1
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 1-13175
VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 74-1828067
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Valero Place
San Antonio, Texas
(Address of principal executive offices)
78212
(Zip Code)
(210) 370-2000
(Registrant's telephone number, including area code)
---------
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
---------
Indicated below is the number of shares outstanding of the
registrant's only class of common stock, as of August 1, 1999.
Number of
Shares
Title of Class Outstanding
-------------- -----------
Common Stock, $.01 Par Value 56,241,188
===============================================================================
2
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 1999 and December 31, 1998..................................... 3
Consolidated Statements of Income - For the Three Months Ended and
Six Months Ended June 30, 1999 and 1998............................................................. 4
Consolidated Statements of Cash Flows - For the Six Months Ended
June 30, 1999 and 1998.............................................................................. 5
Notes to Consolidated Financial Statements............................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................................. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 24
PART II. OTHER INFORMATION................................................................................. 27
Item 1. Legal Proceedings................................................................................ 27
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 27
Item 6. Exhibits and Reports on Form 8-K................................................................. 27
SIGNATURE................................................................................................... 28
2
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
June 30,
1999 December 31,
(Unaudited) 1998
------------- --------------
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments ................................ $ 5,804 $ 11,199
Receivables, less allowance for doubtful accounts of
$1,600 (1999) and $1,150 (1998) .................................. 302,428 283,456
Inventories ........................................................ 329,612 316,405
Current deferred income tax assets ................................. 79,946 4,851
Prepaid expenses and other ......................................... 20,359 23,799
----------- -----------
738,149 639,710
----------- -----------
PROPERTY, PLANT AND EQUIPMENT - including
construction in progress of $147,467 (1999)
and $179,136 (1998), at cost ....................................... 2,628,453 2,572,190
Less: Accumulated depreciation .................................. 655,578 612,847
----------- -----------
1,972,875 1,959,343
----------- -----------
DEFERRED CHARGES AND OTHER ASSETS .................................... 158,960 126,611
----------- -----------
$ 2,869,984 $ 2,725,664
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt .................................................... $ 31,000 $ 160,000
Accounts payable ................................................... 422,022 283,183
Accrued expenses ................................................... 60,139 54,561
----------- -----------
513,161 497,744
----------- -----------
LONG-TERM DEBT ....................................................... 916,104 822,335
----------- -----------
DEFERRED INCOME TAXES ................................................ 271,606 210,389
----------- -----------
DEFERRED CREDITS AND OTHER LIABILITIES ............................... 112,989 109,909
----------- -----------
COMMON STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 150,000,000 shares authorized;
issued 56,314,798 (1999 and 1998) shares ......................... 563 563
Additional paid-in capital ......................................... 1,100,615 1,112,726
Accumulated deficit ................................................ (42,419) (17,618)
Treasury stock, 99,353 (1999) and 378,130 (1998) shares, at cost ... (2,635) (10,384)
----------- -----------
1,056,124 1,085,287
----------- -----------
$ 2,869,984 $ 2,725,664
=========== ===========
See Notes to Consolidated Financial Statements.
3
4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
OPERATING REVENUES .................................. $ 1,824,450 $ 1,448,104 $ 3,161,553 $ 2,810,463
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of sales and operating expenses .............. 1,808,653 1,346,460 3,096,000 2,638,729
Write-down of inventories to market value ......... -- -- -- 37,673
Selling and administrative expenses ............... 14,540 18,585 32,728 35,915
Depreciation expense .............................. 21,990 18,735 45,038 36,239
----------- ----------- ----------- -----------
Total ........................................... 1,845,183 1,383,780 3,173,766 2,748,556
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) ............................. (20,733) 64,324 (12,213) 61,907
OTHER INCOME, NET ................................... 1,066 482 987 437
INTEREST AND DEBT EXPENSE:
Incurred .......................................... (16,013) (8,292) (30,301) (15,868)
Capitalized ....................................... 1,495 1,125 3,326 1,879
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES ................... (34,185) 57,639 (38,201) 48,355
INCOME TAX EXPENSE (BENEFIT) ........................ (12,100) 17,700 (13,400) 14,300
----------- ----------- ----------- -----------
NET INCOME (LOSS) ................................... $ (22,085) $ 39,939 $ (24,801) $ 34,055
=========== =========== =========== ===========
EARNINGS (LOSS) PER SHARE OF COMMON STOCK ........... $ (.39) $ .71 $ (.44) $ .61
Weighted average common shares outstanding
(in thousands) ...................................... 56,162 56,201 56,109 56,175
EARNINGS (LOSS) PER SHARE OF COMMON STOCK -
ASSUMING DILUTION ................................. $ (.39) $ .70 $ (.44) $ .59
Weighted average common shares outstanding -
assuming dilution (in thousands) ................ 56,162 57,353 56,109 57,319
DIVIDENDS PER SHARE OF COMMON STOCK ................. $ .08 $ .08 $ .16 $ .16
See Notes to Consolidated Financial Statements.
4
5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
Six Months Ended
June 30,
---------------------------
1999 1998
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ............................................. $ (24,801) $ 34,055
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation expense ...................................... 45,038 36,239
Amortization of deferred charges and other, net ........... 26,090 18,733
Write-down of inventories to market value ................. -- 37,673
Changes in current assets and current liabilities ......... 114,472 13,453
Deferred income tax expense (benefit) ..................... (13,800) 3,000
Changes in deferred items and other, net .................. 880 (460)
--------- ---------
Net cash provided by operating activities ............... 147,879 142,693
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .......................................... (58,270) (68,942)
Deferred turnaround and catalyst costs ........................ (52,763) (39,886)
Earn-out payment in connection with Basis acquisition ......... -- (10,325)
Other, net .................................................... (127) 857
--------- ---------
Net cash used in investing activities ....................... (111,160) (118,296)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in short-term debt, net ................... (129,000) 3,000
Long-term borrowings .......................................... 592,794 103,741
Long-term debt reduction ...................................... (501,000) (125,000)
Common stock dividends ........................................ (8,978) (8,986)
Issuance of common stock ...................................... 4,696 933
Purchase of treasury stock .................................... (626) (1,442)
--------- ---------
Net cash used in financing activities ....................... (42,114) (27,754)
--------- ---------
NET DECREASE IN CASH AND TEMPORARY
CASH INVESTMENTS .............................................. (5,395) (3,357)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD ........................................... 11,199 9,935
--------- ---------
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD ................................................. $ 5,804 $ 6,578
========= =========
See Notes to Consolidated Financial Statements.
5
6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements included herein have been
prepared by Valero Energy Corporation ("Valero") and subsidiaries (collectively
referred to as the "Company"), without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC"). However, all
adjustments have been made to the accompanying financial statements which are,
in the opinion of the Company's management, necessary for a fair presentation
of the Company's results for the periods presented. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented herein not
misleading. Certain prior period amounts have been reclassified for comparative
purposes.
2. ACQUISITION OF PAULSBORO REFINERY
On September 16, 1998, the Company and Mobil Oil Corporation ("Mobil")
entered into an asset sale and purchase agreement for the acquisition by the
Company of substantially all of the assets and the assumption of certain
liabilities related to Mobil's 155,000 barrel-per-day ("BPD") refinery in
Paulsboro, New Jersey ("Paulsboro Refinery"). The acquisition was accounted for
using the purchase method of accounting and the purchase price was allocated to
the assets acquired and liabilities assumed based on estimated fair values,
pending the completion of an independent appraisal. Pursuant to the purchase
method of accounting, the accompanying Consolidated Statements of Income for
the three months ended and six months ended June 30, 1998 do not include the
results of operations of the Paulsboro Refinery.
