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 JUNE 30, 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)
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 [ ]
Indicated below is the number of shares outstanding of the registrant's
only class of common stock, as of August 1, 2001.
Number of
Shares
Title of Class Outstanding
-------------- -----------
COMMON STOCK, $.01 PAR VALUE 60,677,549
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2
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 2001 and December 31, 2000............................ 3
Consolidated Statements of Income - for the Three Months Ended and
Six Months Ended June 30, 2001 and 2000................................................. 4
Consolidated Statements of Cash Flows - for the Six Months Ended
June 30, 2001 and 2000.................................................................. 5
Notes to Consolidated Financial Statements................................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................... 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................. 38
PART II. OTHER INFORMATION....................................................................... 41
Item 1. Legal Proceedings....................................................................... 41
Item 4. Submission of Matters to a Vote of Security Holders..................................... 42
Item 6. Exhibits and Reports on Form 8-K........................................................ 42
SIGNATURE.......................................................................................... 43
2
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
June 30,
2001 December 31,
(Unaudited) 2000
----------- ------------
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments ........................................... $ 42,459 $ 14,596
Receivables, less allowance for doubtful
accounts of $7,830 (2001) and $5,612 (2000) ................................. 676,894 585,892
Inventories ................................................................... 773,376 539,882
Current deferred income tax assets ............................................ 66,800 105,817
Prepaid expenses and other .................................................... 44,494 38,880
----------- -----------
1,604,023 1,285,067
----------- -----------
PROPERTY, PLANT AND EQUIPMENT - including
construction in progress of $261,404 (2001)
and $158,445 (2000), at cost .................................................. 4,043,066 3,481,117
Less: Accumulated depreciation ............................................. 869,696 804,437
----------- -----------
3,173,370 2,676,680
----------- -----------
DEFERRED CHARGES AND OTHER ASSETS ............................................... 436,822 345,957
----------- -----------
$ 5,214,215 $ 4,307,704
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt ............................................................... $ -- $ 27,000
Accounts payable .............................................................. 793,658 806,879
Accrued expenses .............................................................. 227,496 176,880
Income taxes payable .......................................................... 106,942 28,233
----------- -----------
1,128,096 1,038,992
----------- -----------
LONG-TERM DEBT .................................................................. 1,041,830 1,042,417
----------- -----------
CAPITAL LEASE OBLIGATIONS ....................................................... 285,831 --
----------- -----------
DEFERRED INCOME TAXES ........................................................... 492,872 406,634
----------- -----------
DEFERRED CREDITS AND OTHER LIABILITIES .......................................... 142,716 120,106
----------- -----------
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 .................................................... 1,249,892 1,249,127
Retained earnings ............................................................. 722,729 321,566
Accumulated other comprehensive income -- net gains on
cash flow hedges ............................................................ 29,720 --
Treasury stock, 1,440,609 (2001) and 1,472,698 (2000) shares, at cost ......... (52,594) (44,261)
----------- -----------
1,950,370 1,527,055
----------- -----------
$ 5,214,215 $ 4,307,704
=========== ===========
See Notes to Consolidated Financial Statements.
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4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
2001 2000 2001 2000
----------- ----------- ----------- -----------
OPERATING REVENUES ............................................... $ 4,499,108 $ 3,372,502 $ 8,268,396 $ 6,301,119
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of sales and operating expenses ......................... 3,947,509 3,163,485 7,411,569 5,990,340
Selling and administrative expenses .......................... 53,834 23,597 90,204 43,752
Depreciation expense ......................................... 33,482 27,028 65,281 50,868
----------- ----------- ----------- -----------
Total ..................................................... 4,034,825 3,214,110 7,567,054 6,084,960
----------- ----------- ----------- -----------
OPERATING INCOME ................................................. 464,283 158,392 701,342 216,159
OTHER INCOME (EXPENSE), NET ...................................... (743) 271 (1,061) 2,203
INTEREST AND DEBT EXPENSE:
Incurred ..................................................... (22,644) (24,510) (43,841) (38,657)
Capitalized .................................................. 2,109 2,037 4,589 3,424
DISTRIBUTIONS ON PREFERRED SECURITIES
OF SUBSIDIARY TRUST .......................................... (3,342) (110) (6,684) (110)
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES ....................................... 439,663 136,080 654,345 183,019
INCOME TAX EXPENSE ............................................... 164,800 48,400 243,400 64,600
----------- ----------- ----------- -----------
NET INCOME ....................................................... $ 274,863 $ 87,680 $ 410,945 $ 118,419
=========== =========== =========== ===========
EARNINGS PER SHARE OF COMMON STOCK ............................... $ 4.50 $ 1.56 $ 6.73 $ 2.11
Weighted average common shares outstanding (in thousands) .... 61,133 56,174 61,099 56,024
EARNINGS PER SHARE OF COMMON STOCK -
ASSUMING DILUTION ............................................ $ 4.23 $ 1.51 $ 6.35 $ 2.05
Weighted average common shares outstanding (in thousands) .... 64,943 58,113 64,738 57,676
DIVIDENDS PER SHARE OF COMMON STOCK .............................. $ .08 $ .08 $ .16 $ .16
See Notes to Consolidated Financial Statements.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
Six Months Ended
June 30,
---------------------------
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ........................................................................ $ 410,945 $ 118,419
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense .......................................................... 65,281 50,868
Amortization of deferred charges and other, net ............................... 50,716 21,011
Changes in current assets and current liabilities ............................. (98,997) (130,884)
Deferred income tax expense ................................................... 108,200 42,700
Changes in deferred items and other, net ...................................... (22,673) (8,407)
----------- -----------
Net cash provided by operating activities ................................... 513,472 93,707
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .............................................................. (137,744) (76,012)
Deferred turnaround and catalyst costs ............................................ (78,967) (59,776)
Purchase of inventories in connection with acquisition of El Paso facilities ...... (108,883) --
Acquisition of Huntway ............................................................ (75,325) --
Earn-out payment in connection with acquisition of Basis .......................... (35,000) --
Benicia Acquisition ............................................................... -- (889,730)
Investment in joint ventures and other, net ....................................... (2) (1,890)
----------- -----------
Net cash used in investing activities ........................................... (435,921) (1,027,408)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in short-term debt, net ....................................... (27,000) 185,000
Long-term borrowings, including proceeds from senior notes offering in 2000 ....... 18,095 1,754,306
Long-term debt reduction .......................................................... (18,500) (1,371,000)
Proceeds from common stock offering, net .......................................... -- 167,060
Issuance of common stock in connection with employee benefit plans ................ 23,097 9,563
Proceeds from offering of preferred securities of subsidiary trust, net ........... -- 167,193
Common stock dividends ............................................................ (9,782) (8,956)
Purchase of treasury stock ........................................................ (35,598) (19,173)
----------- -----------
Net cash provided by (used in) financing activities ............................. (49,688) 883,993
----------- -----------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY
CASH INVESTMENTS .................................................................. 27,863 (49,708)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD ............................................................... 14,596 60,087
----------- -----------
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD ..................................................................... $ 42,459 $ 10,379
=========== ===========
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.
2. PROPOSED MERGER WITH ULTRAMAR DIAMOND SHAMROCK
On May 7, 2001, Valero and Ultramar Diamond Shamrock Corporation ("UDS")
jointly announced that they had entered into an agreement and plan of merger,
dated as of May 6, 2001, under which UDS will merge with and into Valero, with
Valero as the surviving corporation. The boards of directors of both companies
have approved the merger, which is subject to regulatory approval and approval
by both companies' shareholders. Under the terms of the merger agreement, each
outstanding share of UDS common stock, with limited exceptions, will be
converted into the right to receive, at the shareholder's election but subject
to proration, either (i) cash, (ii) a number of shares of Valero common stock,
or (iii) a combination of cash and Valero stock, in each case having a value
equal to the sum of $27.50 and .614 shares of Valero common stock (valued at the
average closing Valero common stock price over a ten trading-day period ending
three days prior to the merger). Based on average per share prices for Valero
and UDS common stock for the ten trading-day period ending April 26, 2001, the
total consideration to be paid to UDS shareholders in the merger would have been
approximately $4 billion, representing an approximate 30% premium to the average
UDS share price. Depending on the average share price of Valero common stock for
the measurement period prior to closing, however, the total consideration to be
paid to UDS shareholders may be higher or lower than this amount. The merger is
expected to close in the fourth quarter of 2001.
UDS is an independent refiner and retailer of refined products and
convenience store merchandise in the central, southwest and northeast regions of
the United States and eastern Canada. UDS's operations consist of refineries,
convenience stores, pipelines and terminals, a home heating oil business, and
petrochemical and natural gas liquids operations. UDS owns and operates seven
refineries, including two in Texas, two in California and one each in Oklahoma,
Colorado, and Quebec, Canada, with a combined throughput capacity of
approximately 850,000 barrels per day. UDS markets refined products
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
and a broad range of convenience store merchandise through a network of
approximately 4,600 convenience stores under the Diamond Shamrock(R), Beacon(R),
Ultramar(R), and Total(R) brand names in the United States and eastern Canada.
