EXHIBIT 99.1
FINANCIAL STATEMENTS OF BUSINESS ACQUIRED
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Valero Energy Corporation:
We have audited the accompanying consolidated balance sheets of Ultramar Diamond
Shamrock Corporation (a Delaware corporation) and subsidiaries (the Company) as
of December 31, 2001 and 2000, and the related consolidated statements of
income, stockholders' equity, cash flows and comprehensive income for each of
the three years in the period ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Ultramar Diamond Shamrock
Corporation and subsidiaries as of December 31, 2001 and 2000, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
March 5, 2002
1
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
--------------------------------
2001 2000
-------------- --------------
(in millions, except share data)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (including $76.6 million of cash held in trust
as of December 31, 2001) ................................................. $ 338.8 $ 197.1
Accounts and notes receivable, net .......................................... 324.2 700.5
Inventories ................................................................. 892.3 808.8
Prepaid expenses and other current assets ................................... 61.7 29.3
Income taxes receivable ..................................................... 137.0 --
Current deferred income tax assets .......................................... 60.7 117.6
Asset held for sale ......................................................... 106.8 --
-------------- --------------
TOTAL CURRENT ASSETS ..................................................... 1,921.5 1,853.3
-------------- --------------
Property, plant and equipment .................................................. 5,458.0 5,136.0
Less accumulated depreciation and amortization ................................. (1,707.9) (1,501.7)
-------------- --------------
Property, plant and equipment, net ......................................... 3,750.1 3,634.3
Other assets, net .............................................................. 650.8 500.8
-------------- --------------
TOTAL ASSETS ............................................................... $ 6,322.4 $ 5,988.4
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Advance from Valero Energy Corporation ...................................... $ 703.0 $ --
Current portion of long-term debt ........................................... 305.6 1.7
Accounts payable ............................................................ 789.8 988.2
Accrued expenses and other current liabilities .............................. 285.1 203.9
Taxes other than income taxes ............................................... 230.8 289.8
Income taxes payable ........................................................ -- 59.3
-------------- --------------
TOTAL CURRENT LIABILITIES ................................................ 2,314.3 1,542.9
Long-term debt, less current portion ........................................... 966.9 1,659.8
Other long-term liabilities .................................................... 362.5 366.3
Deferred income tax liabilities ................................................ 613.4 394.1
Commitments and contingencies
Minority interest in consolidated partnership .................................. 115.6 --
Company-obligated preferred stock of subsidiary trust .......................... 200.0 200.0
STOCKHOLDERS' EQUITY:
Common Stock, par value $0.01 per share:
250,000,000 shares authorized; 74,736,000 and 86,987,000 shares
issued and outstanding as of December 31, 2001 and 2000 ................... 0.7 0.9
Additional paid-in capital .................................................. 940.0 1,516.9
Treasury stock, at cost; 1,099,026 shares and 51,795 shares
as of December 31, 2001 and 2000 .......................................... (44.6) (1.2)
Grantor trust stock ownership program, at cost; no shares and
3,583,000 shares as of December 31, 2001 and 2000 ......................... -- (95.8)
Retained earnings ........................................................... 997.0 509.0
Accumulated other comprehensive loss ........................................ (143.4) (104.5)
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY ................................................ 1,749.7 1,825.3
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 6,322.4 $ 5,988.4
============== ==============
</Table>
See accompanying notes to consolidated financial statements.
2
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-----------------------------------------
2001 2000 1999
----------- ----------- -----------
(in millions, except per share data)
SALES AND OTHER REVENUES ........................... $ 16,860.0 $ 17,061.1 $ 13,939.3
----------- ----------- -----------
COSTS AND EXPENSES:
Cost of products sold ........................... 11,037.5 11,806.8 8,975.3
Operating expenses .............................. 1,263.7 1,092.8 994.5
Selling, general and administrative expenses .... 368.9 326.4 300.9
Taxes other than income taxes ................... 2,936.4 2,768.7 2,990.5
Depreciation and amortization ................... 277.8 253.1 240.8
Restructuring and other expenses, net ........... (4.6) 1.2 8.2
----------- ----------- -----------
TOTAL COSTS AND EXPENSES ..................... 15,879.7 16,249.0 13,510.2
----------- ----------- -----------
OPERATING INCOME ................................... 980.3 812.1 429.1
Interest income .................................. 8.3 21.0 12.4
Interest expense, net ............................ (119.2) (134.1) (141.5)
Equity income from joint ventures ................ 5.8 18.4 14.6
Minority interest in net income of
consolidated partnership ....................... (9.4) -- --
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND DIVIDENDS OF
SUBSIDIARY TRUST ................................. 865.8 717.4 314.6
Provision for income taxes ....................... (320.5) (262.8) (131.1)
Dividends on preferred stock of subsidiary
trust .......................................... (10.3) (10.3) (10.3)
----------- ----------- -----------
NET INCOME ......................................... $ 535.0 $ 444.3 $ 173.2
=========== =========== ===========
BASIC NET INCOME PER SHARE ......................... $ 7.22 $ 5.12 $ 2.00
=========== =========== ===========
DILUTED NET INCOME PER SHARE ....................... $ 7.08 $ 5.11 $ 2.00
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES:
Basic ........................................... 74.052 86.773 86.615
Diluted ......................................... 75.537 87.002 86.742
</Table>
See accompanying notes to consolidated financial statements.
3
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(in millions)
<Table>
<Caption>
Grantor
Trust Accumulated
Additional Stock Other Total
Common Paid-in Treasury Ownership Retained Comprehensive Stockholders'
Stock Capital Stock Program Earnings Loss Equity
-------- ------------ -------- ------------ -------- ------------ ---------------
BALANCE AS OF JANUARY 1, 1999 ..... $ 0.9 $ 1,512.7 $ (100.1) $ -- $ 82.5 $ (112.0) $ 1,384.0
Net income ....................... -- -- -- -- 173.2 -- 173.2
Issuance of Common Stock ......... -- 3.6 (0.6) -- -- -- 3.0
Shares transferred to Grantor
Trust Stock Ownership
Program ........................ -- -- 100.0 (100.0) -- -- --
Cash dividends ................... -- -- -- -- (95.3) -- (95.3)
Other, net ....................... -- -- -- -- -- 28.4 28.4
-------- ------------ -------- ------------ -------- ------------ ---------------
BALANCE AS OF DECEMBER 31, 1999 ... 0.9 1,516.3 (0.7) (100.0) 160.4 (83.6) 1,493.3
Net income ...................... -- -- -- -- 444.3 -- 444.3
Issuance of restricted stock,
net of forfeitures ............ -- 0.6 (0.5) 4.2 -- -- 4.3
Cash dividends .................. -- -- -- -- (95.7) -- (95.7)
Other, net ...................... -- -- -- -- -- (20.9) (20.9)
-------- ------------ -------- ------------ -------- ------------ ---------------
BALANCE AS OF DECEMBER 31, 2000 ... 0.9 1,516.9 (1.2) (95.8) 509.0 (104.5) 1,825.3
Net income ....................... -- -- -- -- 535.0 -- 535.0
Issuance of restricted stock,
net of forfeitures ............. -- (0.1) 0.6 5.9 -- -- 6.4
Exercise of stock options ........ -- 22.8 38.9 89.9 -- -- 151.6
Shares purchased under Common
Stock buyback program ........... -- -- (682.7) -- -- -- (682.7)
Retirement of Common Stock held
in treasury ..................... (0.2) (599.6) 599.8 -- -- -- --
Cash dividends ................... -- -- -- -- (47.0) -- (47.0)
Other, net ....................... -- -- -- -- -- (38.9) (38.9)
-------- ------------ -------- ------------ -------- ------------ ---------------
BALANCE AS OF DECEMBER 31, 2001 ... $ 0.7 $ 940.0 $ (44.6) $ -- $ 997.0 $ (143.4) $ 1,749.7
======== ============ ======== ============ ======== ============ ===============
</Table>
See accompanying notes to consolidated financial statements.
4
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
-------- -------- --------
(in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ..................................................................... $ 535.0 $ 444.3 $ 173.2
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ............................................... 277.8 253.1 240.8
Loss on derivative instruments .............................................. 3.1 -- --
Provision for losses on receivables ......................................... 16.6 21.4 9.2
Gain on sale of property, plant and equipment ............................... (0.7) (1.4) (116.0)
Write-down of property, plant and equipment and goodwill .................... 1.2 5.2 131.4
Equity income from joint ventures ........................................... (5.8) (18.4) (14.6)
Minority interest in net income of consolidated partnership ................. 9.4 -- --
Deferred income tax provision ............................................... 252.8 97.3 72.4
Other, net .................................................................. 12.0 4.6 3.6
Changes in operating assets and liabilities, net of acquisitions:
Decrease (increase) in accounts and notes receivable ...................... 363.2 (104.1) (79.2)
Decrease (increase) in inventories ........................................ (68.7) (109.9) 87.4
Decrease (increase) in prepaid expenses and other current assets .......... (3.7) (8.3) 13.1
Increase (decrease) in accounts payable, accrued expenses and other
current liabilities ...................................................... (379.0) 306.5 56.0
Decrease in other assets .................................................... 2.5 26.6 18.2
Increase (decrease) in other long-term liabilities .......................... 4.9 (20.1) (58.8)
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............................... 1,020.6 896.8 536.7
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ......................................................... (426.2) (191.7) (167.6)
Acquisitions, net of cash acquired ........................................... (6.8) (21.0) (17.3)
Acquisition of Golden Eagle Refinery ......................................... (148.2) (807.7) --
Deferred refinery maintenance turnaround costs ............................... (109.9) (18.7) (33.9)
Proceeds from sales of property, plant and equipment ......................... 31.7 27.8 289.4
-------- -------- --------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES ........................ (659.4) (1,011.3) 70.6
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Advance from Valero Energy Corporation ....................................... 703.0 -- --
Proceeds from bridge loan facility ........................................... 554.9 -- --
Net change in commercial paper and working capital borrowings ................ (320.6) 354.9 (371.4)
Repayment of long-term debt .................................................. (640.8) (41.5) (231.4)
Proceeds from the exercise of stock options .................................. 111.4 3.0 3.5
Shares purchased under Common Stock buyback program .......................... (682.7) -- --
Payment of cash dividends .................................................... (47.0) (95.7) (95.3)
Proceeds from sale of minority interest in consolidated partnership .......... 111.9 -- --
Payment of cash distributions to minority interest
in consolidated partnership ................................................ (5.7) -- --
-------- -------- --------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES ........................ (215.6) 220.7 (694.6)
-------- -------- --------
Effect of exchange rate changes on cash ........................................ (3.9) (1.9) 4.0
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................... 141.7 104.3 (83.3)
CASH AND CASH EQUIVALENTS AS OF BEGINNING OF YEAR .............................. 197.1 92.8 176.1
-------- -------- --------
CASH AND CASH EQUIVALENTS AS OF END OF YEAR .................................... $ 338.8 $ 197.1 $ 92.8
======== ======== ========
</Table>
See accompanying notes to consolidated financial statements.
5
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
------- ------- -------
(in millions)
NET INCOME ................................................................... $ 535.0 $ 444.3 $ 173.2
------- ------- -------
Other comprehensive income (loss):
Foreign currency translation adjustment .................................... (36.8) (20.4) 29.7
------- ------- -------
Minimum pension liability adjustment,
net of income tax benefit .............................................. (2.9) (0.5) (1.3)
------- ------- -------
Derivative instruments adjustments, net of income tax expense (benefit):
Cumulative effect of accounting change,
net of income tax expense of $8.5 million ............................. 13.3 -- --
Change in fair value of derivative instruments,
net of income tax benefit of $4.1 million ............................. (6.3) -- --
Reclassification adjustment for gains included in net income,
net of income tax benefit of $4.0 million .............................. (6.2) -- --
------- ------- -------
Derivative instruments adjustment, net ................................ 0.8 -- --
------- ------- -------
COMPREHENSIVE INCOME ......................................................... $ 496.1 $ 423.4 $ 201.6
======= ======= =======
</Table>
See accompanying notes to consolidated financial statements.
6
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1: BUSINESS DESCRIPTION AND ACQUISITION OF UDS BY VALERO ENERGY CORPORATION
UDS' BUSINESS
Ultramar Diamond Shamrock Corporation (UDS) was 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
owned and operated seven refineries located in Texas (2), California (2),
Oklahoma, Colorado and Quebec, Canada, and marketed its products through
approximately 4,500 company-operated and dealer-operated convenience stores and
86 unattended cardlock stations. In the northeast region of the United States
and in eastern Canada, UDS sold, on a retail basis, home heating oil to
approximately 250,000 households.
UDS' operations were affected by:
o company-specific factors, primarily refinery utilization rates and
refinery maintenance turnarounds;
o seasonal factors, such as the demand for refined products during the
summer driving season and heating oil during the winter season; and
o industry factors, such as movements in and the level of crude oil
prices, the demand for and prices of refined products, industry supply
capacity, refinery maintenance turnarounds and availability of refined
product pipeline capacity.
ACQUISITION OF UDS BY VALERO ENERGY CORPORATION
On May 7, 2001, UDS announced that it had entered into an Agreement and Plan of
Merger (the acquisition agreement) with Valero Energy Corporation (Valero)
whereby UDS agreed to be acquired by Valero for total consideration of
approximately $4.3 billion. In September 2001, the board of directors and
shareholders of both UDS and Valero approved the acquisition and, on December
31, 2001, Valero completed its acquisition of UDS. Under the acquisition
agreement, UDS shareholders received, for each share of UDS common stock they
held, at their election, cash, Valero common stock or a combination of cash and
Valero common stock, having a value equal to the sum of $27.50 plus 0.614 shares
of Valero common stock (based on the average Valero common stock price over a
ten trading-day period ending three days prior to closing).