Pursuant to the asset sale and purchase agreement, Mobil is entitled
to receive payments in any of the five years following the acquisition if
certain average refining margins during any of such years exceed a specified
level. Any payments under this earn-out arrangement, which will be determined
in September of each year beginning in 1999, are limited to $20 million in any
year and $50 million in the aggregate.
In connection with the acquisition of the Paulsboro Refinery, Mobil
agreed to indemnify the Company for certain environmental matters and
conditions existing on or prior to the acquisition and the Company agreed to
assume Mobil's environmental liabilities, with certain limited exceptions
(including "superfund" liability for off-site waste disposal). Mobil's
indemnities and the periods of indemnification include (i) third party
environmental claims for a period of five years, (ii) governmental fines and/or
penalties for a period of five years, (iii) required remediation of known
environmental conditions for a period of five years, subject to a cumulative
deductible, (iv) required remediation of unknown environmental conditions for a
period of seven years, subject to a sharing arrangement with a cap on the
Company's obligation and subject to a cumulative deductible, and (v) certain
capital expenditures required by a governmental entity for a three-year period,
to the extent required to cure a breach of certain representations of Mobil
concerning compliance with environmental laws, subject to a specified
deductible. The Company's assumed liabilities include remediation obligations
to the New Jersey Department of Environmental Protection. These remediation
obligations relate primarily to clean-up costs associated with groundwater
contamination, landfill closure and post-closure monitoring costs, and tank
farm spill prevention costs. As of June 30, 1999, the
6
7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Company has recorded approximately $20 million in Accrued Expenses and Deferred
Credits and Other Liabilities representing its best estimate of costs to be
borne by the Company related to these remediation obligations. The majority of
such costs are expected to be incurred in relatively level amounts over the
next 20 years.
The following unaudited pro forma financial information of the Company
for the six months ended June 30, 1998 assumes that the acquisition of the
Paulsboro Refinery occurred at the beginning of such period. Such pro forma
information is not necessarily indicative of the results of future operations.
(Dollars in thousands, except per share amounts.)
Operating revenues............................................................. $3,329,658
Operating income............................................................... 97,373
Net income..................................................................... 49,490
Earnings per common share...................................................... .88
Earnings per common share - assuming dilution.................................. .86
3. INVENTORIES
Refinery feedstocks and refined products and blendstocks are carried
at the lower of cost or market, with the cost of feedstocks purchased for
processing and produced products determined under the last-in, first-out
("LIFO") method of inventory pricing, and the cost of feedstocks and products
purchased for resale determined under the weighted average cost method. During
the first quarter of 1999, LIFO inventory quantities were reduced causing prior
year LIFO costs, which were lower than current year replacement costs, to be
charged to cost of sales. This LIFO liquidation resulted in a decrease in cost
of sales of $10.5 million and a decrease in the net loss of $6.8 million, or
$.12 per share, for the first six months of 1999. At June 30, 1999, the
replacement cost of the Company's LIFO inventories exceeded their LIFO carrying
values by approximately $92 million. Materials and supplies are carried
principally at weighted average cost not in excess of market. Inventories as of
June 30, 1999 and December 31, 1998 were as follows (in thousands):
June 30, December 31,
1999 1998
--------- ------------
Refinery feedstocks .................... $ 67,881 $ 80,036
Refined products and blendstocks ....... 200,743 174,125
Materials and supplies ................. 60,988 62,244
--------- ---------
$ 329,612 $ 316,405
========= =========
7
8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
4. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net
income (loss) has been adjusted by, among other things, changes in current
assets and current liabilities. The changes in the Company's current assets and
current liabilities are shown in the following table as an (increase)/decrease
in current assets and an increase/(decrease) in current liabilities (in
thousands). These amounts exclude, among other things, a $37.7 million noncash
write-down of inventory to market value in the first quarter of 1998 and
changes in cash and temporary cash investments, current deferred income tax
assets and short-term debt.
Six Months Ended
June 30,
--------------------------
1999 1998
--------- --------
Receivables, net .................. $ (18,966) $ 43,672
Inventories ....................... (14,080) 4,757
Prepaid expenses and other ........ 3,440 3,107
Accounts payable .................. 138,500 (21,157)
Accrued expenses .................. 5,578 (16,926)
--------- --------
Total .......................... $ 114,472 $ 13,453
========= ========
Cash flows related to interest and income taxes were as follows (in
thousands):
Six Months Ended
June 30,
------------------------
1999 1998
-------- --------
Interest paid (net of amount capitalized) ........ $ 20,536 $ 13,390
Income tax refunds received ...................... 7,505 9,000
Income taxes paid ................................ 531 5,282
Noncash investing activities for the six months ended June 30, 1998
included various adjustments to property, plant and equipment and certain
current assets and current liabilities resulting from the completion of an
independent appraisal performed in connection with the May 1997 acquisition of
Basis Petroleum, Inc. ("Basis") and the allocation of the Basis purchase price
to the assets acquired and liabilities assumed.
5. LONG-TERM DEBT
In March 1999, the Company completed a public offering of $300 million
principal amount of 7 3/8% notes which are due on March 15, 2006. The notes
were issued under the Company's $600 million universal shelf registration
statement which was previously declared effective by the SEC on June 30, 1998.
Net proceeds from the financing of approximately $297.5 million were used to
pay down borrowings under the Company's revolving bank credit facility.
Also in March 1999, the Company refinanced $25 million of its Series
1998 taxable, variable rate Waste Disposal Revenue Bonds with tax-exempt bonds.
These Series 1999 tax-exempt bonds have a fixed interest rate of 5.7% and
mature on April 1, 2032.
8
9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. EARNINGS PER SHARE
The computation of basic and diluted per-share amounts, as required by
the Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 128, is as follows (dollars and shares in
thousands, except per share amounts):
Three Months Ended June 30,
-----------------------------------------------------------------
1999 1998
----------------------------- ----------------------------
Per- Per-
Net Share Net Share
(Loss) Shares Amt. Income Shares Amt.
------ ------ ---- ------ ------ ----
Net income (loss)......................... $(22,085) $ 39,939
======== ========
BASIC EARNINGS PER SHARE:
Net income (loss) available to
common stockholders..................... $(22,085) 56,162 $(.39) $ 39,939 56,201 $ .71
===== =====
EFFECT OF DILUTIVE SECURITIES:
Stock options............................. -- -- -- 1,038
Performance awards........................ -- -- -- 114
-------- -------- -------- ------
DILUTED EARNINGS PER SHARE:
Net income (loss) available to
common stockholders
plus assumed conversions................ $(22,085) 56,162 $(.39) $ 39,939 57,353 $ .70
======== ======= ===== ======== ====== =====
Six Months Ended June 30,
------------------------------------------------------------------
1999 1998
----------------------------- -----------------------------
Per- Per-
Net Share Net Share
(Loss) Shares Amt. Income Shares Amt.
------ ------ ---- ------ ------ ----
Net income (loss)......................... $(24,801) $ 34,055
======== ========
BASIC EARNINGS PER SHARE:
Net income (loss) available to
common stockholders..................... $(24,801) 56,109 $(.44) $34,055 56,175 $ .61
===== =====
EFFECT OF DILUTIVE SECURITIES:
Stock options............................. -- -- -- 1,034
Performance awards........................ -- -- -- 110
-------- -------- -------- ------
DILUTED EARNINGS PER SHARE:
Net income (loss) available to
common stockholders
plus assumed conversions................ $(24,801) 56,109 $(.44) $ 34,055 57,319 $ .59
======== ======= ===== ======== ====== =====
9
10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Because the Company reported a net loss for the three months and six
months ended June 30, 1999, various stock options and performance awards which
were granted to employees in connection with the Company's stock compensation
plans and were outstanding during such periods were not included in the
computation of diluted earnings per share because the effect would have been
antidilutive. At June 30, 1999, options to purchase approximately 6.4 million
common shares and performance awards totaling approximately 317,000 common
shares were outstanding.
7. NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." This SOP
provides guidance for determining when to capitalize or expense costs incurred
to develop or obtain internal-use software. This statement became effective for
the Company's financial statements beginning January 1, 1999, with its
requirements applied to costs incurred on or after such date. The adoption of
this SOP did not have a material effect on the Company's consolidated financial
statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in a derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's gains and losses
to offset related results on the hedged item in the income statement, and
requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting. As issued, this
statement was to become effective for the Company's financial statements
beginning January 1, 2000. However, in June 1999, the FASB issued SFAS No. 137
which delayed for one year the effective date of SFAS No. 133. As a result,
SFAS No. 133 will become effective for the Company's financial statements
beginning January 1, 2001 and is not allowed to be applied retroactively to
financial statements of prior periods. At such effective date, SFAS No. 133
must be applied to (i) all freestanding derivative instruments and (ii) all
embedded derivative instruments required by the statement to be separated from
their host contracts (or, at the Company's election, only those derivatives
embedded in hybrid instruments issued, acquired or substantively modified on or
after January 1, 1998 or January 1, 1999). The Company is currently evaluating
the impact on its financial statements of adopting this statement. Adoption of
this statement could result in increased volatility in the Company's earnings
and other comprehensive income.
8. LITIGATION AND CONTINGENCIES
Prior to July 31, 1997, Valero was a wholly owned subsidiary of Valero
Energy Corporation ("Energy"). Energy was engaged in both the refining and
marketing business and the natural gas related services business. On July 31,
1997, Energy spun off Valero to Energy's stockholders and merged its remaining
natural gas related services business with a wholly owned subsidiary of PG&E
Corporation ("PG&E") (the "Restructuring"). Energy and certain of its natural
gas related subsidiaries, as well as the Company, have been sued by Teco
Pipeline Company ("Teco") regarding the operation of the 340-mile
10
11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
West Texas pipeline in which a subsidiary of Energy holds a 50% undivided
interest. In 1985, a subsidiary of Energy sold a 50% undivided interest in the
pipeline and entered into a joint venture through an ownership agreement and an
operating agreement, each dated February 28, 1985, with the purchaser of the
interest. In 1988, Teco succeeded to that purchaser's 50% interest. A
subsidiary of Energy has at all times been the operator of the pipeline.
Notwithstanding the written ownership and operating agreements, the plaintiff
alleges that a separate, unwritten partnership agreement exists, and that the
defendants have exercised improper dominion over such alleged partnership's
affairs. The plaintiff also alleges that the defendants acted in bad faith by
negatively affecting the economics of the joint venture in order to provide
financial advantages to facilities or entities owned by the defendants and by
allegedly usurping for the defendants' own benefit certain opportunities
available to the joint venture. The plaintiff asserts causes of action for
breach of fiduciary duty, fraud, tortious interference with business
relationships, professional malpractice and other claims, and seeks
unquantified actual and punitive damages. Energy's motion to compel arbitration
was denied, but Energy has filed an appeal. Energy has also filed a
counterclaim alleging that the plaintiff breached its own obligations to the
joint venture and jeopardized the economic and operational viability of the
pipeline by its actions. Energy is seeking unquantified actual and punitive
damages. Although PG&E previously acquired Teco and now owns both Teco and
Energy, PG&E's Teco acquisition agreement purports to assign the benefit or
detriment of this lawsuit to the former shareholders of Teco. Pursuant to the
agreement by which the Company was spun off to Energy's stockholders in
connection with the Restructuring, the Company has agreed to indemnify Energy
with respect to this lawsuit to the extent of 50% of the amount of any final
judgment or settlement amount not in excess of $30 million, and 100% of that
part of any final judgment or settlement amount in excess of $30 million.
The Company is also a party to additional claims and legal proceedings
arising in the ordinary course of business. The Company believes it is unlikely
that the final outcome of any of the claims or proceedings to which the Company
is a party would have a material adverse effect on the Company's financial
statements; however, due to the inherent uncertainty of litigation, the range
of possible loss, if any, cannot be estimated with a reasonable degree of
precision and there can be no assurance that the resolution of any particular
claim or proceeding would not have an adverse effect on the Company's results
of operations for the interim period in which such resolution occurred.
9. SUBSEQUENT EVENTS
On July 29, 1999, the Company's Board of Directors declared a regular
quarterly cash dividend of $.08 per common share payable September 8, 1999, to
holders of record at the close of business on August 11, 1999.
11
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
SECOND QUARTER 1999 COMPARED TO SECOND QUARTER 1998
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended June 30,
------------------------------------------------------------------
Change
------------------------
1999 1998 (1) Amount %
------------ ------------ ---------- -----
Operating revenues ........................... $ 1,824,450 $ 1,448,104 $ 376,346 26%
Cost of sales ................................ (1,680,888) (1,234,326) (446,562) (36)
Operating costs:
Cash (fixed and variable) ................ (115,098) (102,818) (12,280) (12)
Depreciation and amortization ............ (33,738) (27,504) (6,234) (23)
Selling and administrative expenses (including
related depreciation expense) ............ (15,459) (19,132) 3,673 19
------------ ------------ ----------
Total operating income (loss) ........ $ (20,733) $ 64,324 $ (85,057) (132)
============ ============ ==========
Other income, net ............................ $ 1,066 $ 482 $ 584 121
Interest and debt expense, net ............... $ (14,518) $ (7,167) $ (7,351) (103)
Income tax (expense) benefit ................. $ 12,100 $ (17,700) $ 29,800 168
Net income (loss) ............................ $ (22,085) $ 39,939 $ (62,024) (155)
Earnings (loss) per share of common stock -
assuming dilution ........................ $ (.39) $ .70 $ (1.09) (156)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") .............. $ 15,129 $ 93,299 $ (78,170) (84)
Ratio of EBITDA to interest incurred ......... .9x 11.3x (10.4)x (92)
- ---------
(1) Excludes the operations of the Paulsboro Refinery which commenced
September 17, 1998.
12
13
OPERATING HIGHLIGHTS
Three Months Ended June 30,
-----------------------------------------------
Change
---------------------
1999 1998 (1) Amount %
------- ------- ------- -------
Sales volumes (Mbbls per day) .................... 1,037 873 164 19%
Throughput volumes (Mbbls per day) ............... 716(2) 550 166 30
Average throughput margin per barrel ............. $ 2.20 $ 4.27 $ (2.07) (48)
Operating costs per barrel:
Cash (fixed and variable) .................... $ 1.76 $ 2.05 $ (.29) (14)
Depreciation and amortization ................ .52 .55 (.03) (5)
------- ------- -------
Total operating costs per barrel ......... $ 2.28 $ 2.60 $ (.32) (12)
======= ======= =======
Charges:
Crude oils:
Sour ..................................... 43% 29% 14% 48%
Heavy sweet .............................. 16 26 (10) (38)
Light sweet .............................. 9 13 (4) (31)
------- ------- -------
Total crude oils ..................... 68 68 -- --
High-sulfur residual fuel oil ("resid") ...... 3 11 (8) (73)
Low-sulfur resid ............................. 7 1 6 600
Other feedstocks and blendstocks ............. 22 20 2 10
------- ------- -------
Total charges ............................ 100% 100% -- % --
======= ======= =======
Yields:
Gasolines and blendstocks .................... 53% 54% (1)% (2)%
Distillates .................................. 28 28 -- --
Petrochemicals ............................... 4 4 -- --
Lubes and asphalts ........................... 3 -- 3 --
Other products ............................... 12 14 (2) (14)
------- ------- -------
Total yields ............................. 100% 100% -- % --
======= ======= =======
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
(U.S. GULF COAST) (DOLLARS PER BARREL)
Three Months Ended June 30,
-----------------------------------------------
Change
------------------
1999 1998 Amount %
--------- --------- -------- ----
Feedstocks:
West Texas Intermediate ("WTI") crude oil ......... $ 17.63 $ 14.65 $ 2.98 20%
WTI less sour crude oil (Arab medium) (3) ......... $ 2.85 $ 3.92 $ (1.07) (27)
WTI less heavy sweet crude oil (Cabinda) (3) ...... $ 1.29 $ .94 $ .35 37
WTI less high-sulfur resid (Singapore) (3) ........ $ 2.36 $ 1.33 $ 1.03 77
Products:
Conventional 87 gasoline less WTI ................. $ 2.85 $ 4.75 $ (1.90) (40)
No. 2 fuel oil less WTI ........................... $ (.62) $ 1.76 $ (2.38) (135)
Propylene less WTI ................................ $ (1.90) $ 1.47 $ (3.37) (229)
- ---------
(1) Excludes the operations of the Paulsboro Refinery which commenced
September 17, 1998.