UDS's Northeast operations also include the marketing of refined products
through 85 cardlocks and a retail home heating oil business that sells heating
oil to approximately 250,000 households.
Valero expects to finance the cash portion of the merger consideration,
currently estimated to be approximately $2 billion, with proceeds from a $1.5
billion bridge loan facility and borrowings under a new $1.5 billion revolving
bank credit facility. Valero anticipates finalizing both the bridge loan
facility and the revolving credit facility prior to completing the merger, but
expects that borrowing under those facilities will be simultaneous with and
contingent upon completion of the merger.
The bridge loan facility is expected to have a one year maturity at
interest rates and on other terms presently being negotiated. Valero currently
expects to repay the bridge loan facility after the merger via a combination of
proceeds from capital market issuances of debt securities and cash flow from
operations of the combined company.
Valero currently expects that the revolving bank credit facility
presently being negotiated will provide for commitments of $750 million for a
five-year term and $750 million for a 364-day term and, subject to the
commitment amounts and terms, provide for borrowings thereunder to be made at
various amounts, maturities and interest rates, at the option of Valero. Valero
expects the revolving credit facility will also be used after the merger to
finance the combined company's working capital and other cash requirements.
Valero currently expects to repay amounts borrowed under the credit facility
with cash flow from operations of the combined company.
If Valero is unable to finalize either or both of the above
negotiations, it could seek to negotiate with alternative lenders, undertake
capital market issuances of debt securities or a combination of those options.
Arrangement of financing for the cash portion of the merger consideration is not
a condition to closing the transaction.
On May 25, 2001, Valero filed a registration statement on Form S-4 with
the SEC, which was last amended on August 3, 2001 but has not yet been declared
effective, to register the shares of Valero common stock that may be issued or
become issuable to UDS shareholders in connection with the merger.
If and when completed, the merger will be accounted for under the
purchase method of accounting. Accordingly, the results of UDS's operations will
be included in the consolidated financial statements of Valero beginning on the
effective date of the transaction.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. ACQUISITIONS
HUNTWAY REFINING COMPANY
Effective June 1, 2001, Valero completed the acquisition of Huntway
Refining Company, a leading supplier of asphalt in California. 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 purchase
price, net of Huntway's cash balance on the date of acquisition, was
approximately $75 million and included payment to Huntway's common stockholders
of $1.90 per share, as well as amounts required to retire Huntway's outstanding
debt and satisfy payment obligations under outstanding stock options.
The acquisition of Huntway was accounted for under the purchase method
of accounting, with the purchase price allocated to the assets acquired and
liabilities assumed based on estimated fair values pending the completion of
independent appraisals and other evaluations. In accordance with the purchase
method, the accompanying Consolidated Statements of Income for the three months
ended and six months ended June 30, 2001 include the results of Huntway's
operations beginning June 1, 2001.
The preliminary purchase price allocation was as follows (in thousands):
Current assets ............................ $ 32,999
Property, plant and equipment ............. 58,020
Deferred charges and other assets ......... 278
Current liabilities ....................... (13,794)
Deferred income taxes and deferred credits
and other liabilities ................... (2,178)
--------
$ 75,325
========
EL PASO REFINERY AND RELATED PRODUCT LOGISTICS BUSINESS
Effective June 1, 2001, Valero completed the acquisition of El Paso
Corporation's Corpus Christi, Texas refinery and related product logistics
business through lease agreements entered into with certain wholly owned
subsidiaries of El Paso. The lease agreements, which are being accounted for as
capital leases, are for a term of 20 years and provide for Valero to make annual
lease payments of $18.5 million for the first two years and increased amounts
thereafter. Valero has an option to purchase the facilities for approximately
$294 million at the end of the second year of the lease, and for increasing
amounts in each succeeding year through the end of the lease term. As part of
the acquisition, Valero also purchased inventories for approximately $109
million and assumed certain environmental liabilities (see Note 11).
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The El Paso Corpus Christi refinery, which is located near Valero's
existing Corpus Christi refinery, is a high-complexity refinery capable of
processing approximately 110,000 barrels per day of heavy, high-sulfur crude
oil. Approximately 70% of the refinery's production is light products, including
conventional gasoline, diesel, jet fuel, petrochemicals, propane, butane and
light naphthas. In addition, the refinery produces multiple grades of asphalt
and petroleum coke. The product logistics facilities consist of three intrastate
common carrier pipelines and related terminal facilities that enable refined
products to be shipped from Corpus Christi to markets in Houston, San Antonio,
Victoria, and the Rio Grande Valley.
The acquisition of El Paso's Corpus Christi refinery and related product
logistics business was accounted for under the purchase method of accounting,
with the purchase price allocated to the assets acquired and liabilities assumed
based on estimated fair values pending the completion of independent appraisals
and other evaluations. The preliminary purchase price allocation was as follows:
inventories of approximately $109 million as noted above, property, plant and
equipment of approximately $324 million, and deferred credits and other
liabilities of approximately $38 million related primarily to an estimate of
assumed environmental liabilities as noted above. The inventories were purchased
with cash from operations while the remaining net assets were acquired through
capital lease obligations of approximately $286 million. The accompanying
Consolidated Statements of Income for the three months ended and six months
ended June 30, 2001 reflect the results of operations of the El Paso Corpus
Christi refinery and product logistics business beginning June 1, 2001.
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"). 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.
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 structured lease arrangement for
the Service Stations and the Benicia Refinery's dock facility. The structured
lease has a five-year non-cancelable lease term and is being accounted for as an
operating lease. After the non-cancelable lease term, the lease may be extended
by agreement of Valero and the lessor, or Valero may purchase the leased
properties under its purchase option described below or arrange for the sale of
the leased properties to one or more third parties. Valero has an option to
purchase all or a portion of the leased properties at any time during
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
the lease term for a price that approximates fair value. In connection with a
sale of the leased properties to one or more third parties, the lease provides
for a maximum residual value guarantee equal to 85% of the appraised value of
the leased properties at the end of the lease term, as determined at the
inception of the lease.
The Service Stations, which are leased by Valero under the structured
lease arrangement as noted above, included 10 company-operated service stations
and approximately 70 dealer-operated service stations subleased from Valero, all
of which are in the greater San Francisco Bay area. In July 2000, the dealers
were offered an option to purchase at fair value the stations that they were
leasing and enter into a new fuels purchase agreement with Valero for a term of
15 years. As a result, during the second quarter of 2001, 48 stations were
purchased by these dealers.
The acquisition of the Benicia Refinery and Distribution Assets was
accounted for under the purchase method of accounting, with the purchase price
allocated to the assets acquired and liabilities assumed based on estimated fair
values as determined by independent appraisals and other valuations. In
accordance with the purchase method, the accompanying Consolidated Statements of
Income for the three months ended and six months ended June 30, 2000 include 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 Stations beginning June 16, 2000.
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information of Valero for
the six months ended June 30, 2001 and 2000 assumes that the acquisition of
Huntway and the acquisition of the El Paso Corpus Christi refinery and related
product logistics business occurred at the beginning of 2001 and 2000,
respectively, and that the Benicia Acquisition and related senior notes, PEPS
Units and common stock offerings occurred at the beginning of 2000. This pro
forma information is not necessarily indicative of the results of future
operations. (Dollars in thousands, except per share amounts.)
Six Months Ended
June 30,
------------------------
2001 2000
---------- ----------
Operating revenues .................................... $8,773,240 $7,712,898
Operating income ...................................... 737,450 234,800
Net income ............................................ 427,471 104,433
Earnings per common share ............................. 7.00 1.69
Earnings per common share - assuming dilution ......... 6.60 1.64
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11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 June 30, 2001, the
replacement cost of Valero's LIFO inventories exceeded their LIFO carrying
values by approximately $63 million. The cost of materials and supplies is
determined principally under the weighted average cost method. Inventories as of
June 30, 2001 and December 31, 2000 were as follows (in thousands):
June 30, December 31,
2001 2000
-------- ------------
Refinery feedstocks ...................... $249,884 $142,522
Refined products and blendstocks ......... 445,596 332,653
Materials and supplies ................... 77,896 64,707
-------- --------
$773,376 $539,882
======== ========
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." Also excluded from the
following amounts are the current assets and current liabilities acquired in
connection with the Huntway and El Paso transactions in 2001 and the Benicia
acquisition in 2000 (see Note 3 above), all of which are reflected separately in
the Statement of Cash Flows.
