UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
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
--- ---
The number of shares of the registrant's only class of common stock, $0.01 par
value, outstanding as of October 31, 2002 was 106,556,824.
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001....... 3
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2002 and 2001............................................... 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2002 and 2001............................................... 5
Consolidated Statements of Comprehensive Income (Loss) for the
Three and Nine Months Ended September 30, 2002 and 2001......................... 6
Notes to Consolidated Financial Statements....................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................ 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk................ 44
Item 4. Controls and Procedures................................................... 49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................... 49
Item 6. Exhibits and Reports on Form 8-K.......................................... 50
SIGNATURE........................................................................... 51
CERTIFICATIONS PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002..................................................... 52
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Millions of Dollars, Except Par Value)
September 30, December 31,
2002 2001
---- ----
(Unaudited) (Note 1)
ASSETS
Current assets:
Cash and temporary cash investments.............................. $ 319.6 $ 269.4
Restricted cash.................................................. 30.4 76.6
Receivables, net................................................. 1,027.3 750.4
Inventories...................................................... 1,466.6 1,453.1
Income taxes receivable.......................................... 6.9 176.7
Current deferred income tax assets............................... 81.1 -
Prepaid expenses and other current assets........................ 77.0 85.6
Assets held for sale............................................. - 1,303.6
-------- --------
Total current assets........................................... 3,008.9 4,115.4
-------- --------
Property, plant and equipment, at cost............................ 8,564.5 8,154.6
Less accumulated depreciation..................................... (1,160.5) (937.3)
-------- --------
Property, plant and equipment, net.............................. 7,404.0 7,217.3
-------- --------
Goodwill.......................................................... 2,619.3 2,210.5
Intangible assets, net............................................ 353.4 366.7
Deferred charges and other assets, net............................ 572.1 469.5
-------- --------
Total assets.................................................. $ 13,957.7 $ 14,379.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt............ $ 266.0 $ 505.7
Payable to UDS shareholders...................................... - 2,055.2
Accounts payable................................................. 1,445.5 1,369.8
Accrued expenses................................................. 332.4 420.9
Taxes other than income taxes.................................... 288.5 320.2
Current deferred income tax liabilities.......................... - 60.7
-------- --------
Total current liabilities...................................... 2,332.4 4,732.5
-------- --------
Long-term debt, less current portion.............................. 4,425.6 2,517.4
-------- --------
Capital lease obligations......................................... 291.0 287.9
-------- --------
Deferred income tax liabilities................................... 1,453.4 1,388.1
-------- --------
Other long-term liabilities....................................... 758.9 762.8
-------- --------
Company-obligated preferred securities of subsidiary trusts....... 372.5 372.5
-------- --------
Minority interest in consolidated partnership..................... 115.8 115.6
-------- --------
Stockholders' equity:
Common stock, $0.01 par value; 300,000,000 shares authorized;
108,198,992 shares issued..................................... 1.1 1.1
Additional paid-in capital...................................... 3,437.5 3,468.6
Treasury stock, at cost; 1,852,989 and 4,001,683 shares as of
September 30, 2002 and December 31, 2001, respectively........ (74.5) (149.6)
Retained earnings............................................... 835.3 864.4
Accumulated other comprehensive income.......................... 8.7 18.1
-------- --------
Total stockholders' equity.................................... 4,208.1 4,202.6
-------- --------
Total liabilities and stockholders' equity.................... $ 13,957.7 $ 14,379.4
======== ========
See Notes to Consolidated Financial Statements.
3
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Millions of Dollars, Except per Share Amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------ ------------
2002 2001 2002 2001
---- ---- ---- ----
Operating revenues................................... $ 7,191.7 $ 3,858.7 $ 18,866.5 $ 12,127.1
------- ------- -------- --------
Costs and expenses:
Cost of sales....................................... 6,382.3 3,355.5 16,643.3 10,310.0
Refining operating expenses......................... 334.8 216.0 973.3 631.1
Retail selling expenses............................. 166.5 1.7 491.1 4.6
Administrative expenses............................. 69.9 34.4 193.3 118.8
Depreciation and amortization expense............... 107.9 62.7 334.9 172.9
------- ------- -------- --------
Total costs and expenses........................... 7,061.4 3,670.3 18,635.9 11,237.4
------- ------- -------- --------
Operating income..................................... 130.3 188.4 230.6 889.7
Other income (expense), net.......................... 6.4 (0.3) 11.3 (1.4)
Interest and debt expense:
Incurred........................................... (81.8) (26.4) (218.0) (70.2)
Capitalized........................................ 3.9 2.5 13.2 7.1
Minority interest in net income of consolidated
partnership........................................ (3.8) - (10.4) -
Distributions on preferred securities
of subsidiary trusts............................... (7.5) (3.3) (22.5) (10.0)
------- ------- -------- --------
Income before income tax expense..................... 47.5 160.9 4.2 815.2
Income tax expense................................... 17.7 59.8 1.7 303.2
------- ------- -------- --------
Net income........................................... $ 29.8 $ 101.1 $ 2.5 $ 512.0
======= ======= ======== ========
Earnings per common share............................ $ 0.28 $ 1.66 $ 0.02 $ 8.40
Weighted average common shares outstanding
(in millions)..................................... 105.9 60.7 105.6 61.0
Earnings per common share
- assuming dilution................................. $ 0.27 $ 1.58 $ 0.02 $ 7.96
Weighted average common equivalent shares
outstanding (in millions).......................... 109.1 63.9 109.9 64.3
Dividends per share of common stock.................. $ 0.10 $ 0.08 $ 0.30 $ 0.24
See Notes to Consolidated Financial Statements.
4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
Nine Months Ended September 30,
------------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income............................................................ $ 2.5 $ 512.0
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization expense.............................. 334.9 172.9
Noncash interest expense and other income, net..................... 4.2 9.0
Minority interest in net income of consolidated partnership........ 10.4 -
Deferred income tax expense (benefit).............................. (34.7) 173.9
Changes in current assets and current liabilities.................. (176.2) (145.2)
Changes in deferred charges and credits and other, net............. (73.5) (22.8)
------- -----
Net cash provided by operating activities......................... 67.6 699.8
------- -----
Cash flows from investing activities:
Capital expenditures................................................. (483.0) (228.6)
Deferred turnaround and catalyst costs............................... (138.6) (115.1)
Proceeds from liquidation of investment in Diamond-Koch.............. 300.9 -
Proceeds from disposition of Golden Eagle Business................... 925.0 -
Capital expenditures, deferred turnaround costs and other cash
flows related to assets held for sale............................... (183.5) -
Purchase of inventories in connection with El Paso acquisition....... - (108.6)
Huntway acquisition, net of cash acquired............................ - (75.7)
Earn-out payments in connection with acquisitions.................... (23.9) (35.0)
Investment in joint ventures......................................... (10.3) -
Other investing activities, net...................................... 10.5 (1.2)
------- -----
Net cash provided by (used in) investing activities............... 397.1 (564.2)
------- -----
Cash flows from financing activities:
Cash payment to UDS shareholders in connection with
UDS Acquisition.................................................... (2,055.2) -
Increase (decrease) in short-term debt, net.......................... 61.0 (27.0)
Long-term debt borrowings, net of issuance costs..................... 3,316.4 18.1
Long-term debt repayments............................................ (1,725.2) (18.5)
Issuance of common stock in connection
with employee benefit plans........................................ 71.9 27.6
Common stock dividends............................................... (31.6) (14.6)
Purchase of treasury stock........................................... (44.7) (44.6)
Payment of cash distributions to minority interest in
consolidated partnership........................................... (10.2) -
------- -----
Net cash used in financing activities............................ (417.6) (59.0)
------- -----
Effect of foreign exchange rate changes on cash....................... 3.1 -
------- -----
Net increase in cash and temporary cash investments................... 50.2 76.6
Cash and temporary cash investments at beginning of period............ 269.4 14.6
------- -----
Cash and temporary cash investments at end of period.................. $ 319.6 $ 91.2
======= =====
See Notes to Consolidated Financial Statements.
5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Millions of Dollars)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------ ------------
2002 2001 2002 2001
---- ---- ---- ----
Net income.................................................... $ 29.8 $ 101.1 $ 2.5 $ 512.0
---- ----- ---- -----
Other comprehensive income (loss):
Foreign currency translation adjustment...................... (31.3) - 7.3 -
---- ----- ---- -----
Net gain (loss) on derivative instruments
designated and qualifying as cash flow hedges:
Statement No. 133 transition adjustment,
net of income tax expense of $15.2..................... - - - 28.3
Net gain (loss) arising during the period,
net of income tax (expense) benefit of
$(7.2), $9.1, $(37.4) and $12.3......................... 13.4 (16.9) 69.4 (22.8)
Net (gain) loss reclassified into income,
net of income tax expense (benefit) of
$32.8, $(8.6), $46.4 and $(12.6)........................ (60.9) 16.0 (86.1) 23.3
---- ----- ---- -----
Net gain (loss) on cash flow hedges.......................... (47.5) (0.9) (16.7) 28.8
---- ----- ---- -----
Comprehensive income (loss)................................... $(49.0) $ 100.2 $ (6.9) $ 540.8
==== ===== ==== =====
See Notes to Consolidated Financial Statements.
6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
As used in this report, the term Valero may refer to Valero Energy Corporation,
one or more of its consolidated subsidiaries, or all of them taken as a whole.
Valero, an independent refining and marketing company, owns and operates 12
refineries in the United States and Canada with a combined throughput capacity
of approximately 1.9 million barrels per day. Valero markets refined products
through a network of approximately 4,200 retail outlets in the United States and
eastern Canada under various brand names including Diamond Shamrock(R),
Ultramar(R), Valero(R), Beacon(R), Total(R) and Exxon(R). Valero's operations
are 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, and competitor refinery maintenance turnarounds.
The accompanying unaudited consolidated financial statements include the
accounts of Valero and subsidiaries in which Valero has a controlling interest.
Valero owns approximately 73% of Valero L.P., a consolidated partnership that
owns and operates most of the crude oil and refined product pipeline,
terminalling and storage assets that support three of Valero's refineries.
Investments in 50% or less owned entities are accounted for using the equity
method of accounting. Intercompany balances and transactions have been
eliminated in consolidation.
These consolidated financial statements have been prepared in accordance with
United States generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all
of the information and notes required by United States generally accepted
accounting principles for complete consolidated financial statements. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Certain
previously reported amounts have been reclassified to conform to the 2002
presentation. Operating results for the nine months ended September 30, 2002 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2002.
The balance sheet as of December 31, 2001 has been derived from the audited
financial statements as of that date but does not include all of the information
and notes required by United States generally accepted accounting principles for
complete consolidated financial statements. For further information, refer to
the consolidated financial statements and notes thereto included in Valero's
Annual Report on Form 10-K for the year ended December 31, 2001.
2. ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 142
Effective January 1, 2002, Valero adopted Statement of Financial Accounting
Standards (Statement) No. 142, "Goodwill and Other Intangible Assets," issued by
7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
the Financial Accounting Standards Board (FASB). This statement, which
supercedes APB Opinion No. 17, "Intangible Assets," provides that goodwill and
other intangible assets that have indefinite useful lives will not be amortized
but instead will be tested at least annually for impairment. Intangible assets
that have finite useful lives will continue to be amortized over their useful
lives, but such lives will not be limited to 40 years. Statement No. 142
provides specific guidance for testing goodwill and other nonamortized
intangible assets for impairment. Additionally, the statement requires certain
disclosures about goodwill and other intangible assets subsequent to their
acquisition, including changes in the carrying amount of goodwill from period to
period, the carrying amount of intangible assets by major intangible asset class
for those assets subject to amortization and for those not subject to
amortization, and the estimated intangible asset amortization expense for the
next five years.
Goodwill and other intangible assets acquired in connection with the acquisition
of Ultramar Diamond Shamrock Corporation (UDS) (see Note 3) are accounted for in
accordance with the provisions of Statement No. 142.
Valero did not have goodwill prior to July 1, 2001 (the date that amortization
of goodwill ceased for new acquisitions under Statement No. 142) but did have
finite-lived intangible assets that were amortized over their useful lives. The
useful lives of those previously recognized intangible assets were reassessed
using the guidance in Statement No. 142; however, no adjustment to the remaining
amortization periods was necessary. Therefore, there was no impact to Valero's
financial position or results of operations as a result of the adoption of this
statement.
FASB Statement No. 144
Effective January 1, 2002, Valero adopted Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement No. 144, which
supercedes Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and
reporting provisions of 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,"
establishes accounting standards for the impairment and disposal of long-lived
assets and criteria for determining when a long-lived asset is held for sale.
Statement No. 144 removes the requirement to allocate goodwill to long-lived
assets to be tested for impairment, requires that the depreciable life of a
long-lived asset to be abandoned be revised in accordance with APB Opinion No.
20, "Accounting Changes," provides that one accounting model be used for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and broadens the presentation of discontinued operations to
include more disposal transactions. There was no impact to Valero's financial
position or results of operations as a result of the adoption of this statement.
As of December 31, 2001, Valero classified certain long-lived assets held for
disposal as assets held for sale (see Note 6). Since these assets were committed
to be disposed of under a plan established prior to the adoption of Statement
No. 144, they were accounted for in accordance with Statement No. 121, APB
Opinion No. 30 and other relevant pronouncements that preceded Statement No.
144.
8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
FASB Statement No. 145
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement:
o rescinds Statement No. 4, "Reporting Gains and Losses from
Extinguishment of Debt,"
o rescinds Statement No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements,"
o rescinds Statement No. 44, "Accounting for Intangible Assets of Motor
Carriers," and
o amends Statement No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease
modifications that have economic effects that are similar to
sale-leaseback transactions.
This statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings or describe their applicability
under changed conditions. Valero adopted the provisions of this statement
effective May 15, 2002, except for the provision to rescind Statement No. 4,
which must be adopted no later than January 1, 2003. There was no impact to
Valero's financial position or results of operations as a result of adopting
this statement and no impact is expected from adopting the provision to rescind
Statement No. 4.
FASB Statement No. 146
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. Such costs include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operations, plant closings or other exit or disposal activities.
Statement No. 146 supercedes previous accounting guidance, principally Emerging
Issues Task Force (EITF) Issue No. 94-3. Valero will adopt the provisions of
Statement No. 146 for restructuring activities initiated after December 31,
2002. Statement No. 146 requires that the liability for costs associated with an
exit or disposal activity be recognized, at fair value, when the liability is
incurred. Under EITF Issue No. 94-3, a liability for an exit cost was
recognized at the date of the entity's commitment to an exit or disposal plan.
EITF Issue No. 02-3
In October 2002, the EITF reached a consensus on certain issues in EITF Issue
No. 02-3, "Issues Involved in Accounting for Derivative Contracts Held for
Trading Purposes and Contracts Involved in Energy Trading and Risk Management
Activities." Consensus was reached on two issues:
o EITF Issue No. 98-10, "Accounting for Contracts Involved in Energy
Trading and Risk Management Activities," is rescinded and
mark-to-market accounting for energy trading contracts that are not
derivatives is precluded, and
o gains and losses (realized and unrealized) on all derivative
instruments should be shown net in the statement of income, whether or
not settled physically, if the derivative instruments are held for
trading purposes.