The average closing price of Valero common stock for the ten trading-day period
specified in the acquisition agreement was $35.78 per share. Based on the
exchange election results, UDS' shareholders electing Valero shares received,
for each share of UDS common stock, 0.9265 shares of Valero common stock and
$16.32 in cash. Shareholders electing cash and non-electing UDS shareholders
received $49.47 in cash for each share of UDS common stock. The acquisition was
accounted for by Valero using the purchase method.
As a condition of the acquisition, on December 19, 2001, the U.S. Federal Trade
Commission (FTC) approved a consent decree requiring divestiture of certain UDS
assets. Pursuant to the consent decree, the assets to be divested were required
to be put into a trust, with the future operations of those assets managed by an
independent trustee approved by the FTC. The assets and their related operations
are referred to as the Golden Eagle Refining and Marketing Assets Business and
include:
o the 168,000 barrel-per-day Golden Eagle Refinery located in the San
Francisco Bay area and all tangible assets used in the operation of the
refinery including docks, tanks and pipelines;
o the wholesale marketing business generally associated with the Golden
Eagle Refinery production, which includes primarily sales to unbranded
customers located in the northern half of California, Fresno and north,
and Reno, Nevada; and
o 70 Beacon- and Ultramar-branded convenience stores located in Northern
California, including land, buildings, pump equipment, underground
storage tanks and various store equipment.
7
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Prior to the acquisition, Valero owned and operated six refineries, including
three in Texas and one each in Louisiana, New Jersey and California with a
combined throughput capacity of more than one million barrels per day. Valero
markets its gasoline, diesel and other refined products in 34 states through a
bulk and rack marketing network and, in California, through approximately 350
retail locations.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: These consolidated financial statements include the
accounts of UDS and its wholly-owned subsidiaries and majority-owned partnership
in which a controlling interest is held. Investments in 50% or less owned
companies and joint ventures are accounted for using the equity method of
accounting. All intercompany balances and transactions are eliminated in
consolidation. These consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles and
reflect UDS' historical cost basis and do not include any purchase price
adjustments that resulted from the acquisition of UDS by Valero.
USE OF ESTIMATES: The preparation of financial statements in accordance with
United States generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results could
differ from those estimates. On an ongoing basis, management reviews their
estimates, including those related to restructurings, litigation, environmental
liabilities, and employee benefit obligations, based on currently available
information. Changes in facts and circumstances may result in revised estimates.
CASH AND CASH EQUIVALENTS: All highly liquid investments with an original
maturity of three months or less when purchased are considered to be cash
equivalents. Cash and cash equivalents include $76.6 million of cash held in
trust related to change-in-control payments to be made to UDS officers and key
employees in connection with the acquisition by Valero, and cash restricted for
use for environmental remediation costs.
INVENTORIES: Crude oil, other feedstock and refined product inventories are
valued at the lower of cost or market (net realizable value). Cost is determined
primarily on the last-in, first-out (LIFO) basis. Materials, supplies and
convenience store merchandise are valued at average cost, not in excess of
market value.
PROPERTY, PLANT AND EQUIPMENT: Additions to property, plant and equipment,
including capitalized interest, are recorded at cost. Depreciation is provided
principally using the straight-line method over the estimated useful lives of
the related assets. Assets recorded under capital leases and leasehold
improvements are amortized using the straight-line method over the shorter of
the lease term or the estimated useful life of the related asset.
GOODWILL: The excess of purchase price over the fair value of net assets of
businesses acquired (goodwill) was being amortized using the straight-line
method primarily over 15 to 20 years. Effective January 1, 2002, amortization of
goodwill will cease and the unamortized balance will be tested annually for
impairment. See the discussion of the Financial Accounting Standards Board's
(FASB) Statement No. 142 below regarding these required accounting changes.
IMPAIRMENT: Long-lived assets, including goodwill, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. The evaluation of recoverability is performed using
undiscounted estimated net cash flows generated by the related assets. If an
asset is deemed to be impaired, the amount of impairment is determined as the
amount by which the net carrying value exceeds discounted estimated net cash
flows. Effective January 1, 2002, impairment accounting requirements will
change. See the discussion of FASB Statement No. 144 below regarding the
required accounting change.
REFINERY MAINTENANCE TURNAROUND COSTS: Refinery maintenance turnaround costs are
deferred when incurred and amortized over the period of time estimated to lapse
until the next turnaround occurs which is typically three to four
8
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
years. Deferred costs include, among other items, the cost to repair, restore,
refurbish or replace refinery equipment such as vessels, tanks, reactors,
piping, valves, electrical equipment and heat exchangers.
COMPUTER SOFTWARE COSTS: Purchased computer software costs, and the direct
costs, both external and internal, associated with internally developed computer
software are capitalized at cost. The internal costs are limited to capitalized
interest and payroll costs of employees involved in the development. During 2001
and 2000, UDS capitalized $4.4 million and $14.7 million, respectively, of
external and internal software costs, primarily related to the new stand-alone
enterprise-wide information technology system implemented in February 2000 and
upgraded in September 2001. Amortization is provided using the straight-line
method over the estimated useful life of the related software, generally three
to seven years.
ENVIRONMENTAL REMEDIATION COSTS: Environmental remediation costs are expensed
and the related accrual established when site restoration and environmental
remediation and cleanup obligations are either known or considered probable and
can be reasonably estimated. Accrued liabilities are not discounted to present
value and are not reduced by possible recoveries from third parties.
Environmental costs include initial site surveys, costs for remediation and
restoration, including direct internal costs, and ongoing monitoring costs, as
well as fines, damages and other costs, when estimable. Adjustments to initial
estimates are recorded, from time to time, to reflect changing circumstances and
estimates based upon additional information developed in subsequent periods.
REVENUE RECOGNITION: Sales and other revenues are recognized when the related
goods are shipped and all significant obligations have been satisfied.
SHIPPING AND HANDLING FEES AND COSTS: The FASB's Emerging Issues Task Force
issued EITF Issue No. 00-10, "Accounting for Shipping and Handling Fees and
Costs" which addresses the income statement classification of amounts billed to
a customer for shipping and handling and the related costs incurred for shipping
and handling. The Task Force concluded that all amounts billed to a customer in
a sale transaction related to shipping and handling, if any, represent revenues
earned for the goods provided and should be classified as revenue. The Task
Force also concluded that the classification of shipping and handling costs is
an accounting policy that should be disclosed. Registrants were required to
apply the consensus guidance in the financial statements for the fourth quarter
of their fiscal year beginning after December 15, 1999. Upon application of the
consensus, comparative financial statements for prior periods were reclassified
to comply with the classification guidelines of this Issue. During the fourth
quarter of 2000, $30.5 million of freight costs was reclassified which had been
netted against sales and other revenues during 2000 to cost of products sold. No
other reclassifications to prior years' statements were necessary.
Shipping and handling fees and costs are classified in cost of products sold.
Such fees and costs relate to the transportation (via ship, train, truck or
pipeline) of crude oil and other feedstocks to the refineries and refined
products from the refineries to wholesale markets and company-operated and
dealer-operated convenience stores.
EXCISE TAXES: Federal excise and state motor fuel taxes collected on the sale of
products and remitted to governmental agencies are included in sales and other
revenues and in taxes other than income taxes. For the years ended December 31,
2001, 2000 and 1999, excise taxes were $2,820.9 million, $2,664.5 million and
$2,895.9 million, respectively.
INCOME TAXES: Income taxes are accounted for under the asset and liability
method. Under this method, deferred income tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective income tax bases. Deferred amounts are measured using enacted
tax rates expected to apply to taxable income in the year those temporary
differences are expected to be recovered or settled.
9
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
FOREIGN CURRENCY TRANSLATION: The functional currency of the Canadian operations
is the Canadian dollar. The translation into U.S. dollars is performed for
balance sheet accounts using exchange rates in effect as of the balance sheet
date and for revenue and expense accounts using the weighted average exchange
rate during the year. Adjustments resulting from this translation are reported
in other comprehensive income.
STOCK-BASED COMPENSATION: Stock-based compensation is accounted for using the
intrinsic value method. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of UDS' common stock
at the date of grant over the amount an employee must pay to acquire the stock.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation," which clarified certain issues from
APB Opinion No. 25, "Accounting for Stock Issued to Employees." Interpretation
No. 44 clarified the definition of an employee for purposes of applying Opinion
No. 25, the criteria for determining whether a plan qualifies as a
noncompensatory plan, the accounting consequence of various modifications to the
terms of a previously fixed stock option or award, and the accounting for an
exchange of stock compensation awards in a business combination. Interpretation
No. 44 was effective July 1, 2000. UDS has reviewed the guidance of this
interpretation and believes that its accounting policies and the disclosures in
the consolidated financial statements are appropriate and adequately address the
requirements of Interpretation No. 44.
INCOME PER SHARE: The computation of basic income per share is based on the
weighted average number of common shares outstanding during the year. Diluted
income per share is based on the weighted average number of common shares
outstanding during the year and, to the extent dilutive, common stock
equivalents consisting of stock options, stock awards subject to restrictions
and stock appreciation rights.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: Effective January 1, 2001, UDS
adopted FASB Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended. This statement established accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that all derivative instruments be recognized as either assets or
liabilities in the balance sheet and be measured at their fair value. The
statement requires that changes in the derivative instrument's fair value be
recognized currently in income unless specific hedge accounting criteria are
met.
The application of Statement No. 133, as amended, could increase volatility in
net income and other comprehensive income based on the level of derivative
instruments utilized and the extent of hedging activities, which are subject to
change from time to time based on management's decision as to the appropriate
strategies and overall risk exposure levels.
Interest rate swap agreements are used to manage the exposure to interest rate
risk on fixed-rate debt obligations. Under Statement No. 133, as amended, these
interest rate swap agreements are designated and documented as fair value hedges
of the related fixed-rate debt obligations. The net gain or loss arising from
marking to market the interest rate swap agreements, which have been designated
and have qualified as fair value hedging instruments, and the related hedged
debt are recorded in interest expense.
UDS operations utilize contracts that provide for the purchase of crude oil and
other feedstocks and for the sale of refined products. Certain of these
contracts meet the definition of a derivative instrument in accordance with
Statement No. 133, as amended. Management believes these contracts qualify for
the normal purchases and normal sales exception under Statement No. 133, as
amended, because they will be delivered in quantities expected to be used or
sold over a reasonable period of time in the normal course of business.
Accordingly, these contracts are designated as normal purchases and normal sales
contracts and are not required to be recorded as derivative instruments under
Statement No. 133, as amended.
10
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Commodity futures and options contracts are used to procure a large portion of
UDS crude oil requirements and to hedge the exposure to crude oil, refined
product, and natural gas price volatility. Under Statement No. 133, as amended,
these commodity futures contracts are not designated as hedging instruments.
Commodity price and spread swaps contracts are used to manage the exposure to
price volatility related to forecasted purchases of crude oil, refined products
and natural gas and sales of refined products. Under Statement No. 133, as
amended, certain commodity swaps are designated and documented as cash flow
hedges of forecasted purchases. Other commodity swaps are not designated as
hedging instruments. The net gain or loss arising from marking to market the
commodity futures and swaps contracts is recorded in cost of products sold.
Periodically, UDS enters into short-term foreign exchange and purchase contracts
to manage the exposure to exchange rate fluctuations on the trade payables of
the Canadian operations that are denominated in U.S. dollars. Under Statement
No. 133, as amended, these contracts are not designated as hedging instruments.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS
OF LIABILITIES: In September 2000, the FASB issued Statement No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, a replacement of FASB Statement No. 125." Statement No. 140
revises the standards for accounting for securitizations and other transfers of
financial assets and collateral and requires certain disclosures, but it carries
over most of the provisions of Statement No. 125 without reconsideration. Except
as otherwise provided, Statement No. 140 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. The statement shall be applied prospectively; earlier or
retroactive application of this statement is not permitted. UDS has reviewed the
requirements of Statement No. 140 and believes that the accounting policies and
disclosures in the consolidated financial statements are appropriate and
adequately address the requirements of Statement No. 140. There was no impact to
UDS' financial position or results of operations as a result of implementation
of this statement.
RECLASSIFICATIONS: Certain previously reported amounts have been reclassified to
conform to the 2001 presentation.
NEW ACCOUNTING PRONOUNCEMENTS
FASB STATEMENT NO. 141
In June 2001, the FASB issued Statement No. 141, "Business Combinations."
Statement No. 141 addresses financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, "Business Combinations," and
Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises." All business combinations within the scope of Statement No. 141
are to be accounted for using the purchase method. The provisions of Statement
No. 141 apply 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. Since UDS has not consummated a
business combination subsequent to June 30, 2001, there was no impact to its
financial position or results of operations as a result of implementation of
this statement.