Six Months Ended
June 30,
--------------------------
2001 2000
--------- ---------
Receivables, net ................... $ (74,989) $(279,331)
Inventories ........................ (106,328) (17,068)
Prepaid expenses and other ......... (16,911) (13,333)
Accounts payable ................... (33,103) 115,063
Accrued expenses ................... 45,466 55,727
Income taxes payable ............... 86,868 8,058
--------- ---------
Total .......................... $ (98,997) $(130,884)
========= =========
11
12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Cash flows related to interest and income taxes were as follows (in
thousands):
Six Months Ended
June 30,
---------------------
2001 2000
------- -------
Interest paid (net of amount capitalized) ......... $36,127 $32,993
Income taxes paid ................................. 50,209 13,495
Income tax refunds received ....................... 1,906 333
Noncash investing and financing activities for the six months ended June
30, 2001 included increases to property, plant and equipment, deferred credits
and other liabilities, and capital lease obligations resulting from the
acquisition of the El Paso Corpus Christi refinery and related product logistics
business as described above in Note 3.
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):
Three Months Ended June 30,
-------------------------------------------------------------------------------
2001 2000
------------------------------------- -------------------------------------
Per Per
Net Share Net Share
Income Shares Amount Income Shares Amount
--------- --------- --------- --------- --------- ---------
Net income ................................... $ 274,863 $ 87,680
========= =========
BASIC EARNINGS PER SHARE:
Net income available to
common stockholders ........................ $ 274,863 61,133 $ 4.50 $ 87,680 56,174 $ 1.56
========= =========
EFFECT OF DILUTIVE SECURITIES:
Stock options ................................ -- 2,108 -- 1,400
Performance and other benefit plan awards .... -- 933 -- 539
PEPS units ................................... -- 769 -- --
--------- --------- --------- ---------
DILUTED EARNINGS PER SHARE:
Net income available to
common stockholders
plus assumed conversions ................... $ 274,863 64,943 $ 4.23 $ 87,680 58,113 $ 1.51
========= ========= ========= ========= ========= =========
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13
Six Months Ended June 30,
-------------------------------------------------------------------------------
2001 2000
------------------------------------- -------------------------------------
Per Per
Net Share Net Share
Income Shares Amount Income Shares Amount
--------- --------- --------- --------- --------- ---------
Net income ................................... $ 410,945 $ 118,419
========= =========
BASIC EARNINGS PER SHARE:
Net income available to
common stockholders ........................ $ 410,945 61,099 $ 6.73 $ 118,419 56,024 $ 2.11
========= =========
EFFECT OF DILUTIVE SECURITIES:
Stock options ................................ -- 1,944 -- 1,121
Performance and other benefit plan awards .... -- 926 -- 531
PEPS units ................................... -- 769 -- --
--------- --------- --------- ---------
DILUTED EARNINGS PER SHARE:
Net income available to
common stockholders
plus assumed conversions ................... $ 410,945 64,738 $ 6.35 $ 118,419 57,676 $ 2.05
========= ========= ========= ========= ========= =========
8. NEW ACCOUNTING PRONOUNCEMENTS
FASB 143
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." FASB 143 requires entities to record the fair value of
a liability for an asset retirement obligation in the period in which it is
incurred. The statement requires that the amount recorded as a liability be
capitalized by increasing the carrying amount of the related long-lived asset.
Subsequent to initial measurement, the liability is accreted to the ultimate
amount anticipated to be paid, and is also adjusted for revisions to the timing
or amount of estimated cash flows. The capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or loss
upon settlement. FASB 143 will be effective for Valero's financial statements
beginning January 1, 2003, with earlier application encouraged. Valero is
currently evaluating the impact on its financial statements of adopting this
statement.
FASB 142
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other
Intangible Assets." This statement, which supersedes APB Opinion No. 17,
"Intangible Assets," provides that goodwill and other intangible assets that
have indefinite useful lives will not be amortized but instead will be tested at
least annually for impairment. Intangible assets that have finite useful lives
will continue to be amortized over their useful lives, but such lives will not
be limited by an arbitrary ceiling. The statement provides specific guidance for
testing goodwill and other nonamortized intangible assets for impairment.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Additionally, the statement requires certain disclosures about goodwill and
other intangible assets subsequent to their acquisition, including changes in
the carrying amount of goodwill from period to period, the carrying amount of
intangible assets by major intangible asset class for those assets subject to
amortization and for those not subject to amortization, and the estimated
intangible asset amortization expense for the next five years. The provisions of
this statement must be applied in Valero's financial statements beginning
January 1, 2002, except that any goodwill and other intangible assets acquired
after June 30, 2001 will be subject immediately to the amortization provisions
of this statement. Since Valero does not currently have any goodwill or other
intangible assets with indefinite useful lives recognized in its financial
statements, the adoption of this statement will not affect its existing
consolidated financial statements. Any goodwill or other intangible assets that
may be acquired in connection with Valero's proposed merger with UDS described
in Note 2 will be accounted for in accordance with the provisions of this
statement. Accordingly, any goodwill that may be recognized will not be
amortized.
FASB 141
Also in June 2001, the FASB issued Statement No. 141, "Business
Combinations." This statement, which supersedes APB Opinion No. 16, "Business
Combinations" and FASB Statement No. 38, "Accounting for Preacquisition
Contingencies of Purchased Enterprises," requires that all business combinations
be accounted for by the purchase method. FASB 141 also requires that acquired
intangible assets should be recognized as assets apart from goodwill if they
meet one of two specified criteria. Additionally, the statement adds certain
disclosure requirements to those required by APB 16, including disclosure of the
primary reasons for the business combination and the allocation of the purchase
price paid to the assets acquired and liabilities assumed by major balance sheet
caption. This statement is required to be applied to all business combinations
initiated after June 30, 2001 and to all business combinations accounted for
using the purchase method for which the date of acquisition is July 1, 2001 or
later. As described in Note 2, Valero's proposed merger with UDS, if completed,
will be accounted for under the purchase method of accounting.
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 did not have a material effect on Valero's consolidated financial
statements.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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) using derivative commodity instruments to
hedge its exposure to changes in the cash flows of these forecasted
transactions. 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
that do not receive hedge accounting treatment under FASB 133 (see below under
New Accounting Pronouncement). These derivative instruments are considered
economic hedges for which changes in their fair value are reported currently in
earnings. 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 swaps, futures and options.
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
15
16
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, 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.
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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 and the gain or loss
on the derivative is recognized currently in earnings. 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 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, net of tax ............... (28,304)
During the three months and six months ended June 30, 2001, the net loss
recognized in earnings representing the amount of hedge ineffectiveness was $3.0
million and $6.4 million, respectively, for fair value hedges and $7.6 million
and $15.9 million, respectively, for cash flow hedges. These amounts are
included in "Cost of sales and operating expenses" in the accompanying
Consolidated Statements of Income. Valero did not exclude any component of the
derivative instruments' gain or loss from the
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 losses included in accumulated other
comprehensive income as of June 30, 2001 that is expected to be reclassified
into earnings within the next 12 months is $9.0 million. As of June 30, 2001,
the maximum length of time over which Valero was hedging its exposure to the
variability in future cash flows for forecasted transactions was 14 months.
During the three months and six months ended June 30, 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 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 and six months ended June 30, 2001 and 2000 (in thousands):
Three Months Ended
June 30,
------------------------
2001 2000
--------- ---------
Net income ............................................................................ $ 274,863 $ 87,680
--------- ---------
Other comprehensive loss, net of tax benefit:
Net loss on derivative instruments designated and qualifying as cash flow
hedging instruments:
Net loss arising during the
period (net of tax benefit of $8,288) ..................................... (15,391) --
Net amount of reclassifications into
earnings (net of tax benefit of $1,317) .................................. 2,446 --
--------- ---------
Total net loss on cash flow hedges ................................................ (12,945) --
--------- ---------
Other comprehensive loss .............................................................. (12,945) --
--------- ---------
Comprehensive income .................................................................. $ 261,918 $ 87,680
========= =========
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Six Months Ended
June 30,
------------------------
2001 2000
--------- ---------
Net income ............................................................................ $ 410,945 $ 118,419
--------- ---------
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 loss arising during the
period (net of tax benefit of $3,169) .................................... (5,885) --
Net amount of reclassifications into
earnings (net of tax benefit of $3,931) .................................. 7,301 --
--------- ---------
Total net gains on cash flow hedges ............................................... 29,720 --
--------- ---------
Other comprehensive income ............................................................ 29,720 --
--------- ---------
Comprehensive income .................................................................. $ 440,665 $ 118,419
========= =========
11. ENVIRONMENTAL MATTERS
Liabilities for future remediation costs are recorded when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Other than for assessments, the timing and magnitude of these
accruals are generally based on the completion of investigations or other
studies or a commitment to a formal plan of action. Environmental liabilities
are based on best estimates of probable undiscounted future costs using
currently available technology and applying current regulations, as well as
Valero's own internal environmental policies.
