-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Tyz10P7E9lMsd3yP84sJ/YWP/l5VhTbLDXsl8XXmkx1+RtwD6Z2PQk0u8Ug9I4v3 cG9YVkAlkUx3Jk+bXm6JfA== 0000950134-01-505223.txt : 20010814 0000950134-01-505223.hdr.sgml : 20010814 ACCESSION NUMBER: 0000950134-01-505223 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VALERO ENERGY CORP/TX CENTRAL INDEX KEY: 0001035002 STANDARD INDUSTRIAL CLASSIFICATION: PETROLEUM REFINING [2911] IRS NUMBER: 741828067 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13175 FILM NUMBER: 1707637 BUSINESS ADDRESS: STREET 1: ONE VALERO PLACE CITY: SAN ANTONIO STATE: TX ZIP: 78212 BUSINESS PHONE: 2103702000 MAIL ADDRESS: STREET 1: ONE VALERO PLACE CITY: SAN ANTONIO STATE: TX ZIP: 78230 10-Q 1 d89903e10-q.txt FORM 10-Q FOR QUARTER ENDED JUNE 30, 2001 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ Commission file number 1-13175 ---------- VALERO ENERGY CORPORATION (Exact name of registrant as specified in its charter) Delaware 74-1828067 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Valero Place San Antonio, Texas (Address of principal executive offices) 78212 (Zip Code) (210) 370-2000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicated below is the number of shares outstanding of the registrant's only class of common stock, as of August 1, 2001.
Number of Shares Title of Class Outstanding -------------- ----------- COMMON STOCK, $.01 PAR VALUE 60,677,549
================================================================================ 2 VALERO ENERGY CORPORATION AND SUBSIDIARIES INDEX
Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - June 30, 2001 and December 31, 2000............................ 3 Consolidated Statements of Income - for the Three Months Ended and Six Months Ended June 30, 2001 and 2000................................................. 4 Consolidated Statements of Cash Flows - for the Six Months Ended June 30, 2001 and 2000.................................................................. 5 Notes to Consolidated Financial Statements................................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 24 Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................. 38 PART II. OTHER INFORMATION....................................................................... 41 Item 1. Legal Proceedings....................................................................... 41 Item 4. Submission of Matters to a Vote of Security Holders..................................... 42 Item 6. Exhibits and Reports on Form 8-K........................................................ 42 SIGNATURE.......................................................................................... 43
2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)
June 30, 2001 December 31, (Unaudited) 2000 ----------- ------------ ASSETS CURRENT ASSETS: Cash and temporary cash investments ........................................... $ 42,459 $ 14,596 Receivables, less allowance for doubtful accounts of $7,830 (2001) and $5,612 (2000) ................................. 676,894 585,892 Inventories ................................................................... 773,376 539,882 Current deferred income tax assets ............................................ 66,800 105,817 Prepaid expenses and other .................................................... 44,494 38,880 ----------- ----------- 1,604,023 1,285,067 ----------- ----------- PROPERTY, PLANT AND EQUIPMENT - including construction in progress of $261,404 (2001) and $158,445 (2000), at cost .................................................. 4,043,066 3,481,117 Less: Accumulated depreciation ............................................. 869,696 804,437 ----------- ----------- 3,173,370 2,676,680 ----------- ----------- DEFERRED CHARGES AND OTHER ASSETS ............................................... 436,822 345,957 ----------- ----------- $ 5,214,215 $ 4,307,704 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Short-term debt ............................................................... $ -- $ 27,000 Accounts payable .............................................................. 793,658 806,879 Accrued expenses .............................................................. 227,496 176,880 Income taxes payable .......................................................... 106,942 28,233 ----------- ----------- 1,128,096 1,038,992 ----------- ----------- LONG-TERM DEBT .................................................................. 1,041,830 1,042,417 ----------- ----------- CAPITAL LEASE OBLIGATIONS ....................................................... 285,831 -- ----------- ----------- DEFERRED INCOME TAXES ........................................................... 492,872 406,634 ----------- ----------- DEFERRED CREDITS AND OTHER LIABILITIES .......................................... 142,716 120,106 ----------- ----------- VALERO-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL TRUST SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY VALERO SENIOR NOTES ...................................... 172,500 172,500 ----------- ----------- COMMON STOCKHOLDERS' EQUITY: Common stock, $.01 par value - 150,000,000 shares authorized; issued 62,311,166 (2001 and 2000) shares .................................... 623 623 Additional paid-in capital .................................................... 1,249,892 1,249,127 Retained earnings ............................................................. 722,729 321,566 Accumulated other comprehensive income -- net gains on cash flow hedges ............................................................ 29,720 -- Treasury stock, 1,440,609 (2001) and 1,472,698 (2000) shares, at cost ......... (52,594) (44,261) ----------- ----------- 1,950,370 1,527,055 ----------- ----------- $ 5,214,215 $ 4,307,704 =========== ===========
See Notes to Consolidated Financial Statements. 3 4 VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
Three Months Ended Six Months Ended June 30, June 30, --------------------------- --------------------------- 2001 2000 2001 2000 ----------- ----------- ----------- ----------- OPERATING REVENUES ............................................... $ 4,499,108 $ 3,372,502 $ 8,268,396 $ 6,301,119 ----------- ----------- ----------- ----------- COSTS AND EXPENSES: Cost of sales and operating expenses ......................... 3,947,509 3,163,485 7,411,569 5,990,340 Selling and administrative expenses .......................... 53,834 23,597 90,204 43,752 Depreciation expense ......................................... 33,482 27,028 65,281 50,868 ----------- ----------- ----------- ----------- Total ..................................................... 4,034,825 3,214,110 7,567,054 6,084,960 ----------- ----------- ----------- ----------- OPERATING INCOME ................................................. 464,283 158,392 701,342 216,159 OTHER INCOME (EXPENSE), NET ...................................... (743) 271 (1,061) 2,203 INTEREST AND DEBT EXPENSE: Incurred ..................................................... (22,644) (24,510) (43,841) (38,657) Capitalized .................................................. 2,109 2,037 4,589 3,424 DISTRIBUTIONS ON PREFERRED SECURITIES OF SUBSIDIARY TRUST .......................................... (3,342) (110) (6,684) (110) ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES ....................................... 439,663 136,080 654,345 183,019 INCOME TAX EXPENSE ............................................... 164,800 48,400 243,400 64,600 ----------- ----------- ----------- ----------- NET INCOME ....................................................... $ 274,863 $ 87,680 $ 410,945 $ 118,419 =========== =========== =========== =========== EARNINGS PER SHARE OF COMMON STOCK ............................... $ 4.50 $ 1.56 $ 6.73 $ 2.11 Weighted average common shares outstanding (in thousands) .... 61,133 56,174 61,099 56,024 EARNINGS PER SHARE OF COMMON STOCK - ASSUMING DILUTION ............................................ $ 4.23 $ 1.51 $ 6.35 $ 2.05 Weighted average common shares outstanding (in thousands) .... 64,943 58,113 64,738 57,676 DIVIDENDS PER SHARE OF COMMON STOCK .............................. $ .08 $ .08 $ .16 $ .16
See Notes to Consolidated Financial Statements. 4 5 VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS) (UNAUDITED)
Six Months Ended June 30, --------------------------- 2001 2000 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ........................................................................ $ 410,945 $ 118,419 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................................................... 65,281 50,868 Amortization of deferred charges and other, net ............................... 50,716 21,011 Changes in current assets and current liabilities ............................. (98,997) (130,884) Deferred income tax expense ................................................... 108,200 42,700 Changes in deferred items and other, net ...................................... (22,673) (8,407) ----------- ----------- Net cash provided by operating activities ................................... 513,472 93,707 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures .............................................................. (137,744) (76,012) Deferred turnaround and catalyst costs ............................................ (78,967) (59,776) Purchase of inventories in connection with acquisition of El Paso facilities ...... (108,883) -- Acquisition of Huntway ............................................................ (75,325) -- Earn-out payment in connection with acquisition of Basis .......................... (35,000) -- Benicia Acquisition ............................................................... -- (889,730) Investment in joint ventures and other, net ....................................... (2) (1,890) ----------- ----------- Net cash used in investing activities ........................................... (435,921) (1,027,408) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase (decrease) in short-term debt, net ....................................... (27,000) 185,000 Long-term borrowings, including proceeds from senior notes offering in 2000 ....... 18,095 1,754,306 Long-term debt reduction .......................................................... (18,500) (1,371,000) Proceeds from common stock offering, net .......................................... -- 167,060 Issuance of common stock in connection with employee benefit plans ................ 23,097 9,563 Proceeds from offering of preferred securities of subsidiary trust, net ........... -- 167,193 Common stock dividends ............................................................ (9,782) (8,956) Purchase of treasury stock ........................................................ (35,598) (19,173) ----------- ----------- Net cash provided by (used in) financing activities ............................. (49,688) 883,993 ----------- ----------- NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS .................................................................. 27,863 (49,708) CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD ............................................................... 14,596 60,087 ----------- ----------- CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD ..................................................................... $ 42,459 $ 10,379 =========== ===========