FASB STATEMENT NO. 142
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible
Assets." Statement No. 142 addresses financial accounting and reporting for
acquired goodwill and other intangible assets and supersedes APB Opinion No. 17,
"Intangible Assets." Statement No. 142 addresses how intangible assets that are
acquired individually or with a group of other assets (but not those acquired in
a business combination) should be accounted for in financial statements upon
their acquisition. This statement also addresses how goodwill and other
intangible assets should be accounted for after they have been initially
recognized in the financial statements. The provisions of Statement No. 142 are
required to be applied starting with fiscal years beginning after December 15,
2001. This statement is required to be applied at the beginning of an entity's
fiscal year and to be applied to all goodwill and other intangible assets
recognized in its financial statements at that date. The statement 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
11
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
useful lives, but such lives will not be limited to 40 years. Impairment losses
for goodwill and indefinite-lived intangible assets that arise due to the
initial application of Statement No. 142 are to be reported as resulting from a
change in accounting principle. UDS has reviewed the requirements of Statement
No. 142, and the impact of adoption effective January 1, 2002 will result in the
cessation of goodwill amortization beginning January 1, 2002, which amortization
approximates $15.0 million annually. In addition, UDS believes that future
reported net income may be more volatile because impairment losses related to
goodwill are likely to occur irregularly and in varying amounts.
FASB STATEMENT NO. 143
Also in June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes standards for accounting for
an obligation associated with the retirement of a tangible long-lived asset. An
asset retirement obligation should be recognized in the financial statements in
the period in which it meets the definition of a liability as defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements." The amount of the
liability would initially be measured at fair value. Subsequent to initial
measurement, an entity would recognize changes in the amount of the liability
resulting from (a) the passage of time and (b) revisions to either the timing or
amount of estimated cash flows. Statement No. 143 also establishes standards for
accounting for the cost associated with an asset retirement obligation. It
requires that, upon initial recognition of a liability for an asset retirement
obligation, an entity capitalize that cost by recognizing an increase in the
carrying amount of the related long-lived asset. The capitalized asset
retirement cost would then be allocated to expense using a systematic and
rational method. Statement No. 143 will be effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier application
encouraged. UDS is currently evaluating the impact of adopting this new
statement.
FASB STATEMENT NO. 144
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement No. 144 addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. This statement supersedes Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," but retains Statement No. 121's fundamental
provisions for recognition and measurement of impairment of long-lived assets to
be held and used and measurement of long-lived assets to be disposed of by sale.
This statement also supersedes APB Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business. Statement No. 144 does not apply to
goodwill or other intangible assets, the accounting and reporting of which is
addressed in newly issued Statement No. 142, "Goodwill and Other Intangible
Assets." The provisions of Statement No. 144 are effective for financial
statements for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years, with early application encouraged. UDS is
currently evaluating the impact of adopting this new statement.
NOTE 3: ACQUISITIONS
GOLDEN EAGLE REFINERY
On August 31, 2000, UDS acquired Tosco Corporation's 168,000 barrel-per-day Avon
Refinery (renamed the Golden Eagle Refinery) located in the San Francisco bay
area of California. The original purchase price of $806.8 million also included
crude oil, feedstock and refined product inventories and the assumption of
certain employee benefit liabilities. In addition, the terms of the purchase and
sale agreement provided for additional consideration of up to $150.0 million
over an eight-year period if average annual West Coast refinery margins exceeded
historical averages. The purchase price was funded by a combination of proceeds
from a $350.0 million bridge loan, $250.0 million from the sale of accounts
receivable under the existing sales facility, and the remainder from commercial
paper borrowings and cash on hand. In October 2000, the bridge loan was
refinanced with commercial paper borrowings.
12
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The acquisition was accounted for using the purchase method. The purchase price
was allocated based on the estimated fair values of the individual assets and
liabilities at the date of acquisition. During the subsequent year, it was
determined that the estimated fair values of inventories, accrued liabilities
and other long-term liabilities were understated and property, plant and
equipment was overstated. In addition, West Coast refinery margins exceeded
historical averages resulting in the full $150.0 million of contingent
consideration becoming due to Tosco Corporation. In accordance with the purchase
and sale agreement, the $150.0 million was paid to Tosco Corporation in November
2001.
The following table summarizes the revisions to the initial allocation of
purchase price:
<Table>
<Caption>
FINAL INITIAL
ALLOCATION ALLOCATION ALLOCATION
AUGUST 31, DECEMBER 31, AUGUST 31,
2001 2000 2000
------------ ------------ ------------
(in millions)
Inventories and other current assets ............. $ 179.8 $ 150.3 $ 150.3
Property, plant and equipment .................... 642.0 646.0 650.0
Goodwill ......................................... 205.3 33.4 28.6
Accrued expenses and other current liabilities ... (47.4) -- --
Other long-term liabilities ...................... (23.8) (22.0) (22.1)
------------ ------------ ------------
Total purchase price .................... $ 955.9 $ 807.7 $ 806.8
============ ============ ============
</Table>
VALLEY SHAMROCK
On September 29, 2000, UDS purchased Valley Shamrock, Inc., in a purchase
business combination, for $16.2 million, which included the assumption of $6.2
million of debt. Valley Shamrock operates 23 convenience stores and two
wholesale facilities in the Rio Grande Valley of south Texas.
A summary of the purchase price allocation for Valley Shamrock is shown below:
<Table>
<Caption>
FINAL ALLOCATION
----------------
(in millions)
Working capital ....................... $ 0.7
Property, plant and equipment ......... 19.8
Goodwill .............................. 2.6
Other assets .......................... 0.5
Long-term debt ........................ (6.2)
Other long-term liabilities ........... (1.2)
----------------
Total purchase price ......... $ 16.2
================
</Table>
The operating results of these acquired businesses have been included in the
consolidated statements of income from the dates of acquisition.
13
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 4: RESTRUCTURING AND OTHER EXPENSES
Restructuring and other expenses consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
(in millions)
Gain on sale of other property, plant and equipment ......................... $ (0.7) $ (1.4) $ (31.2)
Write-down of property, plant and equipment ................................. -- 5.2 6.0
Loss on permanent closure of Alma Refinery .................................. 1.2 -- 138.2
Gain on sale of Michigan convenience stores, pipelines and terminals ........ -- -- (97.6)
Transaction costs related to the proposed Diamond 66 joint venture .......... -- -- 11.0
Restructuring reserve reductions related to retail, refining
and pipeline operations ................................................... (5.1) (2.6) (18.2)
------------ ------------ ------------
Restructuring and other expenses, net ................................... $ (4.6) $ 1.2 $ 8.2
============ ============ ============
</Table>
ASSET SALES AND JOINT VENTURES
In March 2001, a $6.6 million gain on the sale of the Ardmore crude oil
gathering operations to Teppco Partners, L.P. was recognized and throughout
2001, net losses totaling $5.9 million primarily related to retail asset sales
and retirements were recognized. In December 2001, UDS recognized a loss of $1.2
million to write down the Alma Refinery salvage value.
In June 2000, a $5.2 million impairment write-down was recognized related to
certain pipelines and crude oil gathering operations in Colorado (carrying value
prior to writedown was $5.7 million). In June 1999, UDS recognized a $6.0
million impairment write-down related to certain pipelines and crude oil
gathering operations in Oklahoma and Kansas (carrying value prior to writedown
was $9.5 million).
In December 1999, UDS finalized the sale of the Michigan convenience stores,
pipelines and terminals, with a net carrying value of $124.6 million, to
Marathon Ashland Petroleum LLC and recognized a gain of $97.6 million. Upon
completion of the sale, the Alma Refinery was permanently closed and a loss of
$138.2 million was recognized, which included a $125.4 million impairment
write-down and $12.8 million of severance and closure costs. The impairment
write-down consisted of $100.4 million related to property, plant and equipment
(carrying value prior to write-down was $128.4 million), $22.0 million related
to goodwill and $3.0 million related to deferred refinery maintenance turnaround
costs.
Included in gain on sale of other property, plant and equipment of $31.2 million
for the year ended December 31, 1999 is a $22.6 million gain related to the sale
or closure of 239 convenience stores including 162 of the under-performing
convenience stores identified in June 1998. The net carrying value of the 239
convenience stores was $38.7 million, including goodwill. In addition, UDS
recognized a $2.2 million gain on the sale of an 8.33% interest in the McKee to
El Paso refined product pipeline and terminal to Phillips Petroleum Company.
In March 1999, UDS terminated discussions with Phillips Petroleum Company
related to the formation of a proposed joint venture (Diamond 66). During the
first quarter of 1999, $11.0 million of transaction costs related to the
formation of Diamond 66 were expensed.
RESTRUCTURINGS
In June 1998, UDS adopted a three-year restructuring plan to reduce the cost
structure of its US retail system by eliminating employee positions to improve
operating efficiencies and to close and sell 316 under-performing convenience
stores. In addition, UDS restructured certain pipeline and terminal operations
and support infrastructure. Under the restructuring plan, the convenience stores
were to be operated until closed and management decided the best sales
alternative. Operating income before retail overhead expense allocations for the
316
14
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
convenience stores for the six months ended June 30, 2001 and the years ended
December 31, 2000 and 1999 was breakeven, $0.7 million and $3.8 million,
respectively, including the results for the sold stores through the date of
sale.
From July 1998 through June 2001, 286 convenience stores were sold or closed,
and 261 retail employees and 76 pipeline and terminal employees were terminated.
In addition, it was subsequently determined that the operations of 12
convenience stores could be improved and those stores would not be sold. The
remaining 18 under-performing convenience stores, which have not been sold, are
in the process of being disposed of and management does not anticipate incurring
additional expenses related to the disposal of those stores. Effective June 30,
2001, the three-year restructuring program was completed and the balance of the
various restructuring reserves was credited into income.
During 1999 and 2000, the market demand for convenience stores increased
significantly as both large and small operators sought to increase the number of
stores they operated. As a result, UDS was able to sell many of the
under-performing convenience stores, instead of closing them and selling the
underlying property as originally planned. Because UDS was able to sell these
properties as operating stores, a portion of the fuel system removal costs,
lease buyout costs and severance costs have not been incurred, and the
restructuring reserves were reduced accordingly during the six months ended June
30, 2001, and the years ended December 31, 2000 and 1999.
Changes in accrued restructuring reserves were as follows:
<Table>
<Caption>
SEVERANCE AND LEASE BUYOUT FUEL SYSTEM
RELATED COSTS COSTS REMOVAL COSTS TOTAL
------------- ------------- ------------- -------------
(in millions)
Balance as of December 31, 1998 .... $ 19.0 $ 14.0 $ 16.1 $ 49.1
Payments ......................... (12.8) (1.8) (2.7) (17.3)
Reserve reductions ............... (1.1) (6.2) (10.9) (18.2)
------------- ------------- ------------- -------------
Balance as of December 31, 1999 .... 5.1 6.0 2.5 13.6
Payments ......................... (2.4) (0.5) (0.5) (3.4)
Reserve reductions ............... -- (1.6) (1.0) (2.6)
------------- ------------- ------------- -------------
Balance as of December 31, 2000 .... 2.7 3.9 1.0 7.6
Payments ......................... (0.1) (2.0) (0.4) (2.5)
Reserve reductions ............... (2.6) (1.9) (0.6) (5.1)
------------- ------------- ------------- -------------
Balance as of December 31, 2001 .... $ -- $ -- $ -- $ --
============= ============= ============= =============
</Table>
NOTE 5: ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consisted of the following:
<Table>
<Caption>
DECEMBER 31,
------------------------
2001 2000
---------- ----------
(in millions)
Accounts receivable ......................... $ 253.8 $ 393.0
Notes receivable ............................ 66.1 307.7
---------- ----------
Total ..................................... 319.9 700.7
Allowance for uncollectible accounts ........ (3.4) (5.3)
Other ....................................... 7.7 5.1
---------- ----------
Accounts and notes receivable, net ........ $ 324.2 $ 700.5
========== ==========
</Table>
15
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The changes in allowance for uncollectible accounts consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
(in millions)
Balance as of beginning of year .................. $ 5.3 $ 3.4 $ 14.3
Provision charged to expense ................... 0.4 3.4 0.4
Accounts written off, net of recoveries ........ (2.3) (1.5) (11.3)
------------ ------------ ------------
Balance as of end of year ........................ $ 3.4 $ 5.3 $ 3.4
============ ============ ============
</Table>
In March 1999, UDS arranged a $250.0 million revolving accounts receivable sales
facility. On March 1, 2001, the facility was increased $110.0 million to $360.0
million. On an ongoing basis, UDS sells eligible accounts receivable to Coyote
Funding, L.L.C. (Coyote), a non-consolidated, wholly owned subsidiary. Coyote
sells a percentage ownership in these receivables, without recourse, to a third
party cooperative corporation. UDS' retained interest in receivables sold to
Coyote is included in notes receivable and is recorded at fair value. The fair
value of the retained interest in these receivables approximates the eligible
accounts receivable sold to Coyote less the amount of receivables sold to the
third party cooperative corporation.
As of December 31, 2001 and 2000, the outstanding amount of receivables sold to
the third party cooperative corporation was $273.0 million and $250.0 million,
respectively. Discounts and net expenses associated with the sales of
receivables totaled $13.1 million, $10.9 million and $11.2 million and are
included in interest expense in the consolidated statements of income for the
years ended December 31, 2001, 2000 and 1999, respectively.