In connection with Valero's acquisition of El Paso Corporation's Corpus
Christi refinery and product logistics business described in Note 3, Valero
assumed all environmental liabilities related to the facilities with certain
exceptions. El Paso retained liabilities for, and agreed to indemnify Valero
against (a) all environmental claims and costs related to offsite hazardous
materials on or under certain adjacent properties, and all claims and costs
pertaining to offsite environmental conditions arising under the requirements of
an agreed final judgment dated April 1, 1998 between the State of Texas and
Coastal Refining and Marketing, Inc. (a subsidiary of El Paso), (b) any
environmental claim or cost related to the transportation or offsite disposal of
any hazardous substance related to the facilities prior to June 1, 2001, (c)
bodily injury and property damage resulting from exposure to or contamination by
hazardous materials arising from El Paso's operation and use of the facilities
prior to June 1, 2001, and (d) environmental claims and costs relating to the
presence of hazardous materials resulting from El Paso's continued use of its
assets that are located at or adjacent to the site of the facilities leased by
Valero. El Paso also retained liabilities for all third-party claims relating
to or arising out of the operation of the refinery prior to June 1, 2001 and for
any pre-existing orders, judgments or citations that El Paso failed to disclose
prior to June 1, 2001. Valero's assumed liabilities include certain
environmental remediation obligations relating primarily to soil and groundwater
contamination at the leased facilities. As of
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
June 30, 2001, approximately $32 million has been accrued in "Deferred credits
and other liabilities" representing an estimate of the costs to be incurred in
connection with Valero's assumption of these environmental liabilities.
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.
In connection with the Benicia Acquisition, Valero assumed all
environmental liabilities of ExxonMobil related to the acquired assets with
certain exceptions. Valero's assumed liabilities include remediation obligations
relating primarily to clean-up costs associated with refinery and terminal soil
and groundwater contamination. As of June 30, 2001, approximately $2 million had
been accrued in "Deferred credits and other liabilities" in connection with
Valero's assumption of these environmental liabilities.
In connection with the acquisition of the Paulsboro refinery, Mobil Oil
Corporation (now ExxonMobil) agreed to indemnify Valero for certain
environmental matters and conditions existing on or prior to the acquisition
date and Valero agreed to assume Mobil's environmental liabilities, with certain
limited exceptions. Valero's assumed liabilities include remediation obligations
to the New Jersey Department of Environmental Protection relating primarily to
clean-up costs associated with groundwater contamination, landfill closure and
post-closure monitoring costs, and tank farm spill prevention costs. As of June
30, 2001, approximately $18 million is included in "Accrued expenses" and
"Deferred credits and other liabilities" representing Valero's best estimate of
its remaining costs to be borne related to these remediation obligations. The
majority of these costs are expected to be incurred in relatively level amounts
over the next 17 years.
In connection with the acquisition of Basis Petroleum, Inc. from Salomon
Inc in 1997, Valero received $9.5 million from Salomon in settlement of certain
contingent environmental obligations previously assumed by Salomon, and recorded
an accrual for the amount received. As of June 30, 2001, approximately $5.6
million of this accrual remained outstanding.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Valero believes that it has adequately provided for its environmental
exposures with the accruals referred to above. These liabilities have not been
reduced by possible recoveries from insurance carriers or other third parties.
Environmental liabilities are difficult to assess and estimate due to unknown
factors such as the magnitude of possible contamination, the timing and extent
of remediation, the determination of Valero's liability in proportion to other
parties, improvements in cleanup technologies, and the extent to which
environmental laws and regulations may change in the future. Although
environmental costs may have a significant impact on results of operations for a
single period, Valero believes that these costs will not have a material adverse
effect on its financial position.
12. 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 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 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.
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 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.
On May 14, 2001, the City of Dallas added Valero as a named defendant in
a suit filed previously against Explorer Pipeline Company, Inc. and certain
other refiners and suppliers who transport gasoline
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
through Explorer's petroleum products pipeline in North Texas. On March 9, 2000,
Explorer's pipeline ruptured and discharged gasoline into East Caddo Creek in
Hunt County, Texas. The plaintiff alleges that its source of water supply from
Lake Tawakoni (located approximately 28 miles from the site of the pipeline
rupture) was contaminated by gasoline containing MTBE causing the plaintiff to
discontinue the use of water from Lake Tawakoni as a source of water supply, and
requiring the construction of an emergency water supply pipeline from another
source. The plaintiff asserts causes of action for negligence, nuisance, strict
product liability, and gross negligence, and seeks the recovery of an
unspecified amount of actual and punitive damages, including costs for the
construction of the alternate supply pipeline. In a related matter, on July 3,
2001, Valero received a notice from several residents of Hunt County, Texas, of
their intent to commence a citizen's suit under the Resource Conservation and
Recovery Act to require an investigation and remediation of the rupture site.
Valero has not been served with a citation in the proposed citizen's suit.
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.
13. SUBSEQUENT EVENTS
On July 19, 2001, Valero's Board of Directors declared a regular
quarterly cash dividend of $.08 per common share payable September 12, 2001, to
holders of record at the close of business on August 15, 2001.
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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, including without limitation the discussion below under
the heading "Results of Operations - Outlook," 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:
- - the proposed merger with UDS;
- - future refining margins, including gasoline and heating oil margins;
- - expectations regarding feedstock costs, including crude oil discounts,
and operating costs;
- - anticipated levels of crude oil and refined product inventories;
- - 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;
- - anticipated trends in the supply and demand for crude oil feedstocks and
refined products in the United States and elsewhere;
- - expectations regarding environmental and other regulatory initiatives;
and
- - 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:
- - the domestic and foreign supplies of refined products such as gasoline,
diesel, heating oil and petrochemicals;
- - the domestic and foreign supplies of crude oil and other feedstocks;
- - the ability of the members of the Organization of Petroleum Exporting
Countries to agree on and to maintain oil price and production controls;
- - the level of consumer demand, including seasonal fluctuations;
- - refinery overcapacity or undercapacity;
- - the actions taken by competitors, including both pricing and the
expansion and retirement of refining capacity in response to market
conditions;
- - environmental and other regulations at both the state and federal levels
and in foreign countries;
24
25
- - political conditions in oil producing regions, including the Middle
East;
- - the level of foreign imports;
- - accidents or other unscheduled shutdowns affecting Valero's plants,
machinery, pipelines or equipment, or those of Valero's suppliers or
customers;
- - changes in the cost or availability of transportation for feedstocks and
refined products;
- - the price, availability and acceptance of alternative fuels and
alternative-fuel vehicles;
- - cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such
projects;
- - irregular weather, which can unforeseeably affect the price or
availability of feedstocks and refined products;
- - rulings, judgments, or settlements in litigation or other legal or
regulatory matters, including unexpected environmental remediation costs
in excess of any reserves;
- - the introduction or enactment of federal or state legislation which may
adversely affect Valero's business or operations;
- - changes in the credit ratings assigned to Valero's debt securities and
trade credit; and
- - 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.
25
26
RESULTS OF OPERATIONS
SECOND QUARTER 2001 COMPARED TO SECOND QUARTER 2000
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended June 30,
--------------------------------------------------------------
Change
----------------------------
2001 (a) 2000 (b) Amount %
----------- ----------- ----------- -----------
Operating revenues ...................................... $ 4,499,108 $ 3,372,502 $ 1,126,606 33%
Cost of sales ........................................... (3,705,759) (2,996,111) (709,648) (24)
Operating costs:
Cash (fixed and variable) ........................... (219,405) (156,121) (63,284) (41)
Depreciation and amortization ....................... (53,798) (36,785) (17,013) (46)
Selling and administrative expenses
(including related depreciation expense) ............ (55,863) (25,093) (30,770) --(c)
----------- ----------- -----------
Total operating income .......................... $ 464,283 $ 158,392 $ 305,891 --(c)
=========== =========== ===========
Other income (expense), net ............................. $ (743) $ 271 $ (1,014) --(c)
Interest and debt expense, net .......................... $ (20,535) $ (22,473) $ 1,938 9
Distributions on preferred securities of subsidiary trust $ (3,342) $ (110) $ (3,232) --(c)
Income tax expense ...................................... $ (164,800) $ (48,400) $ (116,400) --(c)
Net income .............................................. $ 274,863 $ 87,680 $ 187,183 --(c)
Earnings per share of common stock - assuming dilution .. $ 4.23 $ 1.51 $ 2.72 --(c)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") (d) ..................... $ 521,148 $ 197,705 $ 323,443 --(c)
Ratio of EBITDA to interest incurred (d) ................ 20.1x 8.0x 12.1x --(c)
- -------------------
(a) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and product logistics business beginning
June 1, 2001.
(b) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Stations beginning June 16, 2000.
(c) Percentage variance is greater than 100%.
(d) For purposes of this calculation, distributions on preferred securities
of subsidiary trust are included in interest incurred.