(2) Includes 177 Mbbls per day related to the Paulsboro Refinery.
(3) Excludes $.25 to $.50 per barrel for other delivery-related costs into the
Company's refineries.
13
14
The Company reported a net loss for the second quarter of 1999 of
$22.1 million, or $.39 per share, compared to net income of $40.0 million, or
$.70 per share, for the second quarter of 1998. The decline in second quarter
results was due primarily to exceptionally weak refining industry fundamentals
in the 1999 period which resulted in the lowest refining margins in over 15
years, and, to a lesser extent, to increased interest expense. Partially
offsetting the decreases in income resulting from these factors were
significant reductions in cash operating costs (excluding the effect of the
Paulsboro Refinery which was acquired in September 1998) and selling and
administrative expenses resulting from the Company's comprehensive cost
reduction efforts.
Operating revenues increased $376.3 million, or 26%, to $1.8 billion
during the second quarter of 1999 compared to the same period in 1998 due to a
19% increase in average daily sales volumes and a $1.10, or 6%, increase in the
average sales price per barrel. The increase in sales volumes was due to
additional volumes attributable to the acquisition of the Paulsboro Refinery.
The increase in sales prices was attributable primarily to markedly higher
crude oil prices resulting from a decision by OPEC in March 1999 to reduce
crude oil production. However, refined product prices did not increase as much
as crude oil prices due to above-average refined product inventory levels.
Inventories continued to be at above-average levels due to high refinery
utilization rates, higher gasoline imports and weak distillate demand.
Operating income decreased $85.1 million during the second quarter of
1999 compared to the second quarter of 1998 resulting in an operating loss in
the 1999 period of $20.7 million. This decrease in operating income was due
primarily to an approximate $70 million decrease in total throughput margins.
Also contributing to the decrease in operating income was the inclusion in the
1999 quarter of approximately $31 million of operating costs attributable to
the Paulsboro Refinery. Partially offsetting these decreases was an approximate
$13 million decrease in operating costs for all refineries exclusive of the
Paulsboro Refinery, as well as an approximate $4 million decrease in selling
and administrative expenses (including related depreciation expense), resulting
mainly from a Company-wide effort to reduce costs.
Total throughput margins were negatively affected, both in total and
on a per-barrel basis, by (i) significantly lower gasoline and distillate
margins (average distillate margins were negative in the 1999 second quarter)
resulting primarily from the change in crude oil prices noted above in the
discussion of operating revenues, and (ii) lower petrochemical margins
resulting from continuing depressed demand for petrochemical feedstocks due to
the Asian economic crisis. Total throughput margins were also negatively
affected by an approximate $19 million decrease in benefits from the Company's
price risk management program, including an approximate $7 million decrease in
results from trading activities. Partially offsetting the effects of the above
factors was a positive contribution to total throughput margins from the
Paulsboro Refinery.
The above-noted decrease in operating costs for all refineries
exclusive of the Paulsboro Refinery was due to a $16 million decrease in cash
operating expenses resulting mainly from lower maintenance, fuel and other
costs, partially offset by a $3 million increase in depreciation expense and
amortization of deferred turnaround and catalyst costs.
Net interest and debt expense increased $7.4 million to $14.5 million
during the second quarter of 1999 compared to the same period in 1998 due
primarily to an increase in borrowings resulting from the acquisition of the
Paulsboro Refinery.
Income taxes decreased $29.8 million, from a $17.7 million expense
during the second quarter of 1998 to a $12.1 million benefit during the second
quarter of 1999, due primarily to the decrease in pre-tax income.
14
15
YEAR-TO-DATE 1999 COMPARED TO YEAR-TO-DATE 1998
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Six Months Ended June 30,
----------------------------------------------------------------------
Change
----------------------------
1999 1998 (1) Amount %
------------ ------------ ---------- --------
Operating revenues .................................... $ 3,161,553 $ 2,810,463 $ 351,090 12%
Cost of sales ......................................... (2,835,848) (2,422,102) (413,746) (17)
Operating costs:
Cash (fixed and variable) ......................... (234,540) (199,582) (34,958) (18)
Depreciation and amortization ..................... (68,865) (52,443) (16,422) (31)
Selling and administrative expenses (including
related depreciation expense) ..................... (34,513) (36,756) 2,243 6
------------ ------------ ----------
Operating income (loss), before inventory
write-down ........................................ (12,213) 99,580 (111,793) (112)
Write-down of inventories to market value ............. -- (37,673) 37,673 100
------------ ------------ ----------
Total operating income (loss) ..................... $ (12,213) $ 61,907 $ (74,120) (120)
============ ============ ==========
Other income, net ..................................... $ 987 $ 437 $ 550 126
Interest and debt expense, net ........................ $ (26,975) $ (13,989) $ (12,986) (93)
Income tax (expense) benefit .......................... $ 13,400 $ (14,300) $ 27,700 194
Net income (loss) ..................................... $ (24,801) $ 34,055 $ (58,856) (173)
Earnings (loss) per share of common stock -
assuming dilution ................................. $ (.44) $ .59 $ (1.03) (175)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") ....................... $ 60,240 $ 154,057(2) $ (93,817) (61)
Ratio of EBITDA to interest incurred .................. 2.0x 9.7x (7.7)x (79)
- ---------
(1) Excludes the operations of the Paulsboro Refinery which commenced
September 17, 1998.
(2) Excludes the $37.7 million pre-tax write-down of inventories to market
value.
15
16
OPERATING HIGHLIGHTS
Six Months Ended June 30,
-----------------------------------------------------------
Change
-------------------------
1999 1998 (1) Amount %
------- -------- ------- -------
Sales volumes (Mbbls per day) .................... 1,043 845 198 23%
Throughput volumes (Mbbls per day) ............... 707(2) 539 168 31
Average throughput margin per barrel ............. $ 2.54 $ 3.98(3) $ (1.44) (36)
Operating costs per barrel:
Cash (fixed and variable) .................... $ 1.83 $ 2.05 $ (.22) (11)
Depreciation and amortization ................ .54 .54 -- --
------- ------- -------
Total operating costs per barrel ......... $ 2.37 $ 2.59 $ (.22) (8)
======= ======= =======
Charges:
Crude oils:
Sour ..................................... 47% 31% 16% 52%
Heavy sweet .............................. 14 21 (7) (33)
Light sweet .............................. 10 13 (3) (23)
------- ------- -------
Total crude oils ..................... 71 65 6 9
High-sulfur resid ............................ 3 11 (8) (73)
Low-sulfur resid ............................. 6 3 3 100
Other feedstocks and blendstocks ............. 20 21 (1) (5)
------- ------- -------
Total charges ............................ 100% 100% -- % --
======= ======= =======
Yields:
Gasolines and blendstocks .................... 52% 54% (2)% (4)
Distillates .................................. 29 28 1 4
Petrochemicals ............................... 4 4 -- --
Lubes and asphalts ........................... 3 -- 3 --
Other products ............................... 12 14 (2) (14)
------- ------- -------
Total yields ............................. 100% 100% -- % --
======= ======= =======
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
(U.S. GULF COAST) (DOLLARS PER BARREL)
Six Months Ended June 30,
-------------------------------------------------
Change
--------------------
1999 1998 Amount %
--------- --------- -------- ------
Feedstocks:
WTI crude oil ..................................... $ 15.34 $ 15.30 $ .04 -- %
WTI less sour crude oil (Arab medium) (4) ......... $ 2.95 $ 3.58 $ (.63) (18)
WTI less heavy sweet crude oil (Cabinda) (4) ...... $ 1.13 $ 1.29 $ (.16) (12)
WTI less high-sulfur resid (Singapore) (4) ........ $ 1.68 $ 2.59 $ (.91) (35)
Products:
Conventional 87 gasoline less WTI ................. $ 2.26 $ 3.78 $ (1.52) (40)
No. 2 fuel oil less WTI ........................... $ (.16) $ 1.77 $ (1.93) (109)
Propylene less WTI ................................ $ (1.10) $ 2.68 $ (3.78) (141)
- ---------
(1) Excludes the operations of the Paulsboro Refinery which commenced
September 17, 1998.