The cash flows related to this sales facility consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
---------------------------
2001 2000
------------ ------------
(in millions)
Proceeds from the sales of receivables .............. $ 84.1 $ 313.0
Proceeds from collections under the facility ........ 8,875.0 7,916.9
</Table>
Proceeds from the sales of receivables were used partially to fund the share
buyback program in 2001 (see Note 14: Stockholders' Equity) and partially to
fund the acquisition of the Golden Eagle Refinery in 2000. Proceeds from
collections under the sales facility were reinvested in the program by the third
party cooperative corporation. The third party cooperative corporation's
interest in UDS receivables was never in excess of $360.0 million and $250.0
million during the years ended December 31, 2001 and 2000, respectively.
Included in accrued expenses and other current liabilities is the allowance for
uncollectible accounts related to the accounts receivable sales facility. The
changes in this allowance for uncollectible accounts consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
Balance as of beginning of year .................. $ 11.0 $ 8.8 $ --
Provision charged to expense ................... 16.2 18.0 8.8
Accounts written off, net of recoveries ........ (15.3) (15.8) --
---------- ---------- ----------
Balance as of end of year ........................ $ 11.9 $ 11.0 $ 8.8
========== ========== ==========
</Table>
16
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 6: INVENTORIES
Inventories consisted of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
(in millions)
Crude oil and other feedstocks .............. $ 362.1 $ 279.1
Refined and other finished products ......... 376.2 380.2
Convenience store merchandise ............... 83.0 83.7
Materials and supplies ...................... 71.0 65.8
---------- ----------
Total inventories ......................... $ 892.3 $ 808.8
========== ==========
</Table>
The LIFO value of the crude oil and other feedstocks and refined and other
finished products inventories as of December 31, 2001 was based on an average
cost of $20.98 per barrel and the average market price was $24.31 per barrel.
The LIFO value of the crude oil and other feedstocks and refined and other
finished products inventories as of December 31, 2000 was based on an average
cost of $20.29 per barrel and the average market price was $36.05 per barrel. As
of December 31, 2001, replacement cost exceeded the LIFO cost of inventories by
$106.0 million.
NOTE 7: PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
<Table>
<Caption>
DECEMBER 31,
ESTIMATED ------------------------------
USEFUL LIVES 2001 2000
------------- ------------- -------------
(in millions)
Land .................................... -- $ 320.6 $ 291.7
Crude oil processing facilities ......... 15 - 30 years 3,245.0 3,103.5
Pipelines and terminals ................. 15 - 30 years 594.7 564.6
Retail facilities ....................... 5 - 30 years 886.0 844.6
Petrochemical processing facilities ..... 5 - 25 years 62.1 61.9
Other ................................... 3 - 10 years 118.0 92.0
Construction in progress ................ 231.6 177.7
------------- -------------
Total ................................. 5,458.0 5,136.0
Accumulated depreciation and
amortization........................... (1,707.9) (1,501.7)
------------- -------------
Property, plant and equipment, net .... $ 3,750.1 $ 3,634.3
============= =============
</Table>
17
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 8: OTHER ASSETS
Other assets consisted of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
(in millions)
Goodwill, net of accumulated amortization of $92.4 million
in 2001 and $74.3 million in 2000 ....................................... $ 387.4 $ 235.8
Non-current notes receivable, net ......................................... 28.8 30.5
Refinery maintenance turnaround costs, net of accumulated
amortization of $71.4 million in 2001 and $64.7 million in 2000 ......... 140.5 43.0
Equity investment in Diamond-Koch, L.P. ................................... -- 109.3
Equity investment in Skelly-Belvieu Pipeline Company, LLC ................. 16.5 16.2
Other non-current assets .................................................. 77.6 66.0
---------- ----------
Other assets, net ....................................................... $ 650.8 $ 500.8
========== ==========
</Table>
During the year ended December 31, 2001, goodwill increased $169.7 million due
primarily to the $150.0 million contingency payment paid to Tosco Corporation
relating to the acquisition of the Golden Eagle Refinery.
UDS has a 50% interest in Diamond-Koch, L.P., a joint venture with Koch
Industries, Inc., which includes each entity's petrochemical assets located at
Mont Belvieu, Texas. In the latter part of 2001, Koch Industries and UDS decided
to sell Diamond-Koch's four operating units and began soliciting bids from
interested parties. See Note 24: Subsequent Events for details regarding sales
that have been completed. As of December 31, 2001, the equity investment in
Diamond-Koch has been reclassified to asset held for sale in the consolidated
balance sheet. During the years ended December 31, 2001, 2000 and 1999, equity
income from Diamond-Koch totaled $2.3 million, $14.5 million and $10.7 million,
respectively. Also during the years ended December 31, 2001, 2000 and 1999,
distributions received from Diamond-Koch totaled $4.8 million, $19.2 million and
$10.9 million, respectively.
UDS has a 50% equity investment in Skelly-Belvieu Pipeline Company, LLC, a
partnership with Phillips Petroleum Company, which owns a natural gas pipeline
that transports refinery-grade propylene from UDS' McKee Refinery and Phillips'
Borger Refinery to Mont Belvieu, Texas. During the years ended December 31,
2001, 2000 and 1999, equity income from Skelly-Belvieu totaled $3.2 million,
$3.9 million and $3.9 million, respectively. Also during the years ended
December 31, 2001, 2000 and 1999, distributions received from Skelly-Belvieu
totaled $2.9 million, $4.7 million and $3.7 million, respectively.
NOTE 9: ADVANCE FROM VALERO ENERGY CORPORATION
On December 31, 2001, prior to the closing of the acquisition of UDS by Valero,
UDS ceased borrowing under its commercial paper program that was used to fund
its operations. As a result, Valero advanced to UDS $703.0 million to repay all
amounts outstanding under the commercial paper program.
18
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 10: LONG-TERM DEBT
Long-term debt consisted of the following:
<Table>
<Caption>
DECEMBER 31,
---------------------------
MATURITY 2001 2000
-------- ---------- ---------
(in millions)
8.625% Guaranteed Notes...................... 2002 $ 282.6 $ 274.8
Medium-term Notes:
7.4% (average rate)....................... 2005 46.0 46.0
8.0%...................................... 2005 161.3 149.9
8.5% (average rate)....................... 2003 24.0 24.0
9.375%.................................... 2001 -- 75.0
Debentures:
7.25% (non-callable)...................... 2010 25.0 25.0
7.65% (putable July 1, 2006).............. 2026 100.0 100.0
8.00% (callable April 1, 2003)............ 2023 98.8 100.0
8.75% (non-callable)...................... 2015 75.0 75.0
Total Senior Notes:
6.75% (putable October 15, 2009; callable
thereafter)............................ 2037 100.0 100.0
7.20% (callable).......................... 2017 200.0 200.0
7.45% (callable).......................... 2097 100.0 100.0
Partnership Revolving Credit Facility........ 2006 16.0 --
Commercial Paper............................. -- 354.3
Other........................................ Various 43.8 37.5
---------- ---------
Total long-term debt....................... 1,272.5 1,661.5
Less current portion......................... (305.6) (1.7)
---------- ---------
Long-term debt, less current portion....... $ 966.9 $ 1,659.8
========== =========
</Table>
Generally, UDS' outstanding debt is unsecured with interest payable
semi-annually.
In 1992, Ultramar Credit Corporation (UCC), a financing subsidiary, issued the
8.625% Guaranteed Notes in a public offering and such notes are guaranteed by
UDS.
The 2017 Total Senior Notes and the 2097 Total Senior Notes may be redeemed at
any time at UDS' option, in whole or in part, at a redemption price equal to the
greater of: (a) 100% of the principal amount, or (b) the sum of the present
value of outstanding principal and interest thereon, discounted at the U.S.
Treasury Yield plus 20 basis points, together with accrued interest, if any, to
the date of redemption. The 2037 Total Senior Notes may be redeemed, in whole or
in part, by the holders on October 15, 2009, at a redemption price equal to 100%
of the principal plus accrued interest. After October 15, 2009, the 2037 Total
Senior Notes are redeemable at UDS' option in the same manner as the 2017 Total
Senior Notes and 2097 Total Senior Notes.
During the year ended December 31, 2001, UDS had the following debt facilities
available:
o a $700.0 million U.S. revolving credit facility (U.S. Bank Facility)
along with a $700.0 million commercial paper program supported by the
U.S. Bank Facility;
o a Cdn. $200.0 million revolving credit facility for Canadian Ultramar
Company (CUC), a Canadian subsidiary of UDS;
o money market lines of credit with numerous financial institutions which
provided borrowing capacity of $470.0 million and Cdn. $195.0 million;
and
19
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
o a Partnership facility under which Shamrock Logistics, L.P. (now Valero
L.P.) may borrow up to $120.0 million (the Partnership Revolving Credit
Facility).
In order for Valero to finalize its financing arrangements related to the
acquisition of UDS on December 31, 2001, UDS was required to terminate its
$700.0 million U.S. Bank Facility and commercial paper program on December 31,
2001. In addition, the available borrowing capacity under the U.S. money market
lines of credit was reduced from $470.0 million to $35.0 million. The various
Canadian debt facilities were not impacted by the acquisition.
Borrowings under the money market lines are typically short-term and bear
interest at prevailing market rates as established by the financial
institutions. As of December 31, 2001 and 2000, there were no outstanding
borrowings under these money market lines.
The Revolving Credit Facilities require annual fees on the total used and unused
portion of the facilities. The interest rate under the Revolving Credit
Facilities is floating based upon the prime rate, the London interbank offered
rate or other floating interest rates, at UDS' option. Amounts outstanding under
the Canadian Facility and the Partnership Revolving Credit Facility are due in
2002 and 2006, respectively, upon expiration. Outstanding letters of credit
totaled $134.6 million and $145.8 million as of December 31, 2001 and 2000,
respectively.
The aggregate maturity of long-term debt as of December 31, 2001 was as follows
(in millions):
<Table>
2002............................................. $ 305.6
2003............................................. 28.8
2004............................................. 0.6
2005............................................. 207.9
2006............................................. 16.7
Thereafter....................................... 712.9
---------
Total long-term debt.......................... $ 1,272.5
=========
</Table>
The Revolving Credit Facility and the indentures governing the
various notes contain restrictive covenants relating to UDS' financial
condition, operations and properties. Under these covenants, UDS and certain of
its subsidiaries are required to maintain, among other things, certain specified
consolidated interest coverage and debt-to-total capitalization ratios. Although
these covenants have the effect of limiting UDS' ability to pay dividends, it is
not anticipated that these limitations will affect its present ability to pay
dividends.
In order to manage interest costs on outstanding long-term debt, UDS entered
into various interest rate swap agreements (see Note 20: Financial Instruments).
The interest rate swap agreements modify the interest rate characteristics of a
portion of UDS' long-term debt from a fixed to a floating rate. As of December
31, 2001 and 2000, the following interest rate swap agreements were outstanding:
<Table>
<Caption>
YEAR OF MATURITY
-------------------------------------------
FIXED TO FLOATING 2002 2005 2023
------- ------- -------
Notional amount (in millions).................... $ 200.0 $ 150.0 $ 100.0
Weighted average rate received................... 6.23% 6.36% 6.93%
Weighted average rate paid in 2001............... 4.16% 4.22% 4.42%
Weighted average rate paid in 2000............... 6.22% 6.10% 6.47%
</Table>
Interest payments totaled $123.2 million, $122.5 million and $127.9 million for
the years ended December 31, 2001, 2000 and 1999, respectively.
20
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 11: OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following:
<Table>
<Caption>
DECEMBER 31,
------------------------
2001 2000
------- -------
(in millions)
Employee benefit plan liabilities.................................. $ 181.7 $ 150.1
Environmental liabilities.......................................... 78.5 100.0
Other.............................................................. 102.3 116.2
------- -------
Other long-term liabilities.................................... $ 362.5 $ 366.3
======= =======
</Table>
NOTE 12: MINORITY INTEREST IN CONSOLIDATED PARTNERSHIP
On April 16, 2001, Shamrock Logistics, L.P. (renamed Valero L.P. on December 31,
2001), previously a wholly owned partnership of UDS, issued 5.2 million limited
partnership common units in an initial public offering at a price of $24.50 per
unit. Proceeds from the offering totaled $111.9 million, net of offering
expenses of $14.9 million, and were used to pay down debt. Subsequent to the
initial public offering, UDS owned approximately 74% of Shamrock Logistics'
ownership equity. The issuance of Shamrock Logistics' common units was accounted
for as a capital transaction in the consolidated financial statements; thus no
gain or loss was recognized in the consolidated statement of income.
As a result of UDS' owning a majority of the ownership interest, Shamrock
Logistics is consolidated in UDS' consolidated financial statements. The
minority interest in consolidated partnership on the consolidated balance sheet
of $115.6 million represents the minority unitholders' investment in Shamrock
Logistics plus their share of the net income of Shamrock Logistics since April
16, 2001 less distributions paid to minority unitholders. The minority interest
in net income of consolidated partnership in the consolidated statement of
income of $9.4 million represents the minority unitholders' share of the net
income of Shamrock Logistics.
Shamrock Logistics declared quarterly partnership distributions as follows (in
millions, except per unit amounts):
<Table>
<Caption>
DISTRIBUTION
TOTAL PAID TO
DATE DISTRIBUTION DISTRIBUTION DISTRIBUTION MINORITY
WAS PAID PER UNIT PAID UNITHOLDERS
----------------- ------------ ------------ -----------
August 14, 2001 $ 0.50 $ 9.8 $ 2.6
November 14, 2001 0.60 11.7 3.1
</Table>
NOTE 13: COMPANY-OBLIGATED PREFERRED STOCK OF SUBSIDIARY TRUST
On June 25, 1997, UDS Capital I (the Trust) issued 8,000,000 shares of 8.32%
Trust Originated Preferred Securities (TOPrS), with a $25.00 liquidation amount
per security, in an underwritten public offering. Total proceeds from the
offering were $200.0 million. Holders of the TOPrS have limited voting rights
and are not entitled to vote to appoint, remove or replace, or to increase or
decrease the number of trustees, which voting rights are vested exclusively with
UDS.