See Notes to Consolidated Financial Statements. 5 6 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION As used in this report, the term "Valero" may refer, depending upon the context, to Valero Energy Corporation, one or more of its consolidated subsidiaries, or all of them taken as a whole. The consolidated financial statements included in this report have been prepared by Valero without audit, in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC. However, all adjustments have been made to these financial statements which are, in the opinion of Valero's management, necessary for a fair presentation of Valero's results of operations for the periods covered. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted as permitted under the SEC's rules and regulations, although Valero believes that the disclosures are adequate to make the information presented not misleading. Certain prior period amounts have been reclassified for comparative purposes. 2. PROPOSED MERGER WITH ULTRAMAR DIAMOND SHAMROCK On May 7, 2001, Valero and Ultramar Diamond Shamrock Corporation ("UDS") jointly announced that they had entered into an agreement and plan of merger, dated as of May 6, 2001, under which UDS will merge with and into Valero, with Valero as the surviving corporation. The boards of directors of both companies have approved the merger, which is subject to regulatory approval and approval by both companies' shareholders. Under the terms of the merger agreement, each outstanding share of UDS common stock, with limited exceptions, will be converted into the right to receive, at the shareholder's election but subject to proration, either (i) cash, (ii) a number of shares of Valero common stock, or (iii) a combination of cash and Valero stock, in each case having a value equal to the sum of $27.50 and .614 shares of Valero common stock (valued at the average closing Valero common stock price over a ten trading-day period ending three days prior to the merger). Based on average per share prices for Valero and UDS common stock for the ten trading-day period ending April 26, 2001, the total consideration to be paid to UDS shareholders in the merger would have been approximately $4 billion, representing an approximate 30% premium to the average UDS share price. Depending on the average share price of Valero common stock for the measurement period prior to closing, however, the total consideration to be paid to UDS shareholders may be higher or lower than this amount. The merger is expected to close in the fourth quarter of 2001. UDS is an independent refiner and retailer of refined products and convenience store merchandise in the central, southwest and northeast regions of the United States and eastern Canada. UDS's operations consist of refineries, convenience stores, pipelines and terminals, a home heating oil business, and petrochemical and natural gas liquids operations. UDS owns and operates seven refineries, including two in Texas, two in California and one each in Oklahoma, Colorado, and Quebec, Canada, with a combined throughput capacity of approximately 850,000 barrels per day. UDS markets refined products 6 7 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) and a broad range of convenience store merchandise through a network of approximately 4,600 convenience stores under the Diamond Shamrock(R), Beacon(R), Ultramar(R), and Total(R) brand names in the United States and eastern Canada. UDS's Northeast operations also include the marketing of refined products through 85 cardlocks and a retail home heating oil business that sells heating oil to approximately 250,000 households. Valero expects to finance the cash portion of the merger consideration, currently estimated to be approximately $2 billion, with proceeds from a $1.5 billion bridge loan facility and borrowings under a new $1.5 billion revolving bank credit facility. Valero anticipates finalizing both the bridge loan facility and the revolving credit facility prior to completing the merger, but expects that borrowing under those facilities will be simultaneous with and contingent upon completion of the merger. The bridge loan facility is expected to have a one year maturity at interest rates and on other terms presently being negotiated. Valero currently expects to repay the bridge loan facility after the merger via a combination of proceeds from capital market issuances of debt securities and cash flow from operations of the combined company. Valero currently expects that the revolving bank credit facility presently being negotiated will provide for commitments of $750 million for a five-year term and $750 million for a 364-day term and, subject to the commitment amounts and terms, provide for borrowings thereunder to be made at various amounts, maturities and interest rates, at the option of Valero. Valero expects the revolving credit facility will also be used after the merger to finance the combined company's working capital and other cash requirements. Valero currently expects to repay amounts borrowed under the credit facility with cash flow from operations of the combined company. If Valero is unable to finalize either or both of the above negotiations, it could seek to negotiate with alternative lenders, undertake capital market issuances of debt securities or a combination of those options. Arrangement of financing for the cash portion of the merger consideration is not a condition to closing the transaction. On May 25, 2001, Valero filed a registration statement on Form S-4 with the SEC, which was last amended on August 3, 2001 but has not yet been declared effective, to register the shares of Valero common stock that may be issued or become issuable to UDS shareholders in connection with the merger. If and when completed, the merger will be accounted for under the purchase method of accounting. Accordingly, the results of UDS's operations will be included in the consolidated financial statements of Valero beginning on the effective date of the transaction. 7 8 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 3. ACQUISITIONS HUNTWAY REFINING COMPANY Effective June 1, 2001, Valero completed the acquisition of Huntway Refining Company, a leading supplier of asphalt in California. Huntway owns and operates two California refineries at Benicia and Wilmington, which primarily process California crude oil to produce liquid asphalt for use in road construction and repair, primarily in California and Nevada, as well as smaller amounts of gas oil, naphtha, kerosene distillate and bunker fuels. The purchase price, net of Huntway's cash balance on the date of acquisition, was approximately $75 million and included payment to Huntway's common stockholders of $1.90 per share, as well as amounts required to retire Huntway's outstanding debt and satisfy payment obligations under outstanding stock options. The acquisition of Huntway was accounted for under the purchase method of accounting, with the purchase price allocated to the assets acquired and liabilities assumed based on estimated fair values pending the completion of independent appraisals and other evaluations. In accordance with the purchase method, the accompanying Consolidated Statements of Income for the three months ended and six months ended June 30, 2001 include the results of Huntway's operations beginning June 1, 2001. The preliminary purchase price allocation was as follows (in thousands): Current assets ............................ $ 32,999 Property, plant and equipment ............. 58,020 Deferred charges and other assets ......... 278 Current liabilities ....................... (13,794) Deferred income taxes and deferred credits and other liabilities ................... (2,178) -------- $ 75,325 ========
EL PASO REFINERY AND RELATED PRODUCT LOGISTICS BUSINESS Effective June 1, 2001, Valero completed the acquisition of El Paso Corporation's Corpus Christi, Texas refinery and related product logistics business through lease agreements entered into with certain wholly owned subsidiaries of El Paso. The lease agreements, which are being accounted for as capital leases, are for a term of 20 years and provide for Valero to make annual lease payments of $18.5 million for the first two years and increased amounts thereafter. Valero has an option to purchase the facilities for approximately $294 million at the end of the second year of the lease, and for increasing amounts in each succeeding year through the end of the lease term. As part of the acquisition, Valero also purchased inventories for approximately $109 million and assumed certain environmental liabilities (see Note 11). 8 9 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) The El Paso Corpus Christi refinery, which is located near Valero's existing Corpus Christi refinery, is a high-complexity refinery capable of processing approximately 110,000 barrels per day of heavy, high-sulfur crude oil. Approximately 70% of the refinery's production is light products, including conventional gasoline, diesel, jet fuel, petrochemicals, propane, butane and light naphthas. In addition, the refinery produces multiple grades of asphalt and petroleum coke. The product logistics facilities consist of three intrastate common carrier pipelines and related terminal facilities that enable refined products to be shipped from Corpus Christi to markets in Houston, San Antonio, Victoria, and the Rio Grande Valley. The acquisition of El Paso's Corpus Christi refinery and related product logistics business was accounted for under the purchase method of accounting, with the purchase price allocated to the assets acquired and liabilities assumed based on estimated fair values pending the completion of independent appraisals and other evaluations. The preliminary purchase price allocation was as follows: inventories of approximately $109 million as noted above, property, plant and equipment of approximately $324 million, and deferred credits and other liabilities of approximately $38 million related primarily to an estimate of assumed environmental liabilities as noted above. The inventories were purchased with cash from operations while the remaining net assets were acquired through capital lease obligations of approximately $286 million. The accompanying Consolidated Statements of Income for the three months ended and six months ended June 30, 2001 reflect the results of operations of the El Paso Corpus Christi refinery and product logistics business beginning June 1, 2001. CALIFORNIA REFINING AND MARKETING ASSETS During the second quarter of 2000, Valero completed the acquisition of Exxon Mobil Corporation's Benicia, California refinery (the "Benicia Refinery") and Exxon-branded California retail assets, which consisted of approximately 80 service stations (the "Service Stations") and branded supplier relationships with over 260 Exxon-branded service stations (the "Distribution Assets") (collectively, the "Benicia Acquisition"). The purchase price for the Benicia Refinery, the Distribution Assets and the Service Stations was $895 million, plus approximately $150 million for refinery inventories acquired in the transaction and certain costs incurred in connection with the acquisition. The Benicia Acquisition was funded through a $400 million senior notes offering, a $172.5 million offering of premium equity participating security units ("PEPS Units"), a common stock offering totaling approximately $174.2 million and borrowings under Valero's existing bank credit facilities. In addition, Valero entered into a $155 million structured lease arrangement for the Service Stations and the Benicia Refinery's dock facility. The structured lease has a five-year non-cancelable lease term and is being accounted for as an operating lease. After the non-cancelable lease term, the lease may be extended by agreement of Valero and the lessor, or Valero may purchase the leased properties under its purchase option described below or arrange for the sale of the leased properties to one or more third parties. Valero has an option to purchase all or a portion of the leased properties at any time during 9 10 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) the lease term for a price that approximates fair value. In connection with a sale of the leased properties to one or more third parties, the lease provides for a maximum residual value guarantee equal to 85% of the appraised value of the leased properties at the end of the lease term, as determined at the inception of the lease. The Service Stations, which are leased by Valero under the structured lease arrangement as noted above, included 10 company-operated service stations and approximately 70 dealer-operated service stations subleased from Valero, all of which are in the greater San Francisco Bay area. In July 2000, the dealers were offered an option to purchase at fair value the stations that they were leasing and enter into a new fuels purchase agreement with Valero for a term of 15 years. As a result, during the second quarter of 2001, 48 stations were purchased by these dealers. The acquisition of the Benicia Refinery and Distribution Assets was accounted for under the purchase method of accounting, with the purchase price allocated to the assets acquired and liabilities assumed based on estimated fair values as determined by independent appraisals and other valuations. In accordance with the purchase method, the accompanying Consolidated Statements of Income for the three months ended and six months ended June 30, 2000 include the results of operations related to the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the results of operations related to the Service Stations beginning June 16, 2000. PRO FORMA FINANCIAL INFORMATION The following unaudited pro forma financial information of Valero for the six months ended June 30, 2001 and 2000 assumes that the acquisition of Huntway and the acquisition of the El Paso Corpus Christi refinery and related product logistics business occurred at the beginning of 2001 and 2000, respectively, and that the Benicia Acquisition and related senior notes, PEPS Units and common stock offerings occurred at the beginning of 2000. This pro forma information is not necessarily indicative of the results of future operations. (Dollars in thousands, except per share amounts.)