(2) Includes 175 Mbbls per day related to the Paulsboro Refinery.
(3) Excludes a $.39 per barrel reduction resulting from the effect of the
$37.7 million pre-tax write-down of inventories to market value.
(4) Excludes $.25 to $.50 per barrel for other delivery-related costs into the
Company's refineries.
16
17
The Company reported a net loss for the first six months of 1999 of
$24.8 million, or $.44 per share, compared to net income of $34.1 million, or
$.59 per share, for the first six months of 1998. The results for the 1998
period were reduced by a $37.7 million ($23.9 million after-tax) write-down in
the carrying amount of the Company's refinery inventories resulting from a
significant decline in feedstock and refined product prices during the 1998
first quarter. Excluding the effect of the 1998 inventory write-down, results
for the first six months of 1999 were significantly below 1998 levels for the
same period due primarily to extremely weak refining industry fundamentals in
the 1999 period, the effect of significant downtime at the Company's Corpus
Christi refinery in early 1999 due to a major maintenance turnaround and
expansion of the heavy oil cracker and related units, and increased interest
expense. Partially offsetting the decreases in income resulting from these
factors were significant reductions in cash operating costs (excluding the
effect of the Paulsboro Refinery which was acquired in September 1998) and
selling and administrative expenses resulting from the Company's comprehensive
cost reduction efforts, increased benefits from the Company's price risk
management activities, and a benefit to income related to a permanent reduction
in LIFO inventories during the first quarter of 1999 (see Note 3 of Notes to
Consolidated Financial Statements).
Operating revenues increased $351.1 million, or 12%, to $3.2 billion
during the first six months of 1999 compared to the same period in 1998 due to
a 23% increase in average daily sales volumes, partially offset by a $1.62, or
9%, decrease in the average sales price per barrel. The increase in sales
volumes was due primarily to additional volumes attributable to the September
1998 acquisition of the Paulsboro Refinery, while the decrease in sales prices
was due to the industry's high level of refined product inventories which
resulted in depressed refined product prices.
Excluding the effect of the $37.7 million inventory write-down in the
first six months of 1998 described above, operating income decreased $111.8
million during the first six months of 1999 compared to the same period in 1998
resulting in an operating loss in the 1999 period of $12.2 million. This
decrease in operating income was due primarily to an approximate $63 million
decrease in total throughput margins, approximately $66 million of operating
costs attributable to the Paulsboro Refinery in the 1999 period, and a $9
million increase in depreciation expense and amortization of deferred
turnaround and catalyst costs for all refineries exclusive of the Paulsboro
Refinery. Partially offsetting these decreases was an approximate $24 million
reduction in cash operating costs for all refineries exclusive of the Paulsboro
Refinery resulting mainly from lower maintenance and fuel costs as well as
other cost-reduction efforts, and an approximate $2 million decrease in selling
and administrative expenses (including related depreciation expense) due mainly
to Company-wide cost reduction initiatives.
Total throughput margins were negatively affected, both in total and
on a per-barrel basis, by (i) significantly lower gasoline and distillate
margins resulting primarily from the depressed refined product prices noted
above and higher crude oil prices attributable to OPEC production cuts
announced in March 1999, (ii) a decrease in feedstock discounts relative to
WTI, and (iii) lower petrochemical margins resulting from continuing depressed
demand for petrochemical feedstocks due to the Asian economic crisis. The
negative effect on throughput margins resulting from the changes in gasoline
and distillate margins and feedstock discounts was partially offset by a
positive contribution from the Paulsboro Refinery in the 1999 period, an
approximate $15 million increase in benefits from the Company's price risk
management program, including an approximate $6 million increase in gains from
trading activities, and a $10.5 million benefit resulting from the liquidation
of LIFO inventories in the 1999 period.
Net interest and debt expense increased $13.0 million, or 93%, to
$27.0 million during the first six months of 1999 compared to the same period
in 1998 due primarily to an increase in borrowings resulting from the
acquisition of the Paulsboro Refinery in September 1998.
17
18
Income taxes decreased $27.7 million, from a $14.3 million expense
during the first six months of 1998 to a $13.4 million benefit during the same
period in 1999, due primarily to a decrease in pre-tax income.
OUTLOOK
Thus far in the third quarter of 1999, gasoline margins have improved
significantly from second quarter levels, rising above average historical
levels, and are in excess of third quarter 1998 margins. This improvement has
been due to a decline in gasoline inventories resulting from strong demand and
a moderation of refinery utilization rates and European imports. Heating oil
margins, although still below historical averages and third quarter 1998
levels, have recovered substantially from the negative margins in the 1999
second quarter and are approaching third quarter 1998 margins due to declining
inventories resulting from reduced production. If these trends continue, and
combined with anticipated benefits from the Company's cost-cutting initiatives
begun earlier in 1999, earnings for the third quarter of 1999 should be
significantly higher than earnings reported for the third quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $147.9 million during
the first six months of 1999, a $5.2 million increase compared to the same
period in 1998. The net cash provided by operating activities for the 1999
period was achieved primarily through a $114.5 million decrease in the amount
of cash utilized for working capital purposes, as detailed in Note 4 of Notes
to Consolidated Financial Statements. In the first six months of 1999, both
accounts receivable and accounts payable increased due to a significant
increase in commodity prices from December 31, 1998 to June 30, 1999. Combined
with concerted efforts by the Company during such period to collect accounts
receivable, which helped reduce the increase in receivables resulting from
higher commodity prices, the Company realized a net decrease in cash utilized
for working capital purposes. Included in the changes in current assets and
current liabilities for the 1998 period was a decrease in both accounts
receivable and accounts payable due primarily to a reduction in commodity
prices from December 31, 1997 to June 30, 1998. During the first six months of
1999, cash provided by operating activities, proceeds from the issuance of the
7 3/8% notes described in Note 5 of Notes to Consolidated Financial Statements
(approximately $298 million) and a portion of existing cash balances were
utilized to reduce bank borrowings, fund capital expenditures and deferred
turnaround and catalyst costs, and pay common stock dividends.