The rescission of EITF Issue No. 98-10 is effective for all new contracts
entered into after October 25, 2002. The net reporting requirement for
derivative instruments held for trading purposes is effective for Valero's
financial statements issued for fiscal years commencing January 1, 2003. The
impact to Valero's results of operations as a result of implementing this
consensus is currently being evaluated but is not expected to be material.
9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. ACQUISITIONS
Ultramar Diamond Shamrock Corporation
On December 31, 2001, Valero completed its acquisition of UDS (UDS Acquisition).
UDS owned and operated seven refineries (two in Texas, two in California and one
in each of Oklahoma, Colorado and Quebec, Canada) with a combined throughput
capacity of approximately 850,000 barrels per day. UDS also marketed refined
products and a broad range of convenience store merchandise through a network of
approximately 4,500 convenience stores under the Diamond Shamrock(R),
Ultramar(R), Beacon(R) and Total(R) brand names. As a condition for the
regulatory approval of the acquisition, the Federal Trade Commission's (FTC)
consent decree required Valero to divest the 168,000 barrel-per-day Golden Eagle
Refinery located in the San Francisco Bay area, the associated wholesale
marketing business, and 70 associated Beacon- and Ultramar-branded convenience
stores located throughout Northern California (see Note 6). As consideration for
the UDS Acquisition, Valero paid approximately $2.1 billion of cash and issued
approximately 45.9 million shares of Valero common stock to UDS shareholders.
Huntway Refining Company
Effective June 1, 2001, Valero completed the acquisition of Huntway Refining
Company, a leading supplier of asphalt in California (Huntway Acquisition).
Huntway owned and operated two California refineries, at Benicia and Wilmington,
respectively, which primarily process California crude oil to produce liquid
asphalt for use in road construction and repair. The purchase price, net of
Huntway's cash balance on the date of acquisition, was approximately $76
million.
El Paso Refinery and Related Refined Product Logistics Business
Effective June 1, 2001, Valero completed the acquisition of El Paso
Corporation's Corpus Christi, Texas refinery and related refined product
logistics business (El Paso Acquisition) through capital lease agreements
entered into with certain wholly owned subsidiaries of El Paso Corporation. The
lease agreements are for a term of 20 years and provide for Valero to make
annual lease payments of $18.5 million for the first two years and increased
amounts thereafter. Valero has an option to purchase the facilities for
approximately $294 million at the end of the second year of the lease, and for
increasing amounts in each succeeding year through the end of the lease term. As
part of the acquisition, Valero also purchased inventories for approximately
$109 million and assumed certain environmental liabilities.
Purchase Price Allocations for Acquisitions in 2001
The UDS, Huntway and El Paso Acquisitions were accounted for using the purchase
method. The purchase price for each acquisition was initially allocated based on
the estimated fair values of the individual assets and liabilities at the date
of acquisition based on each asset's anticipated contribution to the enterprise,
pending the completion of independent appraisals and other evaluations performed
on the same basis. During the second quarter of 2002, independent appraisals for
the Huntway and El Paso Acquisitions, and a final allocation of the purchase
price for those acquisitions, were completed, and no significant adjustments to
the initial allocation were necessary. For the UDS Acquisition, the purchase
price exceeded the estimated fair values of the net assets acquired; the excess
was recorded as goodwill.
10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Subsequent adjustments to the preliminary purchase price allocation for the UDS
Acquisition through September 30, 2002 were as follows (in millions):
Current assets, excluding assets held for sale... $ (15.7)
Assets held for sale............................. (204.6)
Property, plant and equipment.................... (43.3)
Goodwill......................................... 378.9
Deferred charges and other assets, net........... (40.5)
Current liabilities, less current portion
of long-term debt and advance from Valero....... (24.0)
Other long-term liabilities...................... (43.1)
Deferred income tax liabilities.................. (7.7)
The change in assets held for sale was due primarily to a reallocation of
Valero's purchase price of UDS resulting from the difference between the net
cash received by Valero for assets held for sale and the amount recorded as
assets held for sale as of December 31, 2001 (see Note 6).
The operating results of the Huntway and El Paso Acquisitions are included in
the Consolidated Statements of Income beginning June 1, 2001. The operating
results of the UDS Acquisition are included in the Consolidated Statements of
Income beginning January 1, 2002.
Pro Forma Financial Information
The following unaudited pro forma financial information for the nine months
ended September 30, 2001 assumes that the UDS, Huntway and El Paso Acquisitions
occurred at the beginning of 2001. The effect of the UDS Acquisition included in
this pro forma financial information assumes:
o the Golden Eagle Business, as described and defined in Note 6, was
sold as of the beginning of 2001;
o approximately $795 million of the cash proceeds from the sale of the
Golden Eagle Business was used to pay down debt; and
o approximately $130 million of the cash proceeds was used to repurchase
2.9 million shares of common stock at $44.99 per share.
This pro forma information is not necessarily indicative of the results of
future operations (in millions, except per share amounts).
Nine Months Ended
September 30, 2001
------------------
Operating revenues................................. $ 21,843.1
Operating income................................... 1,712.3
Net income......................................... 925.9
Earnings per common share.......................... 8.91
Earnings per common share - assuming dilution...... 8.51
11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. RESTRICTED CASH
Restricted cash as of September 30, 2002 and December 31, 2001 included cash
held in trust related to change-in-control payments to be made to UDS officers
and key employees in connection with the UDS Acquisition, and cash restricted
for use for environmental remediation costs related to the Alma Refinery that
was shut down by UDS in 1999. During the first nine months of 2002, $46.4
million was paid to UDS officers and key employees in connection with the UDS
Acquisition.
5. INVENTORIES
Inventories were as follows (in millions):
September 30, December 31,
2002 2001
---- ----
Refinery feedstocks.................. $ 509.3 $ 513.4
Refined products and blendstocks..... 742.0 727.8
Convenience store merchandise........ 87.3 87.9
Materials and supplies............... 128.0 124.0
------- -------
Inventories........................ $ 1,466.6 $ 1,453.1
======= =======
As of September 30, 2002, the replacement cost of Valero's LIFO inventories
exceeded their LIFO carrying values by approximately $553 million. As of
December 31, 2001, the replacement cost of LIFO inventories approximated their
carrying value.
6. ASSETS HELD FOR SALE
Golden Eagle Business
In conjunction with the UDS Acquisition, the FTC approved a consent decree
requiring divestiture of certain UDS assets. Similar decrees were finalized with
the states of Oregon and California. Pursuant to the consent decrees, the assets
to be divested were required to be held separate from other Valero operations,
with the operations of the assets overseen by an independent trustee approved by
the FTC.
These assets and their related operations were referred to as the Golden Eagle
Business and included:
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 included sales primarily to unbranded customers
located in the northern half of California 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.
Assets held for sale as of December 31, 2001 included the amount expected to be
realized from the disposition of the Golden Eagle Business. The amount recorded
was based on an agreement for the sale of the Golden Eagle Business to Tesoro
Refining and Marketing Company (Tesoro) discussed below and expected cash flows
from operations of the Golden Eagle Business from January 1, 2002 through the
12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
anticipated date of sale. Pursuant to the sale agreement, Valero agreed to sell
the Golden Eagle Business to Tesoro for $1.075 billion, which included an
estimated $130 million for refinery feedstock and refined product inventories.
On May 17, 2002, the sale of the Golden Eagle Business was completed. Valero
received cash proceeds of $925 million and two ten-year junior subordinated
notes with face amounts totaling $150 million as follows:
o a $100 million note, due July 17, 2012, which is non-interest bearing for
the first five years and carries a 7.5% interest rate for the remaining
five-year period, and
o a $50 million note, due July 17, 2012, which bears no interest during the
first year and bears interest at approximately 7.5% for years two through
ten.
The two notes were recorded with an initial fair value of $58.9 million using a
discount rate of 16%, which represented Valero's best estimate of the fair value
of the notes at the closing date of the sale. The discount is being amortized
over the life of the notes and is reported as interest income in other income
(expense), net in the Consolidated Statements of Income. The notes receivable
are included in Valero's Consolidated Balance Sheet in deferred charges and
other assets, net.
The sales price included the assumption by Tesoro of various employee benefit
and lease obligations, but excluded certain assets and liabilities of the Golden
Eagle Business that were retained by Valero, including accounts receivable,
accounts payable, certain accrued liabilities and income tax obligations.
Results of operations for the Golden Eagle Business are excluded from Valero's
results of operations. The difference between the net cash received by Valero
related to the Golden Eagle Business and the amount recorded as assets held for
sale as of December 31, 2001 was accounted for by reallocating Valero's purchase
price for UDS. No gain or loss was recorded by Valero on this transaction.
Diamond-Koch
During 2001, Koch Industries, Inc. and UDS, both 50% partners in the
Diamond-Koch, L.P. joint venture, decided to sell the operating assets of
Diamond-Koch and began soliciting bids from interested parties. Assets held for
sale as of December 31, 2001 included the amount expected to be realized from
the disposition of the operating assets of Diamond-Koch, L.P. During the quarter
ended March 31, 2002, Diamond-Koch completed the sales of its operating assets
for total proceeds of approximately $576 million. All cash in the joint venture
in excess of amounts necessary to wind up its business was distributed,
resulting in proceeds received by Valero from the liquidation of its investment
of $300.9 million. Proceeds received by Valero in excess of the amount recorded
as of December 31, 2001 were accounted for by reallocating Valero's purchase
price for UDS. No gain or loss was recorded by Valero on this transaction.
13
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. INTANGIBLE ASSETS
Intangible assets were as follows (in millions):
September 30, 2002 December 31, 2001
----------------------------- ----------------------------
Gross Accumulated Gross Accumulated
Cost Amortization Cost Amortization
---- ------------ ---- ------------
Intangible assets subject to amortization:
Customer lists................................... $ 90.2 $ (4.5) $ 90.0 $ -
U.S. retail intangible assets.................... 77.2 (12.3) 77.2 (6.5)
Air emission credits............................. 50.0 (3.4) 50.0 -
Pension benefits................................. 32.8 (1.9) 32.8 -
Royalties and licenses........................... 35.4 (8.3) 32.3 (7.0)
----- ---- ----- ----
Intangible assets subject to amortization....... 285.6 $(30.4) 282.3 $(13.5)
==== ====
Intangible assets not subject to amortization:
Trade name - Canadian retail operations.......... 98.2 97.9
----- -----
Total...................................... $ 383.8 $ 380.2
===== =====
Amortization expense for intangible assets subject to amortization was
$16.9 million and $3.8 million for the nine months ended September 30, 2002 and
2001, respectively. The estimated aggregate amortization expense for the years
ending December 31, 2002 through 2006 is approximately $23 million per year for
each of the next five years.
8. GOODWILL
The changes in the carrying amount of goodwill for the nine months ended
September 30, 2002 were as follows (in millions):
Balance as of December 31, 2001.............................. $ 2,210.5
Adjustments to purchase price allocation
related to the UDS Acquisition (see Note 3)................ 378.9
Earn-out payments in connection with
other acquisitions......................................... 29.9
-------
Balance as of September 30, 2002............................. $ 2,619.3
=======
As of December 31, 2001, goodwill by reportable segments was not available
because the UDS Acquisition was not completed until December 31, 2001. As of
September 30, 2002, a preliminary allocation of goodwill among reportable
segments was completed using a preliminary purchase price allocation for the UDS
Acquisition, and all of the goodwill was allocated to the refining segment.
14
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. LONG-TERM DEBT
On January 7, 2002, Valero financed the $2.1 billion cash portion of the UDS
Acquisition, which was recorded as payable to UDS shareholders as of December
31, 2001, with proceeds from a $1.5 billion bridge loan facility and borrowings
under two new $750 million revolving bank credit facilities.
The bridge loan facility was a single-draw facility with a one-year maturity.
Borrowings under this facility were repaid in April 2002 with proceeds from a
$1.8 billion debt offering discussed below. The two revolving bank credit
facilities provide for commitments of $750 million for a five-year term and $750
million for a 364-day term and, subject to the commitment amounts and terms,
provide for borrowings to be made at various amounts, maturities and interest
rates, at the option of Valero.
On April 15, 2002, Valero sold $1.8 billion of notes as follows:
o $300 million of 6.125% Senior Notes due April 15, 2007,
o $750 million of 6.875% Senior Notes due April 15, 2012, and
o $750 million of 7.5% Senior Notes due April 15, 2032.
Proceeds from this offering were used to repay all borrowings under Valero's
$1.5 billion bridge loan facility associated with the UDS Acquisition and reduce
borrowings under Valero's revolving bank credit facilities.
On July 1, 2002, $275 million of 8.625% guaranteed notes and related interest
rate swaps with a notional amount of $200 million matured. Valero refinanced the
debt in July 2002 with borrowings under its revolving bank credit facilities.
On July 15, 2002, Valero Logistics Operations, L.P., a subsidiary of Valero
L.P., completed the sale of $100 million of 6.875% senior notes, which mature on
July 15, 2012. Proceeds from the offering were used to reduce borrowings under
Valero Logistics Operations, L.P.'s revolving credit facility and for general
corporate purposes.
On September 20, 2002, Valero amended its interest coverage ratio covenant in
its 364-day and five-year $750 million revolving bank credit facilities. The
amendment provides that Valero's trailing four-quarter coverage ratio must not
be less than:
o 2.4 times for the fourth quarter of 2002 and the first quarter of
2003,
o 2.5 times for the second, third and fourth quarters of 2003, and
o 2.75 times thereafter.
Valero has various other credit facilities that contain this covenant, and those
facilities have also been amended accordingly.
10. STOCKHOLDERS' EQUITY
Common Stock Repurchase Programs
Under common stock repurchase programs approved by Valero's Board of Directors,
Valero repurchases shares of its common stock from time to time for use in
connection with its employee benefit plans and other general corporate purposes.
During the nine months ended September 30, 2002 and 2001, Valero repurchased
shares of its common stock under these programs at a cost of $44.7 million and
$44.6 million, respectively.