26
27
OPERATING HIGHLIGHTS
Three Months Ended June 30,
----------------------------------------------------
Change
---------------------
2001 (a) 2000 (b) Amount %
-------- -------- ------ -----
Sales volumes (Mbbls per day) ............... 1,418 1,086 332 31%
Throughput volumes (Mbbls per day) .......... 1,045 820 225 27
Average throughput margin per barrel ........ $8.34 $5.04 $3.30 65
Operating costs per barrel:
Cash (fixed and variable) ............... $2.30 $2.10 $ .20 10
Depreciation and amortization ........... .56 .49 .07 14
----- ----- -----
Total operating costs per barrel .... $2.86 $2.59 $ .27 10
===== ===== =====
Charges:
Crude oils:
Sour ................................ 62% 51% 11% 22
Heavy sweet ......................... 4 11 (7) (64)
Light sweet ......................... 7 8 (1) (13)
----- ----- -----
Total crude oils ................ 73 70 3 4
High-sulfur residual fuel oil, or "resid" 4 3 1 33
Low-sulfur resid ........................ 5 4 1 25
Other feedstocks and blendstocks ........ 18 23 (5) (22)
----- ----- -----
Total charges ....................... 100% 100% -% --
===== ===== =====
Yields:
Gasolines and blendstocks ............... 54% 52% 2% 4
Distillates ............................. 27 28 (1) (4)
Petrochemicals .......................... 3 3 -- --
Lubes and asphalts ...................... 3 3 -- --
Other products .......................... 13 14 (1) (7)
----- ----- -----
Total yields ........................ 100% 100% -% --
===== ===== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Three Months Ended June 30,
------------------------------------------------------
Change
----------------------
2001 2000 Amount %
------ ------ ------ ------
Feedstocks (at U.S. Gulf Coast, except as noted):
West Texas Intermediate, or "WTI," crude oil .......... $27.91 $28.82 $ (.91) (3)%
WTI less sour crude oil (c) (e) ....................... $ 6.10 $ 3.14 $ 2.96 94
WTI less ANS (U.S. West Coast) ........................ $ 1.83 $ 1.91 $ (.08) (4)
WTI less sweet crude oil (d) .......................... $ (.62) $ (.43) $ (.19) (44)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI ................. $ 8.86 $ 7.37 $ 1.49 20
No. 2 fuel oil less WTI ........................... $ 3.22 $ 1.61 $ 1.61 100
Propylene less WTI ................................ $(6.79) $14.54 $(21.33) --(f)
U.S. East Coast:
Conventional 87 gasoline less WTI ................. $ 8.18 $ 7.35 $ .83 11
No. 2 fuel oil less WTI ........................... $ 4.20 $ 2.76 $ 1.44 52
Lube oils less WTI ................................ $26.56 $16.40 $ 10.16 62
U.S. West Coast:
CARB 87 gasoline less ANS ......................... $20.57 $12.93 $ 7.64 59
Low-sulfur diesel less ANS ........................ $ 9.97 $ 6.42 $ 3.55 55
- ----------
(a) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and product logistics business beginning
June 1, 2001.
(b) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Stations beginning June 16, 2000.
(c) The market reference differential for sour crude oil is based on posted
prices for 50% Arab medium and 50% Arab light crude oils.
(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 June 30, 2000 Form 10-Q to conform
to the components used in the 2001 period.
(f) Percentage variance is greater than 100%.
27
28
Valero reported net income for the second quarter of 2001 of $274.8
million, or $4.23 per share, compared to net income of $87.7 million, or $1.51
per share, for the second quarter of 2000. The substantial increase in second
quarter results was due primarily to a significant increase in throughput
margins as discussed further below and the full quarter contribution from the
Benicia Acquisition which was completed during the second quarter of 2000.
Partially offsetting the increase in throughput margins for Valero's operations,
excluding Benicia, were higher operating costs and selling and administrative
expenses, and an increase in income tax expense.
Operating revenues increased $1.1 billion, or 33%, to $4.5 billion
during the second quarter of 2001 compared to the same period in 2000 due
primarily to a 31% increase in average daily sales volumes. The increase in
sales volumes was due primarily to an increase in the sale of feedstocks and
products purchased for resale, the full quarter effect of additional volumes
resulting from the Benicia Acquisition, capacity expansions at various
refineries since the second quarter of 2000, less refinery downtime in the 2001
period, and the effect of including the operations of the Huntway and El Paso
refineries beginning June 1, 2001.
Operating income increased $305.9 million to $464.3 million during the
second quarter of 2001 compared to the second quarter of 2000 due in part to the
above-noted full quarter contribution from the Benicia Acquisition which
resulted in an increase in operating income of approximately $88 million.
Excluding the effect of the Benicia Acquisition, operating income increased due
to an approximate $292 million increase in total throughput margins (discussed
below), partially offset by an approximate $49 million increase in operating
costs (including a $37 million increase in cash operating costs and a $12
million increase in depreciation and amortization expense), and an approximate
$25 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
electricity costs attributable mainly to an increase in natural gas prices, and
increases in maintenance costs and ad valorem taxes. Depreciation and
amortization expense was higher due primarily to an increase in turnaround and
catalyst amortization. Selling and administrative expenses (including related
depreciation expense) were higher primarily as a result of an increase in
employee salaries, benefits, and variable compensation.
Total throughput margins (operating revenues less cost of sales),
excluding the effect of the Benicia Acquisition, increased significantly due to
(i) the effect of higher throughput volumes resulting from the factors noted
above in the discussion of operating revenues, including a significant increase
in the volume of Valero's sour crude oil charges during the quarter to take
advantage of higher sour crude discounts discussed below, (ii) substantially
higher per barrel feedstock discounts for sour crude oil resulting primarily
from an increase in supplies of heavier crudes without a corresponding increase
in demand while at the same time demand for sweeter crudes increased to meet
lower sulfur requirements for certain refined products without a corresponding
increase in supply, (iii) higher gasoline margins in April and May attributable
primarily to continued strong demand and the carryover effects of high refinery
turnaround activity during the first quarter of 2001 which reduced gasoline
production and kept inventories low, (iv) higher distillate margins resulting
from improved industrial demand partially as a result of continued fuel
switching due to high natural gas prices, and increased diesel demand for both
on-road and off-road use, and (v) 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)
substantially lower gasoline margins in June (discussed in the Outlook section
which
28
29
follows), and (ii) significantly lower margins for propylene and other
petrochemical feedstocks due to slowing economic activity throughout the world.
Net interest and debt expense decreased $1.9 million to $20.5 million in
the second quarter of 2001 compared to the same period in 2000 due primarily to
a decrease in bank borrowings resulting from Valero's strong earnings and cash
flow, partially offset by a full quarter of interest in 2001 on borrowings
incurred to fund the Benicia Acquisition, including interest on the senior notes
issued in June 2000, and interest recognized in connection with the capital
leases associated with the El Paso acquisition which was effective June 1, 2001.
Distributions on preferred securities of subsidiary trust increased from
$.1 million in the second quarter of 2000 to $3.3 million in the second quarter
of 2001 due to distributions on the PEPS Units issued in June 2000 in connection
with funding the Benicia Acquisition.
Income tax expense increased $116.4 million to $164.8 million during the
second quarter of 2001 compared to the same period in 2000 due primarily to the
significant increase in pre-tax income.
29
30
YEAR-TO-DATE 2001 COMPARED TO YEAR-TO-DATE 2000
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Six Months Ended June 30,
-----------------------------------------------------------
Change
---------------------------
2001 (a) 2000 (b) Amount %
----------- ----------- ----------- -----------
Operating revenues ...................................... $ 8,268,396 $ 6,301,119 $ 1,967,277 31%
Cost of sales ........................................... (6,953,249) (5,681,234) (1,272,015) (22)
Operating costs:
Cash (fixed and variable) ........................... (416,315) (286,563) (129,752) (45)
Depreciation and amortization ....................... (103,304) (70,547) (32,757) (46)
Selling and administrative expenses (including related
depreciation expense) ............................... (94,186) (46,616) (47,570) -(c)
----------- ----------- -----------
Total operating income .......................... $ 701,342 $ 216,159 $ 485,183 -(c)
=========== =========== ===========
Other income (expense), net ............................. $ (1,061) $ 2,203 $ (3,264) -(c)
Interest and debt expense, net .......................... $ (39,252) $ (35,233) $ (4,019) (11)
Distributions on preferred securities of subsidiary
trust ............................................... $ (6,684) $ (110) $ (6,574) -(c)
Income tax expense ...................................... $ (243,400) $ (64,600) $ (178,800) -(c)
Net income .............................................. $ 410,945 $ 118,419 $ 292,526 -(c)
Earnings per share of common stock - assuming dilution .. $ 6.35 $ 2.05 $ 4.30 -(c)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") (d) ..................... $ 810,720 $ 292,940 $ 517,780 -(c)
Ratio of EBITDA to interest incurred (d) ................ 16.0x 7.6x 8.4x -(c)
- ----------
(a) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and product logistics business beginning
June 1, 2001.
(b) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Stations beginning June 16, 2000.
(c) Percentage variance is greater than 100%.
(d) For purposes of this calculation, distributions on preferred securities
of subsidiary trust are included in interest incurred.