The TOPrS are redeemable on or after June 30, 2002 at the option of the Trust,
in whole or in part, at a redemption price equal to $25.00 per security.
Distributions on the TOPrS are cumulative and payable quarterly in arrears on
March 31, June 30, September 30 and December 31 of each year, if and when the
Trust has funds available for distribution, at the annual rate of 8.32% of the
liquidation amount of $25.00 per TOPrS.
21
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Trust is a wholly-owned subsidiary trust and UDS has guaranteed, on a
subordinated basis, the dividend payments due on the TOPrS if and when declared.
NOTE 14: STOCKHOLDERS' EQUITY
GRANTOR TRUST STOCK OWNERSHIP PROGRAM
In November 1999, UDS created the Grantor Trust Stock Ownership Program (GSOP)
to which 3,740,000 shares of treasury stock were contributed. UDS instructed the
trustee to sell shares as necessary and to use the proceeds from those sales and
any dividends paid on those contributed shares, toward the satisfaction of a
portion of UDS' future obligations under certain compensation and employee
benefit plans. The shares held in trust were not considered outstanding for
income per share purposes until they were committed to be released. During the
years ended December 31, 2001 and 2000, 156,661 shares and 3,583,339 shares,
respectively, were transferred directly to employees or employee benefit plan
participants in satisfaction of UDS' obligation to pay compensation and
benefits. The majority of shares transferred related to stock option exercise
activity. For financial reporting purposes, the GSOP was consolidated with UDS
and all dividends and interest transactions between the GSOP and UDS were
eliminated.
COMMON STOCK BUYBACK PROGRAM
On February 7, 2001, the Board of Directors of UDS approved a share buyback
program to repurchase $750.0 million of UDS common stock. As of December 31,
2001, 17,050,109 shares of common stock had been purchased at a total cost of
$682.7 million, including 7,050,109 shares at a price of $32.85 per share which
were held by TotalFinaElf since UDS acquired Total Petroleum (North America)
Ltd. in September 1997. In conjunction with the share buyback program, UDS
entered into an agreement to repurchase 10,000,000 shares under an accelerated
program with a financial institution at an initial cost of $323.3 million. In
May 2001, the accelerated stock buyback program was settled with an additional
payment of $126.3 million as a result of an increase in the UDS common stock
price.
In order to fund the share buyback program, UDS entered into a short-term bridge
loan agreement on February 7, 2001 with two banks that committed to lend up to
$750.0 million. Borrowings under the short-term bridge loan totaled $554.9
million. In May 2001, the outstanding balance of the bridge loan was paid off
with proceeds received from commercial paper borrowings and available cash.
INCENTIVE PLANS
UDS had adopted several Long-Term Incentive Plans (the LTIPs) which are
administered by the Compensation Committee of the Board of Directors (the
Committee). Under the terms of the LTIPs, the Committee could grant restricted
shares, stock options, stock appreciation rights and performance units to
officers and key employees. The vesting period for awards under the LTIPs was
established by the Committee at the time of grant. Restricted shares awarded
under the 1992 and 1996 LTIPs generally vested on the third anniversary of the
date of grant. Restricted shares granted under the 1987 and 1990 LTIPs vested
generally over a four-year period. Stock options could not be granted at less
than the fair market value of the common stock on the date of grant and could
not expire more than ten years from the date of grant. The majority of stock
options became exercisable 30%, 30% and 40% on the first, second and third
anniversaries of the date of grant.
During the year ended December 31, 2001, under the LTIPs, the Committee granted
217,800 performance restricted shares, 10,814,610 performance units and 5,006
restricted shares to officers and certain key employees. During the year ended
December 31, 2000, under the LTIPs, the Committee granted 148,800 performance
restricted shares, 6,768,100 performance units and 10,961 restricted shares to
officers and certain key employees. The performance restricted shares would vest
if UDS achieved specific financial objectives over a three-year performance
period and the ultimate number of performance restricted shares granted for a
particular grant year could have been increased
22
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
up to 200% (i.e. 435,600 shares for the performance restricted shares granted in
2001). The performance units, equal to $1 per unit, would vest if UDS achieved
specific financial objectives over a two-year performance period and the
ultimate number of performance units granted for a particular grant year could
have been increased up to 200% (i.e. 21,629,220 units for the 2001 grant). The
restricted shares vested on the second anniversary from the date of grant.
During the performance periods, a grantee could vote and receive dividends on
the performance restricted shares and the restricted shares. However, the
performance restricted shares and restricted shares were subject to transfer
restrictions and were all or partially forfeited if a grantee terminated. Upon
issuance of the performance restricted shares, unearned compensation cost
equivalent to the market value of the shares granted was charged to
stockholders' equity and was amortized to salary expense over the vesting period
as the performance objectives were achieved. The unamortized compensation cost
was adjusted periodically based on changes in the market value of the shares.
Any additional performance restricted shares earned in excess of the granted
shares were to be paid in cash and were accrued based on the market value of the
equivalent shares earned to date. Compensation expense for the performance units
was recognized over the vesting period as the performance objectives were
achieved.
During the years ended December 31, 2001 and 2000, UDS recognized compensation
expense of $23.7 million and $6.6 million, respectively, related to performance
restricted shares, performance units and restricted shares.
All of the LTIPs included a "change in control" provision under which all
granted and outstanding performance restricted shares, performance units and
restricted shares would vest upon a "change in control" as defined in the LTIP
agreements. In the case of the performance restricted shares and performance
units, the level of achievement for the performance objectives during the
remaining performance period was assumed to equal 100%. In addition, all
outstanding stock options vested and became 100% exercisable upon a "change in
control" as defined in the stock option agreements. A "change in control"
occurred when UDS was acquired by Valero on December 31, 2001 and all
outstanding stock options, performance restricted shares, performance units and
restricted shares became vested.
In addition to the above, UDS had previously entered into employment agreements
with its officers and certain key employees that provided for "change in
control" payments equivalent to three years of salary and bonus and additional
retirement benefits if the acquiring company did not retain the services of such
officers or key employees.
The consolidated financial statements do not reflect the acquisition of UDS by
Valero; thus the impact of the "change in control" provisions relating to the
LTIP agreements and the employment agreements have not been recognized in the
accompanying consolidated financial statements. In January 2002, subsequent to
the acquisition, Valero paid $90.1 million to the officers and certain key
employees of UDS pursuant to the change in control provisions of the LTIP
agreements and the employment agreements.
23
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Stock option transactions under the various LTIPs are summarized as follows:
<Table>
<Caption>
NUMBER OF WEIGHTED AVERAGE
STOCK OPTIONS EXERCISE PRICE
------------- ----------------
Outstanding as of December 31, 1998 ................... 7,196,599 $ 27.67
Granted ............................................. 290,900 21.71
Canceled ............................................ (597,199) 30.26
Exercised ........................................... (157,339) 20.38
------------
Outstanding as of December 31, 1999 ................... 6,732,961 27.35
Granted ............................................. 1,115,987 23.32
Canceled ............................................ (420,034) 28.70
Exercised ........................................... (132,943) 19.32
------------
Outstanding as of December 31, 2000 ................... 7,295,971 26.80
Granted ............................................. 2,060,952 36.23
Canceled ............................................ (38,687) 29.43
Exercised ........................................... (5,159,478) 26.91
------------
Outstanding as of December 31, 2001 ................... 4,158,758 31.32
============
Stock options exercisable as of December 31:
1999 ................................................ 3,941,934 26.92
2000 ................................................ 4,076,591 26.56
2001 (excluding the impact of the
change in control) ............................... 2,110,966 26.52
</Table>
The above stock options had terms ranging from 5 to 10 years. As of
December 31, 2001, prior to the acquisition by Valero, there were 4,423,892
shares available for future issuance under the LTIPs. For the year ended
December 31, 2001, UDS recorded in stockholders' equity a $38.0 million non-cash
tax benefit resulting from the exercise of stock options.
Stock options outstanding and exercisable (exclusive of the impact of the change
in control) as of December 31, 2001 were as follows:
<Table>
<Caption>
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
----------------------------------------------------- --------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING LIFE AVERAGE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING IN YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------- ----------- -------------- -------------- ----------- --------------
$15.00 - $19.49 66,620 0.8 $15.83 66,620 $15.83
$20.40 - $24.88 780,160 6.2 23.31 780,160 23.31
$25.00 - $29.90 666,158 3.6 27.00 666,158 27.00
$30.13 - $34.63 2,172,611 5.9 32.29 567,011 31.09
$35.52 - $38.93 66,176 2.5 36.89 31,017 36.29
$43.40 - $44.35 14,544 2.5 43.67 -- --
$46.40 - $49.90 166,044 5.6 48.99 -- --
$50.05 - $55.58 226,445 5.6 51.44 -- --
---------- ----------
$15.00 - $55.58 4,158,758 4.1 $31.32 2,110,966 $26.52
========== ==========
</Table>
UDS accounts for its stock option plans using the intrinsic value method and,
accordingly, has not recognized compensation expense for stock options granted,
since the option price equaled the common stock price on the date
24
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
of grant. The weighted average fair value of stock options granted during the
years ended December 31, 2001, 2000 and 1999 was $7.00, $4.74 and $3.96 per
option, respectively. The fair value for these stock options was estimated at
the respective grant dates using the Black-Scholes option pricing model with the
following assumptions:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------------------------------
2001 2000 1999
------------- ------------- -------------
Risk free interest rate.................... 1.79% - 5.05% 6.02% - 6.79% 4.77% - 6.02%
Expected life.............................. 4 years 4 years 4 years
Expected volatility........................ 28% - 34% 24% - 26% 24% - 25%
Expected dividend yield.................... 3.70% - 4.41% 4.00% - 4.19% 3.70% - 3.94%
</Table>
Had UDS accounted for stock options granted in 2001, 2000 and 1999 using the
fair value method at the date of grant, additional compensation expense would
have been recorded and the pro forma effect would have been as follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
----------------------------------------
2001 2000 1999
------ ------ ------
(in millions, except per share data)
Pro forma net income....................... $531.0 $440.7 $170.1
Pro forma net income per share:
Basic.................................... $ 7.17 $ 5.08 $ 1.96
Diluted.................................. $ 7.03 $ 5.07 $ 1.96
</Table>
For purposes of the pro forma disclosures, the estimated fair value of stock
options is amortized to expense over the stock options' vesting periods.
The Committee adopted the 2001, 2000 and 1999 Annual Incentive Plans (AIP) which
provide for cash awards based on certain criteria to officers and certain key
employees. For the years ended December 31, 2001, 2000 and 1999, the related AIP
expense was $18.3 million, $11.3 million and $8.6 million, respectively.
Under the terms of the Non-Employee Director Equity Plan, non-employee directors
are granted restricted shares on the date elected to the Board of Directors
equal to at least 50% of the non-employee director's annual retainer. Additional
restricted shares are granted to the non-employee director every five years
following the initial date of grant. At each annual meeting, each non-employee
director is also granted stock options for 1,000 shares. The stock options are
fully exercisable at the following annual meeting. The stock options expire ten
years from the date of grant. During the year ended December 31, 2001, 18,000
stock options and 44,583 restricted share awards were granted. During the year
ended December 31, 2000, 20,000 stock options and 4,530 restricted share awards
were granted. During the year ended December 31, 1999, 11,000 stock options and
2,502 restricted share awards were granted. As of December 31, 2001, a total of
235,285 shares were available for future issuance under this plan.
In 1993, the Committee adopted the Ultramar Corporation Stock Purchase Plan and
Dividend Reinvestment Plan which allows eligible holders of common stock to use
dividends to purchase common stock and to make optional cash payments to buy
additional shares of common stock. UDS had reserved a total of 2,000,000 shares
of common stock for issuance under this plan. As of December 31, 2001, a total
of 57,441 shares had been issued under the plan and 1,942,559 shares remain
available for future issuance.
25
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
NOTE 15: COMPUTATION OF NET INCOME PER SHARE
Basic net income per share is calculated as net income divided by the weighted
average number of common shares outstanding. Diluted net income per share
assumes, when dilutive, issuance of the net incremental shares from stock
options and restricted shares. The following table reconciles the net income
amounts and share numbers used in the computation of net income per share.
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
BASIC NET INCOME PER SHARE:
Weighted average common shares outstanding (in thousands) ............ 74,052 86,773 86,615
========== ========== ==========
Net income (in millions) .......................................... $ 535.0 $ 444.3 $ 173.2
========== ========== ==========
Basic net income per share ........................................... $ 7.22 $ 5.12 $ 2.00
========== ========== ==========
DILUTED NET INCOME PER SHARE:
Weighted average common shares outstanding (in thousands) ............ 74,052 86,773 86,615
Net effect of dilutive stock options based on the treasury stock
method using the average market price (in thousands) .............. 1,485 229 127
---------- ---------- ----------
Weighted average common equivalent shares (in thousands) .......... 75,537 87,002 86,742
========== ========== ==========
Net income (in millions) .......................................... $ 535.0 $ 444.3 $ 173.2
========== ========== ==========
Diluted net income per share ......................................... $ 7.08 $ 5.11 $ 2.00
========== ========== ==========
</Table>
NOTE 16: EMPLOYEE BENEFIT PLANS
UDS has several qualified, non-contributory defined benefit plans (the Qualified
Plans) covering substantially all salaried employees in the United States and
Canada, including certain plans subject to collective bargaining agreements.