15
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. EARNINGS PER COMMON SHARE
Earnings per common share amounts were computed as follows (dollars and shares
in millions, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
------------ ------------
2002 2001 2002 2001
---- ---- ---- ----
Earnings per Common Share:
Net income applicable to common shares............. $ 29.8 $ 101.1 $ 2.5 $ 512.0
==== ===== === =====
Weighted-average common shares outstanding......... 105.9 60.7 105.6 61.0
===== ==== ===== ====
Earnings per common share.......................... $ 0.28 $ 1.66 $ 0.02 $ 8.40
==== ==== ==== ====
Earnings per Common Share - Assuming Dilution:
Net income available to
common equivalent shares.......................... $ 29.8 $ 101.1 $ 2.5 $ 512.0
==== ===== === =====
Weighted-average common shares outstanding......... 105.9 60.7 105.6 61.0
Effect of dilutive securities:
Stock options.................................... 2.0 1.8 3.1 1.9
Performance awards and other benefit plans....... 1.2 1.0 1.2 1.0
PEPS Units....................................... - 0.4 - 0.4
----- ---- ----- ----
Weighted-average common equivalent
shares outstanding................................ 109.1 63.9 109.9 64.3
===== ==== ===== ====
Earnings per common share
- assuming dilution............................... $ 0.27 $ 1.58 $ 0.02 $ 7.96
==== ==== ==== ====
16
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net income is
adjusted by, among other things, changes in current assets and current
liabilities as follows (in millions):
Nine Months Ended September 30,
------------------------------
2002 2001
---- ----
Decrease (increase) in current assets:
Restricted cash.................................. $ 46.2 $ -
Receivables, net................................. (270.3) (159.1)
Inventories...................................... (12.6) (37.1)
Income taxes receivable.......................... 156.7 -
Prepaid expenses and other current assets........ (12.6) 15.2
Increase (decrease) in current liabilities:
Accounts payable................................. 70.7 (84.8)
Accrued expenses................................. (122.3) 40.4
Taxes other than income taxes.................... (32.0) 3.7
Income taxes payable............................. - 76.5
----- -----
Changes in current assets and current liabilities.. $ (176.2) $ (145.2)
===== =====
These changes in current assets and current liabilities differ from changes
between amounts reflected in the applicable consolidated balance sheets for the
respective periods for the following reasons. The amounts shown above exclude
changes in cash and temporary cash investments, assets held for sale, current
deferred income tax assets and liabilities, and short-term debt and current
portion of long-term debt. Also excluded from the table above are the current
assets and current liabilities acquired in connection with the Huntway and El
Paso Acquisitions in 2001, which are reflected separately in the Consolidated
Statements of Cash Flows, and the effect of certain noncash investing activities
discussed below. In addition, certain differences between balance sheet changes
and the cash flow changes reflected above result from translating foreign
currency denominated cash flows and balance sheets at different exchange rates.
Noncash investing activities for the nine months ended September 30, 2002
included:
o the adjustment to goodwill and assets held for sale to reflect the
difference between estimated and actual proceeds received on the
liquidation of the investment in Diamond-Koch and the disposition of the
Golden Eagle Business;
o the receipt of $150 million of notes from Tesoro with an estimated fair
value of $58.9 million in connection with the disposition of the Golden
Eagle Business; and
o various adjustments to property, plant and equipment, goodwill and certain
current and noncurrent assets and liabilities resulting from adjustments to
the purchase price allocations related to the Huntway, El Paso and UDS
Acquisitions.
17
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Noncash investing and financing activities for the nine months ended
September 30, 2001 included:
o increases to property, plant and equipment, other long-term liabilities and
capital lease obligations resulting from the El Paso Acquisition and
o an increase to property, plant and equipment resulting from the accrual of
a $20 million earn-out contingency payment made to Exxon Mobil Corporation
in October 2001 in connection with Valero's 1998 acquisition of the
Paulsboro Refinery.
Cash flows related to interest and income taxes were as follows (in millions):
Nine Months Ended September 30,
------------------------------
2002 2001
---- ----
Interest paid (net of amount capitalized)... $ 143.6 $ 49.7
Income taxes paid........................... 22.4 54.8
Income tax refunds received................. 142.7 2.0
13. PRICE RISK MANAGEMENT ACTIVITIES
Commodity Price Risk
Valero is exposed to market risks related to the volatility of crude oil and
refined product prices, as well as volatility in the price of natural gas used
in its refining operations. To reduce the impact of this price volatility,
Valero uses derivative commodity instruments (swaps, futures and options) to
manage its exposure to:
o changes in the fair value of a portion of its refinery feedstock and
refined product inventories and a portion of its unrecognized firm
commitments to purchase these inventories (fair value hedges);
o changes in cash flows of certain forecasted transactions such as forecasted
feedstock purchases, natural gas purchases and refined product sales (cash
flow hedges); and,
o price volatility on a portion of its refined product inventories and on
certain forecasted feedstock and refined product purchases that are not
designated as either fair value or cash flow hedges (economic hedges).
In addition, Valero uses derivative commodity instruments for trading purposes
based on its fundamental and technical analysis of market conditions.
Interest Rate Risk
Valero is exposed to market risk for changes in interest rates related to
certain of its long-term debt obligations. Interest rate swap agreements, which
have been designated and qualify as fair value hedging instruments, are used to
manage a portion of the exposure to changing interest rates by converting
certain fixed-rate debt to floating rate.
During September 2002, Valero entered into two interest rate cash flow hedges,
each with a notional amount of $250 million. As of September 30, 2002, these
agreements had a negative fair value of $9.9 million, the after-tax effect of
which was included in accumulated other comprehensive income in the Consolidated
Balance Sheet.
18
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Foreign Currency Risk
Valero is exposed to exchange rate fluctuations on transactions related to its
Canadian operations. To manage its exposure to these exchange rate fluctuations,
Valero uses foreign currency exchange and purchase contracts. These contracts
are not designated as hedging instruments.
During May 2002, Valero entered into foreign currency exchange contracts to
hedge its exposure to exchange rate fluctuations on an investment in its
Canadian operations. Under these contracts, Valero sold $400 million of Canadian
dollars and bought $253.4 million of U.S. dollars. These contracts mature
annually at various amounts from 2003 through 2007. As of September 30, 2002,
these contracts had a fair value of $8.4 million. The gain recognized in income
on these contracts, which was $14.5 million and $8.4 million for the three
months and nine months ended September 30, 2002, respectively, was substantially
offset by a loss of $11.7 million and $4.6 million, respectively, recognized in
income from the effect of the exchange rate fluctuation on the hedged investment
for the three-month and nine-month periods.
Certain Financial Statement Disclosures
The net gain (loss) recognized in income representing the amount of hedge
ineffectiveness was as follows (in millions):
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Fair value hedges........ $ 2.5 $ 9.8 $ 5.5 $ 3.4
Cash flow hedges......... 8.2 0.6 20.6 (15.3)
The above amounts were included in cost of sales in the Consolidated Statements
of Income. No component of the derivative instruments' gains or losses was
excluded from the assessment of hedge effectiveness. No amounts were recognized
in income for hedged firm commitments that no longer qualify as fair value
hedges.
For cash flow hedges, gains and losses currently reported in accumulated other
comprehensive income in the Consolidated Balance Sheets will be reclassified
into income when the forecasted transactions affect income. The estimated amount
of existing net gain included in accumulated other comprehensive income as of
September 30, 2002 that is expected to be reclassified into income within the
next 12 months is $8.5 million. As of September 30, 2002, the maximum length of
time over which Valero was hedging its exposure to the variability in future
cash flows for forecasted transactions was seven years, with the majority of the
transactions maturing in less than one year.
Market and Credit Risk
Valero's price risk management activities involve the receipt or payment of
fixed price commitments into the future. These transactions give rise to market
risk, the risk that future changes in market conditions may make an instrument
less valuable. Valero closely monitors and manages its exposure to market risk
on a daily basis in accordance with policies approved by its Board of Directors.
Market risks are monitored by a risk control group to ensure compliance with
Valero's stated risk management policy. Concentrations of customers in the
refining industry may impact Valero's overall exposure to credit risk, in that
19
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
these customers may be similarly affected by changes in economic or other
conditions. Valero believes that its counterparties will be able to satisfy
their obligations under their price risk management contracts with Valero.
14. SEGMENT INFORMATION
Prior to the UDS Acquisition, Valero had one reportable segment, the refining
and marketing of refined products. Beginning January 1, 2002, Valero has two
reportable segments, refining and retail, because of Valero's acquisition of UDS
on December 31, 2001, and its significant retail operations. Valero's refining
segment includes refining operations, wholesale marketing, product supply and
distribution, and transportation operations. The retail segment includes
company-operated convenience stores, Canadian dealers/jobbers and truckstop
facilities, cardlock facilities and home heating oil operations. Operations that
are not included in either of the two reportable segments are included in the
corporate category. Segment information for the three months and nine months
ended September 30, 2001 have been restated to conform to the 2002 reportable
segment presentation.
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. Intersegment sales are generally derived from transactions
made at prevailing market rates.
Refining Retail Corporate Total
-------- ------ --------- -----
(in millions)
Three months ended September 30, 2002:
Operating revenues from external customers..... $ 5,862.3 $ 1,329.4 $ - $ 7,191.7
Intersegment revenues.......................... 573.5 - - 573.5
Operating income (loss)........................ 169.1 31.0 (69.8) 130.3
Three months ended September 30, 2001:
Operating revenues from external customers..... 3,847.1 11.6 - 3,858.7
Intersegment revenues.......................... 7.1 - - 7.1
Operating income (loss)........................ 224.5 0.6 (36.7) 188.4
Nine months ended September 30, 2002:
Operating revenues from external customers..... 15,037.6 3,828.9 - 18,866.5
Intersegment revenues.......................... 1,771.5 - - 1,771.5
Operating income (loss)........................ 356.0 81.8 (207.2) 230.6
Nine months ended September 30, 2001:
Operating revenues from external customers..... 12,093.0 34.1 - 12,127.1
Intersegment revenues.......................... 21.8 - - 21.8
Operating income (loss)........................ 1,014.4 0.6 (125.3) 889.7
20
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Total assets by reportable segment have not changed significantly since
December 31, 2001, except for the preliminary allocation of goodwill to the
refining segment as discussed in Note 3.
15. ENVIRONMENTAL MATTERS
Liabilities for future remediation costs are recorded when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Other than for assessments, the timing and magnitude of these
accruals are generally based on the completion of investigations or other
studies or a commitment to a formal plan of action. Environmental liabilities
are based on best estimates of probable undiscounted future costs using
currently available technology and applying current regulations, as well as
Valero's own internal environmental policies.
The balance of and changes in the accruals for environmental matters, which are
principally included in other long-term liabilities, were as follows (in
millions):
Balance as of December 31, 2001........................ $ 173.8
Additions to accrual, net............................. 1.0
Payments, net of third-party recoveries............... (15.9)
-----
Balance as of September 30, 2002....................... $ 158.9
=====
Valero believes that it has adequately provided for its environmental
liabilities with the accruals referred to above. These liabilities have not been
reduced by potential future recoveries from third parties. Environmental
liabilities are difficult to assess and estimate due to unknown factors such as
the magnitude of possible contamination, the timing and extent of remediation,
the determination of Valero's liability in proportion to other parties,
improvements in cleanup technologies, and the extent to which environmental laws
and regulations may change in the future.
16. LITIGATION AND CONTINGENCIES
Unocal
On January 22, 2002, Union Oil Company of California (Unocal) filed a patent
infringement lawsuit against Valero in California federal court. The complaint
seeks a 5.75 cent 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
alleged willful infringement of Unocal's patents and Valero's alleged conduct to
induce others to infringe the patents. In a previous lawsuit involving its '393
patent, Unocal prevailed against five other major refiners. The Federal Trade
Commission has begun an antitrust investigation concerning Unocal's conduct with
a joint industry research group during the time that Unocal was prosecuting its
patents 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 FTC investigation. Each of the '393 and '126 patents is subject to
reexamination by the PTO. This year, the PTO issued a notice of rejection of all
claims of each of these patents, but the PTO has not issued a final decision
with respect to either patent. The pending reexaminations could affect the scope
and validity of the patents. The patent lawsuit is presently stayed as a result
of the PTO reexamination proceedings. Notwithstanding the judgment against the
other refiners in the previous litigation, Valero believes that it has several
strong defenses to Unocal's lawsuit, including those arising from Unocal's
misconduct, and Valero believes it will prevail in the lawsuit.
21
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
However, due to the inherent uncertainty of litigation, there can be no
assurance that Valero will prevail, and an adverse result could have a material
adverse effect on Valero's results of operations and financial position.
MTBE Litigation
Valero has been named as a defendant in various cases alleging MTBE
contamination in groundwater in New York, Texas and California. The plaintiffs
generally allege that refiners and manufacturers of gasoline containing MTBE are
liable for manufacturing a defective product. The New York and Texas cases have
been either dismissed or settled or are deemed immaterial. In California, the
lawsuits have been filed by local water providers, including the City of Santa
Monica, the City of Dinuba and Fruitridge Vista Water Company. These cases are
primarily based on a product liability/product defect theory and seek
individual, unquantified compensatory and punitive damages and attorneys' fees.
Valero believes it is unlikely that the final outcome of any one of these claims
or proceedings would have a material adverse effect on its results of operations
or financial position, but that an adverse result in a majority of these cases
could have a material adverse effect on Valero's results of operations and
financial position.
Valero is also a party to additional claims and legal proceedings arising in the
ordinary course of business. Valero believes it is unlikely that the final
outcome of any of the claims or proceedings to which it is a party would have a
material adverse effect on its financial 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 Valero's results of operations,
financial position or liquidity.
17. SUBSEQUENT EVENTS
In connection with the UDS Acquisition, Valero assumed a $360 million revolving
accounts receivable sales facility, under which Valero could sell eligible
credit card and trade accounts receivable on an ongoing basis through a wholly
owned subsidiary to a third-party financial institution. Valero also had an
existing accounts receivable sales facility with a third-party financial
institution to sell on a revolving basis up to $150 million of eligible trade
accounts receivable. On October 8, 2002, Valero renewed and amended its
agreement to, among other things, increase the size of its facility from $150
million to $250 million, incorporate credit card receivables into the program
and extend the maturity date to October 2005. The assumed UDS facility was
terminated in connection with the renewal and amendment of the Valero facility.
On October 18, 2002, Valero's Board of Directors declared a regular quarterly
cash dividend of $0.10 per common share payable December 11, 2002 to holders of
record as of the close of business on November 13, 2002.
On October 21, 2002, Valero L.P. declared a quarterly partnership distribution
of $0.70 per unit payable on November 14, 2002 to unitholders of record on
November 1, 2002. The total distribution is expected to be approximately
$14.1 million of which approximately $3.6 million is payable to minority
unitholders.
22
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During October 2002, Valero entered into several fixed-to-floating interest rate
swaps, which have been designated and qualify as fair value hedging instruments,
totaling $350 million in order to manage interest costs on its outstanding debt.
The following table summarizes the terms of the interest rate swap agreements:
Year of Maturity
----------------
2006 2007
---- ----
Notional amount (in millions)............ $ 125.0 $ 225.0
Weighted average fixed rate
to be received.......................... 7.375% 6.125%
Weighted average floating rate 6-Month LIBOR 6-Month LIBOR
to be paid............................... + 3.854% + 2.453%
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FORWARD-LOOKING STATEMENTS
This Form 10-Q, including without limitation the discussion below under the
heading "Results of Operations - Outlook," contains certain estimates,
predictions, projections, assumptions and other "forward-looking statements" (as
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) that involve various risks and uncertainties.
While these forward-looking statements, and any assumptions upon which they are
based, are made in good faith and reflect Valero's current judgment regarding
the direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, assumptions or other
future performance suggested in this report. These forward-looking statements
can generally be identified by the words "anticipate," "believe," "expect,"
"plan," "intend," "estimate," "project," "budget," "forecast," "will," "could,"
"should," "may" and similar expressions. These forward-looking statements
include, among other things, statements regarding:
o the effect of Valero's acquisition of UDS on Valero's business,
results of operations and financial position;
o future refining margins, including gasoline and heating oil margins;
o future retail margins, including gasoline, diesel, home heating oil
and convenience store merchandise margins;
o expectations regarding feedstock costs, including crude oil discounts,
and operating expenses;
o anticipated levels of crude oil and refined product inventories;
o Valero's anticipated level of capital investments, including deferred
refinery turnaround and catalyst costs and capital expenditures for
environmental and other purposes, and the effect of these capital
investments on Valero's results of operations;
o anticipated trends in the supply and demand for crude oil feedstocks
and refined products in the United States, Canada and elsewhere;
o expectations regarding environmental and other regulatory initiatives;
and
o the effect of general economic and other conditions on refining and
retail industry fundamentals.