The Company currently maintains an unsecured $835 million revolving
bank credit and letter of credit facility that matures in November 2002 and is
available for general corporate purposes including working capital needs and
letters of credit. Borrowings under this facility bear interest at either LIBOR
plus a margin, a base rate or a money market rate. The Company is also charged
various fees and expenses in connection with this facility, including a
facility fee and various letter of credit fees. The interest rate and fees
under the credit facility are subject to adjustment based upon the credit
ratings assigned to the Company's long-term debt. The credit facility includes
certain restrictive covenants including a coverage ratio, a capitalization
ratio, and a minimum net worth test. As of June 30, 1999, outstanding
borrowings and letters of credit under this committed bank credit and letter of
credit facility totaled approximately $295 million. The Company also has
uncommitted short-term bank credit facilities under which amounts up to $130
million may be borrowed, along with uncommitted bank letter of credit
facilities totaling $285 million. As of June 30, 1999, $31 million was
outstanding under the short-term bank credit facilities, and letters of credit
totaling approximately $48 million were outstanding under the uncommitted
letter of credit facilities. As of June 30, 1999, the Company's debt to
capitalization ratio was 47.3%.
18
19
During the first six months of 1999, the Company reduced its exposure
to increases in interest rates and increased its financial flexibility by (i)
issuing $300 million of seven-year 7 3/8% notes under its $600 million shelf
registration statement and using the net proceeds to reduce variable rate bank
borrowings and (ii) refinancing $25 million of its taxable, variable rate
industrial revenue bonds with tax-exempt 5.7% fixed rate bonds. See Note 5 of
Notes to Consolidated Financial Statements.
As described in Note 2 of Notes to Consolidated Financial Statements,
Mobil is entitled to receive payments from the Company in any of the five years
following the Company's September 1998 acquisition of the Paulsboro Refinery if
certain average refining margins during any of such years exceed a specified
level. Based on margin levels since the acquisition date, no earn-out payments
are currently anticipated to be made to Mobil in 1999.
During the first six months of 1999, the Company expended
approximately $111 million for capital investments, including capital
expenditures of $58 million and deferred turnaround and catalyst costs of $53
million. The deferred turnaround and catalyst costs related primarily to (i) a
major maintenance turnaround of the heavy oil cracker and related units at the
Corpus Christi refinery in the first quarter, (ii) a catalyst change for the
Corpus Christi hydrodesulfurization unit in the second quarter, and (iii) a
turnaround and catalyst change of the Texas City Residfiner also in the second
quarter. For total year 1999, the Company currently expects to incur
approximately $175 million for capital investments, including approximately
$110 million for capital expenditures and approximately $65 million for
deferred turnaround and catalyst costs. The capital expenditure estimate
includes approximately $20 million for computer system projects and
approximately $10 million for projects related to environmental control and
protection.
On July 29, 1999, the Company's Board of Directors declared a regular
quarterly cash dividend of $.08 per common share payable September 8, 1999, to
holders of record at the close of business on August 11, 1999.
The Company believes it has sufficient funds from operations, and to
the extent necessary, from the public and private capital markets and bank
markets, to fund its ongoing operating requirements. The Company expects that,
to the extent necessary, it can raise additional funds from time to time
through equity or debt financings; however, except for borrowings under bank
credit agreements or offerings under its universal shelf registration statement
that may occur from time to time, the Company has no other specific financing
plans.
NEW ACCOUNTING PRONOUNCEMENTS
As discussed in Note 7 of Notes to Consolidated Financial Statements,
various new financial accounting pronouncements have been issued by the AICPA
and FASB which either became effective for the Company's financial statements
beginning in 1999 or become effective in 2001. Except for SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," for which the
impact has not yet been determined, the adoption of these statements has not
had a material effect on the Company's consolidated financial statements.
19
20
YEAR 2000 READINESS DISCLOSURE
BACKGROUND
The transition to January 1, 2000 poses problems for almost all users
of information technology ("IT"). These potential problems result from the fact
that many computer programs created in the past were programmed to identify
calendar dates with only the last two digits of the year. As a result, such
programs are unable to distinguish between the year 1900 and the year 2000,
potentially resulting in miscalculations, malfunctions or failures of such
programs. In addition to its potential effect on computer systems, the century
date change may also result in malfunctions or failures of non-IT equipment
which contain embedded systems with date-sensitive functions. These potential
consequences are generally referred to as the "Year 2000" problem.
STATE OF READINESS
In 1996, in order to improve business processes, reduce costs,
integrate business information, improve access to such information, and provide
flexibility for ongoing business changes, the Company began the implementation
of new client/server based systems which will run substantially all of the
Company's principal business software applications. These new systems have been
represented as Year 2000 compliant by their respective manufacturers and were
substantially implemented by the end of 1998.
In order to verify the Year 2000 compliance of the above noted
systems, and address the Year 2000 problem with respect to other IT systems and
non-IT embedded systems, the Company has developed a compliance plan with
respect to those systems and services that are deemed to be critical to the
Company's operations and safety of its employees. This plan is divided into the
following sections, which represent major business areas that are potentially
affected by the Year 2000 problem: Business Systems (includes IT hardware,
software and network systems serving the Company's corporate, refining,
marketing and supply areas); Plant Facilities (includes non-IT embedded systems
such as process control systems and the physical equipment and facilities at
the Company's refineries); and Office Facilities/Aviation (includes telephone,
security and environmental systems and office equipment at the Company's office
facilities and aviation-related equipment and software). Implementation of the
Company's Year 2000 compliance plan is led by a Management Oversight Committee,
which includes members of executive management, and Year 2000 coordinators for
each of the business areas described above. The compliance plan is monitored
weekly by the business area coordinators and progress reported monthly to the
Management Oversight Committee. The compliance plan includes the following
phases and scheduled completion dates:
Scheduled
Compliance Plan Phase Completion Date
- ---------------------------------------------------------------------------------------- ---------------
o Form internal Year 2000 organizations, both at the corporate and refinery level,
to pursue relevant action plans. Completed
o Inventory affected systems and services for all business areas and prioritize
the importance of each particular system to the Company and its operations
as either high, medium, or low priority. Completed (1)
o Assess the compliance of inventoried items by contacting the vendor or
manufacturer to determine whether the system is Year 2000 compliant. Completed (1)
o Develop action plans to remediate (fix, replace, or discard) each of the
non-compliant high and medium priority items (those items believed by
the Company to have a risk involving the safety of individuals,
20
21
significant damage to equipment, the environment, or communications,
or a significant loss of revenues). Completed (1)
o Remediate the non-compliant high and medium priority items by implementing
the plans developed above. 8/31/99 (2)
o Validate Year 2000 compliance by testing, wherever possible, all high and
medium priority items. 8/31/99 (2)
o Develop contingency plans for (i) the most critical high-priority items, even if
validated as compliant, and (ii) all high and medium priority items that cannot
be tested. 9/30/99 (3)
- ---------
(1) Although the Company-wide inventory, assessment and planning phases have
been completed, other non- compliant items may be discovered during the
remediation and testing phases.
(2) The Company currently expects the remediation and testing phases to be
substantially complete for each of its major business areas by August 31,
1999. Items for which remediation and/or testing is not expected to be
complete by such date are anticipated to be remediated and/or tested prior
to December 31, 1999.
(3) The Company currently expects that each of its major business areas will
have substantially completed its contingency plans by September 30, 1999.
Plans remaining uncompleted at such date will be finalized, and completed
plans will be refined, during the 1999 fourth quarter.
The Company currently anticipates that completion of its Year 2000
compliance plan will be performed primarily by Company personnel. However, in
certain cases, outside contractors or consultants have been engaged to assist
in the Company's Year 2000 efforts and may be required in the future.
Presently, no significant IT projects have been delayed due to the
implementation of the Company's Year 2000 compliance plan. The following table
indicates, as of August 5, 1999, the status of the Company's progress in
completing the remediation and testing phases of its compliance plan. The
"Remediated" percentages reported below represent the estimated percentage of
total inventoried items (high, medium and low priority items for Business
Systems and Office Facilities/Aviation, and high and medium priority items for
Plant Facilities) that are now remediated. For Business Systems, the "Tested"
percentage represents the percentage of total inventoried items that are now
tested. However, for Office Facilities/Aviation and Plant Facilities, not all
inventoried items will be tested due to various factors. Therefore, for these
areas, the "Tested" percentage represents a percentage of items to be tested.