These plans generally provide retirement benefits based on years of service and
compensation during specific periods. Officers and certain key employees covered
by these plans are also entitled to participate in various unfunded supplemental
executive retirement plans (Supplemental Plans) which provide retirement
benefits based on years of service and compensation, including compensation not
permitted to be taken into account under the Qualified Plans. The Supplemental
Plans and the Qualified Plans are collectively referred to as the Pension Plans.
Under the Qualified Plans, UDS' policy is to fund normal cost plus the
amortization of the unfunded actuarial liability for costs arising from
qualifying service determined under the projected unit credit method. The
underlying pension plan assets include cash equivalents, fixed income securities
(primarily obligations of the U.S. government) and equity securities.
26
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The changes in benefit obligation, changes in plan assets and the weighted
average assumptions for the Pension Plans and other postretirement benefits are
as follows:
<Table>
<Caption>
OTHER POSTRETIREMENT
PENSION BENEFITS BENEFITS
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
(in millions)
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation as of the beginning of year ................. $ 292.0 $ 283.5 $ 81.1 $ 81.3
Service cost ................................................. 16.7 14.3 1.9 1.9
Interest cost ................................................ 24.7 22.1 6.7 5.8
Plan participants' contributions ............................. 0.3 0.3 -- --
Acquisitions ................................................. -- 20.3 -- 2.0
Actuarial loss (gain) ........................................ 75.5 (9.0) 15.5 (4.9)
Plan amendments .............................................. 7.9 -- -- --
Foreign currency exchange rate changes ....................... -- -- (0.6) (0.3)
Termination benefits ......................................... 1.8 -- -- --
Benefits paid ................................................ (32.0) (39.5) (5.8) (4.7)
---------- ---------- ---------- ----------
Benefit obligation as of the end of year ....................... 386.9 292.0 98.8 81.1
---------- ---------- ---------- ----------
CHANGE IN PLAN ASSETS:
Fair value of plan assets as of the beginning of year .......... 245.8 261.9 -- --
Actual return on plan assets ................................. (4.0) (1.7) -- --
Employer contributions ....................................... 6.4 24.8 5.8 4.7
Plan participants' contributions ............................. 0.3 0.3 -- --
Benefits paid ................................................ (32.0) (39.5) (5.8) (4.7)
---------- ---------- ---------- ----------
Fair value of plan assets as of the end of year ................ 216.5 245.8 -- --
---------- ---------- ---------- ----------
Funded status as of the end of year ............................ (170.4) (46.2) (98.8) (81.1)
Unrecognized net actuarial loss (gain) ....................... 95.6 (4.2) (6.1) (22.1)
Unrecognized prior service cost .............................. 25.2 20.3 (11.0) (12.2)
Unrecognized net transition obligation ....................... 0.1 0.2 -- --
---------- ---------- ---------- ----------
Accrued benefit cost ........................................... $ (49.5) $ (29.9) $ (115.9) $ (115.4)
========== ========== ========== ==========
Amounts recognized in the consolidated balance sheets:
Prepaid benefit cost ......................................... $ 1.9 $ 6.0 $ -- $ --
Intangible asset ............................................. 12.7 -- -- --
Accrued benefit liability .................................... (51.4) (35.9) (115.9) (115.4)
Additional minimum liability ................................. (20.5) (3.0) -- --
Accumulated other comprehensive loss ......................... 7.8 3.0 -- --
---------- ---------- ---------- ----------
Net amount recognized at end of year ........................... $ (49.5) $ (29.9) $ (115.9) $ (115.4)
========== ========== ========== ==========
WEIGHTED AVERAGE ASSUMPTIONS:
Discount rate ................................................ 7.00% 7.75% 7.00% 7.75%
Expected return on plan assets ............................... 8.75% 9.50% N/A N/A
Rate of compensation increase ................................ 5.00% 4.50% 4.25%-5.00% 4.25%-4.50%
Health care cost trend on covered charges .................... N/A N/A 7.6% 6.4%
</Table>
In connection with the acquisition of the Golden Eagle Refinery and Valley
Shamrock, Inc. in 2000, UDS assumed liabilities totaling $22.3 million related
to certain employee pension and other postretirement benefit obligations.
27
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The projected benefit obligation, accumulated benefit obligation and fair value
of plan assets for the Pension Plans with accumulated benefit obligations in
excess of plan assets consisted of the following:
<Table>
<Caption>
DECEMBER 31,
---------------------------------
2001 2000
--------------- ---------------
(in millions)
Projected benefit obligation ........... $ 366.1 $ 28.4
Accumulated benefit obligation ......... 261.3 21.7
Fair value of plan assets .............. 197.4 9.6
</Table>
The components of net periodic benefit cost are summarized as follows:
<Table>
<Caption>
PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS
-------------------------- -----------------------------
2001 2000 1999 2001 2000 1999
------ ------ ------ -------- -------- -------
(in millions)
COMPONENTS OF NET PERIODIC BENEFIT COST:
Service cost ................................ $ 16.7 $ 14.3 $ 16.1 $ 1.9 $ 1.9 $ 2.1
Interest cost ............................... 24.7 22.1 22.5 6.7 5.8 5.9
Expected return on plan assets .............. (21.8) (22.5) (21.8) -- -- --
Amortization of:
Transition obligation ..................... 0.1 0.1 0.1 -- -- --
Prior service cost ........................ 2.9 2.4 2.4 (1.2) (1.2) (1.2)
Actuarial loss (gain) ..................... 0.1 0.1 1.5 (0.4) (1.2) (0.6)
Termination charge ........................ -- -- 6.4 -- -- --
Curtailment gain .......................... -- -- (1.2) -- -- --
Settlement charge (gain) .................. -- (0.6) 0.2 -- -- --
------ ------ ------ ------ ------ ------
Net periodic benefit cost ................... $ 22.7 $ 15.9 $ 26.2 $ 7.0 $ 5.3 $ 6.2
====== ====== ====== ====== ====== ======
</Table>
In connection with the acquisition of UDS by Valero, UDS implemented an early
retirement program whereby certain UDS employees (47 years old or older) were
eligible to receive additional credits (8 years of combined service or age)
under the Pension Plan. As a result, 75 UDS employees elected to retire early
under this program.
UDS also maintains retirement plans for certain collective bargaining groups
(the Bargaining Unit Plans). The Bargaining Unit Plans generally provide
benefits that are based on the union member's monthly base pay during the five
years prior to retirement.
UDS maintains several defined contribution retirement plans for substantially
all eligible employees in the United States and Canada. Contributions to the
plans are generally determined as a percentage of each eligible employee's
salary. Contributions to these plans amounted to $8.2 million, $6.3 million and
$6.0 million during the years ended December 31, 2001, 2000 and 1999,
respectively.
UDS sponsors unfunded defined benefit postretirement plans, which provide health
care and life insurance benefits to retirees who satisfy certain age and service
requirements. In addition, pursuant to the terms of a distribution agreement
between Diamond Shamrock, Inc. (subsequently merged into UDS) and Maxus, Diamond
Shamrock, Inc.'s parent company prior to its 1987 spin-off, UDS also shares in
the cost of providing similar benefits to former employees of Maxus.
Generally, the health care plans pay a stated percentage of most medical
expenses reduced for any deductibles, payments made by government programs and
other group coverage. The cost of providing these benefits is shared with
retirees.
28
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A 1% change in assumed health care cost
trend rates would have the following effects:
<Table>
<Caption>
1% INCREASE 1% DECREASE
----------- -----------
(in millions)
Effect on total of service and interest cost components........ $ 0.4 $ (0.3)
Effect on postretirement benefit obligation.................... 7.1 (6.0)
</Table>
NOTE 17: INCOME TAXES
Income before income taxes and dividends of subsidiary trust consisted of the
following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------------------
2001 2000 1999
---------- ---------- ----------
(in millions)
United States ......... $ 652.8 $ 505.9 $ 264.9
Canada ................ 213.0 211.5 49.7
---------- ---------- ----------
Total ............... $ 865.8 $ 717.4 $ 314.6
========== ========== ==========
</Table>
Provision for income taxes consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
----------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
Current:
U.S. federal .................. $ 31.6 $ 55.7 $ 6.9
U.S. state .................... 2.2 4.4 (1.4)
Canada ........................ 33.9 105.4 53.2
--------- --------- ---------
Total current ............... 67.7 165.5 58.7
--------- --------- ---------
Deferred:
U.S. federal .................. 196.2 106.4 96.0
U.S. state .................... 19.9 12.3 10.1
Canada ........................ 36.7 (21.4) (33.7)
--------- --------- ---------
Total deferred .............. 252.8 97.3 72.4
--------- --------- ---------
Provision for income taxes ...... $ 320.5 $ 262.8 $ 131.1
========= ========= =========
</Table>
Deferred income taxes arise from temporary differences between the income tax
basis of assets and liabilities and their reported amounts in the consolidated
financial statements.
29
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The components of deferred income tax liabilities and assets consisted of the
following:
<Table>
<Caption>
DECEMBER 31,
------------------------
2001 2000
---------- ----------
(in millions)
Deferred income tax liabilities:
Excess of book basis over tax basis of:
Property, plant and equipment ............................ $ (587.9) $ (518.9)
Equity investment in Diamond-Koch, L.P. .................. (9.7) (9.3)
Excess of tax basis over book basis of
leasing arrangements ..................................... (70.5) (70.8)
Deferred refinery maintenance turnaround costs .............. (63.3) (36.5)
LIFO inventory .............................................. (16.4) --
---------- ----------
Total deferred income tax liabilities .................... (747.8) (635.5)
---------- ----------
Deferred income tax assets:
LIFO inventory .............................................. -- 36.3
Accrued expenses and other long-term liabilities ............ 110.8 131.6
U.S. federal and state income tax credit carryforwards ...... 84.2 147.6
Canadian tax benefit on unrealized foreign exchange
adjustment ................................................ 2.3 3.7
Net operating loss carryforwards ............................ 21.8 40.9
Other ....................................................... -- 7.3
---------- ----------
Total deferred income tax assets ......................... 219.1 367.4
Less valuation allowance .................................... (24.0) (8.4)
---------- ----------
Net deferred income tax assets ........................... 195.1 359.0
---------- ----------
Net deferred income tax liabilities .................... $ (552.7) $ (276.5)
========== ==========
</Table>
As of December 31, 2001, U.S. federal and state and Canadian income tax credit
and loss carryforwards were as follows:
<Table>
<Caption>
AMOUNT EXPIRATION
------ ----------
(in millions)
U.S. federal and state income tax credits.......... $ 12.2 2002 through 2014
Alternative minimum tax (AMT) credits.............. 55.7 Indefinitely
Foreign tax credits................................ 16.3 2006
U.S. federal net operating losses (NOL)............ 20.3 2011 through 2013
Canadian net operating losses...................... 0.9 2007
</Table>
Included in the above are $1.1 million of income tax credit carryforwards, $16.9
million of AMT credit carryforwards and $20.3 million of NOL carryforwards
acquired from Total Petroleum (North America), Ltd., which are subject to annual
U.S. federal income tax limitations.
UDS has established a valuation allowance for certain deferred income tax
assets, primarily state NOLs and foreign tax credit carryforwards, which may not
be realized in future periods. The realization of net deferred income tax
assets recorded as of December 31, 2001 is dependent upon UDS' ability to
generate future taxable income in both the U.S. and Canada. Although realization
is not assured, management believes it is more likely than not that the net
deferred income tax assets will be realized.
UDS has not provided any U.S. federal deferred income taxes or Canadian
withholding taxes on the undistributed earnings of its Canadian subsidiaries
based on the determination that those earnings will be indefinitely reinvested.
30
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
As of December 31, 2001, the cumulative undistributed earnings of these
subsidiaries were approximately $105.9 million. If those earnings were not
considered indefinitely reinvested, U.S. federal deferred income taxes and
Canadian withholding taxes would have been provided after consideration of
foreign tax credits. However, determination of the amount of U.S. federal
deferred income taxes and Canadian withholding taxes is not practical.
The differences between the effective income tax rate and the U.S. federal
statutory rate is reconciled as follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-------------------------------------
2001 2000 1999
--------- --------- ---------
U.S. federal statutory rate .............................. 35.0% 35.0% 35.0%
Effect of foreign operations ............................. (0.5) 1.4 0.6
U.S. state income taxes, net of U.S. federal taxes ....... 1.7 1.5 2.5
Non-deductible goodwill amortization and
impairment charge ...................................... 0.5 0.8 5.6
Other .................................................... 0.3 (2.1) (2.0)
--------- --------- ---------
Effective income tax rate .............................. 37.0% 36.6% 41.7%
========= ========= =========
</Table>
Income taxes paid, net of refunds, for the years ended December 31, 2001, 2000
and 1999 amounted to $189.7 million, $144.7 million and $22.1 million,
respectively.
In December 2000, UDS settled an appeal with the Internal Revenue Service
related to tax issues for the years 1988 through 1994. The appeal pertained to
the IRS's decision to not allow certain income tax deductions taken during those
years. All issues were resolved favorably and a tax refund was received of $12.5
million plus interest of $6.1 million, or $0.19 per share.