Valero's forward-looking statements are based on its beliefs and assumptions
derived from information available at the time the statements are made.
Differences between actual results and any future performance suggested in these
forward-looking statements could result from a variety of factors, including the
following:
o acts of terrorism aimed at either Valero's facilities or other
facilities that could impair Valero's ability to produce and/or
transport refined products or receive foreign feedstocks;
o political conditions in crude oil producing regions, including the
Middle East;
o the domestic and foreign supplies of refined products such as
gasoline, diesel, jet fuel, home heating oil and petrochemicals;
o the domestic and foreign supplies of crude oil and other feedstocks;
o the ability of the members of the Organization of Petroleum Exporting
Countries (OPEC) to agree on and to maintain crude oil price and
production controls;
o the level of consumer demand, including seasonal fluctuations;
o refinery overcapacity or undercapacity;
o the actions taken by competitors, including both pricing and the
expansion and retirement of refining capacity in response to market
conditions;
o environmental and other regulations at both the state and federal
levels and in foreign countries;
o the level of foreign imports of refined products;
24
o accidents or other unscheduled shutdowns affecting Valero's
refineries, machinery, pipelines or equipment, or those of Valero's
suppliers or customers;
o changes in the cost or availability of transportation for feedstocks
and refined products;
o the price, availability and acceptance of alternative fuels and
alternative-fuel vehicles;
o cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such
projects or cost overruns in constructing such planned capital
projects;
o earthquakes, hurricanes, tornadoes and irregular weather, which can
unforeseeably affect the price or availability of feedstocks and
refined products;
o rulings, judgments or settlements in litigation or other legal or
regulatory matters, including unexpected environmental remediation
costs in excess of any reserves or insurance coverage;
o the introduction or enactment of federal or state legislation which
may adversely affect Valero's business or operations;
o changes in the credit ratings assigned to Valero's debt securities and
trade credit;
o changes in the value of the Canadian dollar relative to the U.S.
dollar;
o overall economic conditions; and
o other economic, business, competitive and/or regulatory factors that
may affect Valero's business generally as described in Valero's
filings with the SEC.
Any one of these factors, or a combination of these factors, could materially
affect Valero's future results of operations and whether any forward-looking
statements ultimately prove to be accurate. Valero's forward-looking statements
are not guarantees of future performance, and actual results and future
performance may differ materially from those suggested in any forward-looking
statement. Valero does not intend to update these statements unless it is
required by the securities laws to do so.
All subsequent written and oral forward-looking statements attributable to
Valero or persons acting on its behalf are expressly qualified in their entirety
by the foregoing. Valero undertakes no obligation to publicly release the result
of any revisions to any such forward-looking statements that may be made to
reflect events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events.
25
RESULTS OF OPERATIONS
Third Quarter 2002 Compared to Third Quarter 2001
Financial Highlights (millions of dollars, except per share amounts)
Three Months Ended September 30,
--------------------------------
2002(a) 2001(a) Change
------- ------- ------
Operating revenues.......................................... $ 7,191.7 $ 3,858.7 $ 3,333.0
Cost of sales............................................... (6,382.3) (3,355.5) (3,026.8)
Refining operating expenses:
Cash (fixed and variable).................................. (334.8) (216.0) (118.8)
Depreciation and amortization.............................. (97.2) (60.1) (37.1)
Retail selling expenses:
Cash....................................................... (166.5) (1.7) (164.8)
Depreciation and amortization.............................. (10.7) (0.3) (10.4)
Administrative expenses:
Cash....................................................... (69.9) (34.4) (35.5)
Depreciation and amortization.............................. - (2.3) 2.3
------- ------- -------
Operating income............................................ 130.3 188.4 (58.1)
Other income (expense), net................................. 6.4 (0.3) 6.7
Interest and debt expense, net.............................. (77.9) (23.9) (54.0)
Minority interest in net income of consolidated
partnership................................................ (3.8) - (3.8)
Distributions on preferred securities of subsidiary trusts.. (7.5) (3.3) (4.2)
Income tax expense.......................................... (17.7) (59.8) 42.1
------- ------- -------
Net income .............................................. $ 29.8 $ 101.1 $ (71.3)
======= ======= =======
Earnings per common share - assuming dilution............... $ 0.27 $ 1.58 $ (1.31)
Earnings before interest, taxes, depreciation and
amortization (EBITDA)(b)................................... $ 230.8 $ 247.5 $ (16.7)
Ratio of EBITDA to interest incurred (b).................... 2.8x 9.4x (6.6)x
- --------------------------------------------------------------------------------
The following notes relate to references on pages 26 through 29.
(a) The third quarter of 2002 includes the operations of UDS while the third
quarter of 2001 does not include the operations of UDS since the
acquisition did not occur until December 31, 2001.
(b) EBITDA represents pre-tax income plus net interest expense and depreciation
and amortization expense, reduced by noncash interest income related to the
amortization of the discount on the notes receivable from Tesoro. EBITDA is
a measure of performance that is not defined by generally accepted
accounting principles, and therefore the above calculation of EBITDA may
not be consistent with similar calculations performed by other companies.
(c) The Gulf Coast refining region includes the Corpus Christi, Texas City,
Houston, Three Rivers and Krotz Springs Refineries; the Mid-Continent
refining region includes the McKee, Ardmore and Denver Refineries; the
Northeast refining region includes the Quebec and Paulsboro Refineries; and
the West Coast refining region includes the Benicia and Wilmington
Refineries.
(d) The market reference differential for sour crude oil is based on 50% Arab
Medium and 50% Arab Light posted prices.
26
Operating Highlights
Three Months Ended September 30,
--------------------------------
2002(a) 2001(a) Change
------ ------ ------
Refining:
Operating income......................................... $ 169.1 $ 224.5 $ (55.4)
Throughput volumes (thousand barrels per day)............ 1,604 1,013 591
Average throughput margin per barrel..................... $ 4.08 $ 5.37 $ (1.29)
Operating costs per barrel:
Cash (fixed and variable)............................... $ 2.27 $ 2.32 $ (0.05)
Depreciation and amortization........................... 0.66 0.62 0.04
---- ---- ----
Total operating costs per barrel....................... $ 2.93 $ 2.94 $ (0.01)
==== ==== ====
Charges:
Crude oils:
Sour.................................................. 44% 61% (17)%
Sweet................................................. 35 10 25
--- --- ---
Total crude oils..................................... 79 71 8
Residual fuel oil....................................... 6 10 (4)
Other feedstocks and blendstocks........................ 15 19 (4)
--- --- ---
Total charges.......................................... 100% 100% -%
=== === ===
Yields:
Gasolines and blendstocks............................... 55% 52% 3%
Distillates............................................. 27 26 1
Petrochemicals.......................................... 3 3 -
Lubes and asphalts...................................... 5 5 -
Other products.......................................... 10 14 (4)
--- --- ---
Total yields........................................... 100% 100% -%
=== === ===
Retail - U.S.:
Operating income......................................... $ 18.0 $ 0.6 $ 17.4
Company-operated fuel sites (average).................... 1,322 11 1,311
Fuel volumes (gallons per day per site).................. 4,491 6,919 (2,428)
Fuel margin (per gallon)................................. $ 0.124 $ 0.341 $ (0.217)
Merchandise sales (in millions).......................... $ 263.0 $ 1.0 $ 262.0
Merchandise margin (percentage of sales)................. 27.9% 31.6% (3.7)%
Margin on miscellaneous sales (in millions).............. $ 10.5 $ - $ 10.5
Selling expenses (per gallon)............................ $ 0.233 $ 0.241 $ (0.008)
Retail - Northeast:
Operating income......................................... $ 13.0 N/A
Fuel volumes (thousand gallons per day).................. 3,097 N/A
Fuel margin (per gallon)................................. $ 0.165 N/A
Merchandise sales (in millions).......................... $ 27.9 N/A
Merchandise margin (percentage of sales)................. 22.7% N/A
Margin on miscellaneous sales (in millions).............. $ 3.9 N/A
Selling expenses (per gallon)............................ $ 0.137 N/A
27
Refining Operating Highlights by Region (c)
Three Months Ended September 30,
--------------------------------
2002(a) 2001(a) Change
------ ------ ------
Gulf Coast:
Throughput volumes (thousand barrels per day).......... 678 667 11
Average throughput margin per barrel................... $ 4.80 $ 4.86 $ (0.06)
Operating costs per barrel:
Cash (fixed and variable)............................. $ 2.47 $ 2.11 $ 0.36
Depreciation and amortization......................... 0.76 0.66 0.10
---- ---- ----
Total operating costs per barrel..................... $ 3.23 $ 2.77 $ 0.46
==== ==== ====
Mid-Continent:
Throughput volumes (thousand barrels per day).......... 272 N/A
Average throughput margin per barrel................... $ 4.18 N/A
Operating costs per barrel:
Cash (fixed and variable)............................. $ 1.95 N/A
Depreciation and amortization......................... 0.55 N/A
----
Total operating costs per barrel..................... $ 2.50 N/A
====
Northeast:
Throughput volumes (thousand barrels per day).......... 351 169 182
Average throughput margin per barrel................... $ 2.78 $ 3.65 $(0.87)
Operating costs per barrel:
Cash (fixed and variable)............................. $ 1.55 $ 2.17 $(0.62)
Depreciation and amortization......................... 0.47 0.57 (0.10)
---- ---- ----
Total operating costs per barrel..................... $ 2.02 $ 2.74 $(0.72)
==== ==== ====
West Coast:
Throughput volumes (thousand barrels per day).......... 303 177 126
Average throughput margin per barrel................... $ 3.86 $ 8.66 $(4.80)
Operating costs per barrel:
Cash (fixed and variable)............................. $ 2.95 $ 3.24 $(0.29)
Depreciation and amortization......................... 0.73 0.55 0.18
---- ---- ----
Total operating costs per barrel..................... $ 3.68 $ 3.79 $(0.11)
==== ==== ====
28
Average Market Reference Prices and Differentials (dollars per barrel)
Three Months Ended September 30,
--------------------------------
2002(a) 2001(a) Change
------ ------ ------
Feedstocks:
West Texas Intermediate (WTI) crude oil............. $28.32 $26.69 $ 1.63
WTI less sour crude oil at U.S. Gulf Coast (d)...... $ 2.42 $ 4.37 $(1.95)
WTI less Alaska North Slope (ANS) crude oil......... $ 1.00 $ 2.67 $(1.67)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI................. $ 3.71 $ 3.98 $(0.27)
No. 2 fuel oil less WTI........................... $ 0.95 $ 2.87 $(1.92)
Propylene less WTI................................ $ 1.72 $(2.56) $ 4.28
U.S. Mid-Continent:
Conventional 87 gasoline less WTI................. $ 5.79 $ 9.35 $(3.56)
Low-sulfur diesel less WTI........................ $ 3.89 $ 8.50 $(4.61)
U.S. East Coast:
Conventional 87 gasoline less WTI................. $ 4.01 $ 4.27 $(0.26)
No. 2 fuel oil less WTI........................... $ 1.79 $ 3.44 $(1.65)
Lube oils less WTI................................ $17.99 $25.67 $(7.68)
U.S. West Coast:
CARB 87 gasoline less ANS......................... $ 8.83 $13.76 $(4.93)
Low-sulfur diesel less ANS........................ $ 5.49 $ 9.32 $(3.83)
General
Valero reported net income for the third quarter of 2002 of $29.8 million, or
$0.27 per share, compared to net income of $101.1 million, or $1.58 per share,
in the third quarter of 2001.
Operating revenues increased 86% in the third quarter of 2002 compared to the
third quarter of 2001 primarily as a result of operations acquired in the UDS
Acquisition, attributable to both additional throughput volumes from the
refinery operations and additional revenues generated from the retail
operations, partially offset by a significant decline in refined product prices.
However, operating income for the third quarter of 2002 decreased significantly
to $130.3 million compared to operating income of $188.4 million for the same
period in 2001. The decrease in operating income from 2001 to 2002 was due
mainly to a $55.4 million decrease in operating income generated by the refining
segment and a $33.2 million increase in administrative expenses (including
related depreciation and amortization expense). These decreases were partially
offset by an increase in operating income from the retail segment attributable
to increased retail operations acquired in the UDS Acquisition.
Refining
Operating income for Valero's refining segment was $169.1 million for the
quarter ended September 30, 2002, compared to operating income of $224.5 million
for the quarter ended September 30, 2001. The decrease in operating income
resulted primarily from a 24% decline in refining throughput margin per barrel,
attributable primarily to exceptionally weak discounts for sour crude oil,
Valero's primary feedstock, and significantly lower refined product margins in
virtually all of Valero's markets.
29
In the third quarter of 2002, refining operating results were impacted by the
following factors:
o discounts on Valero's sour crude oil feedstocks during the third
quarter of 2002 declined over 44% from third quarter 2001 levels
primarily due to crude oil production cuts by OPEC and resulting
limited availability of sour crude oil on the world market in 2002,
whereas in 2001 discounts benefited from increased supplies of sour
crude oil without a corresponding increase in demand;
o although gasoline demand was strong, gasoline margins declined in all
regions of the United States, particularly in the West Coast, from the
margins experienced in the third quarter of 2001 resulting mainly from
higher gasoline imports and increased production in the third quarter
of 2002;
o distillate margins declined over 40% in every region from the third
quarter of 2001 due to continued high inventory levels as a result of
weak economic conditions, the unusually warm winter in the
northeastern part of the United States and in Europe last winter, and
lower jet fuel demand; and,
o during the third quarter of 2002, Valero's refinery utilization rates
were lower than normal. The refinery utilization rates in 2002 were
impacted by the following factors:
o The Texas City Refinery was affected by unscheduled downtime
after a lightning strike caused the fluid catalytic cracking unit
(FCCU)to be shut down and, upon start-up of the FCCU, a leak in a
flue gas cooler required repairs in mid-August.
o During the last two weeks of September 2002, production at
Valero's Gulf Coast refineries was reduced as a result of the
impact of hurricanes on crude oil shipments.
o The FCCU at the Wilmington Refinery was taken out of service for
almost three weeks in September due to an unexpected problem in
the unit's main air blower. The shutdown reduced production of
CARB gasoline by approximately 45,000 barrels per day during this
period.
o Production at eight of Valero's refineries was cut during the
third quarter of 2002 by as much as 16% from normal levels due to
continued uneconomic operating conditions resulting from high
U.S. inventories for refined products.
Partially offsetting the above decreases in throughput margin was the effect of
increased throughput volumes resulting from the UDS Acquisition and an
approximate net $62 million benefit resulting from the settlement in August 2002
of a petroleum products purchase agreement and related hedge.
Refining cash operating expenses were 55% higher during the third quarter of
2002 as compared to the third quarter of 2001 due to the additional refinery
operations from the UDS Acquisition. However, cash operating costs per barrel
decreased 2% between the quarters. Refining depreciation and amortization
expense increased $37.1 million, or 62%, from the third quarter of 2001 to the
third quarter of 2002 due mainly to the UDS Acquisition. However, noncash
operating costs increased only $0.04, or 6%, on a per barrel basis.