30
31
OPERATING HIGHLIGHTS
Six Months Ended June 30,
-------------------------------------------------------------
Change
-------------------------
2001 (a) 2000 (b) Amount %
-------- -------- ------ -----
Sales volumes (Mbbls per day) ............... 1,337 1,044 293 28%
Throughput volumes (Mbbls per day) .......... 961 782 179 23
Average throughput margin per barrel ........ $7.56 $4.35 $3.21 74
Operating costs per barrel:
Cash (fixed and variable) ............... $2.39 $2.02 $ .37 18
Depreciation and amortization ........... .59 .50 .09 18
----- ----- -----
Total operating costs per barrel .... $2.98 $2.52 $ .46 18
===== ===== =====
Charges:
Crude oils:
Sour ................................ 61% 51% 10% 20
Heavy sweet ......................... 4 10 (6) (60)
Light sweet ......................... 8 9 (1) (11)
----- ----- -----
Total crude oils ................ 73 70 3 4
High-sulfur resid ....................... 4 4 -- --
Low-sulfur resid ........................ 4 4 -- --
Other feedstocks and blendstocks ........ 19 22 (3) (14)
----- ----- -----
Total charges ....................... 100% 100% --% --
===== ===== =====
Yields:
Gasolines and blendstocks ............... 54% 51% 3% 6
Distillates ............................. 27 29 (2) (7)
Petrochemicals .......................... 3 4 (1) (25)
Lubes and asphalts ...................... 3 3 -- --
Other products .......................... 13 13 -- --
----- ----- -----
Total yields ........................ 100% 100% --% --
===== ===== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Six Months Ended June 30,
------------------------------------------------------------
Change
----------------------
2001 2000 Amount %
--------- --------- --------- ---------
Feedstocks (at U.S. Gulf Coast, except as noted):
WTI crude oil ............................... $ 28.35 $ 28.83 $ (.48) (2)%
WTI less sour crude oil (c) (e) ............. $ 5.72 $ 2.76 $ 2.96 --(f)
WTI less ANS (U.S. West Coast) .............. $ 2.79 $ 1.82 $ .97 53
WTI less sweet crude oil (d) ................ $ (.13) $ (.56) $ .43 77
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI ....... $ 7.31 $ 5.83 $ 1.48 25
No. 2 fuel oil less WTI ................. $ 3.35 $ 1.75 $ 1.60 91
Propylene less WTI ...................... $ (2.06) $ 8.46 $ (10.52) --(f)
U.S. East Coast:
Conventional 87 gasoline less WTI ....... $ 6.73 $ 6.07 $ .66 11
No. 2 fuel oil less WTI ................. $ 4.26 $ 4.11 $ .15 4
Lube oils less WTI ...................... $ 26.40 $ 12.19 $ 14.21 --(f)
U.S. West Coast:
CARB 87 gasoline less ANS ............... $ 20.02 $ 12.13 $ 7.89 65
Low-sulfur diesel less ANS .............. $ 9.68 $ 7.23 $ 2.45 34
- ----------
(a) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and product logistics business beginning
June 1, 2001.
(b) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Stations beginning June 16, 2000.
(c) The market reference differential for sour crude oil is based on posted
prices for 50% Arab medium and 50% Arab light crude oils.
(d) The market reference differential for sweet crude oil is based on posted
prices for 50% 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 June 30, 2000 Form 10-Q to conform
to the components used in the 2001 period.
(f) Percentage variance is greater than 100%.
31
32
Valero reported net income for the first six months of 2001 of $410.9
million, or $6.35 per share, compared to net income of $118.4 million, or $2.05
per share, for the first six months of 2000. The substantial increase in
year-to-date results was due primarily to dramatically improved refining
industry fundamentals during the majority of the period which resulted in a
significant increase in throughput margins, and the full period contribution
from the Benicia Acquisition which was completed during 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 during the
first quarter of 2001, higher operating costs and selling and administrative
expenses, and an increase in income tax expense.
Operating revenues increased $2.0 billion, or 31%, to $8.3 billion
during the first six months of 2001 compared to the same period in 2000 due
primarily to a 28% increase in average daily sales volumes and, to a lesser
extent, to a 3% 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 the other factors noted in the quarter-to-quarter
discussion. The increase in average sales prices was due primarily to slightly
higher prices for conventional gasolines, gasoline blendstocks and distillates
and the effect of higher-priced sales of CARB gasoline and other products in the
California market in connection with the Benicia Acquisition, offset to a large
extent by a significantly lower prices for petrochemicals.
Operating income increased $485.2 million to $701.3 million during the
first six months of 2001 compared to the first six months of 2000 due in part to
the above-noted contribution from the Benicia Acquisition which resulted in an
increase in operating income of approximately $158 million. Excluding the effect
of the Benicia Acquisition, operating income increased due to an approximate
$436 million increase in total throughput margins (discussed below), partially
offset by an approximate $74 million increase in operating costs (including a
$54 million increase in cash operating costs and a $20 million increase in
depreciation and amortization expense), and an approximate $35 million increase
in selling and administrative expenses (including related depreciation expense).
Cash operating costs, depreciation and amortization expense, and selling and
administrative expenses (including related depreciation expense) all were higher
due primarily to the factors noted above in the quarter-to-quarter discussion.
Total throughput margins, excluding the effect of the Benicia
Acquisition, increased due to substantially higher feedstock discounts for sour
crude oil, higher margins for gasoline (including higher premiums for RFG),
distillates, and lube oils, and the effect of higher throughput volumes, all
resulting primarily from the factors noted above in the quarter-to-quarter
discussion. Partially offsetting these increases in total throughput margins
were lower petrochemical margins and the effect of higher natural gas, hydrogen
and methanol feedstock costs.
Other income (expense), net, decreased $3.3 million, from income of $2.2
million during the first six months of 2000 to expense of $1.1 million during
the first six months of 2001 due to reduced results from Valero's 20% equity
interest in the Javelina off-gas processing plant in Corpus Christi attributable
primarily to higher natural gas feedstock costs and lower product prices.
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.
32
33
Net interest and debt expense increased $4.0 million, or 11%, to $39.2
million in the first six months of 2001 compared to the same period in 2000 due
primarily to a full period of interest in 2001 on borrowings incurred to fund
the Benicia Acquisition, including interest on the senior notes issued in June
2000, and interest recognized in connection with the capital leases associated
with the El Paso acquisition which was effective June 1, 2001, partially offset
by a decrease in bank borrowings resulting from Valero's strong earnings and
cash flow.
Distributions on preferred securities of subsidiary trust increased from
$.1 million in the first six months of 2000 to $6.7 million in the first six
months of 2001 due to distributions on the PEPS Units issued in June 2000 in
connection with funding the Benicia Acquisition.
Income tax expense increased $178.8 million to $243.4 million during the
first six months of 2001 compared to the same period in 2000 due primarily to
the significant increase in pre-tax income.
OUTLOOK
Commencing in June 2001 and continuing through July, gasoline margins
weakened substantially from the exceptionally strong conditions that existed
during April and May of 2001. Average gasoline margins, which have been
extremely volatile, are significantly lower than the extraordinarily high
average margins experienced in the second quarter of 2001 due to an increase in
inventories, and are lower than third quarter 2000 levels. After a significant
number of industry-wide refinery turnarounds were completed in the first quarter
of 2001, refiners increased production to unusually high levels to take
advantage of the high margin environment. This increase in production, combined
with higher than normal levels of imports in response to the high domestic
margins and a decrease in demand resulting from high gasoline prices at the pump
and a slowing economy, caused an unusual increase in gasoline inventories during
the latter part of the 2001 second quarter which resulted in rapidly declining
margins and prices. Valero currently believes, however, that the decrease in
gasoline pump prices has resulted in an increase in demand which, combined with
recently announced refinery production cuts, has resulted in improved gasoline
margins in August and should result in improved gasoline margins during the
remainder of the quarter. Similar to gasoline margins, average premiums for RFG
in July 2001 declined substantially from second quarter 2001 levels and are
lower than strong third quarter 2000 premiums. However, RFG margins have
improved in August 2001 along with the increase in gasoline margins.
Although gasoline margins have been extremely volatile, distillate
margins continue to exceed seasonal averages due to increased demand. Although
average distillate margins have also declined thus far in the third quarter of
2001 from second quarter levels and are below third quarter 2000 margins, Valero
currently believes that with continued good demand, combined with the announced
refinery production cuts noted above, distillate margins should remain above
normal levels for the remainder of the year. With regard to other products,
average lube oil margins are essentially unchanged from the strong second
quarter 2001 levels and are well in excess of third quarter 2000 margins.
Propylene margins thus far in the third quarter of 2001 continue to remain under
extreme pressure due to low worldwide demand for petrochemical derivatives and
excess capacity, and are lower than already depressed second quarter 2001 levels
and significantly below third quarter 2000 margins.
33
34
Average discounts for sour crude oil, which were exceptionally strong
during the second quarter of 2001, have declined thus far in the third quarter
of 2001 due primarily to a disruption in crude supply from Iraq in June.