NOTE 18: ENVIRONMENTAL MATTERS
The operations of UDS are subject to environmental laws and regulations adopted
by various federal, state and local governmental authorities in the
jurisdictions in which it operates. Although management believes the operations
are in general compliance with applicable environmental regulations, risks of
additional costs and liabilities are inherent in petroleum refining and retail
marketing operations, and there can be no assurance that significant costs and
liabilities will not be incurred. Moreover, it is possible that other
developments, such as increasingly stringent environmental laws, regulations and
enforcement policies thereunder, and claims for damages to property or persons
resulting from the operations, could result in substantial costs and
liabilities. Accordingly, UDS has adopted policies, practices and procedures in
the areas of pollution control, product safety, occupational health and the
production, handling, storage, use and disposal of hazardous materials to
prevent material environmental or other damage, and to limit the financial
liability which could result from those events. However, some risk of
environmental or other damage is inherent in the refining and marketing
business, as it is with other companies engaged in similar businesses.
UDS has been designated as a potentially responsible party by the U.S.
Environmental Protection Agency (the EPA) under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980, and by certain states under
applicable state laws, with respect to the cleanup of hazardous substances at
several sites. In each instance, other potentially responsible parties also have
been so designated. UDS has accrued liabilities for environmental remediation
obligations at these sites, as well as estimated site restoration costs to be
incurred in the future.
31
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The balances of and changes in accruals for environmental matters which are
principally included in other long-term liabilities consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
Balance as of the beginning of year ....... $ 152.7 $ 171.0 $ 219.4
Additions to accrual .................... 8.1 13.2 4.1
Reductions from accrual ................. (2.1) (4.6) (20.6)
Payments ................................ (36.0) (26.9) (31.9)
--------- --------- ---------
Balance as of the end of year ............. $ 122.7 $ 152.7 $ 171.0
========= ========= =========
</Table>
During the year ended December 31, 2001 and 2000, environmental liabilities were
increased for various refinery and retail environmental remediation projects
including California MTBE issues. During the year ended December 31, 1999, based
on the annual review of environmental liabilities, it was determined that
certain liabilities were overstated as the required cleanup obligation was less
than originally estimated. Accordingly, environmental liabilities were reduced
by $20.6 million.
The accruals noted above represent UDS' best estimate of the costs which will be
incurred over an extended period for restoration and environmental remediation
at various sites. However, environmental exposures 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 UDS' 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
any single period, UDS believes that these costs will not have a material
adverse effect on its financial position. The liabilities reflected above have
not been reduced by possible recoveries from third parties and projected cash
expenditures have not been discounted.
NOTE 19: COMMITMENTS AND CONTINGENCIES
UDS leases convenience stores, office space, refinery equipment and other assets
under operating leases with terms expiring at various dates through 2053.
Certain leases contain renewal options and escalation clauses and require the
payment of property taxes, insurance and maintenance costs. These provisions
vary by lease. Certain convenience store leases provide for the payment of
rentals based solely on sales volume while others provide for payments, in
addition to any established minimums, contingent upon the achievement of
specified levels of sales volumes.
As of December 31, 2001, UDS had various time charters for ocean-going tankers
and coastal vessels which expire on various dates through 2009. Two additional
time charters will commence in mid to late summer 2002. Certain of these
charters include renewal options and escalation clauses, which vary by charter.
In addition, certain time charters provide for the payment of chartering fees
which vary based on usage while others provide for payments, in addition to
established minimums, contingent upon usage.
32
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Future minimum rental payments applicable to non-cancelable operating leases and
time charters as of December 31, 2001 are as follows (in millions):
<Table>
2002............................................... $ 106.2
2003............................................... 89.5
2004............................................... 80.9
2005............................................... 78.3
2006............................................... 67.7
Thereafter......................................... 166.1
-------
Gross minimum lease payments................... 588.7
Less future minimum sublease rental income......... (21.1)
-------
Net future minimum lease payments.............. $ 567.6
=======
</Table>
Rental expense, net of sublease rental income, for all operating leases
consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
Minimum rental expense ........... $ 71.7 $ 75.3 $ 90.3
Contingent rental expense ........ 12.0 10.9 8.5
--------- --------- ---------
Gross rental expense ........... 83.7 86.2 98.8
Less sublease rental income ...... (10.0) (9.8) (10.6)
--------- --------- ---------
Net rental expense ............. $ 73.7 $ 76.4 $ 88.2
========= ========= =========
</Table>
Charges to cost of products sold for marine freight time charters totaled $54.6
million, $61.9 million and $44.9 million for the years ended December 31, 2001,
2000 and 1999, respectively.
To accommodate UDS' convenience store construction program, UDS has three
long-term operating lease arrangements which are summarized below:
<Table>
<Caption>
FACILITY AMOUNT DRAWN AT
AMOUNT DECEMBER 31, 2001 EXPIRATION
-------- ----------------- ----------
(in millions)
Total Lease................................ $ 65.0 $ 18.5 August 2002
Jamestown Lease............................ 76.2 76.2 July 2003
Brazos Lease............................... 186.8 186.8 December 2003
------- --------
$ 328.0 $ 281.5
======= ========
</Table>
These lease arrangements have been used to construct or purchase convenience
stores and to construct the headquarters in San Antonio, Texas. After their
respective non-cancelable lease terms, the leases may be extended by agreement
of the parties, or UDS may purchase or arrange for the sale of the convenience
stores or the corporate headquarters. If UDS were unable to extend the lease or
arrange for the sale of the properties to a third party at the respective
expiration dates of the leases, the amount necessary to purchase the properties
under the leases as of December 31, 2001 would be approximately $271.8 million.
As of December 31, 2001, UDS has available capacity under the Total lease of
$46.5 million.
In conjunction with the construction of a high-pressure gas oil hydrotreater at
the Wilmington Refinery, UDS entered into a long-term contract for the supply of
hydrogen, which expires in 2011. UDS also entered into a long-term contract for
the supply of hydrogen to the Three Rivers Refinery, which expires in 2011. In
conjunction with the acquisition of the Golden Eagle Refinery, a long-term
contract for the supply of hydrogen was assumed, which expires in 2009. All
three of the hydrogen contracts have take-or-pay provisions requiring monthly
payments
33
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
totaling approximately $2.9 million, which are adjusted periodically based on
certain market indices. UDS also has a commitment under a product supply
arrangement to pay a reservation fee of approximately $10.4 million annually
through June 2002.
Also in conjunction with the acquisition of the Golden Eagle Refinery, UDS
assumed an operating lease for the MTBE facility located at the refinery, which
expires in 2010. At the time of the acquisition, governmental regulations
required that the use of MTBE blended gasolines be phased out by 2004. The
Golden Eagle Refinery is completing various capital projects which will allow
it to phase out MTBE effective December 31, 2002. Accordingly, a lease
termination obligation for the MTBE facility lease of $36.1 million was accrued
as part of the allocation of the purchase price. The lease termination
obligation is included in accrued expenses and other current liabilities in the
consolidated balance sheet as of December 31, 2001.
Pursuant to the terms of various agreements, UDS has agreed to indemnify the
former owners of Ultramar, Inc. (UI) and CUC and certain of their affiliates for
any claims or liabilities arising out of, among other things, refining and
retail activities and litigation related to the operations of UI and CUC prior
to their acquisition by UDS in 1992.
UDS is also a party to additional claims and legal proceedings arising in the
ordinary course of business. UDS believes it is unlikely that the final outcome
of any of the claims or proceedings to which it is a party would have a material
adverse effect on its financial position, results of operations or liquidity;
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 UDS' results of operations,
financial position or liquidity.
NOTE 20: FINANCIAL INSTRUMENTS
Financial instruments consisted of the following:
<Table>
<Caption>
DECEMBER 31,
----------------------------------------------------
2001 2000
----------------------- -----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------- --------- -------- ---------
(in millions)
Cash and cash equivalents...................... $ 338.8 $ 338.8 197.1 $ 197.1
Non-current notes receivable................... 28.8 28.8 30.5 30.5
Advance from Valero Energy Corporation......... (703.0) (703.0) -- --
Long-term debt, including current portion...... (1,272.5) (1,257.0) (1,661.5) (1,674.0)
Interest rate swap agreements:
Receivable position.......................... 19.1 19.1 -- 1.8
Payable position............................. (1.3) (1.3) -- --
Commodity contracts............................
Asset position............................... 14.2 14.2 5.4 29.2
Liability position........................... (20.6) (20.6) (8.3) (10.2)
</Table>
Cash and cash equivalents as of December 31, 2001 and 2000 include $204.9
million and $126.6 million, respectively, of investments in marketable
securities with maturities of less than three months. The investments are held
to maturity and are stated at amortized cost, which approximates fair market
value.
The aggregate carrying amount of non-current notes receivable approximated fair
value as determined based on the discounted cash flow method.
34
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The fair value of the fixed rate debt as of December 31, 2001 and 2000 was
$1,219.5 million and $1,306.2 million, respectively (carrying amounts of
$1,235.0 million and $1,293.7 million, respectively) and was estimated based on
the quoted market price of similar debt instruments. The carrying amounts of the
borrowings under the revolving credit agreements and money market facilities
approximate fair value because these obligations generally bear interest at
floating rates.
The fair value of interest rate swap agreements is determined based on the
differences between the contract rate of interest and the rates currently quoted
for agreements of similar terms and maturities.
The fair value of commodity futures and options contracts is based on quoted
market prices. The fair value of commodity price and spread swap contracts is
determined based on the differences between the contract rate of the swap and
quoted market prices for contracts of similar terms.
UDS is subject to the market risk associated with changes in the market price of
the underlying crude oil and refined products; however, these changes in values
are generally offset by changes in the sales price of the related refined
products.
UDS is exposed to credit risk in the event of nonperformance by the
counterparties in all interest rate swap agreements, price swap contracts and
foreign exchange contracts. Generally, UDS does not anticipate nonperformance by
any of the counterparties; however to the extent nonperformance is expected, a
provision to reduce the amount due from the counterparty is recorded. The amount
of this exposure is generally the unrealized gains or losses on those contracts.
Other financial instruments, which potentially subject UDS to credit risk,
consist principally of accounts receivable. Concentration of credit risk with
respect to accounts receivable is limited due to the large number of customers
comprising the customer base and their dispersion across different geographic
areas. As of December 31, 2001 and 2000, UDS had no significant concentrations
of credit risk.
NOTE 21: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
UDS is exposed to various market risks, including changes in interest rates,
commodity prices related to crude oil, refined products and natural gas and
foreign currency rates. To manage or reduce these market risks, interest rate
swaps, commodity contracts and foreign exchange and purchase contracts are used.
Interest rate swap agreements are used to manage the exposure to interest rate
risk on fixed-rate debt obligations.
Commodity futures and options contracts are used to procure a large portion of
the crude oil requirements of the refineries and to hedge the exposure to crude
oil, refined product, and natural gas price volatility. Commodity price and
spread swap contracts are used to manage the exposure to price volatility
related to forecasted purchases of crude oil, refined products and natural gas
and sales of refined products.
The impact of adopting Statement No. 133, as amended, on January 1, 2001 was to
record derivative assets of $25.6 million, derivative liabilities of $16.1
million and a cumulative effect adjustment to other comprehensive income of
$13.3 million, net of income tax expense.
35
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Derivative assets and liabilities consisted of the following as of December 31,
2001:
<Table>
<Caption>
DERIVATIVE DERIVATIVE
ASSETS LIABILITIES
---------- -----------
(in millions)
Derivative instruments designated as:
Fair value hedge........................................ $ 19.1 $ 1.3
Cash flow hedge......................................... 1.3 --
Not designated.......................................... 12.9 20.6
</Table>
Included in other comprehensive income as of December 31, 2001 are $0.8 million
of gains associated with the cash flow hedge, which will be reclassified into
income during June 2002 when the forecasted transactions impact income.
For the year ended December 31, 2001, there was no net gain or loss recognized
in the consolidated statement of income related to hedge ineffectiveness for
fair value hedges or cash flow hedges, and no component of the derivative
instruments' gain or loss from the assessment of hedge effectiveness was
excluded. No amounts were recognized in income for hedged firm commitments no
longer qualifying as fair value hedges.
The above transactions are non-cash items which were excluded from the
consolidated statement of cash flows for the year ended December 31, 2001.
NOTE 22: BUSINESS SEGMENTS AND GEOGRAPHIC INFORMATION
UDS has three reportable segments: Refining, Retail and Petrochemical/NGL. The
Refining segment includes refinery, wholesale, product supply and distribution,
and transportation operations. The Retail segment includes company-operated
convenience stores, Canadian dealers/jobbers, cardlock and home heating oil
operations. The Petrochemical/NGL segment includes income from Nitromite
fertilizer, NGL marketing and certain NGL pipeline operations. Equity income
from joint ventures is not included in operating income. Operations that are not
included in any of the three reportable segments are included in the corporate
category and consist primarily of corporate office expenditures.
The reportable segments are strategic business units that offer different
products and services. They are managed separately as each business requires
unique technology and marketing strategies. Performance is evaluated based on
operating income and EBITDA which is defined as operating income plus
depreciation and amortization and equity income from joint ventures less gain
(plus loss) on sale of property, plant and equipment. EBITDA is a measure used
for internal analysis and in presentations to analysts, investors and lenders.