Retail
Retail operating income, including both U.S. and Northeast retail operations,
was $31.0 million for the quarter ended September 30, 2002, which included the
effect of retail operations acquired in the UDS Acquisition, compared to
operating income of $0.6 million for the quarter ended September 30, 2001, which
included only 11 northern California retail stores operated by Valero at that
time.
Retail cash selling expenses for the third quarter of 2002 increased $164.8
million from the third quarter of 2001 due to the additional retail stores
acquired in the UDS Acquisition. The additional stores acquired in the UDS
Acquisition also resulted in a $10.4 million increase in retail depreciation and
amortization expense between the quarters.
30
Corporate Expenses and Other
Administrative expenses, including depreciation and amortization expense,
increased $33.2 million in the third quarter of 2002 compared to the third
quarter of 2001 due primarily to the UDS Acquisition.
Other income (expense), net increased $6.7 million in the third quarter of 2002
compared to the third quarter of 2001 due primarily to a $4.0 million increase
in interest income, including $2.4 million related to the notes receivable from
Tesoro in connection with the sale of the Golden Eagle Business.
Net interest expense increased $54.0 million to $77.9 million in the third
quarter of 2002 compared to the third quarter of 2001 due primarily to the
incremental debt incurred to finance the UDS Acquisition and the assumption by
Valero of the UDS debt.
The minority interest in net income of consolidated partnership of $3.8 million
represents the minority unitholders' share of the net income of Valero L.P.
Distributions on preferred securities of subsidiary trusts increased $4.2
million from $3.3 million in the third quarter of 2001 to $7.5 million in the
third quarter of 2002. This increase was due to the distributions incurred on
the $200 million of 8.32% Trust Originated Preferred Securities assumed in the
UDS Acquisition.
Income tax expense decreased $42.1 million from $59.8 million in the third
quarter of 2001 to $17.7 million in the third quarter of 2002, due mainly to a
$113.4 million decrease in pre-tax income resulting mainly from the lower
operating income and higher interest expense.
The decrease in the ratio of EBITDA to interest incurred for the third quarter
of 2002 from the third quarter of 2001 was due mainly to the higher interest
expense in 2002.
31
Nine Months Ended September 30, 2002 Compared to Nine Months Ended
September 30,2001
Financial Highlights (millions of dollars, except per share amounts)
Nine Months Ended September 30,
------------------------------
2002(a) 2001(a) Change
------ ------ ------
Operating revenues............................................ $ 18,866.5 $ 12,127.1 $ 6,739.4
Cost of sales................................................. (16,643.3) (10,310.0) (6,333.3)
Refining operating expenses:
Cash (fixed and variable).................................... (973.3) (631.1) (342.2)
Depreciation and amortization................................ (289.4) (165.4) (124.0)
Retail selling expenses:
Cash......................................................... (491.1) (4.6) (486.5)
Depreciation and amortization................................ (31.5) (1.0) (30.5)
Administrative expenses:
Cash......................................................... (193.3) (118.8) (74.5)
Depreciation and amortization................................ (14.0) (6.5) (7.5)
-------- -------- -------
Operating income.............................................. 230.6 889.7 (659.1)
Other income (expense), net................................... 11.3 (1.4) 12.7
Interest and debt expense, net................................ (204.8) (63.1) (141.7)
Minority interest in net income of consolidated
partnership.................................................. (10.4) - (10.4)
Distributions on preferred securities of subsidiary trusts.... (22.5) (10.0) (12.5)
Income tax expense............................................ (1.7) (303.2) 301.5
-------- -------- -------
Net income .................................................. $ 2.5 $ 512.0 $ (509.5)
======== ======== =======
Earnings per common share - assuming dilution................. $ 0.02 $ 7.96 $ (7.94)
EBITDA (b).................................................... $ 540.4 $ 1,051.2 $ (510.8)
Ratio of EBITDA to interest incurred (b)...................... 2.5x 15.0x (12.5)x
- -----------------------------------------------------------------------------------------------------------------
The following notes relate to references on pages 32 through 35.
(a) The nine months ended September 30, 2002 includes the operations of UDS,
Huntway and the El Paso Corpus Christi Refinery and related refined product
logistics business. The nine months ended September 30, 2001 excludes the
operations of UDS but includes the operations of Huntway and the El Paso
Corpus Christi Refinery and related refined product logistics business
beginning June 1, 2001.
(b) EBITDA represents pre-tax income plus net interest expense and depreciation
and amortization expense, reduced by noncash interest income related to the
amortization of the discount on the notes receivable from Tesoro. EBITDA is
a measure of performance that is not defined by generally accepted
accounting principles, and therefore the above calculation of EBITDA may
not be consistent with similar calculations performed by other companies.
(c) The Gulf Coast refining region includes the Corpus Christi, Texas City,
Houston, Three Rivers and Krotz Springs Refineries; the Mid-Continent
refining region includes the McKee, Ardmore and Denver Refineries; the
Northeast refining region includes the Quebec and Paulsboro Refineries; and
the West Coast refining region includes the Benicia and Wilmington
Refineries.
(d) The market reference differential for sour crude oil is based on 50% Arab
Medium and 50% Arab Light posted prices.
32
Operating Highlights
Nine Months Ended September 30,
-------------------------------
2002(a) 2001(a) Change
------ ------ ------
Refining:
Operating income...................................... $ 356.0 $ 1,014.4 $ (658.4)
Throughput volumes (thousand barrels per day)......... 1,559 979 580
Average throughput margin per barrel.................. $ 3.80 $ 6.78 $ (2.98)
Operating costs per barrel:
Cash (fixed and variable)............................ $ 2.29 $ 2.36 $ (0.07)
Depreciation and amortization........................ 0.68 0.60 0.08
---- ---- ----
Total operating costs per barrel..................... $ 2.97 $ 2.96 $ 0.01
==== ==== ====
Charges:
Crude oils:
Sour............................................... 45% 61% (16)%
Sweet.............................................. 34 11 23
--- --- --
Total crude oils.................................. 79 72 7
Residual fuel oil.................................... 5 9 (4)
Other feedstocks and blendstocks..................... 16 19 (3)
--- --- --
Total charges....................................... 100% 100% -%
=== === ==
Yields:
Gasolines and blendstocks.......................... 55% 53% 2%
Distillates........................................ 27 27 -
Petrochemicals..................................... 3 3 -
Lubes and asphalts................................. 4 4 -
Other products..................................... 11 13 (2)
--- --- --
Total yields..................................... 100% 100% -%
=== === ==
Retail - U.S.:
Operating income...................................... $ 30.5 $ 0.6 $ 29.9
Company-operated fuel sites (average)................. 1,386 11 1,375
Fuel volumes (gallons per day per site)............... 4,434 6,249 (1,815)
Fuel margin (per gallon).............................. $ 0.104 $ 0.289 $ (0.185)
Merchandise sales (in millions)....................... $ 787.0 $ 2.7 $ 784.3
Merchandise margin (percentage of sales).............. 27.4% 31.1% (3.7)%
Margin on miscellaneous sales (in millions)........... $ 33.0 $ - $ 33.0
Selling expenses (per gallon)......................... $ 0.222 $ 0.244 $ (0.022)
Retail - Northeast:
Operating income...................................... $ 51.3 N/A
Fuel volumes (thousand gallons per day)............... 3,183 N/A
Fuel margin (per gallon).............................. $ 0.177 N/A
Merchandise sales (in millions)....................... $ 73.2 N/A
Merchandise margin (percentage of sales).............. 22.6% N/A
Margin on miscellaneous sales (in millions)........... $ 12.0 N/A
Selling expenses (per gallon)......................... $ 0.136 N/A
33
Refining Operating Highlights by Region (c)
Nine Months Ended September 30,
-------------------------------
2002(a) 2001(a) Change
------ ------ ------
Gulf Coast:
Throughput volumes (thousand barrels per day)........ 650 628 22
Average throughput margin per barrel................. $ 3.99 $ 6.43 $(2.44)
Operating costs per barrel:
Cash (fixed and variable)........................... $ 2.46 $ 2.16 $ 0.30
Depreciation and amortization....................... 0.80 0.64 0.16
---- ---- ----
Total operating costs per barrel.................. $ 3.26 $ 2.80 $ 0.46
==== ==== ====
Mid-Continent:
Throughput volumes (thousand barrels per day)........ 262 N/A
Average throughput margin per barrel................. $ 4.18 N/A
Operating costs per barrel:
Cash (fixed and variable)........................... $ 2.11 N/A
Depreciation and amortization....................... 0.55 N/A
----
Total operating costs per barrel.................. $ 2.66 N/A
====
Northeast:
Throughput volumes (thousand barrels per day)........ 348 181 167
Average throughput margin per barrel................. $ 2.42 $ 5.23 $ (2.81)
Operating costs per barrel:
Cash (fixed and variable)........................... $ 1.55 $ 2.26 $ (0.71)
Depreciation and amortization....................... 0.49 0.51 (0.02)
---- ---- ----
Total operating costs per barrel................... $ 2.04 $ 2.77 $ (0.73)
==== ==== ====
West Coast:
Throughput volumes (thousand barrels per day)........ 299 170 129
Average throughput margin per barrel................. $ 4.68 $ 9.60 $ (4.92)
Operating costs per barrel:
Cash (fixed and variable)........................... $ 2.92 $ 3.23 $ (0.31)
Depreciation and amortization....................... 0.75 0.53 0.22
---- ---- ----
Total operating costs per barrel................... $ 3.67 $ 3.76 $ (0.09)
==== ==== ====
34
Average Market Reference Prices and Differentials (dollars per barrel)
Nine Months Ended September 30,
-------------------------------
2002(a) 2001(a) Change
------ ------ -----
Feedstocks:
WTI crude oil....................................... $ 25.38 $ 27.80 $ (2.42)
WTI less sour crude oil at U.S. Gulf Coast (d)...... $ 2.36 $ 5.27 $ (2.91)
WTI less ANS crude oil.............................. $ 1.34 $ 2.75 $ (1.41)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI................. $ 4.19 $ 6.20 $ (2.01)
No. 2 fuel oil less WTI........................... $ 0.88 $ 3.19 $ (2.31)
Propylene less WTI................................ $ 2.53 $(2.22) $ 4.75
U.S. Mid-Continent:
Conventional 87 gasoline less WTI................. $ 5.60 $ 10.13 $ (4.53)
Low-sulfur diesel less WTI........................ $ 2.91 $ 7.87 $ (4.96)
U.S. East Coast:
Conventional 87 gasoline less WTI................. $ 3.80 $ 5.91 $ (2.11)
No. 2 fuel oil less WTI........................... $ 1.86 $ 3.99 $ (2.13)
Lube oils less WTI................................ $ 16.22 $ 26.16 $ (9.94)
U.S. West Coast:
CARB 87 gasoline less ANS......................... $ 10.58 $ 17.93 $ (7.35)
Low-sulfur diesel less ANS........................ $ 4.79 $ 9.56 $ (4.77)
General
Valero reported net income for the nine months ended September 30, 2002 of $2.5
million, or $0.02 per share, compared to net income of $512.0 million, or $7.96
per share, for the nine months ended September 30, 2001.
Operating revenues increased 56% in the first nine months of 2002 to $18.9
billion compared to $12.1 billion in the first nine months of 2001 primarily as
a result of the additional throughput volumes from the refinery operations
acquired in the UDS, El Paso and Huntway Acquisitions and the additional
revenues generated from the retail operations acquired in the UDS Acquisition,
partially offset by a significant decline in refined product prices at the
wholesale and retail levels. However, operating income for the first nine months
of 2002 decreased significantly to $230.6 million compared to operating income
of $889.7 million for the same period in 2001. The decrease in operating income
from 2001 to 2002 was due mainly to a $658.4 million decrease in operating
income generated by the refining segment and an $82.0 million increase in
administrative expenses (including related depreciation and amortization
expense). These decreases were partially offset by an increase in operating
income from the retail segment attributable to increased retail operations
acquired in the UDS Acquisition.
Refining
Operating income for Valero's refining segment was $356.0 million for the nine
months ended September 30, 2002, compared to operating income of $1,014.4
million for the nine months ended September 30, 2001. The decrease in operating
income resulted primarily from a 44% decline in the refining throughput margin
per barrel, attributable primarily to depressed sour crude oil discounts and
significantly lower refined product margins in virtually all of Valero's
markets. In addition to the overall poor refining margin environment, operating
income was also lower due to a significant level of scheduled and unscheduled
downtime at several of Valero's refineries.
35
In the first nine months of 2001, gasoline and distillate margins were
exceptionally high as a result of strong demand, a cold winter and high natural
gas prices, and sour crude oil discounts to WTI were at near-record levels.
However, in the first nine months of 2002, refining operating results were
negatively impacted by the following factors:
o gasoline and distillate margins declined significantly due to high
inventory levels for these products as a result of an increase in
gasoline imports, increased gasoline production (particularly in
California), an unusually warm winter in the northeastern part of the
United States and in Europe, and lower jet fuel demand. Although
gasoline demand increased between the nine-month periods, higher
imports of gasoline have kept inventories at above normal levels and
have moderated price spikes relative to the previous two years;
o discounts on Valero's sour crude oil feedstocks during the first nine
months of 2002 declined almost 55% from the first nine months of 2001
levels primarily due to OPEC's crude oil production cuts, which were
predominantly sour crude oils; and
o Valero's refinery utilization rates were significantly below its
normal operating rates during the nine months ended September 30,
2002, as eight of Valero's twelve refineries were affected by
turnaround activities. In addition to the scheduled downtime, Valero
also experienced some unplanned maintenance during the first nine
months of 2002, and production at several refineries was cut by as
much as 25% due to uneconomic operating conditions resulting from high
U.S. inventories for refined products.
Partially offsetting the above decreases in throughput margin was the effect of
increased throughput volumes resulting from the UDS Acquisition and an
approximate net $76 million benefit resulting from the settlement in June and
August 2002 of petroleum products purchase agreements and related hedges.
Refining cash operating expenses were 54% higher for the nine months ended
September 30, 2002 as compared to the nine months ended September 30, 2001 due
to the additional refinery operations from the UDS, El Paso and Huntway
Acquisitions. However, cash operating costs per barrel decreased 3% between the
periods. Refining depreciation and amortization expense increased $124.0
million, or 75%, from the first nine months of 2001 to the first nine months of
2002 due mainly to the UDS Acquisition. However, noncash operating costs
increased only $0.08, or 13%, on a per barrel basis.
Retail
Retail operating income, including both U.S. and Northeast retail operations,
was $81.8 million for the nine months ended September 30, 2002, which included
the effect of retail operations acquired in the UDS Acquisition, compared to
$0.6 million for the nine months ended September 30, 2001, which included only
11 northern California retail stores operated by Valero at that time. During the
first nine months of 2002, Valero implemented various changes in its retail
operations that benefited reported results in 2002 and are expected to further
benefit future results of that segment. These changes included the closure of
various underperforming stores.
Retail cash selling expenses and retail depreciation and amortization expense
for the first nine months of 2002 were significantly higher than the first nine
months of 2001 due to the additional retail stores acquired in the UDS
Acquisition.
Corporate Expenses and Other
Administrative expenses, including depreciation and amortization expense,
increased from $125.3 million for the nine months ended September 30, 2001 to
$207.3 million for the same period in 2002. This increase was due primarily to
the UDS Acquisition, partially offset by reduced variable compensation as a
result of the lower level of income recognized in the first nine months of 2002.