However, with the return of Iraqi supplies to the market in July and a decrease
in demand resulting from the industry-wide refinery production cuts described
above, sour crude oil discounts for September deliveries have returned to more
favorable levels and are above third quarter 2000 discounts. Although sweet
crude oil continues to trade at a premium to WTI due to increasing demand for
sweet crudes resulting from the implementation in 2000 of lower sulfur
requirements in fuel, thus far in the third quarter of 2001, this differential
is lower than third quarter 2000 levels due to the current decline in 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.
In the third quarter of 2001, Valero intends to upgrade the lubricants
crude unit and lubricants plant at the Paulsboro Refinery in conjunction with a
scheduled turnaround. In addition, Valero has accelerated maintenance at its
Gulf Coast refineries that was previously scheduled for later in the year as a
result of the current decline in margins. As a result, Valero expects third
quarter 2001 throughput volumes to decline from second quarter 2001 levels.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities increased $419.8 million to
$513.5 million during the first six months of 2001 compared to the same period
in 2000 due primarily to the significant increase in earnings discussed above
under "Results of Operations." During the first six months of 2001, $635.1
million of cash was generated from earnings, approximately $121.7 million of
which was used for other operating activities, primarily working capital
requirements. As detailed in Note 5 of Notes to Consolidated Financial
Statements, the major changes in working capital resulted from an increase in
operating inventory levels and an increase in receivables resulting from both
increased sales volumes and amounts that were billed and collected in July
rather than June due to certain delays resulting from the implementation of a
new accounting system. Partially offsetting these increased working capital
requirements was an increase in federal income taxes payable due to the
significant increase in earnings. During the first six months of 2001, cash and
temporary cash investments increased $27.9 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, deferred turnaround
and catalyst costs and the earn-out contingency payment to Salomon Inc discussed
below, (ii) fund the acquisition of Huntway and inventories related to the
acquisition of El Paso's Corpus Christi refinery and related product logistics
business, (iii) reduce short-term bank borrowings, (iv) repurchase shares of
Valero common stock, and (v) 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
34
35
capitalization ratio, and a minimum net worth test. As of June 30, 2001, there
were no outstanding borrowings under this committed facility, while letters of
credit outstanding were approximately $37 million. Valero also currently has
certain uncommitted short-term bank credit facilities and various uncommitted
bank letter of credit facilities. As of June 30, 2001, there were no outstanding
borrowings under the short-term bank credit facilities, while letters of credit
totaling approximately $101 million were outstanding under the uncommitted
letter of credit facilities.
See Note 2 of Notes to Consolidated Financial Statements for a detailed
description of Valero's anticipated financing plans with respect to its proposed
merger with UDS, including the establishment of a bridge loan facility and a new
revolving bank credit agreement to finance the cash portion of the merger
consideration, and the registering of common stock in connection with the
issuance of shares to UDS shareholders for the stock portion of the merger
consideration.
During the first six months 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 June 30, 2001, Valero's debt-to-capitalization ratio was 39.5%,
which includes the effect of completing both the Huntway and El Paso
acquisitions in the second quarter of 2001. Despite the inclusion of these
transactions, Valero's debt-to-capitalization ratio at June 30, 2001 decreased
from 39.9% at December 31, 2000. (Note: For purposes of these
debt-to-capitalization ratio computations, 20% of the aggregate liquidation
amount of trust preferred securities issued as part of the PEPS Units is deemed
to be debt).
In May 2001, Valero made a $35 million earn-out contingency payment to
Salomon Inc in connection with Valero's 1997 acquisition of Basis Petroleum,
Inc. In addition, based on estimated margin levels through September of 2001,
Valero anticipates that it will make an earn-out contingency payment to Mobil
(now ExxonMobil) of approximately $20 million in October 2001 in connection with
Valero's 1998 acquisition of the Paulsboro Refinery. Valero accounts for any
payments under these arrangements as an additional cost of the respective
acquisition which is depreciated over the remaining lives of the assets to which
the additional cost is allocated.
As discussed in Note 3 of Notes to Consolidated Financial Statements,
effective June 1, 2001, Valero completed the acquisition of Huntway Refining
Company for a total cost of approximately $75 million. Also effective June 1,
2001, Valero purchased for approximately $109 million inventories related to the
acquisition of El Paso Corporation's Corpus Christi, Texas refinery and related
product logistics business. These expenditures were funded by cash from
operations.
The following discussion of capital investments excludes (i) the
earn-out contingency payments to Salomon and ExxonMobil described above, (ii)
the acquisition cost of Huntway, and (iii) the acquisition cost of El Paso's
Corpus Christi refinery and related product logistics business. During the first
six months of 2001, Valero expended approximately $217 million for capital
investments, including capital expenditures of $138 million and deferred
turnaround and catalyst costs of $79 million. Capital expenditures included
approximately $13 million for environmental projects (excluding approximately
$10 million of costs related to a flue gas scrubber at the Texas City Refinery
which is being financed through a lease arrangement). These environmental
projects include new equipment and improvements to
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existing equipment that prevent or reduce the likelihood of environmental
contamination from future operations. For total year 2001, Valero currently
expects to incur approximately $415 million for capital investments, including
approximately $285 million for capital expenditures and approximately $130
million for deferred turnaround and catalyst costs. The capital expenditure
estimate includes approximately $35 million for environmental projects.
Valero is subject to extensive federal, state and local environmental
laws and regulations, including those relating to the discharge of materials
into the environment, waste management, pollution prevention measures and
characteristics and composition of gasoline and diesel fuels. If Valero violates
or fails to comply with these laws and regulations, it could be fined or
otherwise sanctioned. Because environmental laws and regulations are
increasingly becoming more stringent and new environmental laws and regulations
are continuously being enacted or proposed (such as the Environmental Protection
Agency's, or EPA's, Tier II gasoline and distillate standards discussed further
below), the level of future expenditures required for environmental matters
could increase in the future. In addition, any major upgrades in any of Valero's
refineries could require material additional expenditures to comply with
environmental laws and regulations. Although environmental costs may have a
significant impact on results of operations for a single period, Valero believes
that these costs will not have a material adverse effect on its financial
position or liquidity.
In February 2000, the EPA's "Tier II" gasoline standard was published in
final form pursuant to the Clean Air Act. The standard will ultimately require
the sulfur content in gasoline to be reduced from approximately 300 parts per
million to 30 parts per million; the regulation will be phased in beginning in
2004. In addition, the EPA finalized its Tier II distillate standard to reduce
the sulfur content of diesel fuel sold to highway consumers by 97%, from 500
parts per million to 15 parts per million, beginning June 1, 2006. The new Tier
II specifications for the reduction of sulfur in both gasoline and distillates
are expected to cost the refining industry as much as $16 billion to meet.
Valero has determined that modifications will be required at each of its
refineries as a result of the Tier II standards. Based on preliminary estimates,
Valero believes that the new Tier II specifications will require approximately
$270 million in capital expenditures for Valero's refineries to comply, split
evenly between expenditures to meet the gasoline standard and expenditures to
meet the distillate standard, but excluding the cost to install hydrogen
production facilities. Valero currently plans to begin implementing the
modifications in 2001 and expects all modifications to be complete by 2006.
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 second quarter and first six months of 2001, Valero
repurchased shares of its common stock under these programs at a cost of
approximately $25 million and $36 million, respectively. Thus far in the third
quarter of 2001 (through July 31), Valero has repurchased additional common
shares under these programs at a cost of approximately $8 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.
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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 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
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. 143, "Accounting for Asset
Retirement Obligations," for which the effect on Valero's consolidated financial
statements has not yet been determined, and 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 that do not receive hedge accounting treatment under FASB 133.
These derivative instruments are considered economic hedges for which changes in
their fair value are reported currently in earnings. 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 swaps, futures and options. 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 June 30, 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 June 30, 2001 (which mature in 2001 and 2002)
(dollars in thousands, except amounts per barrel, or bbl).