The calculation of EBITDA is not based on United States generally accepted
accounting principles and should not be considered as an alternative to net
income or cash flows from operating activities (which are determined in
accordance with U.S. GAAP). This measure may not be comparable to similarly
titled measures used by other entities as other entities may not calculate
EBITDA in the same manner. Intersegment sales are generally derived from
transactions made at prevailing market rates.
36
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Total expenditures include capital expenditures, acquisition costs of refining
and retail operations, net of cash acquired, and deferred refinery maintenance
turnaround costs.
<Table>
<Caption>
PETROCHEMICAL/
REFINING RETAIL NGL CORPORATE TOTAL
--------- --------- ------------- --------- ---------
(in millions)
YEAR ENDED DECEMBER 31, 2001:
Sales and other revenues from
external customers ................. $10,382.6 $ 6,356.8 $ 120.6 $ -- $16,860.0
Intersegment sales .................... 3,015.7 -- -- -- 3,015.7
EBITDA ................................ 1,245.3 180.7 5.3 (166.9) 1,264.4
Depreciation and amortization ......... 190.8 74.3 -- 12.7 277.8
Operating income (loss) ............... 1,060.2 100.2 (0.2) (179.9) 980.3
Total assets .......................... 4,393.9 1,190.1 150.6 587.8 6,322.4
Total expenditures .................... 575.6 105.1 -- 10.4 691.1
YEAR ENDED DECEMBER 31, 2000:
Sales and other revenues from
external customers ................ 10,273.3 6,625.1 162.7 -- 17,061.1
Intersegment sales .................... 3,375.9 -- 1.4 -- 3,377.3
EBITDA ................................ 1,022.0 172.7 21.4 (128.7) 1,087.4
Depreciation and amortization ......... 170.6 70.2 0.9 11.4 253.1
Operating income (loss) ............... 846.3 104.5 2.1 (140.8) 812.1
Total assets .......................... 4,295.4 1,270.7 117.8 304.5 5,988.4
Total expenditures .................... 913.7 94.6 -- 30.8 1,039.1
YEAR ENDED DECEMBER 31, 1999:
Sales and other revenues from
external customers ................ 7,921.0 5,883.2 135.1 -- 13,939.3
Intersegment sales .................... 2,683.7 8.1 -- -- 2,691.8
EBITDA ................................ 615.8 202.0 19.5 (137.4) 699.9
Depreciation and amortization ......... 168.2 67.8 1.4 3.4 240.8
Operating income (loss) ............... 358.6 202.5 3.5 (135.5) 429.1
Total assets .......................... 3,326.5 1,220.2 148.2 241.1 4,936.0
Total expenditures .................... 109.2 62.2 0.1 47.3 218.8
</Table>
37
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following summarizes the reconciliation of reportable segment sales and
other revenues, operating income, and assets to consolidated sales and other
revenues, operating income and total assets:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
SALES AND OTHER REVENUES:
Total sales for reportable segments ............... $19,875.7 $20,438.4 $16,631.1
Elimination of intersegment sales ................. (3,015.7) (3,377.3) (2,691.8)
--------- --------- ---------
Consolidated sales and other revenues ........ $16,860.0 $17,061.1 $13,939.3
========= ========= =========
OPERATING INCOME:
Total operating income for reportable segments .... $ 1,160.2 $ 952.9 $ 564.6
Other unallocated expenses ........................ (179.9) (140.8) (135.5)
--------- --------- ---------
Consolidated operating income ................ $ 980.3 $ 812.1 $ 429.1
========= ========= =========
</Table>
<Table>
<Caption>
DECEMBER 31,
-------------------
2001 2000
-------- --------
(in millions)
TOTAL ASSETS:
Total assets for reportable segments .... $5,734.6 $5,683.9
Other unallocated assets ................ 587.8 304.5
-------- --------
Consolidated total assets .......... $6,322.4 $5,988.4
======== ========
</Table>
Sales and other revenues from external customers by reportable segment by
refined product were as follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
REFINING:
Gasoline and blendstocks ............................... $ 5,934.1 $ 5,168.5 $ 4,987.7
Distillates (diesel, jet fuel, heating oil, etc.) ...... 3,336.0 3,922.3 2,278.5
Petrochemicals ......................................... 430.7 486.4 319.1
Asphalt and lubes ...................................... 453.9 457.0 270.0
Other .................................................. 227.9 239.1 65.7
--------- --------- ---------
10,382.6 10,273.3 7,921.0
--------- --------- ---------
RETAIL:
Fuel sales (gasoline and diesel) ....................... 4,817.8 5,073.9 4,472.7
Merchandise sales ...................................... 1,487.6 1,505.0 1,186.9
Home heating oil ....................................... 51.4 46.2 223.6
--------- --------- ---------
6,356.8 6,625.1 5,883.2
PETROCHEMICAL/NGL ........................................ 120.6 162.7 135.1
--------- --------- ---------
Total sales and other revenues from
external customers ............................... $16,860.0 $17,061.1 $13,939.3
========= ========= =========
</Table>
38
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Geographic information by country for sales and other revenues from external
customers based on location of customer consisted of the following:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(in millions)
United States ................................ $13,247.3 $13,006.2 $11,140.2
Canada ....................................... 3,607.5 4,054.9 2,799.1
Italy ........................................ 5.2 -- --
--------- --------- ---------
Consolidated sales and other revenues ...... $16,860.0 $17,061.1 $13,939.3
========= ========= =========
</Table>
Long-lived assets include property, plant and equipment, goodwill and refinery
maintenance turnaround costs, net of related accumulated depreciation and
amortization. Geographic information by country for long-lived assets consisted
of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
(in millions)
United States ........................... $ 3,735.0 $ 3,424.4
Canada .................................. 543.0 488.7
---------- ----------
Consolidated long-lived assets ......... $ 4,278.0 $ 3,913.1
========== ==========
</Table>
NOTE 23: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<Table>
<Caption>
2001 QUARTERS
---------------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
---------- ---------- ---------- ---------- ----------
(in millions, except per share data)
Sales and other revenues .......................... $ 4,214.1 $ 5,105.6 $ 4,019.9 $ 3,520.4 $ 16,860.0
Cost of products sold and
operating expenses ............................... 3,122.5 3,748.5 2,823.4 2,606.8 12,301.2
Operating income .................................. 254.5 464.6 252.1 9.1 980.3
Net income (loss) ................................. 136.7 266.4 149.0 (17.1) 535.0
Net income (loss) per share:
Basic ........................................... $ 1.77 $ 3.72 $ 2.04 $ (0.23) $ 7.22
Diluted ......................................... $ 1.73 $ 3.63 $ 2.00 $ (0.23) $ 7.08
Weighted average number of shares:
Basic............................................ 77.440 71.619 73.129 74.065 74.052
Diluted.......................................... 78.883 73.410 74.616 75.349 75.537
</Table>
In March 2001, the No. 3 crude oil unit of the Golden Eagle Refinery was
restarted which increased the refinery's capability to process more crude oil
and increased the production of California Air Resource Board gasoline and
diesel fuel. Refining operating costs were higher in the first and second
quarters of 2001 due to higher fuel gas and electricity costs, which began
increasing in 2000 as a result of higher crude oil and natural gas prices.
During the third and fourth quarter of 2001, natural gas prices declined to more
normal levels.
39
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Net income per share for the second quarter of 2001 increased due to higher
refining margins, especially on the West Coast. Net income per share also
increased as a result of a decrease in the number of outstanding shares of
common stock as a result of the shares repurchased under the share buyback
program (see Note 14: Stockholders' Equity).
During the fourth quarter of 2001, the refinery margins at all of UDS'
refineries decreased significantly, due to declining demand and increased
industry-wide inventory levels which negatively impacted wholesale and retail
refined product prices. Also during the fourth quarter of 2001, significant
refinery maintenance turnaround work began at both West Coast refineries and at
the McKee Refinery, reducing production and income. UDS also incurred $14.2
million of costs associated with the acquisition of UDS by Valero.
<Table>
<Caption>
2000 QUARTERS
-----------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
-------- -------- -------- -------- ---------
(in millions, except per share data)
Sales and other revenues ................ $3,645.4 $4,009.5 $4,527.9 $4,878.3 $17,061.1
Cost of products sold and
operating expenses .................... 2,698.8 2,952.2 3,417.6 3,831.0 12,899.6
Operating income ........................ 139.1 236.7 240.0 196.3 812.1
Net income .............................. 69.1 128.5 127.6 119.1 444.3
Net income per share:
Basic ................................. $ 0.80 $ 1.48 $ 1.47 $ 1.37 $ 5.12
Diluted ............................... $ 0.80 $ 1.47 $ 1.47 $ 1.37 $ 5.11
Weighted average number of shares
(in thousands):
Basic ................................. 86.713 86.767 86.794 86.816 86.773
Diluted ............................... 86.814 87.024 87.003 87.205 87.002
</Table>
On August 31, 2000, UDS acquired the Golden Eagle Refinery from Tosco
Corporation and on September 29, 2000, UDS purchased Valley Shamrock, which
resulted in increased net income in the third and fourth quarters of 2000.
In December 2000, UDS settled an appeal with the IRS related to tax issues for
the years 1988 through 1994. The appeal was resolved favorably and a tax refund
was received of $12.5 million plus interest of $6.1 million, or $0.19 per basic
share.
NOTE 24: SUBSEQUENT EVENTS
DIAMOND-KOCH, L.P.
In the latter part of 2001, Koch Industries, Inc. and UDS, both 50% partners in
the Diamond-Koch, L.P. joint venture, decided to sell the four operating assets
of Diamond-Koch and began soliciting bids from interested parties. As of
December 31, 2001, the equity investment in Diamond-Koch has been reclassified
to asset held for sale in the consolidated balance sheet.
The four operating assets include the following:
o propane / propylene splitter facility and related distribution pipeline and
terminal;
o hydrocarbon storage facilities;
o natural gas liquids fractionator facility; and
o natural gas liquids gathering and pipeline system.
40
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
On January 16, 2002, Diamond-Koch entered into a purchase and sale agreement
with Enterprise Products Texas Operating L.P. for the sale of the hydrocarbon
storage facilities for $129.3 million, of which $64.7 million was distributed to
UDS in January 2002.
On January 31, 2002, Diamond-Koch entered into an asset purchase and sale
agreement with Enterprise Products Operating L.P. for the sale of the
propane/propylene splitter facility and related distribution pipeline and
terminal for $238.5 million, of which $119.3 million was distributed to UDS in
February 2002.
On March 1, 2002, Diamond-Koch entered into a purchase and sale agreement with
Teppco Partners, L.P. for the sale of the natural gas liquids gathering and
pipeline system for $132.0 million, of which $66.0 million was distributed to
UDS in March 2002.
Diamond-Koch is in the process of finalizing negotiations with purchasers for
the remaining two assets and expects to complete those sales no later than April
2002.
SALE AND PURCHASE AGREEMENT WITH TESORO
In conjunction with the acquisition of UDS by Valero, the consent decree,
approved by the FTC in December 2001, required Valero to divest of certain UDS
assets. In February 2002, Ultramar, Inc. (now a subsidiary of Valero) and Tesoro
Refining and Marketing Company (Tesoro) entered into a sale and purchase
agreement whereby Tesoro will acquire the Golden Eagle Refinery and associated
wholesale marketing operation in Northern California and the network of 70
convenience stores located in the northern half of California. The total
purchase price of $1.1 billion includes an estimated $130.0 million for the
crude oil and refined product inventories and the assumption of various employee
benefit and lease obligations, but excludes other working capital items.
VALERO L.P.
On January 22, 2002, Valero L.P. declared a quarterly partnership distribution
of $0.60 per unit payable on February 14, 2002 to unitholders of record on
February 1, 2002. The total distribution is expected to be approximately $11.8
million of which $3.1 million is payable to minority unitholders.
CONTINGENCY
In January 2002, Union Oil Company of California (Unocal) filed a patent
infringement lawsuit against Valero (in its capacity as the surviving entity in
the merger of UDS into Valero) in California federal court. The complaint seeks
a 5.75 cents per gallon royalty on all reformulated gasoline infringing on
Unocal's `393 and `126 patents. These patents cover certain compositions of
cleaner-burning gasoline. The complaint seeks treble damages for Valero's and
UDS' alleged willful infringement of Unocal's patents. In a previous lawsuit,
Unocal prevailed against five other major petroleum refiners involving the `393
patent. In August 2001, the FTC announced that it would begin an antitrust
investigation concerning Unocal's conduct with a joint industry research group
during the time that Unocal was prosecuting its patent at the U.S. Patent and
Trademark Office (PTO). The FTC could potentially issue an injunction against
Unocal's enforcement of its patents as a result of the investigation. In 2001,
the PTO began a reexamination of Unocal's `393 patent, and in January 2002, the
PTO issued a notice of rejection of all claims of the `393 patent. Unocal has
the opportunity to respond to the PTO's action. Also in January 2002, the PTO
reversed an earlier denial and began a reexamination of Unocal's `126 patent.
Both reexaminations could affect the scope and validity of the patents.
Notwithstanding the judgement against the other petroleum refiners in the
previous litigation, UDS believes that it has several strong defenses to
Unocal's lawsuit, including those arising from Unocal's misconduct, and UDS
believes that it will prevail in the lawsuit. However, due to the inherent
uncertainty of litigation, there can be no assurance that UDS would prevail and
an adverse result could have a material adverse effect on UDS' results of
operations and financial position.
41