36
Other income (expense), net increased $12.7 million for the first nine months of
2002 compared to the first nine months of 2001 due primarily to $6.3 million of
increased income from Valero's investments in joint ventures accounted for on
the equity method and a $6.0 million increase in interest income, including $3.5
million related to the notes receivable from Tesoro in connection with the sale
of the Golden Eagle Business.
Net interest expense increased $141.7 million to $204.8 million in the first
nine months of 2002 compared to the first nine months of 2001 due primarily to
the incremental debt incurred to finance the UDS Acquisition, the assumption by
Valero of the UDS debt, and increased interest incurred in 2002 in connection
with the capital leases associated with the El Paso Acquisition which was
effective June 1, 2001.
The minority interest in net income of consolidated partnership of $10.4 million
represents the minority unitholders' share of the net income of Valero L.P.
Distributions on preferred securities of subsidiary trusts increased $12.5
million from $10.0 million for the nine months ended September 30, 2001 to $22.5
million for the nine months ended September 30, 2002. This increase was due to
the distributions incurred on the $200 million of 8.32% Trust Originated
Preferred Securities assumed in the UDS Acquisition.
Income tax expense decreased $301.5 million from $303.2 million in the first
nine months of 2001 to $1.7 million in the first nine months of 2002, due mainly
to the significant decrease in operating income and increased interest expense.
The decrease in the ratio of EBITDA to interest incurred for the nine months
ended September 30, 2002 from the nine months ended September 30, 2001 was due
mainly to the combination of lower operating income and higher interest expense
in 2002.
OUTLOOK
As the third quarter of 2002 came to a close, refining fundamentals showed a
positive upward trend that is expected to further improve earnings in the fourth
quarter of 2002 and into early 2003. Sour crude oil discounts, which had
recovered somewhat in the third quarter from extremely depressed levels seen
earlier in the year, have continued to recover further thus far in the fourth
quarter. The increase in sour crude oil discounts is attributable to increased
production of sour crude oil by OPEC and non-OPEC sources. Through October,
Valero experienced an increase of approximately $0.50 per barrel in the sour
crude oil discount compared to the third quarter of 2002. Sour crude oil
discounts are expected to increase for the remainder of the fourth quarter and
to continue to trend above 2002 levels next year.
Refined product demand in October of 2002 was strong, with gasoline demand up
4.5% compared to October of 2001. Refinery utilization rates, which were low in
the third quarter of 2002 due to economic run cuts, heavy turnarounds and the
effect of hurricanes during the last two weeks of September, have increased
somewhat in the fourth quarter, but continue to remain below average levels due
to seasonal turnaround activities and unscheduled downtime at various
refineries. Accordingly, inventory levels for both gasoline and distillates have
fallen below historical levels for this time of year. As a result, gasoline and
distillate margins have steadily improved since September 2002. The Gulf Coast
gasoline margins have almost doubled from an average of $3.09 per barrel for
September to an average of $5.78 per barrel for October;
37
Mid-Continent gasoline margins have also improved from $4.69 per barrel for
September to $8.79 per barrel for October; and Northeast gasoline margins have
increased from $3.12 per barrel in September to $5.80 per barrel in October.
Gasoline margins on the West Coast were relatively weak early in October but
have improved more recently as a result of some scheduled and unscheduled
refinery outages.
During October 2002, retail fuel margins in the U.S. declined slightly from
third quarter 2002 levels, averaging approximately $0.11 per gallon. Northeast
retail margins, on the other hand, are expected to increase as cooler
temperatures in the Northeast boost demand for heating oil and reduce already
below normal distillate inventories.
The combination of industry production run cuts, the hurricanes in the Gulf of
Mexico, refinery maintenance turnarounds and strong demand for refined products
have reduced refined product inventories and have improved refined product
margins, although gasoline margins are expected to decline seasonally as winter
approaches with anticipated lower demand and continued high levels of imports.
The improvement in refined product fundamentals, combined with an anticipated
steady improvement in sour crude oil discounts, is expected to significantly
improve Valero's results of operations in the fourth quarter of 2002 and next
year.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows for the Nine Months Ended September 30, 2002 and 2001
During the first nine months of 2002, net cash provided by operating activities
was $67.6 million as compared to net cash provided by operating activities of
$699.8 million during the first nine months of 2001. The decrease in cash
provided by operating activities was due primarily to the unfavorable change in
net income as described above under "Results of Operations."
During the first nine months of 2002, $317.3 million of cash was generated from
earnings, approximately $250 million of which was used for other operating
activities, primarily working capital requirements as detailed in Note 12 of
Notes to Consolidated Financial Statements. The changes in working capital
requirements were attributable mainly to:
o an approximate $107 million increase in receivables due to a reduction
in the receivables transferred under Valero's accounts receivable
sales facilities;
o a significant increase in commodity prices from December 2001 to
September 2002;
o the purchase of approximately $292 million of feedstock and refined
product inventories as a result of the maturity of two petroleum
products purchase agreements discussed further below;
o a decrease in accrued expenses resulting from payments of
change-in-control benefits to former UDS employees and employee
bonuses;
o the receipt of approximately $143 million of income tax refunds during
the first nine months of 2002; and
o a reduction of operating inventory levels company-wide.
During the nine months ended September 30, 2002, cash and temporary cash
investments increased $50.2 million. In addition to the cash provided by
operating activities of $67.6 million, Valero received $300.9 million from the
liquidation of its investment in the Diamond-Koch joint venture, $925.0 million
from the sale of the Golden Eagle Business, and $1.8 billion from the sale of
senior notes. Valero used these proceeds, together with proceeds from a $1.5
billion bridge loan, $100.0 million from the issuance of senior notes by Valero
L.P., $61.0 million of net short-term borrowings and $71.9 million from the
issuance of common stock in connection with employee benefit plans, to:
38
o fund the $2.1 billion cash payment to UDS shareholders in connection
with the UDS Acquisition,
o repay the $1.5 billion bridge loan used to fund the UDS Acquisition,
o fund capital expenditures, deferred turnaround and catalyst costs and
earn-out payments of $645.5 million,
o fund $183.5 million of cash flows related to the Golden Eagle
Business, primarily capital expenditures and deferred turnaround
costs,
o repay $275.0 million of 8.625% guaranteed notes,
o repurchase $44.7 million of its common stock for treasury,
o pay $31.6 million of common stock dividends, and
o pay $10.2 million of distributions related to Valero L.P. common units
held by outside public unitholders.
Net cash provided by operating activities during the first nine months of 2001
was $699.8 million, primarily due to profitable operations as discussed above
under "Results of Operations," partially offset by cash used for working capital
requirements as detailed in Note 12 of Notes to Consolidated Financial
Statements. During the first nine months of 2001, cash and temporary cash
investments increased $76.6 million as the cash provided by operating activities
and $27.6 million from the issuance of common stock related to Valero's employee
benefit plans exceeded amounts required to:
o fund capital expenditures, deferred turnaround and catalyst costs, and
an earn-out contingency payment totaling $378.7 million,
o fund the acquisition of Huntway and inventories related to the
acquisition of El Paso's Corpus Christi refinery and related refined
product logistics business of $184.3 million,
o reduce short-term bank borrowings by $27.0 million,
o repurchase $44.6 million of its common stock for treasury, and
o pay $14.6 million of common stock dividends.
Contractual Obligations and Commercial Bank Commitments
As of September 30, 2002, Valero had two $750 million revolving bank credit
facilities which provide for commitments for a five-year term and a 364-day
term. These facilities contain certain restrictive covenants including an
interest coverage ratio and a debt-to-capitalization ratio. On September 20,
2002, Valero amended its interest coverage ratio covenant in each of the
revolving bank credit facilities. The amendment provides that Valero's trailing
four-quarter interest coverage ratio must not be less than:
o 2.4 times for the fourth quarter of 2002 and the first quarter of
2003,
o 2.5 times for the second, third and fourth quarters of 2003, and
o 2.75 times thereafter.
Valero has various other credit facilities that contain this covenant, and those
facilities have also been amended accordingly.
Valero's $750 million 364-day revolving bank credit facility matures on December
13, 2002. Valero has obtained commitments from various banks sufficient to renew
the credit facility at the same $750 million amount. Valero expects the credit
facility renewal to be closed into escrow during the second half of November
with final closing expected to occur on the date of maturity of the current
facility or sooner.
39
Valero's committed credit facilities as of September 30, 2002 were as follows
(in millions):
Borrowing Borrowings
Capacity Outstanding
-------- -----------
5-year revolving credit facility....................... $ 750.0 $ 555.0
364-day revolving credit facility...................... 750.0 179.0
Committed revolving credit facility for Valero L.P..... 120.0 -
Canadian committed revolving credit facility........... Cdn $ 200.0 -
As of September 30, 2002, Valero had $82.0 million outstanding under various
uncommitted short-term bank credit facilities. In addition, Valero had $147.1
million of letters of credit outstanding under the uncommitted short-term
facilities and $99.4 million of letters of credit outstanding under its
committed facilities.
As of September 30, 2002, Valero had $150 million principal amount of 6.75%
notes outstanding, under which a third party has an option to purchase the notes
under certain circumstances at par on December 15, 2002. If the third party does
not exercise its purchase option, Valero will be required to repurchase the
notes at par on December 15, 2002. Based on current interest rates, Valero
expects that the third party would exercise its purchase option. In that event,
Valero expects that it would refinance this obligation.
In July 2002, Valero refinanced $275 million of 8.625% guaranteed notes with
borrowings under its bank credit facilities.
Under Valero's revolving bank credit facilities, Valero's debt-to-capitalization
ratio (net of cash) was 51.3% as of September 30, 2002. For purposes of this
computation, 50% of the $200 million of 8.32% Trust Originated Preferred
Securities assumed in the UDS Acquisition and 20% of the $172.5 million of
aggregate liquidation amount of trust preferred securities issued as part of the
PEPS Units were included as debt.
On June 6, 2002, Valero L.P. and Valero Logistics Operations filed a $500
million universal shelf registration statement with the Securities and Exchange
Commission, under which debt and equity offerings can be made. On July 15, 2002,
Valero Logistics Operations issued $100 million of 6.875% senior notes under the
registration statement. The net proceeds from the offering were used to repay
$91.0 million outstanding under the Valero Logistics Operations revolving credit
facility and for general corporate purposes.
On March 22, 2002, Valero filed a $3.5 billion universal shelf registration
statement with the Securities and Exchange Commission. On April 15, 2002, Valero
issued $1.8 billion of notes under the registration statement as follows:
o $300 million of 6.125% Senior Notes due April 15, 2007,
o $750 million of 6.875% Senior Notes due April 15, 2012, and
o $750 million of 7.5% Senior Notes due April 15, 2032.
Proceeds from this offering were used to repay all borrowings under Valero's
$1.5 billion bridge loan facility associated with the UDS Acquisition and reduce
borrowings under Valero's revolving bank credit facilities.
In February 2002, Valero entered into a $170 million structured lease
arrangement with a non-consolidated third-party entity to combine a portion of
an existing structured lease assumed in the UDS Acquisition related to the UDS
40
headquarters facility with the funding of planned construction to expand this
facility for future use as Valero's new corporate headquarters. The portion of
the new arrangement related to the existing UDS facility is being accounted for
as an operating lease, while the portion related to planned construction will be
accounted for as an operating lease upon completion of the construction. This
structured lease has a lease term that expires in February 2007 and provides for
up to two one-year renewal periods exercisable at Valero's option. If Valero
elects to renew the lease, Valero is required to provide cash collateral in an
amount equal to the residual value guarantee, which is currently estimated to be
$147.7 million.
In August 2001, Valero entered into a $300 million structured lease arrangement
to fund the construction of a new 45,000 barrel-per-day delayed coker facility
at its Texas City Refinery. This structured lease has a lease term that expires
in August 2006.
Valero has various long-term operating lease commitments that have been funded
through structured lease arrangements with non-consolidated third-party
entities. Certain of these leases, which were assumed in the UDS Acquisition,
were utilized to accommodate the construction of convenience stores. After the
initial lease term, the leases may be extended by agreement of the parties or
Valero may purchase the leased assets or arrange for the sale of the properties
to a third party at the lease expiration date. In August 2002, one of these
structured lease arrangements expired. Valero purchased the convenience stores
associated with this lease for $18.5 million.
In September 1997, Valero sold approximately 7.5 million barrels of feedstock
and refined product inventories for approximately $150 million and entered into
a petroleum products purchase agreement that matured in August 2002. On August
30, 2002, Valero exercised its option to purchase the barrels under this
agreement for $151.0 million, net of the effect of a related commodity price
swap contract that also matured on August 30, 2002, resulting in a net pre-tax
benefit of approximately $62 million in the third quarter of 2002.
In connection with the UDS Acquisition, Valero assumed a similar arrangement,
which matured in June 2002, under which UDS originally sold approximately 6.4
million barrels of feedstock and refined product inventories for approximately
$140 million. On June 20, 2002, Valero exercised its option to purchase the
barrels under this agreement for $140.9 million, net of the effect of a related
commodity price swap contract that also matured on June 20, 2002, resulting in a
net pre-tax benefit of approximately $14 million in the second quarter of 2002.
During September 2002, Valero entered into two interest rate cash flow hedges,
each with a notional amount of $250 million. As of September 30, 2002, these
agreements had a negative fair value of $9.9 million, the after-tax effect of
which was included in accumulated other comprehensive income in the Consolidated
Balance Sheet.
41
During October 2002, Valero entered into several fixed-to-floating interest rate
swaps, which have been designated and qualify as fair value hedging instruments,
totaling $350 million in order to manage interest costs on its outstanding debt.
The following table summarizes the terms of the interest rate swap agreements:
Year of Maturity
----------------
2006 2007
---- ----
Notional amount (in millions)......... $ 125.0 $ 225.0
Weighted average fixed rate
to be received....................... 7.375% 6.125%
Weighted average floating rate 6-Month LIBOR 6-Month LIBOR
to be paid........................... + 3.854% + 2.453%
In connection with the UDS Acquisition, Valero assumed a $360 million revolving
accounts receivable sales facility, under which Valero could sell eligible
credit card and trade accounts receivable on an ongoing basis through a wholly
owned subsidiary to a third-party financial institution. Valero also had an
existing accounts receivable sales facility with a third-party financial
institution to sell on a revolving basis up to $150 million of eligible trade
accounts receivable. On October 8, 2002, Valero renewed and amended its
agreement to, among other things, increase the size of its facility from $150
million to $250 million, incorporate credit card receivables into the program
and extend the maturity date to October 2005. The assumed UDS facility was
terminated in connection with the renewal and amendment of the Valero facility.
Under Valero's program, a wholly owned subsidiary of Valero sells an undivided
percentage ownership interest in the eligible receivables, without recourse, to
a third-party financial institution. Valero remains responsible for servicing
the transferred receivables and pays certain fees related to its sale of
receivables under the program. As of September 30, 2002, the amount of eligible
receivables sold to third-party financial institutions under the two programs
existing at that time was $266.2 million.