Six Months Ended June 30, ------------------------ 2001 2000 ---------- ---------- Operating revenues .................................... $8,773,240 $7,712,898 Operating income ...................................... 737,450 234,800 Net income ............................................ 427,471 104,433 Earnings per common share ............................. 7.00 1.69 Earnings per common share - assuming dilution ......... 6.60 1.64
10 11 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 4. INVENTORIES Inventories are carried at the lower of cost or market. The cost of refinery feedstocks purchased for processing and produced products are determined primarily under the last-in, first-out ("LIFO") method of inventory pricing, and the cost of feedstocks and products purchased for resale are determined under the weighted average cost method. At June 30, 2001, the replacement cost of Valero's LIFO inventories exceeded their LIFO carrying values by approximately $63 million. The cost of materials and supplies is determined principally under the weighted average cost method. Inventories as of June 30, 2001 and December 31, 2000 were as follows (in thousands):
June 30, December 31, 2001 2000 -------- ------------ Refinery feedstocks ...................... $249,884 $142,522 Refined products and blendstocks ......... 445,596 332,653 Materials and supplies ................... 77,896 64,707 -------- -------- $773,376 $539,882 ======== ========
5. STATEMENTS OF CASH FLOWS In order to determine net cash provided by operating activities, net income has been adjusted by, among other things, changes in current assets and current liabilities. The changes in Valero's current assets and current liabilities are shown in the following table as an (increase)/decrease in current assets and an increase/(decrease) in current liabilities (in thousands). These amounts exclude changes in "Cash and temporary cash investments," "Current deferred income tax assets," and "Short-term debt." Also excluded from the following amounts are the current assets and current liabilities acquired in connection with the Huntway and El Paso transactions in 2001 and the Benicia acquisition in 2000 (see Note 3 above), all of which are reflected separately in the Statement of Cash Flows.
Six Months Ended June 30, -------------------------- 2001 2000 --------- --------- Receivables, net ................... $ (74,989) $(279,331) Inventories ........................ (106,328) (17,068) Prepaid expenses and other ......... (16,911) (13,333) Accounts payable ................... (33,103) 115,063 Accrued expenses ................... 45,466 55,727 Income taxes payable ............... 86,868 8,058 --------- --------- Total .......................... $ (98,997) $(130,884) ========= =========
11 12 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Cash flows related to interest and income taxes were as follows (in thousands):
Six Months Ended June 30, --------------------- 2001 2000 ------- ------- Interest paid (net of amount capitalized) ......... $36,127 $32,993 Income taxes paid ................................. 50,209 13,495 Income tax refunds received ....................... 1,906 333
Noncash investing and financing activities for the six months ended June 30, 2001 included increases to property, plant and equipment, deferred credits and other liabilities, and capital lease obligations resulting from the acquisition of the El Paso Corpus Christi refinery and related product logistics business as described above in Note 3. 6. LONG-TERM DEBT In March 2001, Valero refinanced its $18.5 million of Series 1998 taxable, variable-rate Waste Disposal Revenue Bonds with tax-exempt, fixed-rate bonds. These Series 2001 tax-exempt bonds have a fixed interest rate of 6.65% and mature on April 1, 2032. 7. EARNINGS PER SHARE The computation of basic and diluted per share amounts, as required by the Financial Accounting Standards Board's ("FASB") Statement No. 128, is as follows (dollars and shares in thousands, except per share amounts):
Three Months Ended June 30, ------------------------------------------------------------------------------- 2001 2000 ------------------------------------- ------------------------------------- Per Per Net Share Net Share Income Shares Amount Income Shares Amount --------- --------- --------- --------- --------- --------- Net income ................................... $ 274,863 $ 87,680 ========= ========= BASIC EARNINGS PER SHARE: Net income available to common stockholders ........................ $ 274,863 61,133 $ 4.50 $ 87,680 56,174 $ 1.56 ========= ========= EFFECT OF DILUTIVE SECURITIES: Stock options ................................ -- 2,108 -- 1,400 Performance and other benefit plan awards .... -- 933 -- 539 PEPS units ................................... -- 769 -- -- --------- --------- --------- --------- DILUTED EARNINGS PER SHARE: Net income available to common stockholders plus assumed conversions ................... $ 274,863 64,943 $ 4.23 $ 87,680 58,113 $ 1.51 ========= ========= ========= ========= ========= =========
12 13
Six Months Ended June 30, ------------------------------------------------------------------------------- 2001 2000 ------------------------------------- ------------------------------------- Per Per Net Share Net Share Income Shares Amount Income Shares Amount --------- --------- --------- --------- --------- --------- Net income ................................... $ 410,945 $ 118,419 ========= ========= BASIC EARNINGS PER SHARE: Net income available to common stockholders ........................ $ 410,945 61,099 $ 6.73 $ 118,419 56,024 $ 2.11 ========= ========= EFFECT OF DILUTIVE SECURITIES: Stock options ................................ -- 1,944 -- 1,121 Performance and other benefit plan awards .... -- 926 -- 531 PEPS units ................................... -- 769 -- -- --------- --------- --------- --------- DILUTED EARNINGS PER SHARE: Net income available to common stockholders plus assumed conversions ................... $ 410,945 64,738 $ 6.35 $ 118,419 57,676 $ 2.05 ========= ========= ========= ========= ========= =========
8. NEW ACCOUNTING PRONOUNCEMENTS FASB 143 In June 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations." FASB 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The statement requires that the amount recorded as a liability be capitalized by increasing the carrying amount of the related long-lived asset. Subsequent to initial measurement, the liability is accreted to the ultimate amount anticipated to be paid, and is also adjusted for revisions to the timing or amount of estimated cash flows. The capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. FASB 143 will be effective for Valero's financial statements beginning January 1, 2003, with earlier application encouraged. Valero is currently evaluating the impact on its financial statements of adopting this statement. FASB 142 In June 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets." This statement, which supersedes APB Opinion No. 17, "Intangible Assets," provides that goodwill and other intangible assets that have indefinite useful lives will not be amortized but instead will be tested at least annually for impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives, but such lives will not be limited by an arbitrary ceiling. The statement provides specific guidance for testing goodwill and other nonamortized intangible assets for impairment. 13 14 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Additionally, the statement requires certain disclosures about goodwill and other intangible assets subsequent to their acquisition, including changes in the carrying amount of goodwill from period to period, the carrying amount of intangible assets by major intangible asset class for those assets subject to amortization and for those not subject to amortization, and the estimated intangible asset amortization expense for the next five years. The provisions of this statement must be applied in Valero's financial statements beginning January 1, 2002, except that any goodwill and other intangible assets acquired after June 30, 2001 will be subject immediately to the amortization provisions of this statement. Since Valero does not currently have any goodwill or other intangible assets with indefinite useful lives recognized in its financial statements, the adoption of this statement will not affect its existing consolidated financial statements. Any goodwill or other intangible assets that may be acquired in connection with Valero's proposed merger with UDS described in Note 2 will be accounted for in accordance with the provisions of this statement. Accordingly, any goodwill that may be recognized will not be amortized. FASB 141 Also in June 2001, the FASB issued Statement No. 141, "Business Combinations." This statement, which supersedes APB Opinion No. 16, "Business Combinations" and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises," requires that all business combinations be accounted for by the purchase method. FASB 141 also requires that acquired intangible assets should be recognized as assets apart from goodwill if they meet one of two specified criteria. Additionally, the statement adds certain disclosure requirements to those required by APB 16, including disclosure of the primary reasons for the business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption. This statement is required to be applied to all business combinations initiated after June 30, 2001 and to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. As described in Note 2, Valero's proposed merger with UDS, if completed, will be accounted for under the purchase method of accounting. FASB 140 In September 2000, the FASB issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement replaced FASB 125 with the same name. FASB 140 revised the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but carried over most of FASB 125's provisions without reconsideration. FASB 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. In addition, certain provisions regarding the recognition and reclassification of collateral and certain disclosures relating to securitization transactions and collateral became effective for Valero's financial statements for the year ended December 31, 2000. The adoption of this statement did not have a material effect on Valero's consolidated financial statements. 14 15 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) FASB 133 In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 1999, the FASB issued Statement No. 137 which delayed the effective date of FASB 133 for one year to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued Statement No. 138 which amended various provisions of FASB 133. FASB 133, as amended, became effective for Valero's consolidated financial statements beginning January 1, 2001. See Note 9 below for a detailed discussion of FASB 133 and its effect on Valero's accounting for its price risk management activities. 