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Mature in 2001 Mature in 2002
Fixed Price Fixed Price
------------------------- -------------------------
Payor Receiver Payor Receiver
-------- -------- -------- --------
Futures:
Volumes (Mbbls) .................... 18,920 23,107 34 1
Weighted average price (per bbl) ... $ 27.62 $ 27.42 $ 31.03 $ 33.26
Contract amount .................... $522,579 $633,588 $ 1,055 $ 33
Fair value ......................... $510,160 $617,381 $ 1,033 $ 31
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 June 30, 2001 (which mature in
2001 and 2002) (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 2001 Mature in 2002
Fixed Price Fixed Price
---------------------------- -----------------------
Payor Receiver Payor Receiver
--------- --------- --------- ---------
Swaps:
Notional volumes (Mbbls) ..................... 1,600 6,875 -- --
Weighted average pay price (per bbl) ......... $ 1.36 $ 3.29 -- --
Weighted average receive price (per bbl) ..... $ 1.47 $ 3.49 -- --
Fair value (gain) ............................ $ 187 $ 1,402 -- --
Notional volumes (BBtus) ..................... 1,075 920 -- --
Weighted average pay price (per MMBtu) ....... $ 4.47 $ 1.77 -- --
Weighted average receive price (per MMBtu) ... $ 3.33 $ 2.36 -- --
Fair value (gain (loss)) ..................... $ (1,229) $ 1,124 -- --
Futures:
Volumes (Mbbls) .............................. 6,413 7,255 60 --
Weighted average price (per bbl) ............. $ 28.94 $ 30.83 31.75 --
Contract amount .............................. $ 185,609 $ 223,651 1,905 --
Fair value ................................... $ 180,670 $ 214,026 1,857 --
Options:
Volumes (BBtus) .............................. -- 5,720 -- --
Weighted average strike price (per MMBtu) .... -- $ 4.51 -- --
Contract amount .............................. -- $ 2,930 -- --
Fair value ................................... -- $ 6,932 -- --
In addition to the above, as of June 30, 2001, Valero was the fixed
price payor under certain swap contracts held to hedge forecasted purchases of
refinery feedstocks and refined products that mature
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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 June 30, 2001,
these swaps had a weighted average receive price of $24.97 per barrel and a net
after-tax gain recorded in other comprehensive income of approximately $38.7
million.
TRADING ACTIVITIES
The following table provides information about Valero's derivative
commodity instruments held or issued for trading purposes as of June 30, 2001
(which mature in 2001 or 2002) (dollars in thousands, except amounts per barrel
or per million British thermal units). Volumes shown for swaps represent
notional volumes which are used to calculate amounts due under the agreements.
Mature in 2001 Mature in 2002
Fixed Price Fixed Price
---------------------------- ---------------------------
Payor Receiver Payor Receiver
--------- --------- --------- ---------
Swaps:
Notional volumes (Mbbls) ..................... 5,365 4,975 900 1,125
Weighted average pay price (per bbl) ......... $ 4.50 $ 3.12 $ 3.52 $ 3.83
Weighted average receive price (per bbl) ..... $ 3.84 $ 3.47 $ 4.71 $ 4.42
Fair value (gain) ............................ $ (3,515) $ 1,605 $ 282 $ (323)
Notional volumes (BBtus) ..................... 4,190 4,190 -- --
Weighted average pay price (per MMBtu) ....... $ 3.96 $ 2.90 -- --
Weighted average receive price (per MMBtu) ... $ 2.90 $ 3.95 -- --
Fair value (gain (loss)) ..................... $ (4,465) $ 4,433 -- --
Futures:
Volumes (Mbbls) .............................. 8,547 8,668 558 550
Weighted average price (per bbl) ............. $ 28.57 $ 28.54 $ 29.05 $ 27.46
Contract amount .............................. $ 244,155 $ 247,372 $ 16,210 $ 15,105
Fair value ................................... $ 239,439 $ 242,518 $ 15,673 $ 14,750
Volumes (BBtus) .............................. 2,600 2,600 -- --
Weighted average price (per MMBtu) ........... $ 5.21 $ 5.22 -- --
Contract amount .............................. $ 13,558 $ 13,575 -- --
Fair value ................................... $ 8,776 $ 8,776 -- --
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.
City of Dallas v. Explorer Pipeline Company, Inc., Valero Energy
Corporation, et al., 160th State District Court, Dallas County, Texas (filed May
14, 2001). On May 14, 2001, the City of Dallas added Valero as a named defendant
in a suit filed previously against Explorer Pipeline Company, Inc. and certain
other refiners and suppliers who transport gasoline through Explorer's petroleum
products pipeline in North Texas. On March 9, 2000, Explorer's pipeline ruptured
and discharged gasoline into East Caddo Creek in Hunt County, Texas. The
plaintiff alleges that its source of water supply from Lake Tawakoni (located
approximately 28 miles from the site of the pipeline rupture) was contaminated
by gasoline containing MTBE causing the plaintiff to discontinue the use of
water from Lake Tawakoni as a source of water supply, and requiring the
construction of an emergency water supply pipeline from another source. The
plaintiff asserts causes of action for negligence, nuisance, strict product
liability, and gross negligence, and seeks the recovery of an unspecified amount
of actual and punitive damages, including costs for the construction of the
alternate supply pipeline. In a related matter, on July 3, 2001, Valero received
a notice from several residents of Hunt County, Texas, of their intent to
commence a citizen's suit under the Resource Conservation and Recovery Act to
require an investigation and remediation of the rupture site. Valero has not
been served with a citation in the proposed citizen's suit.
Environmental Proceedings:
Texas Natural Resource Conservation Commission (TNRCC). Valero received
the following notices of enforcement from the TNRCC for Valero's Texas
refineries, but the TNRCC has not yet issued any enforcement order related to
these notices. The notices pertain to various inspections of Valero's Texas
refineries conducted earlier in 2001. The notices of enforcement do not assess
any fines or penalties. (i) Notice of Enforcement for a Comprehensive Compliance
Investigation at the Houston refinery, TNRCC ID No. HG-0130-C, served on May 8,
2001, for alleged noncompliance with certain air emission and record keeping
requirements, (ii) Notice of Enforcement for an Upset Maintenance Notification
Investigation at the Houston refinery, TNRCC ID No. HG-0130-C, served on July
17, 2001, for an alleged violation of TNRCC upset/maintenance regulations, (iii)
Notice of Enforcement for the Compliance Certification Inspection at the Texas
City refinery, TNRCC Account No. GB-0073-P, served on July 10, 2001, for alleged
noncompliance with certain air emission and record keeping requirements, and
(iv) Notice of Enforcement for Upset Report Reviews at the Corpus Christi
refinery (Up River Road), TNRCC Air Account No. NE-0112-G, served on May 1,
2001, for alleged noncompliance with certain air emission and record keeping
requirements.
California Environmental Protection Agency Department of Toxic
Substances Control. Valero received a Draft Enforcement Order on July 17, 2001
pertaining to its Benicia, California refinery. The Order alleges noncompliance
with several state and federal waste management requirements, and seeks
penalties of $226,500 and compliance. Valero disagrees with many of the Order's
allegations, and has entered into discussions with the agency to resolve the
matter.
New Jersey Department of Environmental Protection (NJDEP). Valero
disclosed in its Annual Report on Form 10-K for the year ended December 31,
2000, that on July 17, 2000, Valero Refining Company-New Jersey had received an
Administrative Order (EA ID No. PEA000002-55006) from the
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New Jersey Department of Environmental Protection related to alleged excess
emissions from the Paulsboro Refinery. Valero recently reached a settlement
agreement with the NJDEP relating to this order pursuant to which Valero will
pay $286,680 in penalties in the third quarter of 2001.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's annual meeting of stockholders was held May 10, 2001.
Matters voted on at the meeting and the results thereof were (i) a proposal to
elect three Class I directors to serve until the 2004 annual meeting: Ruben M.
Escobedo (approved with 55,243,656 affirmative votes, and 1,093,835
abstentions), Lowell H. Lebermann (approved with 55,249,610 affirmative votes,
and 1,087,880 abstentions), and William B. Richardson (approved with 55,247,000
affirmative votes, and 1,090,490 abstentions); (ii) a proposal to approve the
2001 Executive Stock Incentive Plan for executive officers and employees
(approved with 38,722,295 affirmative votes, 17,246,799 negative votes, and
368,397 abstentions), and (iii) a proposal to ratify the appointment of Arthur
Andersen LLP as independent public accountants (approved with 55,593,336
affirmative votes, 476,560 negative votes, and 267,594 abstentions). Directors
whose terms of office continued after the meeting were: Ronald K. Calgaard,
Donald M. Carlton, Jerry D. Choate, Robert G. Dettmer, William E. Greehey, and
Susan Kaufman Purcell.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
2.1 Agreement and Plan of Merger, dated as of May 6, 2001, by and
between Valero Energy Corporation and Ultramar Diamond Shamrock
Corporation -- incorporated by reference from Exhibit 2.1 to
Valero's Current Report on Form 8-K dated May 6, 2001, and filed
May 10, 2001.
(b) Reports on Form 8-K.
(i) On May 10, 2001, Valero filed a Current Report on Form 8-K
dated May 6, 2001, reporting Item 5 (Other Events) in connection with the
announcement that Valero and UDS had entered into an agreement and plan of
merger dated May 6, 2001, pursuant to which UDS will merge with and into Valero.
Financial statements were not filed with this report.
(ii) On June 4, 2001, Valero filed a Current Report on Form 8-K
dated June 4, 2001, reporting Item 5 (Other Events) in connection with the
announcement that certain subsidiaries of Valero had executed lease agreements
with purchase options for a 115,000 BPD refinery in Corpus Christi and certain
refined product pipelines and terminals in Texas owned and operated by
subsidiaries of El Paso Corporation. Financial statements were not filed with
this report.
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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: August 13, 2001
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