Valero believes it has sufficient funds from operations, and to the extent
necessary, from the public and private capital markets and bank markets, to fund
its ongoing operating requirements. Valero expects that, to the extent
necessary, it can raise additional funds from time to time through equity or
debt financings. However, there can be no assurances regarding the availability
of any future financings or whether such financings can be made available on
terms acceptable to Valero.
Common Stock Repurchase Programs
Under common stock repurchase programs approved by Valero's Board of Directors,
Valero repurchases shares of its common stock from time to time for use in
connection with its employee benefit plans and other general corporate purposes.
During the ten months ended October 31, 2002, Valero repurchased shares of its
common stock at a cost of approximately $45.4 million.
Assets Held For Sale
Valero sold the Golden Eagle Business to Tesoro on May 17, 2002 for $1.075
billion, which included an estimated $130 million for refinery feedstock and
refined product inventories. Valero received cash proceeds of $925 million and
two notes totaling $150 million. The two notes were recorded with an initial
fair value of $58.9 million using a discount rate of 16%, which represented
Valero's best estimate of the fair value of the notes at the closing date of the
sale. The discount is being amortized over the life of the notes and is reported
as interest income in other income (expense), net in the Consolidated Statements
of Income. The proceeds received from the sale of the Golden Eagle Business were
used to reduce bank borrowings and for other general corporate purposes.
42
Capital Investments
In connection with Valero's acquisitions of the Paulsboro Refinery in 1998 and
Basis Petroleum, Inc. in 1997, the sellers are entitled to receive payments in
any of the five years and ten years, respectively, following these acquisitions
if certain average refining margins during any of those years exceed a specified
level. Any payments due under these earn-out arrangements are limited based on
annual and aggregate limits. In May 2002, Valero made an earn-out contingency
payment to Salomon Inc in connection with Valero's acquisition of Basis
Petroleum, Inc. of $23.9 million. No earn-out amount is payable in 2002 related
to the Paulsboro Refinery acquisition.
For the year ending December 31, 2002, Valero expects to incur approximately
$825 million for capital investments, which includes deferred turnaround and
catalyst costs and approximately $135 million for environmental-related
projects. During the nine months ended September 30, 2002, Valero expended
$621.6 million for capital investments of which $483.0 million related to
capital expenditures and $138.6 million related to deferred turnaround and
catalyst costs. Capital expenditures for the nine months ended September 30,
2002 included:
o $90.2 million for the expansion of the fluid catalytic cracking unit
(FCCU) and the expansion of the alkylation unit at the Texas City
Refinery. Aggregate costs incurred for these projects through
September 30, 2002 totaled $152.8 million.
o $50.1 million to reconfigure the Three Rivers Refinery in response to
new low-sulfur regulations and to process a more sour crude oil slate.
Aggregate costs incurred for this project through September 30, 2002
totaled $69.3 million.
o $24.7 million to construct a cogeneration facility at the Benicia
Refinery to produce electric power and steam. Aggregate costs incurred
for this project through September 30, 2002 totaled $64.5 million. The
cogeneration facility began operations in mid-October 2002.
Potential Crude Oil Pipeline Project
On September 9, 2002, Valero executed a nonbinding letter of intent with El Paso
Energy Partners L.P. (EPN) to become a 50% partner in a crude oil pipeline
construction project called the Cameron Highway Oil Pipeline Project. Valero's
participation is subject to negotiation and execution of definitive agreements
by Valero and EPN. When completed, the Cameron Highway Oil Pipeline is expected
to be a 390-mile pipeline that can deliver up to 500,000 barrels per day of
crude oil from major deepwater Gulf of Mexico fields directly to major refining
facilities and pipeline interconnections in Port Arthur and Texas City, Texas.
Valero and EPN plan to fund the project through permanent project debt
financing, which would provide a significant portion of the project's capital
requirements using debt that is non-recourse to the partners. If the parties are
able to reach a definitive agreement, Valero's equity investment in the project
over the next three years is estimated to be approximately $125 million.
Definitive agreements are expected to be completed by the end of 2002.
Environmental Matters
Valero is subject to extensive federal, state and local environmental laws and
regulations, including those relating to the discharge of materials into the
environment, waste management, pollution prevention measures and characteristics
and composition of gasoline and distillates. Because environmental laws and
regulations are becoming more complex and stringent and new environmental laws
and regulations are continuously being enacted or proposed, the level of future
expenditures required for environmental matters will increase in the future. In
addition, any major upgrades in any of Valero's refineries could require
material additional expenditures to comply with environmental laws and
regulations.
In February 2000, the Environmental Protection Agency's (EPA) Tier II gasoline
standard was published in final form under the Clean Air Act. The standard will
ultimately require the sulfur content in gasoline to be reduced from
approximately 300 parts per million to 30 parts per million, on average, at the
refinery gate. The regulation will be phased in beginning in 2004. In addition,
the EPA finalized its Tier II diesel standard to reduce the sulfur content of
43
on-road diesel fuel sold to highway consumers by 97%, from 500 parts per million
to 15 parts per million, maximum, at the retail pump, beginning June 1, 2006.
Valero has determined that modifications will be required at most of its
refineries as a result of the Tier II gasoline and diesel standards. Based on
current estimates, Valero believes capital expenditures of approximately $1
billion will be required, between now and 2006, for Valero to meet the new Tier
II specifications. This includes approximately $300 million for related projects
at two Valero refineries that will improve refinery yield and octane balance in
addition to providing hydrogen necessary for the removal of sulfur in connection
with the production of gasoline and diesel. Valero expects that such estimates
will change as additional engineering analyses are completed and progress is
made toward construction of these various projects. The ultimate impact of these
regulations on Valero is subject to technology selection and timing
uncertainties created by permitting and construction. Valero expects to meet all
Tier II gasoline and distillate standards by the respective effective dates,
both in the U.S. and Canada.
In 2000, the EPA issued to a majority of refiners operating in the United States
a series of information requests pursuant to Section 114 of the Clean Air Act as
part of an enforcement initiative. Valero received a Section 114 information
request and has completed its response to the request. Valero has not been named
in any proceeding, but has been discussing the possibility of settlement with
the EPA regarding this enforcement initiative. Based in part upon announced
settlements and evaluation of its relative position, Valero expects to incur
penalties and related expenses in connection with a potential settlement of this
enforcement initiative. Valero believes that any potential settlement penalties
will be immaterial to its financial position. However, Valero believes that any
potential settlement with the EPA in this matter will require various capital
improvements or changes in operating parameters, or both, at some or all of its
refineries which could be material in the aggregate.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
COMMODITY PRICE RISK
Valero is exposed to market risks related to the volatility of crude oil and
refined product prices, as well as volatility in the price of natural gas used
in its refining operations. In order to reduce the risks of these price
fluctuations, Valero uses derivative commodity instruments to hedge a portion of
its refinery feedstock and refined product inventories and a portion of its
unrecognized firm commitments to purchase these inventories (fair value hedges).
Valero also uses derivative commodity instruments to hedge the price risk of
forecasted transactions such as forecasted feedstock and natural gas purchases
and refined product sales (cash flow hedges). In addition, Valero uses
derivative commodity instruments to manage its exposure to price volatility on a
portion of its refined product inventories and on certain forecasted feedstock
and refined product purchases that do not receive hedge accounting treatment.
These derivative instruments are considered economic hedges for which changes in
their fair value are reported currently in cost of sales. Finally, Valero uses
derivative commodity instruments for trading purposes based on its fundamental
and technical analysis of market conditions.
The types of instruments used in Valero's hedging and trading activities
described above include swaps, futures and options. Valero's positions in
derivative commodity instruments are monitored and managed on a daily basis by a
risk control group to ensure compliance with Valero's stated risk management
policy which has been approved by Valero's Board of Directors.
44
The following tables provide information about Valero's derivative commodity
instruments as of September 30, 2002 and December 31, 2001 (dollars in millions,
except for the weighted-average pay and receive prices as described below),
including:
o fair value hedges - held to hedge refining inventories and
unrecognized firm commitments,
o cash flow hedges - held to hedge forecasted feedstock purchases and
refined product sales,
o economic hedges - (i) held to manage price volatility in refined
product inventories, and (ii) held to manage price volatility in
forecasted feedstock, natural gas and refined product purchases, and
o trading activities - held or issued for trading purposes.
Contract volumes are presented in thousands of barrels (for crude oil and
refined products) or in billions of British thermal units (for natural gas). The
weighted-average pay and receive prices represent amounts per barrel (for crude
oil and refined products) or amounts per million British thermal units (for
natural gas). Volumes shown for swaps represent notional volumes, which are used
to calculate amounts due under the agreements. The gain (loss) on swaps is equal
to the fair value amount and represents the excess of the receive price over the
pay price times the notional contract volumes. For futures and options, the gain
(loss) represents (i) the excess of the fair value amount over the contract
amount for long positions, and (ii) the excess of the contract amount over the
fair value amount for short positions. Additionally, for futures and options,
the weighted-average pay price represents the contract price for long positions
and the weighted-average receive price represents the contract price for short
positions. The weighted-average pay price and weighted-average receive price for
options represents their strike price. All derivative commodity instruments
assumed in connection with the UDS Acquisition were recorded at fair value on
December 31, 2001; therefore no gain (loss) is shown as of that date in the
tables below. Accordingly, swaps assumed in the UDS Acquisition have zero fair
value as of December 31, 2001 as the weighted-average pay price is equal to the
weighted-average receive price. Additionally, for futures and options assumed in
the UDS Acquisition, the contract amount is equal to the fair value of the
assumed contracts as of December 31, 2001.
45
September 30, 2002
-------------------------------------------------------------------------
Wtd Avg Wtd Avg
Contract Pay Receive Contract Fair Gain
Volumes Price Price Value Value (Loss)
------- ----- ----- ----- ----- ----
Fair Value Hedges:
Futures - long:
2002 (crude oil and refined products) 14,384 $29.85 N/A $ 429.3 $ 434.6 $ 5.3
Futures - short:
2002 (crude oil and refined products) 13,595 N/A $ 29.93 406.9 414.6 (7.7)
Cash Flow Hedges:
Swaps - long:
2002 (crude oil and refined products) 261 28.04 30.00 N/A 0.5 0.5
2003 (crude oil and refined products) 14,970 26.10 26.03 N/A (1.1) (1.1)
Swaps - short:
2002 (crude oil and refined products) 2,521 3.43 3.28 N/A (0.4) (0.4)
2003 (crude oil and refined products) 14,970 29.84 29.96 N/A 1.8 1.8
Futures - long:
2002 (crude oil and refined products) 16,535 32.32 N/A 534.5 539.5 5.0
2003 (crude oil and refined products) 1,943 25.87 N/A 50.3 51.9 1.6
Futures - short:
2002 (crude oil and refined products) 8,335 N/A 31.63 263.7 268.2 (4.5)
2003 (crude oil and refined products) 1,870 N/A 28.83 53.9 55.0 (1.1)
Economic Hedges:
Swaps - long:
2002 (crude oil and refined products) 1,014 3.74 4.36 N/A 0.6 0.6
2003 (crude oil and refined products) 19 22.08 23.14 N/A - -
Swaps - short:
2002 (crude oil and refined products) 3,316 2.23 2.29 N/A 0.2 0.2
2003 (crude oil and refined products) 16,200 3.79 4.02 N/A 3.7 3.7
Futures - long:
2002 (crude oil and refined products) 14,292 30.85 N/A 440.8 454.7 13.9
2003 (crude oil and refined products) 427 29.65 N/A 12.7 13.9 1.2
Futures - short:
2002 (crude oil and refined products) 19,629 N/A 31.23 613.1 631.3 (18.2)
2003 (crude oil and refined products) 490 N/A 31.04 15.2 16.3 (1.1)
Options - long:
2002 (crude oil and refined products) 4,906 2.56 N/A 1.1 1.7 0.6
2003 (crude oil and refined products) 1,203 0.19 N/A 0.3 0.5 0.2
Options - short:
2002 (crude oil and refined products) 150 N/A 4.30 (0.1) (0.2) 0.1
Trading Activities:
Swaps - long:
2002 (crude oil and refined products) 6,100 1.80 2.04 N/A 1.4 1.4
2003 (crude oil and refined products) 1,440 8.97 9.11 N/A 0.2 0.2
2004 (crude oil and refined products) 300 3.97 4.00 N/A - -
Swaps - short:
2002 (crude oil and refined products) 4,600 5.53 5.28 N/A (1.1) (1.1)
2003 (crude oil and refined products) 7,740 4.28 4.34 N/A 0.5 0.5
Futures - long:
2002 (crude oil and refined products) 8,922 29.10 N/A 259.7 282.6 22.9
2002 (natural gas) 1,750 3.86 N/A 6.8 7.2 0.4
2003 (crude oil and refined products) 3,218 27.90 N/A 89.8 96.1 6.3
Futures - short:
2002 (crude oil and refined products) 8,789 N/A 28.96 254.5 277.1 (22.6)
2002 (natural gas) 2,750 N/A 4.00 11.0 11.4 (0.4)
2003 (crude oil and refined products) 2,961 N/A 28.73 85.1 91.5 (6.4)
Options - long:
2002 (crude oil and refined products) 19,982 20.36 N/A 23.3 39.9 16.6
2002 (natural gas) 250 3.00 N/A - - -
2003 (crude oil and refined products) 1,832 5.36 N/A 0.5 1.1 0.6
Options - short:
2002 (crude oil and refined products) 6,970 N/A 15.05 (18.5) (3.7) (14.8)
2002 (natural gas) 250 N/A 4.00 - - -
2003 (crude oil and refined products) 183 N/A 0.67 - 0.2 (0.2)
46
December 31, 2001
-------------------------------------------------------------------------
Wtd Avg Wtd Avg
Contract Pay Receive Contract Fair Gain
Volumes Price Price Value Value (Loss)
------- ----- ----- ----- ----- ----
Fair Value Hedges:
Swaps - long:
2002 (crude oil and refined products) 75 $ 1.20 $ 1.37 N/A $ - $ -
Futures - long:
2002 (crude oil and refined products) 1,428 24.73 N/A $ 35.3 33.6 (1.7)
Futures - short:
2002 (crude oil and refined products) 7,177 N/A 24.31 174.5 170.8 3.7
Cash Flow Hedges:
Swaps - short:
2002 (crude oil and refined products) 5,040 3.07 3.93 N/A 4.3 4.3
Futures - long:
2002 (crude oil and refined products) 13,845 21.35 N/A 295.5 291.8 (3.7)
Futures - short:
2002 (crude oil and refined products) 10,706 N/A 21.04 225.3 222.9 2.4
Options - short:
2002 (crude oil and refined products) 2,100 N/A 3.29 1.4 2.7 (1.3)
Economic Hedges:
Swaps - long:
2002 (crude oil and refined products) 724 7.36 7.36 N/A - -
2002 (natural gas) 13,663 2.84 2.84 N/A - -
Swaps - short:
2002 (natural gas) 11,403 3.90 3.90 N/A - -
Futures - long:
2002 (crude oil and refined products) 2,469 21.02 N/A 51.9 51.3 (0.6)
2003 (crude oil and refined products) 13 24.62 N/A 0.3 0.3 -
Futures - short:
2002 (crude oil and refined products) 11,523 N/A 21.30 245.5 244.2 1.3
2002 (natural gas) 300 N/A 2.98 0.9 0.8 0.1
Options - long:
2002 (crude oil and refined products) 250 0.29 N/A 0.1 0.1 -
Trading Activities:
Swaps - long:
2002 (crude oil and refined products) 4,575 5.37 5.24 N/A (0.6) (0.6)
Swaps - short:
2002 (crude oil and refined products) 5,150 3.86 4.15 N/A 1.5 1.5
Futures - long:
2002 (crude oil and refined products) 2,597 23.41 N/A 60.8 56.4 (4.4)
2002 (natural gas) 250 2.97 N/A 0.7 0.6 (0.1)
Futures - short:
2002 (crude oil and refined products) 2,597 N/A 23.66 61.4 57.3 4.1
2002 (natural gas) 900 N/A 2.88 2.6 2.3 0.3
Options - short:
2002 (crude oil and refined products) 600 N/A 4.47 0.5 0.9 (0.4)
2002 (natural gas) 600 N/A 3.29 0.2 0.1 0.1
In addition to the above, as of December 31, 2001, Valero was the fixed price
payor under certain swap contracts held to hedge anticipated purchases of
refinery feedstocks and refined products that matured in August 2002, had
notional volumes totaling approximately 7.5 million barrels, and had a
weighted-average pay price of $20.11 per barrel. As of December 31, 2001, these
swaps had a weighted-average receive price of $20.53 per barrel and a net
after-tax gain recorded in other comprehensive income of approximately $17
million. In connection with the UDS Acquisition, Valero assumed certain swap
contracts under which it was the fixed price payor under contracts held to hedge
anticipated purchases of refinery feedstocks and refined products that matured
in June 2002, had notional volumes totaling approximately 6.4 million barrels,
and had a weighted average pay price of $22.20 per barrel. Since the UDS
contracts were acquired on December 31, 2001 at fair value, no amount was
recorded in other comprehensive income.