9. PRICE RISK MANAGEMENT ACTIVITIES Valero is exposed to market risks related to the volatility of crude oil and refined product prices, as well as volatility in the price of natural gas used in its refining operations. In order to reduce the impact of this price volatility, Valero enters into fair value hedges (see below under New Accounting Pronouncement) using derivative commodity instruments to hedge its exposure to changes in the fair value of a portion of its refinery feedstock and refined product inventories and a portion of its unrecognized firm commitments to purchase these inventories. In order to reduce the impact of price volatility on certain forecasted transactions such as forecasted feedstock and natural gas purchases and product sales, Valero enters into cash flow hedges (see below under New Accounting Pronouncement) using derivative commodity instruments to hedge its exposure to changes in the cash flows of these forecasted transactions. In addition, Valero uses derivative commodity instruments to manage its exposure to price volatility on a portion of its refined product inventories and on certain forecasted feedstock and refined product purchases that do not receive hedge accounting treatment under FASB 133 (see below under New Accounting Pronouncement). These derivative instruments are considered economic hedges for which changes in their fair value are reported currently in earnings. Finally, Valero uses derivative commodity instruments for trading purposes using its fundamental and technical analysis of market conditions to earn additional income. The types of derivative commodity instruments used in Valero's hedging and trading activities described above include swaps, futures and options. Valero's positions in derivative commodity instruments are monitored and managed on a daily basis by a risk control group to ensure compliance with Valero's stated risk management policy which has been approved by Valero's Board of Directors. NEW ACCOUNTING PRONOUNCEMENT As discussed in Note 8, effective January 1, 2001, Valero adopted FASB 133 which establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments embedded in hybrid instruments, be recorded in the balance sheet as either an asset or 15 16 liability measured at its fair value. The statement also requires that changes in a derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. FASB 133 allows special hedge accounting for derivative instruments designated and qualifying as a fair value hedge or a cash flow hedge. A fair value hedge is a hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment, attributable to a particular risk. A cash flow hedge is a hedge of the exposure to variability in the cash flows of a recognized asset or liability, or of a forecasted transaction, attributable to a particular risk. FASB 133 provides that the gain or loss on a derivative instrument designated and qualifying as a fair value hedge, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, be recognized currently in earnings in the same accounting period. FASB 133 also provides that the effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedge be reported outside earnings as a component of other comprehensive income and be reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings. The remaining ineffective portion of the gain or loss on the derivative instrument, if any, must be recognized currently in earnings. FASB 133 requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. FASB 133 is not allowed to be applied retroactively to financial statements of prior periods. The adoption of this statement has not resulted in any significant changes in Valero's business practices, including its hedging and trading activities as described above; however, various systems modifications have been required. ACCOUNTING POLICIES The accounting policies described below reflect the policies followed by Valero with respect to its price risk management activities subsequent to the adoption, effective January 1, 2001, of FASB 133. At the time Valero enters into a derivative commodity instrument, the derivative is designated as either a fair value hedge, a cash flow hedge, an economic hedge or a trading instrument. For those derivatives designated as fair value or cash flow hedges, Valero formally documents the hedging relationship and its risk management objective and strategy for undertaking the hedge. This documentation includes specific identification of the hedging instrument, the hedged asset, liability, firm commitment, or forecasted transaction, the nature of the risk being hedged, and the method Valero will use to assess the hedging instrument's effectiveness in offsetting changes in fair value or cash flows attributable to the hedged risk. Valero formally measures the effectiveness of its fair value and cash flow hedging relationships both at the inception of the hedge and on an ongoing basis using a method that is consistent with the risk management strategy documented for each particular hedging relationship. 16 17 Valero accounts for its hedging relationships designated and qualifying as fair value hedges or cash flow hedges in accordance with the requirements of FASB 133 as discussed above. For Valero's economic hedging relationships, the derivative commodity instrument is recorded at fair value and the gain or loss on the derivative is recognized currently in earnings. For derivative commodity instruments entered into by Valero for trading purposes, the derivative is recorded at fair value and the gain or loss on the derivative is recognized currently in earnings. Valero discontinues hedge accounting prospectively if (i) it is determined that the derivative is no longer highly effective in offsetting changes in fair value or cash flows attributable to the hedged risk, (ii) the derivative expires or is sold, terminated, or exercised, or (iii) the derivative is no longer designated as a hedging instrument. In any of these circumstances, Valero may designate prospectively a new hedging relationship with a new hedging instrument or, in the case of (i) or (iii), a different hedged item or hedged transaction. When a cash flow hedge is discontinued, Valero continues to report the related net derivative gain or loss in accumulated other comprehensive income until the hedged forecasted transaction affects earnings, at which time the net derivative gain or loss is reclassified into earnings. However, if it is probable that the forecasted transaction will not occur either by the end of the originally specified time period or within two months thereafter, Valero reclassifies the related derivative gain or loss from accumulated other comprehensive income into earnings immediately. CURRENT PERIOD DISCLOSURES The transition adjustments recorded by Valero in connection with its adoption of FASB 133 had the following effect on its financial statements as of January 1, 2001 (in thousands):
Amount Balance sheet Debit (Credit) ------------- -------------- Inventories .......................................... $ 3,215 Deferred charges, deferred credits and other ......... 42,865 Accounts payable ..................................... (2,536) Deferred income taxes ................................ (15,240) Other comprehensive income, net of tax ............... (28,304)
During the three months and six months ended June 30, 2001, the net loss recognized in earnings representing the amount of hedge ineffectiveness was $3.0 million and $6.4 million, respectively, for fair value hedges and $7.6 million and $15.9 million, respectively, for cash flow hedges. These amounts are included in "Cost of sales and operating expenses" in the accompanying Consolidated Statements of Income. Valero did not exclude any component of the derivative instruments' gain or loss from the 17 18 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) assessment of hedge effectiveness. No amounts were recognized in earnings for hedged firm commitments no longer qualifying as fair value hedges. For cash flow hedges, gains and losses currently reported in accumulated other comprehensive income will be reclassified into earnings when the forecasted feedstock or natural gas purchase or product sale affects earnings. The estimated amount of existing net losses included in accumulated other comprehensive income as of June 30, 2001 that is expected to be reclassified into earnings within the next 12 months is $9.0 million. As of June 30, 2001, the maximum length of time over which Valero was hedging its exposure to the variability in future cash flows for forecasted transactions was 14 months. During the three months and six months ended June 30, 2001, no amounts were reclassified from accumulated other comprehensive income into earnings as a result of the discontinuance of cash flow hedge accounting. 10. COMPREHENSIVE INCOME Comprehensive income consists of net income and other gains and losses affecting stockholders' equity that, under generally accepted accounting principles, are excluded from net income, such as foreign currency translation adjustments, minimum pension liability adjustments, unrealized gains and losses on certain investments in debt and equity securities, and gains and losses related to certain derivative instruments. The following is a summary of Valero's comprehensive income for the three months and six months ended June 30, 2001 and 2000 (in thousands):
Three Months Ended June 30, ------------------------ 2001 2000 --------- --------- Net income ............................................................................ $ 274,863 $ 87,680 --------- --------- Other comprehensive loss, net of tax benefit: Net loss on derivative instruments designated and qualifying as cash flow hedging instruments: Net loss arising during the period (net of tax benefit of $8,288) ..................................... (15,391) -- Net amount of reclassifications into earnings (net of tax benefit of $1,317) .................................. 2,446 -- --------- --------- Total net loss on cash flow hedges ................................................ (12,945) -- --------- --------- Other comprehensive loss .............................................................. (12,945) -- --------- --------- Comprehensive income .................................................................. $ 261,918 $ 87,680 ========= =========
18 19
Six Months Ended June 30, ------------------------ 2001 2000 --------- --------- Net income ............................................................................ $ 410,945 $ 118,419 --------- --------- Other comprehensive income, net of tax: Net gain on derivative instruments designated and qualifying as cash flow hedging instruments: FASB transition adjustment (net of tax expense of $15,240) .......................................... 28,304 -- Net loss arising during the period (net of tax benefit of $3,169) .................................... (5,885) -- Net amount of reclassifications into earnings (net of tax benefit of $3,931) .................................. 7,301 -- --------- --------- Total net gains on cash flow hedges ............................................... 29,720 -- --------- --------- Other comprehensive income ............................................................ 29,720 -- --------- --------- Comprehensive income .................................................................. $ 440,665 $ 118,419 ========= =========
11. ENVIRONMENTAL MATTERS Liabilities for future remediation costs are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Other than for assessments, the timing and magnitude of these accruals are generally based on the completion of investigations or other studies or a commitment to a formal plan of action. Environmental liabilities are based on best estimates of probable undiscounted future costs using currently available technology and applying current regulations, as well as Valero's own internal environmental policies. In connection with Valero's acquisition of El Paso Corporation's Corpus Christi refinery and product logistics business described in Note 3, Valero assumed all environmental liabilities related to the facilities with certain exceptions. El Paso retained liabilities for, and agreed to indemnify Valero against (a) all environmental claims and costs related to offsite hazardous materials on or under certain adjacent properties, and all claims and costs pertaining to offsite environmental conditions arising under the requirements of an agreed final judgment dated April 1, 1998 between the State of Texas and Coastal Refining and Marketing, Inc. (a subsidiary of El Paso), (b) any environmental claim or cost related to the transportation or offsite disposal of any hazardous substance related to the facilities prior to June 1, 2001, (c) bodily injury and property damage resulting from exposure to or contamination by hazardous materials arising from El Paso's operation and use of the facilities prior to June 1, 2001, and (d) environmental claims and costs relating to the presence of hazardous materials resulting from El Paso's continued use of its assets that are located at or adjacent to the site of the facilities leased by Valero. El Paso also retained liabilities for all third-party claims relating to or arising out of the operation of the refinery prior to June 1, 2001 and for any pre-existing orders, judgments or citations that El Paso failed to disclose prior to June 1, 2001. Valero's assumed liabilities include certain environmental remediation obligations relating primarily to soil and groundwater contamination at the leased facilities. As of 19 20 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) June 30, 2001, approximately $32 million has been accrued in "Deferred credits and other liabilities" representing an estimate of the costs to be incurred in connection with Valero's assumption of these environmental liabilities. In 2000, the EPA issued to a majority of refiners operating in the United States a series of information requests pursuant to Section 114 of the Clean Air Act as part of an enforcement initiative. Valero received a Section 114 information