Remediated Tested
---------- ------
Business Systems........................................................... 96% 87%
Office Facilities/Aviation................................................. 94 (1) 100
Plant Facilities........................................................... 99 96
- ---------
(1) Declined from 96% as disclosed in the Company's first quarter 1999 Form
10-Q due to the inclusion of additional inventoried items which were not
included in the prior disclosure.
In addition to the major business areas described above, the Company's
External Service Providers (third-party relationships material to the Company's
operations, including (i) service providers for the Company's Business Systems,
Plant Facilities and Office Facilities/Aviation described above, (ii) "supply"
relationships such as major suppliers of refinery feedstocks, (iii) "marketing"
relationships such as major customers and pricing services, and (iv)
"logistics" relationships such as pipelines, terminals, ships, barges and
storage facilities) could equally be affected by the Year 2000 problem, which
in turn could have an impact on the Company's business. For that reason, Year
2000 compliance of the External Service Providers
21
22
which the Company believes to be critical is also being assessed as part of the
Company's Year 2000 compliance plan. Over 70 Year 2000 questionnaires have been
sent to External Service Providers deemed to be critical. Additionally,
approximately 700 questionnaires have been sent to External Service Providers
classified as either high or low priority. As of August 5, 1999, responses have
been received for approximately 66% of the total questionnaires sent (78% of
critical service providers). The percentage of questionnaires received for
critical service providers declined from 83% as reported in the Company's first
quarter 1999 Form 10-Q due to a re-prioritization of External Service Providers
during the 1999 second quarter. A risk assessment of the responses is expected
to be completed by August 31, 1999 for all critical and high priority External
Service Providers, and contingency plans are expected to be developed for all
critical External Service Providers by September 30, 1999. Contingency plans
may also be developed for certain External Service Providers not deemed to be
critical depending upon their priority and level of risk.
COSTS
Total external costs incurred to date in connection with the
completion of the Company's Year 2000 compliance plan are approximately $1
million. The estimated total external costs to complete the Company's Year 2000
compliance plan are currently estimated to be approximately $4 million. The
Company does not separately track internal costs, principally consisting of
payroll and related costs for its information systems group and certain other
employees, incurred in connection with its Year 2000 compliance efforts. The
above amounts do not include costs associated with the implementation of the
new client/server based systems described under "State of Readiness."
RISKS
The scheduled completion dates and costs of compliance noted above are
the current best estimates of the Company's management and are believed to be
reasonably accurate. In the event unanticipated problems are encountered which
cause the compliance plan to fall behind schedule, the Company may need to
devote more resources to completing the plan and additional costs may be
incurred. If the Company were not able to satisfactorily complete its Year 2000
compliance plan, including identifying and resolving problems encountered by
the Company's External Service Providers, potential consequences could include,
among other things, unit downtime at or damage to the Company's refineries,
delays in transporting refinery feedstocks and refined products, impairment of
relationships with significant suppliers or customers, loss of accounting data
or delays in processing such data, and loss of or delays in internal and
external communications. The occurrence of any or all of the above could result
in a material adverse effect on the Company's results of operations, liquidity
or financial condition. Although the Company currently believes that it will
satisfactorily complete its Year 2000 compliance plan as described above prior
to January 1, 2000, there can be no assurance that the plan will be completed
by such time or that the Year 2000 problem will not adversely affect the
Company and its business.
CONTINGENCY PLANS
During the second quarter of 1999, the Company made substantial
progress in developing Year 2000 contingency plans for its Business Systems,
Plant Facilities and Office Facilities/Aviation business areas, as well as for
various key corporate departments and certain critical External Service
Providers. These plans consist of documenting established plans of action to be
followed in the event certain assumed Year 2000 disruption scenarios occur
during the period January 1-15, 2000 and are designed to accomplish the
following objectives: (i) continue critical Company business operations; (ii)
minimize the decisions and effort required to continue business operations;
(iii) minimize dependence on any one person to continue business operations;
22
23
(iv) minimize the risks to the Company in terms of diminished cash flow,
income, assets or customer relations; and (v) establish lines of communication
to be followed while the plans are in action. As discussed above, the Company
currently anticipates that contingency planning will be substantially complete
by September 30, 1999.
YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT
To the maximum extent permitted by applicable law, the above
information is being designated as a "Year 2000 Readiness Disclosure" pursuant
to the "Year 2000 Information and Readiness Disclosure Act" which was signed
into law on October 19, 1998.
FORWARD-LOOKING STATEMENTS
The foregoing discussion contains certain estimates, predictions,
projections and other "forward-looking statements" (within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934) that involve various risks and uncertainties. While these
forward-looking statements, and any assumptions upon which they are based, are
made in good faith and reflect the Company's current judgment regarding the
direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, assumptions, or other
future performance suggested herein. Some important factors (but not
necessarily all factors) that could affect the Company's sales volumes, growth
strategies, future profitability and operating results, or that otherwise could
cause actual results to differ materially from those expressed in any
forward-looking statement include the following: renewal or satisfactory
replacement of the Company's feedstock arrangements as well as market,
political or other forces generally affecting the pricing and availability of
refinery feedstocks and refined products; accidents or other unscheduled
shutdowns affecting the Company's, its suppliers' or its customers' pipelines,
plants, machinery or equipment; excess industry capacity; competition from
products and services offered by other energy enterprises; changes in the cost
or availability of third-party vessels, pipelines and other means of
transporting feedstocks and products; cancellation of or failure to implement
planned capital projects and realize the various assumptions and benefits
projected for such projects; the failure to avoid or correct a material Year
2000 problem, including internal problems or problems encountered by third
parties; state and federal environmental, economic, safety and other policies
and regulations, any changes therein, and any legal or regulatory delays or
other factors beyond the Company's control; weather conditions affecting the
Company's operations or the areas in which the Company's products are marketed;
rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any reserves;
the introduction or enactment of federal or state legislation which may
adversely affect the Company's business or operations; and changes in the
credit ratings assigned to the Company's debt securities and trade credit. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by the foregoing. The Company undertakes no obligation to publicly
release the result of any revisions to any such forward-looking statements that
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
23
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COMMODITY PRICE RISK
The Company is exposed to market risks related to the volatility of
crude oil and refined product prices, as well as volatility in the price of
natural gas used in the Company's refining operations. In order to reduce the
risks of these price fluctuations, the Company uses derivative commodity
instruments to hedge certain refinery feedstock and refined product inventories
to reduce the impact of adverse price changes on these inventories before the
conversion of the feedstock to finished products and ultimate sale. The Company
also uses derivative commodity instruments to hedge the price risk of
anticipated transactions. Such transactions include anticipated feedstock,
product and natural gas purchases, and product sales. These instruments are
used to lock in purchase or sales prices or components of refining operating
margins, including feedstock discounts, crack spreads (i.e., the difference
between the price of crude oil and conventional gasoline or heating oil) and
premium product differentials. In addition, the Company uses derivative
commodity instruments for trading purposes using its fundamental and technical
analysis of market conditions to earn additional revenues. The types of
instruments used in the Company's hedging and trading activities described
above include price swaps, options, and futures contracts. The Company's
positions in derivative commodity instruments are monitored and managed on a
daily basis by a risk control group to ensure compliance with the Company's
stated risk management policy which has been approved by the Company's Board of
Directors.
The following table provides information about the Company's
derivative commodity instruments, which mature in 1999, held to hedge refining
inventories as of June 30, 1999 (dollars in thousands, except per barrel
amounts). Volumes shown for swaps represent notional volumes which are used to
calculate amounts due under the agreements.