47
INTEREST RATE RISK
Valero's primary market risk exposure for changes in interest rates relates to
its long-term debt obligations. Valero manages its exposure to changing interest
rates principally through the use of a combination of fixed and floating rate
debt. In connection with the UDS Acquisition, Valero assumed certain interest
rate swap agreements entered into in order to manage interest rate exposure on
certain fixed-rate debt obligations.
The following table provides information about Valero's long-term debt and
interest rate derivative instruments, all of which are sensitive to changes in
interest rates. For long-term debt, principal cash flows and related
weighted-average interest rates by expected maturity dates are presented. For
interest rate swaps, the table presents notional amounts and weighted-average
interest rates by expected (contractual) maturity dates. Notional amounts are
used to calculate the contractual payments to be exchanged under the contract.
Weighted-average floating rates are based on implied forward rates in the yield
curve at the reporting date.
September 30, 2002
-------------------------------------------------------------------------------------------
Expected Maturity Dates
---------------------------------------------------------------
There- Fair
2002 2003 2004 2005 2006 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
(in millions, except interest rates)
Long-term Debt:
Fixed rate................... $ 5.0 $ 24.5 $ 0.6 $ 396.6 $ 300.6 $ 3,156.2 $ 3,883.5 $ 3,836.2
Average interest rate...... 7.1% 8.4% 7.7% 8.1% 7.4% 7.1% 7.3%
Floating rate................ $ 261.0 - - - $ 555.0 - $ 816.0 $ 816.0
Average interest rate...... 2.8% - - - 2.6% - 2.7%
Interest Rate Swaps
Fixed to Floating:
Notional amount.............. $ - $ - $ - $ 150.0 $ - $ 100.0 $ 250.0 $ 20.1
Average pay rate........... 1.4% 1.6% 2.7% 3.3% 4.2% 5.9% 4.5%
Average receive rate....... 6.6% 6.6% 6.6% 6.6% 6.9% 6.9% 6.8%
Interest Rate Hedges
Notional amount.............. $ 500.0 $ - $ - $ - $ - $ - $ 500.0 $ (9.9)
December 31, 2001
-------------------------------------------------------------------------------------------
Expected Maturity Dates
---------------------------------------------------------------
There- Fair
2002 2003 2004 2005 2006 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
(in millions, except interest rates)
Long-term Debt:
Fixed rate................... $ 276.5 $ 28.8 $ 0.6 $ 396.6 $ 300.6 $ 1,256.2 $ 2,259.3 $ 2,310.7
Average interest rate...... 8.6% 8.2% 7.7% 8.1% 7.4% 7.3% 7.6%
Floating rate................ $ 21.5 - - - $ 541.0 - $ 562.5 $ 562.5
Average interest rate...... 4.0% - - - 2.7% - 2.7%
Interest Rate Swaps
Fixed to Floating:
Notional amount.............. $ 200.0 $ - $ - $ 150.0 $ - $ 100.0 $ 450.0 $ 17.8
Average pay rate........... 1.8% 3.9% 5.2% 5.6% 6.1% 6.5% 5.4%
Average receive rate....... 6.4% 6.6% 6.6% 6.6% 6.9% 6.9% 6.7%
48
FOREIGN CURRENCY RISK
Valero enters into foreign currency exchange and purchase contracts to manage
its exposure to exchange rate fluctuations on transactions related to its
Canadian operations. During May 2002, Valero entered into foreign currency
exchange contracts to hedge its exposure to exchange rate fluctuations on an
investment in its Canadian operations. Under these contracts, Valero sold $400
million of Canadian dollars and bought $253.4 million of U.S. dollars. These
contracts mature annually at various amounts from 2003 through 2007. As of
September 30, 2002, these contracts had a fair value of $8.4 million. The gain
recognized in income on these contracts, which was $14.5 million and $8.4
million for the three months and nine months ended September 30, 2002,
respectively, was substantially offset by a loss of $11.7 million and $4.6
million, respectively, recognized in income from the effect of the exchange rate
fluctuation on the hedged investment.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
Valero's principal executive officer and principal financial officer have
evaluated Valero's disclosure controls and procedures (as defined in Rule
13a-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days
of the filing date of this quarterly report on Form 10-Q. Based on that
evaluation, these officers concluded that the design and operation of Valero's
disclosure controls and procedures are effective in ensuring that information
required to be disclosed by Valero in the reports that it files or submits under
the Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the Securities and Exchange Commission's rules and
forms.
(b) Changes in internal controls.
There have been no significant changes in Valero's internal controls, or in
other factors that could significantly affect internal controls, subsequent to
the date the principal executive officer and principal financial officer of
Valero completed their evaluation.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
MTBE Litigation
County of Suffolk, et al. v. Atlantic Richfield Co. et al., United States
District Court for the Eastern District of New York (filed May 6, 2002) (this
matter was last reported in Valero's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002). Valero had been named in a lawsuit filed by the
Suffolk County Water Authority and the County of Suffolk, New York against
several defendants including Valero. The complaint alleged MTBE contamination of
the groundwater of Suffolk County. The plaintiff voluntarily dismissed this
lawsuit on October 10, 2002.
City of Dallas v. Explorer Pipeline Company, Inc. et al. and Related Texas
Landowner Cases (this matter was last reported in Valero's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2002). Valero was named as a defendant
in several Texas cases alleging MTBE contamination based on the alleged
discharge of gasoline into East Caddo Creek in Hunt County, Texas in 2000 when a
pipeline belonging to Explorer Pipeline Company ruptured. As reported in
Valero's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002,
Valero reached a settlement with respect to the lawsuit styled City of Dallas v.
Explorer Pipeline Company, Inc., Valero Energy Corporation, et al. Valero
believes that the remaining lawsuits can be settled or otherwise concluded for
an immaterial amount.
49
Environmental Matters
New Mexico v. General Electric Company, et al., United States District Court for
the District of New Mexico (served January 5, 2000) (this matter was last
reported in Valero's Annual Report on Form 10-K for the year ended December 31,
2001). The South Valley of Albuquerque, New Mexico has been designated as a
federal Superfund site under CERCLA. Under various state and federal
administrative orders, EPA and the State of New Mexico have been directing the
cleanup of certain groundwater contamination plumes that are alleged to impact
the groundwater supply of Albuquerque. In 1999, the State of New Mexico sued
several companies, including General Electric Company and UDS, seeking recovery
of natural resource damage under CERCLA and certain New Mexico environmental
laws. General Electric Company, the single largest potentially responsible
party, filed cross claims against several other parties, including UDS, seeking
contribution. In September 2002, Valero settled this matter for an immaterial
amount, and the judge dismissed all claims against Valero, including the cross
claims of General Electric Company.
Texas Commission on Environmental Quality (TCEQ) (McKee Refinery) (this matter
was last reported in Valero's Annual Report on Form 10-K for the year ended
December 31, 2001). In 2001, UDS received notices of enforcement from the TCEQ
(formerly known as the Texas Natural Resource Conservation Commission) for
alleged noncompliance with certain emissions monitoring and record-keeping
requirements at the McKee Refinery, and Valero also received a similar notice in
early 2002 for alleged noncompliance with certain emissions and property line
requirements at the refinery. In the third quarter of 2002, Valero and the TCEQ
agreed to one final order for all of these notices having a combined penalty
amount of less than $100,000.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit 10.1 Amendment dated October 3, 2002 to Employment Agreement
dated March 25, 1999, between Valero Energy Corporation and
William E. Greehey
Exhibit 12.1 Statement of Computation of Ratio of Earnings to Fixed
Charges
Exhibit 99.1 Certification of William E. Greehey pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Exhibit 99.2 Certification of John D. Gibbons pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
On August 13, 2002, Valero filed pursuant to Regulation FD a Current Report
on Form 8-K dated August 13, 2002 reporting Item 9 (Regulation FD Disclosure)
and furnishing a copy of the statements made by Valero's chief executive officer
and chief financial officer pursuant to SEC Order No. 4-460. Financial
statements were not filed with this report.
50
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By: /s/ John D. Gibbons
--------------------------------------
John D. Gibbons
Executive Vice President and
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Date: November 13, 2002
51
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, William E. Greehey, the principal executive officer of Valero Energy
Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Valero Energy
Corporation (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ William E. Greehey
-----------------------------------
William E. Greehey
Chief Executive Officer and President
52
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, John D. Gibbons, the principal financial officer of Valero Energy
Corporation, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Valero Energy
Corporation (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ John D. Gibbons
-----------------------------------
John D. Gibbons
Executive Vice President and Chief Financial Officer
53
Exhibit 10.1
AMENDMENT TO EMPLOYMENT AGREEMENT
WHEREAS, Valero Energy Corporation, a Delaware corporation ("Valero"), and
William E. Greehey, a resident of San Antonio, Texas ("Mr. Greehey") have
entered into an Employment Agreement (the "Employment Agreement") dated March
25, 1999;
WHEREAS, the parties desire to amend Section 7. of the Employment Agreement
to extend the time periods for certain post-retirement benefits;
NOW THEREFORE, the parties agree that Section 7.(d) of the Employment
Agreement is hereby amended and restated as follows:
"(d) Working Facilities/Tax Planning. Valero shall provide Mr. Greehey with
(i) off-site office facilities and secretarial and other office services
reasonably commensurate with Mr. Greehey's position as retired Chief Executive
Officer of Valero, and (ii) tax planning services, by an independent certified
public accounting firm, of the type furnished to executive officers of Valero.
The foregoing shall be provided to Mr. Greehey until he provides notice to
Valero that he no longer desires such office facilities or tax planning
services."
IN WITNESS WHEREOF, the Parties have executed this Amendment to Employment
Agreement this the 3rd day of October, 2002.
VALERO ENERGY CORPORATION
By: /s/ Keith D. Booke x: /s/ William E. Greehey
------------------------------- ---------------------------------
Keith D. Booke WILLIAM E. GREEHEY
Executive Vice President and
Chief Administrative Officer
Exhibit 12.1
VALERO ENERGY CORPORATION AND SUBSIDIARIES
STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Millions of Dollars, Except Ratios)
Nine Months
Ended
September 30, Years Ended December 31,
----------------------------------------------------------------
2002 2001 2000 1999 1998 1997
---- ---- ---- ---- ---- ----
Earnings:
Income from continuing operations
before income tax expense,
adjustment for minority interest in
consolidated partnership and income
from equity investees.................... $ 34.5 $ 913.0 $ 530.4 $ 17.9 $ (77.8) $ 175.2
Add:
Fixed charges............................ 290.3 143.2 114.6 80.2 53.7 57.3
Amortization of capitalized interest..... 4.2 5.3 5.1 5.2 4.9 4.9
Distributions from equity investees...... 2.9 2.8 9.2 4.0 0.5 1.4
Less:
Interest capitalized..................... (13.2) (10.6) (7.4) (5.8) (5.3) (1.7)
Distributions on preferred securities
of subsidiary trusts................... (22.5) (13.4) (6.8) - - -
Minority interest in net income of
consolidated partnership................ (10.4) - - - - -
----- ------- ----- ----- ---- -----
Total earnings............................. $ 285.8 $ 1,040.3 $ 645.1 $ 101.5 $ (24.0) $ 237.1
===== ======= ===== ===== ==== =====
Fixed charges:
Interest expense, net (1)................ $ 204.8 $ 88.5 $ 76.3 $ 55.4 $ 32.5 $ 42.4
Interest capitalized..................... 13.2 10.6 7.4 5.8 5.3 1.7
Rental expense interest factor (2)....... 49.8 30.7 24.1 19.0 15.9 13.2
Distributions on preferred securities
of subsidiary trusts................... 22.5 13.4 6.8 - - -
----- ----- ----- ---- ---- ----
Total fixed charges........................ $ 290.3 $ 143.2 $ 114.6 $ 80.2 $ 53.7 $ 57.3
===== ===== ===== ==== ==== ====
Ratio of earnings to fixed charges (3)..... 1.0x(4) 7.3x 5.6x 1.3x -(5) 4.1x
=== === === === = ===
(1) During 1995 through September 1997, Valero guaranteed its pro rata share of
the debt of Javelina Company, an equity method investee in which Valero
holds a 20% interest. The interest expense related to the guaranteed debt
is not included in the computation of the ratio as Valero was not required
to satisfy the guarantee.
(2) The interest portion of rental expense represents one-third of rents, which
is deemed representative of the interest portion of rental expense.
(3) Valero paid no dividends on preferred stock with respect to its continuing
operations during the periods indicated; therefore, the ratio of earnings
to combined fixed charges and preferred stock dividends is the same as the
ratio of earnings to fixed charges.
(4) For the nine months ended September 30, 2002, earnings were insufficient to
cover fixed charges by $4.5 million.
(5) For the year ended December 31, 1998, earnings were insufficient to cover
fixed charges by $77.7 million. This deficiency was due primarily to a
$170.9 million pre-tax charge to earnings to write down the carrying amount
of Valero's inventories to market value. Excluding the effect of the
inventory write-down, the ratio of earnings to fixed charges would have
been 2.7x.
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Valero Energy Corporation (the
"Company") on Form 10-Q for the quarter ending September 30, 2002, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
William E. Greehey, Chief Executive Officer and President of the Company, hereby
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ William E. Greehey
- ------------------------------------
William E. Greehey
Chief Executive Officer and President
November 13, 2002
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Valero Energy Corporation (the
"Company") on Form 10-Q for the quarter ending September 30, 2002, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
John D. Gibbons, Executive Vice President and Chief Financial Officer of the
Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ John D. Gibbons
- ---------------------------------------
John D. Gibbons
Executive Vice President and Chief Financial Officer
November 13, 2002