition to the above, as of March 31, 2001, Valero was the fixed
price payor under certain swap contracts held to hedge forecasted 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 March 31, 2001, these swaps had a weighted
average receive price of $24.25 per barrel and a net after-tax gain recorded in
other comprehensive income of approximately $35.2 million.
TRADING ACTIVITIES
The following table provides information about Valero's derivative
commodity instruments held or issued for trading purposes as of March 31, 2001
(which mature in 2001 or 2002) (dollars in thousands, except amounts per barrel,
or amounts per million British thermal units, or MMBtus). Volumes shown for
swaps represent notional volumes which are used to calculate amounts due under
the agreements.
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Mature in 2001 Mature in 2002
---------------------------- ----------------------------
Fixed Price Fixed Price
---------------------------- ----------------------------
Payor Receiver Payor Receiver
------------ ------------ ------------ ------------
Swaps:
Notional volumes (Mbbls) .......................... 6,450 6,255 375 750
Weighted average pay price (per bbl) .............. $ 3.50 $ 3.00 $ 5.61 $ 3.92
Weighted average receive price (per bbl) .......... $ 3.76 $ 3.42 $ 5.63 $ 4.00
Fair value (gain) ................................. $ 1,637 $ 2,623 $ 8 $ 55
Notional volumes (BBtus) .......................... 5,920 5,920 -- --
Weighted average pay price (per MMBtu) ............ $ 3.76 $ 4.34 -- --
Weighted average receive price (per MMBtu) ........ $ 4.34 $ 3.68 -- --
Fair value (gain (loss)) .......................... $ 3,430 $ (3,919) -- --
Futures:
Volumes (Mbbls) ................................... 8,845 8,535 8 100
Weighted average price (per bbl) .................. $ 28.07 $ 28.78 $ 26.10 $ 23.33
Contract amount ................................... $ 248,279 $ 245,602 $ 209 $ 2,333
Fair value ........................................ $ 245,726 $ 244,474 $ 203 $ 2,467
Volumes (BBtus) ................................... 3,150 6,160 -- --
Weighted average price (per MMBtu) ................ $ 4.65 $ 4.99 -- --
Contract amount ................................... $ 14,634 $ 30,753 -- --
Fair value ........................................ $ 16,023 $ 31,590 -- --
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.
Berisha and O'Brien v. Amerada Hess Corporation, et al., Case No. MDL
1358, Master File C.A. No. 1:00-1898 (SAS), United States District Court for the
Southern District of New York. This case was filed on February 28, 2001 within
the consolidated litigation styled as La Susa, et al. v. Amerada Hess Corp., et
al. (filed January 8, 2001, and most recently reported in Valero's Annual Report
on Form 10-K for the year ended December 31, 2000). Like the plaintiffs in the
La Susa litigation, plaintiffs Berisha and O'Brien allege that numerous gasoline
suppliers, including Valero, contaminated groundwater in New York with MTBE. The
complaint alleges that the gasoline suppliers produced and/or distributed
gasoline that is alleged to be defective because it contained MTBE. Both
plaintiffs seek individual, unquantified compensatory and punitive damages and
attorneys' fees. In addition, O'Brien seeks several equitable remedies,
including the institution of a court-mandated well-testing program. This case
has been consolidated by the Judicial Panel on Multidistrict Litigation with
certain other MTBE class action lawsuits for pretrial purposes. Valero has filed
a motion to dismiss the consolidated complaints based upon a failure to state a
claim and based upon federal preemption under the Clean Air Act. Discovery has
been allowed and is proceeding.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
None.
(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
Executive Vice President and Chief
Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Date: May 3, 2001
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