request pertaining to its refineries. Valero has completed its response to the request and has provided additional clarification requested by the EPA. Valero has not been named in any proceeding. However, based in part upon recently announced settlements and evaluation of its relative position, Valero expects total penalties and related expenses of less than $5 million in connection with this enforcement initiative. Valero's estimate of expenses to be incurred related to this issue, which has been provided for in the accompanying consolidated financial statements, is immaterial to its financial position and results of operations. Valero believes that any settlement with the EPA in this matter may require various capital improvements or changes in operating parameters or both at some or all of its refineries. In connection with the Benicia Acquisition, Valero assumed all environmental liabilities of ExxonMobil related to the acquired assets with certain exceptions. Valero's assumed liabilities include remediation obligations relating primarily to clean-up costs associated with refinery and terminal soil and groundwater contamination. As of June 30, 2001, approximately $2 million had been accrued in "Deferred credits and other liabilities" in connection with Valero's assumption of these environmental liabilities. In connection with the acquisition of the Paulsboro refinery, Mobil Oil Corporation (now ExxonMobil) agreed to indemnify Valero for certain environmental matters and conditions existing on or prior to the acquisition date and Valero agreed to assume Mobil's environmental liabilities, with certain limited exceptions. Valero's assumed liabilities include remediation obligations to the New Jersey Department of Environmental Protection relating primarily to clean-up costs associated with groundwater contamination, landfill closure and post-closure monitoring costs, and tank farm spill prevention costs. As of June 30, 2001, approximately $18 million is included in "Accrued expenses" and "Deferred credits and other liabilities" representing Valero's best estimate of its remaining costs to be borne related to these remediation obligations. The majority of these costs are expected to be incurred in relatively level amounts over the next 17 years. In connection with the acquisition of Basis Petroleum, Inc. from Salomon Inc in 1997, Valero received $9.5 million from Salomon in settlement of certain contingent environmental obligations previously assumed by Salomon, and recorded an accrual for the amount received. As of June 30, 2001, approximately $5.6 million of this accrual remained outstanding. 20 21 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Valero believes that it has adequately provided for its environmental exposures with the accruals referred to above. These liabilities have not been reduced by possible recoveries from insurance carriers or other third parties. Environmental liabilities are difficult to assess and estimate due to unknown factors such as the magnitude of possible contamination, the timing and extent of remediation, the determination of Valero's liability in proportion to other parties, improvements in cleanup technologies, and the extent to which environmental laws and regulations may change in the future. Although environmental costs may have a significant impact on results of operations for a single period, Valero believes that these costs will not have a material adverse effect on its financial position. 12. LITIGATION AND CONTINGENCIES Prior to July 31, 1997, Valero was a wholly owned subsidiary of a separate corporation named at that time Valero Energy Corporation, or Old Valero. Old Valero was engaged in both the refining and marketing business and the natural gas related services business. On July 31, 1997, Old Valero spun off Valero to Old Valero's stockholders and, with its remaining natural gas related services business, merged with a wholly owned subsidiary of PG&E Corporation (the "Restructuring"). Old Valero, together with certain of its natural gas related subsidiaries, and Valero were sued by Teco Pipeline Company regarding the operation of a 340-mile pipeline in West Texas in which a subsidiary of Old Valero holds a 50% undivided interest. The case was filed April 24, 1996. In 1985, a subsidiary of Old Valero sold a 50% undivided interest in the pipeline and entered into a joint venture, through an ownership agreement and an operating agreement, with the purchaser of the interest. In 1988, Teco succeeded to that purchaser's 50% interest. A subsidiary of Old Valero has at all times been the operator of the pipeline. The plaintiff contends that the defendants acted in bad faith and negatively affected the economics of the joint venture in order to provide financial advantages to facilities or entities owned by the defendants, and by allegedly taking for the defendants' own benefit certain opportunities available to the joint venture. The plaintiff asserts causes of action for breach of fiduciary duty, fraud, tortious interference with business relationships, professional malpractice and other claims. Old Valero's motion to require arbitration of the case as required in the written agreements was denied by the trial court, but Old Valero appealed, and in August 1999, the court of appeals ruled in Old Valero's favor and ordered arbitration of the entire dispute. Teco has since waived efforts to further appeal this ruling, and an arbitration panel has been selected. Valero was formally added to this proceeding. In January 2001, the panel dismissed the plaintiff's legal malpractice claims. The arbitration hearing began on February 5, 2001 and is proceeding intermittently, with a conclusion expected in this fiscal year. On February 5, 2001, Teco dismissed its claims against Valero, but Valero continues to participate in the hearing. Although PG&E previously acquired Teco and owned both Teco and Old Valero (prior to El Paso Corporation's acquisition of Old Valero in December 2000), PG&E's agreement for the acquisition of Teco purports to assign the benefit or detriment of this lawsuit to the former shareholders of Teco. In connection with the Restructuring, Valero agreed to indemnify Old Valero with respect to this lawsuit for 50% of any final judgment or settlement amount up to $30 million, and 100% of that part of any final judgment or settlement amount over $30 million. El Paso Corporation has assumed Old Valero's liability in this matter. 21 22 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) In 1986, Valero filed suit against M.W. Kellogg Company for damages arising from certain alleged design and construction defects in connection with a major construction project at the Corpus Christi Refinery. Ingersoll-Rand Company was added as a defendant in 1989. In 1991, the trial court granted summary judgment against Valero based in part on certain exculpatory provisions in various agreements connected with the project. In 1993, the court of appeals affirmed the summary judgment and the Texas Supreme Court denied review. Subsequent to the summary judgment, Kellogg and Ingersoll-Rand brought indemnity claims against Valero for attorneys' fees and expenses incurred in defending the original action. In 1996, the trial court rendered summary judgment against Kellogg and Ingersoll-Rand based on procedural grounds, and the court of appeals affirmed that ruling in 1997. However, in 1999, the Texas Supreme Court reversed the court of appeals and remanded Kellogg's and Ingersoll-Rand's claims for attorneys' fees and expenses to the trial court. The case went to trial in August 2000. During trial, the claims of Ingersoll-Rand were settled for an immaterial amount. The jury returned a verdict on Kellogg's claims that resulted in a judgment of $6.3 million. Valero has appealed the judgment. Valero had previously received notice of, but was not served with, a complaint filed April 28, 2000 in federal court by Texas City Railway Company alleging that several companies, including Valero, are liable under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), other environmental laws and tort law theories for alleged contamination of the plaintiff's marine loading and tankering facilities. On September 6, 2000, the complaint was dismissed pursuant to a tolling agreement. The parties are presently seeking to resolve the matter through mediation, and Valero is in the process of evaluating certain settlement possibilities. On May 24, 2000, Valero was served with a complaint seeking to certify a class action that alleged that numerous gasoline suppliers, including Valero, contaminated groundwater in New York with MTBE. As a result of certain procedural changes, on January 8, 2001 certain of these plaintiffs filed a new master complaint to certify a class action, and on February 28, 2001 two other plaintiffs joined the litigation by filing a related claim for individual damages. The complaints allege that the gasoline suppliers produced and/or distributed gasoline that is alleged to be defective because it contained MTBE. The class action plaintiffs have not claimed a specific amount of monetary damages, but seek several equitable remedies, including the institution of a court-mandated well-testing program and the enjoining of further distribution of MTBE in New York. No class has been certified. The two individual plaintiffs seek unquantified compensatory and punitive damages and attorneys' fees; one of these plaintiffs seeks certain of the same equitable remedies as the class action plaintiffs. These cases have been consolidated by the Judicial Panel on Multidistrict Litigation with certain other MTBE class action lawsuits for pretrial purposes. Valero has filed a motion to dismiss the consolidated complaints based upon failure to state a claim and based upon federal preemption under the Clean Air Act. Discovery has been allowed and is proceeding. On May 14, 2001, the City of Dallas added Valero as a named defendant in a suit filed previously against Explorer Pipeline Company, Inc. and certain other refiners and suppliers who transport gasoline 22 23 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) through Explorer's petroleum products pipeline in North Texas. On March 9, 2000, Explorer's pipeline ruptured and discharged gasoline into East Caddo Creek in Hunt County, Texas. The plaintiff alleges that its source of water supply from Lake Tawakoni (located approximately 28 miles from the site of the pipeline rupture) was contaminated by gasoline containing MTBE causing the plaintiff to discontinue the use of water from Lake Tawakoni as a source of water supply, and requiring the construction of an emergency water supply pipeline from another source. The plaintiff asserts causes of action for negligence, nuisance, strict product liability, and gross negligence, and seeks the recovery of an unspecified amount of actual and punitive damages, including costs for the construction of the alternate supply pipeline. In a related matter, on July 3, 2001, Valero received a notice from several residents of Hunt County, Texas, of their intent to commence a citizen's suit under the Resource Conservation and Recovery Act to require an investigation and remediation of the rupture site. Valero has not been served with a citation in the proposed citizen's suit. Valero is also a party to additional claims and legal proceedings arising in the ordinary course of business. Valero believes it is unlikely that the final outcome of any of the claims or proceedings to which it is a party would have a material adverse effect on its consolidated financial statements; however, due to the inherent uncertainty of litigation, the range of possible loss, if any, cannot be estimated with a reasonable degree of precision and there can be no assurance that the resolution of any particular claim or proceeding would not have an adverse effect on Valero's results of operations, financial position or liquidity. 13. SUBSEQUENT EVENTS On July 19, 2001, Valero's Board of Directors declared a regular quarterly cash dividend of $.08 per common share payable September 12, 2001, to holders of record at the close of business on August 15, 2001. 