Fixed Price
------------------------------
Payor Receiver
--------- -----------
Swaps:
Notional volumes (Mbbls)............................. -- 600
Weighted average pay price (per bbl)................. -- $ .26
Weighted average receive price (per bbl)............. -- $ .37
Fair value........................................... -- $ 68
Futures:
Volumes (Mbbls)...................................... 2,679 8,645
Weighted average price (per bbl)..................... $ 18.62 $ 19.95
Contract amount...................................... $ 49,879 $ 172,428
Fair value........................................... $ 52,948 $ 182,242
24
25
The following table provides information about the Company's
derivative commodity instruments held to hedge anticipated feedstock and
product purchases, product sales and refining margins as of June 30, 1999 and
which mature in 1999 or 2000 (dollars in thousands, except amounts per barrel).
Mature in 1999 Mature in 2000
---------------------- ----------------------
Fixed Price Fixed Price
---------------------- ----------------------
Payor Receiver Payor Receiver
------- --------- ------- ---------
Futures:
Volumes (Mbbls) ......................... 14 5 250 402
Weighted average price (per bbl) ........ $ 19.89 $ 19.24 $ 18.39 $ 18.20
Contract amount ......................... $ 279 $ 96 $ 4,598 $ 7,316
Fair value .............................. $ 299 $ 103 $ 5,035 $ 8,160
In addition to the above, as of June 30, 1999, the Company was the
fixed price payor under certain swap contracts held to hedge anticipated
purchases of refinery feedstocks and refined products that mature in 2002 with
notional volumes totaling approximately 7.5 million barrels, a weighted average
pay price of $20.11 per barrel, a weighted average receive price of $17.72 per
barrel, and a net unrecognized fair value of approximately $5 million.
The following table provides information about the Company's
derivative commodity instruments held or issued for trading purposes as of June
30, 1999 and which mature in 1999 or 2000 (dollars in thousands, except amounts
per barrel or per million British thermal units ("MMBtu")). Volumes shown for
swaps represent notional volumes which are used to calculate amounts due under
the agreements.
Mature in 1999 Mature in 2000
-------------------------- ---------------------------
Fixed Price Fixed Price
-------------------------- ---------------------------
Payor Receiver Payor Receiver
--------- -------- --------- ---------
Swaps:
Notional volumes (Mbbls) ..................... 17,250 15,775 13,650 14,025
Weighted average pay price (per bbl) ......... $ 1.97 $ 1.64 $ 1.89 $ 1.82
Weighted average receive price (per bbl) ..... $ 1.89 $ 1.96 $ 1.78 $ 2.17
Fair value ................................... $ (1,393) $ 5,034 $ (1,481) $ 5,005
Notional volumes (MMBtus) .................... 620 620 -- --
Weighted average pay price (per MMBtu) ....... $ 2.13 $ 1.31 -- --
Weighted average receive price (per MMBtu) ... $ 1.31 $ 2.32 -- --
Fair value ................................... $ (504) $ 622 -- --
Options:
Volumes (Mbbls) .............................. 1,500 2,400 -- --
Weighted average strike price (per bbl) ...... $ 17.59 $ 11.59 -- --
Contract amount .............................. $ 544 $ 515 -- --
Fair value ................................... $ 1,674 $ 1,674 -- --
Futures:
Volumes (Mbbls) .............................. 21,369 21,314 6,387 6,447
Weighted average price (per bbl) ............. $ 17.19 $ 17.12 $ 15.22 $ 14.91
Contract amount .............................. $ 367,241 $364,919 $ 97,237 $ 96,131
Fair value ................................... $ 415,242 $409,009 $ 115,800 $116,921
25
26
INTEREST RATE RISK
The Company's primary market risk exposure for changes in interest
rates relates to the Company's long-term debt obligations. The Company manages
its exposure to changing interest rates principally through the use of a
combination of fixed and floating rate debt and currently does not use
derivative financial instruments to manage such risk. See Management's
Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources for a discussion of various initiatives
undertaken by the Company in the first six months of 1999 to reduce its
exposure to increases in interest rates and increase its financial flexibility.
26
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On November 25, 1998, the Texas Natural Resources Conservation
Commission ("TNRCC") initiated an enforcement action against the Company's
Corpus Christi refinery alleging violations of state and federal air
regulations and proposed an Agreed Order settlement of $226,050. The TNRCC
alleged that nitrous oxide emission monitors were not installed in two utility
boiler stacks and certain record keeping and monitoring deficiencies. The
Company challenged the allegations and on June 16, 1999 a final settlement was
reached with the TNRCC for $111,000 in penalties. All deficiencies noted by the
TNRCC have been corrected.
On June 11, 1999, the TNRCC notified the Company of its commencement
of proceedings against the Company's Texas City refinery concerning certain
record keeping deficiencies and alleged emissions exceedances which occurred
prior to the Company's acquisition of the refinery. Corrective action was
immediately taken and all contested matters have been resolved. Settlement
negotiations are ongoing with the TNRCC and the Company expects that the
penalties imposed will be less than $150,000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's annual meeting of stockholders was held April 29, 1999.
Matters voted on at the meeting and the results thereof were (i) a proposal to
elect three Class II directors to serve until 2002: Ronald K. Calgaard
(approved with 50,578,078 affirmative votes, and 146,872 abstentions), William
E. Greehey (approved with 50,567,965 affirmative votes, and 156,985
abstentions), and Susan Kaufman Purcell (approved with 50,577,287 affirmative
votes, and 147,663 abstentions); and (ii) a proposal to ratify the appointment
of Arthur Andersen LLP as independent public accountants (approved with
50,687,560 affirmative votes, 20,259 negative votes, and 17,131 abstentions).
Directors whose term of office continued after the meeting were: Edward C.
Benninger, Robert G.
Dettmer, Ruben M. Escobedo, James L. Johnson and Lowell H. Lebermann.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
*+10.18 Employment Agreement dated March 25, 1999, effective as of
April 29, 1999 between Valero Energy Corporation and
William E. Greehey.
**27.1 Financial Data Schedule (reporting financial information as
of and for the six months ended June 30, 1999).
- --------------------------
* Filed herewith
+ Identifies a management contract or compensatory plan or arrangement
required to be filed as an exhibit hereto pursuant to Item 6(a) of Form
10-Q.
** The Financial Data Schedule shall not be deemed "filed" for purposes of
Section 11 of the Securities Act of 1933 or Section 18 of the Securities
Exchange Act of 1934, and is included as an exhibit only to the electronic
filing of this Form 10-Q in accordance with Item 601(c) of Regulation S-K
and Section 401 of Regulation S-T.
(b) Reports on Form 8-K. The Company did not file any Current Reports
on Form 8-K during the quarter ended June 30, 1999.
27
28
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By: /s/ John D. Gibbons
-----------------------------------
John D. Gibbons
Chief Financial Officer, Vice
President - Finance
(Duly Authorized Officer and
Principal Financial and
Accounting Officer)
Date: August 13, 1999
28
29
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*+10.18 Employment Agreement dated March 25, 1999, effective as of April
29, 1999 between Valero Energy Corporation and William E.
Greehey.
**27.1 Financial Data Schedule (reporting financial information as of
and for the six months ended June 30, 1999).
- --------------------------
* Filed herewith
+ Identifies a management contract or compensatory plan or arrangement
required to be filed as an exhibit hereto pursuant to Item 6(a) of Form
10-Q.
** The Financial Data Schedule shall not be deemed "filed" for purposes of
Section 11 of the Securities Act of 1933 or Section 18 of the Securities
Exchange Act of 1934, and is included as an exhibit only to the electronic
filing of this Form 10-Q in accordance with Item 601(c) of Regulation S-K
and Section 401 of Regulation S-T.