23 24 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In the discussions that follow, all "per share" amounts are on a diluted basis. FORWARD-LOOKING STATEMENTS This Form 10-Q, including without limitation the discussion below under the heading "Results of Operations - Outlook," contains certain estimates, predictions, projections and other "forward-looking statements" (as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect Valero's current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions, or other future performance suggested herein. These forward-looking statements can generally be identified by the words "anticipate," "believe," "expect," "plan," "intend," "estimate," "project," "budget," "forecast," "will," "could," "should," "may" and similar expressions. These forward-looking statements include, among other things, statements regarding: - - the proposed merger with UDS; - - future refining margins, including gasoline and heating oil margins; - - expectations regarding feedstock costs, including crude oil discounts, and operating costs; - - anticipated levels of crude oil and refined product inventories; - - Valero's anticipated level of capital investments, including deferred turnaround and catalyst costs and capital expenditures for environmental and other purposes, and the effect of these capital investments on Valero's results of operations; - - anticipated trends in the supply and demand for crude oil feedstocks and refined products in the United States and elsewhere; - - expectations regarding environmental and other regulatory initiatives; and - - the effect of general economic and other conditions on refining industry fundamentals. Valero's forward-looking statements are based on its beliefs and assumptions derived from information available at the time the statements are made. Differences between actual results and any future performance suggested in these forward-looking statements could result from a variety of factors, including the following: - - the domestic and foreign supplies of refined products such as gasoline, diesel, heating oil and petrochemicals; - - the domestic and foreign supplies of crude oil and other feedstocks; - - the ability of the members of the Organization of Petroleum Exporting Countries to agree on and to maintain oil price and production controls; - - the level of consumer demand, including seasonal fluctuations; - - refinery overcapacity or undercapacity; - - the actions taken by competitors, including both pricing and the expansion and retirement of refining capacity in response to market conditions; - - environmental and other regulations at both the state and federal levels and in foreign countries; 24 25 - - political conditions in oil producing regions, including the Middle East; - - the level of foreign imports; - - accidents or other unscheduled shutdowns affecting Valero's plants, machinery, pipelines or equipment, or those of Valero's suppliers or customers; - - changes in the cost or availability of transportation for feedstocks and refined products; - - the price, availability and acceptance of alternative fuels and alternative-fuel vehicles; - - cancellation of or failure to implement planned capital projects and realize the various assumptions and benefits projected for such projects; - - irregular weather, which can unforeseeably affect the price or availability of feedstocks and refined products; - - rulings, judgments, or settlements in litigation or other legal or regulatory matters, including unexpected environmental remediation costs in excess of any reserves; - - the introduction or enactment of federal or state legislation which may adversely affect Valero's business or operations; - - changes in the credit ratings assigned to Valero's debt securities and trade credit; and - - overall economic conditions. Any one of these factors, or a combination of these factors, could materially affect Valero's future results of operations and whether any forward-looking statements ultimately prove to be accurate. Valero's forward-looking statements are not guarantees of future performance, and actual results and future performance may differ materially from those suggested in any forward-looking statement. Valero does not intend to update these statements unless it is required by the securities laws to do so. All subsequent written and oral forward-looking statements attributable to Valero or persons acting on its behalf are expressly qualified in their entirety by the foregoing. Valero undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. 25 26 RESULTS OF OPERATIONS SECOND QUARTER 2001 COMPARED TO SECOND QUARTER 2000 FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended June 30, -------------------------------------------------------------- Change ---------------------------- 2001 (a) 2000 (b) Amount % ----------- ----------- ----------- ----------- Operating revenues ...................................... $ 4,499,108 $ 3,372,502 $ 1,126,606 33% Cost of sales ........................................... (3,705,759) (2,996,111) (709,648) (24) Operating costs: Cash (fixed and variable) ........................... (219,405) (156,121) (63,284) (41) Depreciation and amortization ....................... (53,798) (36,785) (17,013) (46) Selling and administrative expenses (including related depreciation expense) ............ (55,863) (25,093) (30,770) --(c) ----------- ----------- ----------- Total operating income .......................... $ 464,283 $ 158,392 $ 305,891 --(c) =========== =========== =========== Other income (expense), net ............................. $ (743) $ 271 $ (1,014) --(c) Interest and debt expense, net .......................... $ (20,535) $ (22,473) $ 1,938 9 Distributions on preferred securities of subsidiary trust $ (3,342) $ (110) $ (3,232) --(c) Income tax expense ...................................... $ (164,800) $ (48,400) $ (116,400) --(c) Net income .............................................. $ 274,863 $ 87,680 $ 187,183 --(c) Earnings per share of common stock - assuming dilution .. $ 4.23 $ 1.51 $ 2.72 --(c) Earnings before interest, taxes, depreciation and amortization ("EBITDA") (d) ..................... $ 521,148 $ 197,705 $ 323,443 --(c) Ratio of EBITDA to interest incurred (d) ................ 20.1x 8.0x 12.1x --(c)
- ------------------- (a) Includes the operations of Huntway and the operations related to the El Paso Corpus Christi refinery and product logistics business beginning June 1, 2001. (b) Includes the operations related to the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the operations related to the Service Stations beginning June 16, 2000. (c) Percentage variance is greater than 100%. (d) For purposes of this calculation, distributions on preferred securities of subsidiary trust are included in interest incurred. 26 27 OPERATING HIGHLIGHTS
Three Months Ended June 30, ---------------------------------------------------- Change --------------------- 2001 (a) 2000 (b) Amount % -------- -------- ------ ----- Sales volumes (Mbbls per day) ............... 1,418 1,086 332 31% Throughput volumes (Mbbls per day) .......... 1,045 820 225 27 Average throughput margin per barrel ........ $8.34 $5.04 $3.30 65 Operating costs per barrel: Cash (fixed and variable) ............... $2.30 $2.10 $ .20 10 Depreciation and amortization ........... .56 .49 .07 14 ----- ----- ----- Total operating costs per barrel .... $2.86 $2.59 $ .27 10 ===== ===== ===== Charges: Crude oils: Sour ................................ 62% 51% 11% 22 Heavy sweet ......................... 4 11 (7) (64) Light sweet ......................... 7 8 (1) (13) ----- ----- ----- Total crude oils ................ 73 70 3 4 High-sulfur residual fuel oil, or "resid" 4 3 1 33 Low-sulfur resid ........................ 5 4 1 25 Other feedstocks and blendstocks ........ 18 23 (5) (22) ----- ----- ----- Total charges ....................... 100% 100% -% -- ===== ===== ===== Yields: Gasolines and blendstocks ............... 54% 52% 2% 4 Distillates ............................. 27 28 (1) (4) Petrochemicals .......................... 3 3 -- -- Lubes and asphalts ...................... 3 3 -- -- Other products .......................... 13 14 (1) (7) ----- ----- ----- Total yields ........................ 100% 100% -% -- ===== ===== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Three Months Ended June 30, ------------------------------------------------------ Change ---------------------- 2001 2000 Amount % ------ ------ ------ ------ Feedstocks (at U.S. Gulf Coast, except as noted): West Texas Intermediate, or "WTI," crude oil .......... $27.91 $28.82 $ (.91) (3)% WTI less sour crude oil (c) (e) ....................... $ 6.10 $ 3.14 $ 2.96 94 WTI less ANS (U.S. West Coast) ........................ $ 1.83 $ 1.91 $ (.08) (4) WTI less sweet crude oil (d) .......................... $ (.62) $ (.43) $ (.19) (44) Products: U.S. Gulf Coast: Conventional 87 gasoline less WTI ................. $ 8.86 $ 7.37 $ 1.49 20 No. 2 fuel oil less WTI ........................... $ 3.22 $ 1.61 $ 1.61 100 Propylene less WTI ................................ $(6.79) $14.54 $(21.33) --(f) U.S. East Coast: Conventional 87 gasoline less WTI ................. $ 8.18 $ 7.35 $ .83 11 No. 2 fuel oil less WTI ........................... $ 4.20 $ 2.76 $ 1.44 52 Lube oils less WTI ................................ $26.56 $16.40 $ 10.16 62 U.S. West Coast: CARB 87 gasoline less ANS ......................... $20.57 $12.93 $ 7.64 59 Low-sulfur diesel less ANS ........................ $ 9.97 $ 6.42 $ 3.55 55
- ---------- (a) Includes the operations of Huntway and the operations related to the El Paso Corpus Christi refinery and product logistics business beginning June 1, 2001. (b) Includes the operations related to the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the operations related to the Service Stations beginning June 16, 2000. (c) The market reference differential for sour crude oil is based on posted prices for 50% Arab medium and 50% Arab light crude oils. (d) The market reference differential for sweet crude oil is based on posted prices for 50% light Louisiana sweet, or "LLS," and 50% Cusiana crude oils, with LLS adjusted for backwardation. (e) The market reference differential for the 2000 period has been restated from the amount reported in Valero's June 30, 2000 Form 10-Q to conform to the components used in the 2001 period. (f) Percentage variance is greater than 100%. 27 28 Valero reported net income for the second quarter of 2001 of $274.8 million, or $4.23 per share, compared to net income of $87.7 million, or $1.51 per share, for the second quarter of 2000. The substantial increase in second quarter results was due primarily to a significant increase in throughput margins as discussed further below and the full quarter contribution from the Benicia Acquisition which was completed during the second quarter of 2000. Partially offsetting the increase in throughput margins for Valero's operations, excluding Benicia, were higher operating costs and selling and administrative expenses, and an increase in income tax expense. Operating revenues increased $1.1 billion, or 33%, to $4.5 billion during the second quarter of 2001 compared to the same period in 2000 due primarily to a 31% increase in average daily sales volumes. The increase in sales volumes was due primarily to an increase in the sale of feedstocks and products purchased for resale, the full quarter effect of additional volumes resulting from the Benicia Acquisition, capacity expansions at various refineries since the second quarter of 2000, less refinery downtime in the 2001 period, and the effect of including the operations of the Huntway and El Paso refineries beginning June 1, 2001. Operating income increased $305.9 million to $464.3 million during the second quarter of 2001 compared to the second quarter of 2000 due in part to the above-noted full quarter contribution from the Benicia Acquisition which resulted in an increase in operating income of approximately $88 million. Excluding the effect of the Benicia Acquisition, operating income increased due to an approximate $292 million increase in total throughput margins (discussed below), partially offset by an approximate $49 million increase in operating costs (including a $37 million increase in cash operating costs and a $12 million increase in depreciation and amortization expense), and an approximate $25 million increase in selling and administrative expenses (including related depreciation expense). Cash operating costs were higher due primarily to an increase in employee salaries, benefits and variable compensation, higher electricity costs attributable mainly to an increase in natural gas prices, and increases in maintenance costs and ad valorem taxes. Depreciation and amortization expense was higher due primarily to an increase in turnaround and catalyst amortization. Selling and administrative expenses (including related depreciation expense) were higher primarily as a result of an increase in employee salaries, benefits, and variable compensation. Total throughput margins (operating revenues less cost of sales), excluding the effect of the Benicia Acquisition, increased significantly due to (i) the effect of higher throughput volumes resulting from the factors noted above in the discussion of operating revenues, including a significant increase in the volume of Valero's sour crude oil charges during the quarter to take advantage of higher sour crude discounts discussed below, (ii) substantially higher per barrel feedstock discounts for sour crude oil resulting primarily from an increase in supplies of heavier crudes without a corresponding increase in demand while at the same time demand for sweeter crudes increased to meet lower sulfur requirements for certain refined products without a corresponding increase in supply, (iii) higher gasoline margins in April and May attributable primarily to continued strong demand and the carryover effects of high refinery turnaround activity during the first quarter of 2001 which reduced gasoline production and kept inventories low, (iv) higher distillate margins resulting from improved industrial demand partially as a result of continued fuel switching due to high natural gas prices, and increased diesel demand for both on-road and off-road use, and (v) significantly higher lube oil margins resulting mainly from improved market conditions. Partially offsetting the increases in total throughput margins resulting from these factors were (i) substantially lower gasoline margins in June (discussed in the Outlook section which 28 29 follows), and (ii) significantly lower margins for propylene and other petrochemical feedstocks due to slowing economic activity throughout the world. Net interest and debt expense decreased $1.9 million to $20.5 million in the second quarter of 2001 compared to the same period in 2000 due primarily to a decrease in bank borrowings resulting from Valero's strong earnings and cash flow, partially offset by a full quarter of interest in 2001 on borrowings incurred to fund the Benicia Acquisition, including interest on the senior notes issued in June 2000, and interest recognized in connection with the capital leases associated with the El Paso acquisition which was effective June 1, 2001. Distributions on preferred securities of subsidiary trust increased from $.1 million in the second quarter of 2000 to $3.3 million in the second quarter of 2001 due to distributions on the PEPS Units issued in June 2000 in connection with funding the Benicia Acquisition. Income tax expense increased $116.4 million to $164.8 million during the second quarter of 2001 compared to the same period in 2000 due primarily to the significant increase in pre-tax income. 29 30 YEAR-TO-DATE 2001 COMPARED TO YEAR-TO-DATE 2000 FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Six Months Ended June 30, ----------------------------------------------------------- Change --------------------------- 2001 (a) 2000 (b) Amount % ----------- ----------- ----------- ----------- Operating revenues ...................................... $ 8,268,396 $ 6,301,119 $ 1,967,277 31% Cost of sales ........................................... (6,953,249) (5,681,234) (1,272,015) (22) Operating costs: Cash (fixed and variable) ........................... (416,315) (286,563) (129,752) (45) Depreciation and amortization ....................... (103,304) (70,547) (32,757) (46) Selling and administrative expenses (including related depreciation expense) ............................... (94,186) (46,616) (47,570) -(c) ----------- ----------- ----------- Total operating income .......................... $ 701,342 $ 216,159 $ 485,183 -(c) =========== =========== =========== Other income (expense), net ............................. $ (1,061) $ 2,203 $ (3,264) -(c) Interest and debt expense, net .......................... $ (39,252) $ (35,233) $ (4,019) (11) Distributions on preferred securities of subsidiary trust ............................................... $ (6,684) $ (110) $ (6,574) -(c) Income tax expense ...................................... $ (243,400) $ (64,600) $ (178,800) -(c) Net income .............................................. $ 410,945 $ 118,419 $ 292,526 -(c) Earnings per share of common stock - assuming dilution .. $ 6.35 $ 2.05 $ 4.30 -(c) Earnings before interest, taxes, depreciation and amortization ("EBITDA") (d) ..................... $ 810,720 $ 292,940 $ 517,780 -(c) Ratio of EBITDA to interest incurred (d) ................ 16.0x 7.6x 8.4x -(c)
- ---------- (a) Includes the operations of Huntway and the operations related to the El Paso Corpus Christi refinery and product logistics business beginning June 1, 2001. (b) Includes the operations related to the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the operations related to the Service Stations beginning June 16, 2000. (c) Percentage variance is greater than 100%. (d) For purposes of this calculation, distributions on preferred securities of subsidiary trust are included in interest incurred. 30 31 OPERATING HIGHLIGHTS
Six Months Ended June 30, ------------------------------------------------------------- Change ------------------------- 2001 (a) 2000 (b) Amount % -------- -------- ------ ----- Sales volumes (Mbbls per day) ............... 1,337 1,044 293 28% Throughput volumes (Mbbls per day) .......... 961 782 179 23 Average throughput margin per barrel ........ $7.56 $4.35 $3.21 74 Operating costs per barrel: Cash (fixed and variable) ............... $2.39 $2.02 $ .37 18 Depreciation and amortization ........... .59 .50 .09 18 ----- ----- ----- Total operating costs per barrel .... $2.98 $2.52 $ .46 18 ===== ===== ===== Charges: Crude oils: Sour ................................ 61% 51% 10% 20 Heavy sweet ......................... 4 10 (6) (60) Light sweet ......................... 8 9 (1) (11) ----- ----- ----- Total crude oils ................ 73 70 3 4 High-sulfur resid ....................... 4 4 -- -- Low-sulfur resid ........................ 4 4 -- -- Other feedstocks and blendstocks ........ 19 22 (3) (14) ----- ----- ----- Total charges ....................... 100% 100% --% -- ===== ===== ===== Yields: Gasolines and blendstocks ............... 54% 51% 3% 6 Distillates ............................. 27 29 (2) (7) Petrochemicals .......................... 3 4 (1) (25) Lubes and asphalts ...................... 3 3 -- -- Other products .......................... 13 13 -- -- ----- ----- ----- Total yields ........................ 100% 100% --% -- ===== ===== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (DOLLARS PER BARREL)
Six Months Ended June 30, ------------------------------------------------------------ Change ---------------------- 2001 2000 Amount % --------- --------- --------- --------- Feedstocks (at U.S. Gulf Coast, except as noted): WTI crude oil ............................... $ 28.35 $ 28.83 $ (.48) (2)% WTI less sour crude oil (c) (e) ............. $ 5.72 $ 2.76 $ 2.96 --(f) WTI less ANS (U.S. West Coast) .............. $ 2.79 $ 1.82 $ .97 53 WTI less sweet crude oil (d) ................ $ (.13) $ (.56) $ .43 77 Products: U.S. Gulf Coast: Conventional 87 gasoline less WTI ....... $ 7.31 $ 5.83 $ 1.48 25 No. 2 fuel oil less WTI ................. $ 3.35 $ 1.75 $ 1.60 91 Propylene less WTI ...................... $ (2.06) $ 8.46 $ (10.52) --(f) U.S. East Coast: Conventional 87 gasoline less WTI ....... $ 6.73 $ 6.07 $ .66 11 No. 2 fuel oil less WTI ................. $ 4.26 $ 4.11 $ .15 4 Lube oils less WTI ...................... $ 26.40 $ 12.19 $ 14.21 --(f) U.S. West Coast: CARB 87 gasoline less ANS ............... $ 20.02 $ 12.13 $ 7.89 65 Low-sulfur diesel less ANS .............. $ 9.68 $ 7.23 $ 2.45 34
- ---------- (a) Includes the operations of Huntway and the operations related to the El Paso Corpus Christi refinery and product logistics business beginning June 1, 2001. (b) Includes the operations related to the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the operations related to the Service Stations beginning June 16, 2000. (c) The market reference differential for sour crude oil is based on posted prices for 50% Arab medium and 50% Arab light crude oils. (d) The market reference differential for sweet crude oil is based on posted prices for 50% LLS and 50% Cusiana crude oils, with LLS adjusted for backwardation. (e) The market reference differential for the 2000 period has been restated from the amount reported in Valero's June 30, 2000 Form 10-Q to conform to the components used in the 2001 period. (f) Percentage variance is greater than 100%. 31 32 Valero reported net income for the first six months of 2001 of $410.9 million, or $6.35 per share, compared to net income of $118.4 million, or $2.05 per share, for the first six months of 2000. The substantial increase in year-to-date results was due primarily to dramatically improved refining industry fundamentals during the majority of the period which resulted in a significant increase in throughput margins, and the full period contribution from the Benicia Acquisition which was completed during the second quarter of 2000. Partially offsetting the increase in throughput margins for Valero's operations excluding Benicia were the effects of refinery downtime related to scheduled turnarounds at Valero's Texas City and Houston refineries during the first quarter of 2001, higher operating costs and selling and administrative expenses, and an increase in income tax expense. Operating revenues increased $2.0 billion, or 31%, to $8.3 billion during the first six months of 2001 compared to the same period in 2000 due primarily to a 28% increase in average daily sales volumes and, to a lesser extent, to a 3% increase in the average sales price per barrel. The increase in average daily sales volumes was due primarily to additional volumes attributable to the Benicia Acquisition and the other factors noted in the quarter-to-quarter discussion. The increase in average sales prices was due primarily to slightly higher prices for conventional gasolines, gasoline blendstocks and distillates and the effect of higher-priced sales of CARB gasoline and other products in the California market in connection with the Benicia Acquisition, offset to a large extent by a significantly lower prices for petrochemicals. Operating income increased $485.2 million to $701.3 million during the first six months of 2001 compared to the first six months of 2000 due in part to the above-noted contribution from the Benicia Acquisition which resulted in an increase in operating income of approximately $158 million. Excluding the effect of the Benicia Acquisition, operating income increased due to an approximate $436 million increase in total throughput margins (discussed below), partially offset by an approximate $74 million increase in operating costs (including a $54 million increase in cash operating costs and a $20 million increase in depreciation and amortization expense), and an approximate $35 million increase in selling and administrative expenses (including related depreciation expense). Cash operating costs, depreciation and amortization expense, and selling and administrative expenses (including related depreciation expense) all were higher due primarily to the factors noted above in the quarter-to-quarter discussion. Total throughput margins, excluding the effect of the Benicia Acquisition, increased due to substantially higher feedstock discounts for sour crude oil, higher margins for gasoline (including higher premiums for RFG), distillates, and lube oils, and the effect of higher throughput volumes, all resulting primarily from the factors noted above in the quarter-to-quarter discussion. Partially offsetting these increases in total throughput margins were lower petrochemical margins and the effect of higher natural gas, hydrogen and methanol feedstock costs. Other income (expense), net, decreased $3.3 million, from income of $2.2 million during the first six months of 2000 to expense of $1.1 million during the first six months of 2001 due to reduced results from Valero's 20% equity interest in the Javelina off-gas processing plant in Corpus Christi attributable primarily to higher natural gas feedstock costs and lower product prices. Partially offsetting the reduced results from the Javelina plant was an increase in interest income earned on excess cash balances and lower costs related to the agreement entered into by Valero in September 1999 to sell a portion of its accounts receivable. 32 33 Net interest and debt expense increased $4.0 million, or 11%, to $39.2 million in the first six months of 2001 compared to the same period in 2000 due primarily to a full period of interest in 2001 on borrowings incurred to fund the Benicia Acquisition, including interest on the senior notes issued in June 2000, and interest recognized in connection with the capital leases associated with the El Paso acquisition which was effective June 1, 2001, partially offset by a decrease in bank borrowings resulting from Valero's strong earnings and cash flow. Distributions on preferred securities of subsidiary trust increased from $.1 million in the first six months of 2000 to $6.7 million in the first six months of 2001 due to distributions on the PEPS Units issued in June 2000 in connection with funding the Benicia Acquisition. Income tax expense increased $178.8 million to $243.4 million during the first six months of 2001 compared to the same period in 2000 due primarily to the significant increase in pre-tax income. OUTLOOK Commencing in June 2001 and continuing through July, gasoline margins weakened substantially from the exceptionally strong conditions that existed during April and May of 2001. Average gasoline margins, which have been extremely volatile, are significantly lower than the extraordinarily high average margins experienced in the second quarter of 2001 due to an increase in inventories, and are lower than third quarter 2000 levels. After a significant number of industry-wide refinery turnarounds were completed in the first quarter of 2001, refiners increased production to unusually high levels to take advantage of the high margin environment. This increase in production, combined with higher than normal levels of imports in response to the high domestic margins and a decrease in demand resulting from high gasoline prices at the pump and a slowing economy, caused an unusual increase in gasoline inventories during the latter part of the 2001 second quarter which resulted in rapidly declining margins and prices. Valero currently believes, however, that the decrease in gasoline pump prices has resulted in an increase in demand which, combined with recently announced refinery production cuts, has resulted in improved gasoline margins in August and should result in improved gasoline margins during the remainder of the quarter. Similar to gasoline margins, average premiums for RFG in July 2001 declined substantially from second quarter 2001 levels and are lower than strong third quarter 2000 premiums. However, RFG margins have improved in August 2001 along with the increase in gasoline margins. Although gasoline margins have been extremely volatile, distillate margins continue to exceed seasonal averages due to increased demand. Although average distillate margins have also declined thus far in the third quarter of 2001 from second quarter levels and are below third quarter 2000 margins, Valero currently believes that with continued good demand, combined with the announced refinery production cuts noted above, distillate margins should remain above normal levels for the remainder of the year. With regard to other products, average lube oil margins are essentially unchanged from the strong second quarter 2001 levels and are well in excess of third quarter 2000 margins. Propylene margins thus far in the third quarter of 2001 continue to remain under extreme pressure due to low worldwide demand for petrochemical derivatives and excess capacity, and are lower than already depressed second quarter 2001 levels and significantly below third quarter 2000 margins. 33 34 Average discounts for sour crude oil, which were exceptionally strong during the second quarter of 2001, have declined thus far in the third quarter of 2001 due primarily to a disruption in crude supply from Iraq in June. However, with the return of Iraqi supplies to the market in July and a decrease in demand resulting from the industry-wide refinery production cuts described above, sour crude oil discounts for September deliveries have returned to more favorable levels and are above third quarter 2000 discounts. Although sweet crude oil continues to trade at a premium to WTI due to increasing demand for sweet crudes resulting from the implementation in 2000 of lower sulfur requirements in fuel, thus far in the third quarter of 2001, this differential is lower than third quarter 2000 levels due to the current decline in margins for light products. Valero expects to continue to recognize significant benefits from its ability to meet current fuel specifications using predominantly sour crude oil feedstocks as the supply of sour crudes and the demand for sweet crudes continue to increase in the future. In the third quarter of 2001, Valero intends to upgrade the lubricants crude unit and lubricants plant at the Paulsboro Refinery in conjunction with a scheduled turnaround. In addition, Valero has accelerated maintenance at its Gulf Coast refineries that was previously scheduled for later in the year as a result of the current decline in margins. As a result, Valero expects third quarter 2001 throughput volumes to decline from second quarter 2001 levels. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities increased $419.8 million to $513.5 million during the first six months of 2001 compared to the same period in 2000 due primarily to the significant increase in earnings discussed above under "Results of Operations." During the first six months of 2001, $635.1 million of cash was generated from earnings, approximately $121.7 million of which was used for other operating activities, primarily working capital requirements. As detailed in Note 5 of Notes to Consolidated Financial Statements, the major changes in working capital resulted from an increase in operating inventory levels and an increase in receivables resulting from both increased sales volumes and amounts that were billed and collected in July rather than June due to certain delays resulting from the implementation of a new accounting system. Partially offsetting these increased working capital requirements was an increase in federal income taxes payable due to the significant increase in earnings. During the first six months of 2001, cash and temporary cash investments increased $27.9 million as cash provided by operating activities and issuances of common stock related to Valero's benefit plans exceeded amounts required to (i) fund capital expenditures, deferred turnaround and catalyst costs and the earn-out contingency payment to Salomon Inc discussed below, (ii) fund the acquisition of Huntway and inventories related to the acquisition of El Paso's Corpus Christi refinery and related product logistics business, (iii) reduce short-term bank borrowings, (iv) repurchase shares of Valero common stock, and (v) pay common stock dividends. Valero currently maintains an unsecured $835 million revolving bank credit and letter of credit facility which matures in November 2002 and is available for general corporate purposes including working capital needs and letters of credit. Borrowings under this facility bear interest at either LIBOR plus a margin, a base rate or a money market rate. Valero is also charged various fees and expenses in connection with this facility, including a facility fee and various letter of credit fees. The interest rate and fees under this credit facility are subject to adjustment based upon the credit ratings assigned to Valero's long-term debt. The credit facility includes certain restrictive covenants including a coverage ratio, a 34 35 capitalization ratio, and a minimum net worth test. As of June 30, 2001, there were no outstanding borrowings under this committed facility, while letters of credit outstanding were approximately $37 million. Valero also currently has certain uncommitted short-term bank credit facilities and various uncommitted bank letter of credit facilities. As of June 30, 2001, there were no outstanding borrowings under the short-term bank credit facilities, while letters of credit totaling approximately $101 million were outstanding under the uncommitted letter of credit facilities. See Note 2 of Notes to Consolidated Financial Statements for a detailed description of Valero's anticipated financing plans with respect to its proposed merger with UDS, including the establishment of a bridge loan facility and a new revolving bank credit agreement to finance the cash portion of the merger consideration, and the registering of common stock in connection with the issuance of shares to UDS shareholders for the stock portion of the merger consideration. During the first six months of 2001, Valero reduced its exposure to increases in interest rates by refinancing its $18.5 million of taxable, variable-rate industrial revenue bonds with tax-exempt fixed-rate bonds that bear interest at 6.65%. See Note 6 of Notes to Consolidated Financial Statements. As of June 30, 2001, Valero's debt-to-capitalization ratio was 39.5%, which includes the effect of completing both the Huntway and El Paso acquisitions in the second quarter of 2001. Despite the inclusion of these transactions, Valero's debt-to-capitalization ratio at June 30, 2001 decreased from 39.9% at December 31, 2000. (Note: For purposes of these debt-to-capitalization ratio computations, 20% of the aggregate liquidation amount of trust preferred securities issued as part of the PEPS Units is deemed to be debt). In May 2001, Valero made a $35 million earn-out contingency payment to Salomon Inc in connection with Valero's 1997 acquisition of Basis Petroleum, Inc. In addition, based on estimated margin levels through September of 2001, Valero anticipates that it will make an earn-out contingency payment to Mobil (now ExxonMobil) of approximately $20 million in October 2001 in connection with Valero's 1998 acquisition of the Paulsboro Refinery. Valero accounts for any payments under these arrangements as an additional cost of the respective acquisition which is depreciated over the remaining lives of the assets to which the additional cost is allocated. As discussed in Note 3 of Notes to Consolidated Financial Statements, effective June 1, 2001, Valero completed the acquisition of Huntway Refining Company for a total cost of approximately $75 million. Also effective June 1, 2001, Valero purchased for approximately $109 million inventories related to the acquisition of El Paso Corporation's Corpus Christi, Texas refinery and related product logistics business. These expenditures were funded by cash from operations. The following discussion of capital investments excludes (i) the earn-out contingency payments to Salomon and ExxonMobil described above, (ii) the acquisition cost of Huntway, and (iii) the acquisition cost of El Paso's Corpus Christi refinery and related product logistics business. During the first six months of 2001, Valero expended approximately $217 million for capital investments, including capital expenditures of $138 million and deferred turnaround and catalyst costs of $79 million. Capital expenditures included approximately $13 million for environmental projects (excluding approximately $10 million of costs related to a flue gas scrubber at the Texas City Refinery which is being financed through a lease arrangement). These environmental projects include new equipment and improvements to 35 36 existing equipment that prevent or reduce the likelihood of environmental contamination from future operations. For total year 2001, Valero currently expects to incur approximately $415 million for capital investments, including approximately $285 million for capital expenditures and approximately $130 million for deferred turnaround and catalyst costs. The capital expenditure estimate includes approximately $35 million for environmental projects. Valero is subject to extensive federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the environment, waste management, pollution prevention measures and characteristics and composition of gasoline and diesel fuels. If Valero violates or fails to comply with these laws and regulations, it could be fined or otherwise sanctioned. Because environmental laws and regulations are increasingly becoming more stringent and new environmental laws and regulations are continuously being enacted or proposed (such as the Environmental Protection Agency's, or EPA's, Tier II gasoline and distillate standards discussed further below), the level of future expenditures required for environmental matters could increase in the future. In addition, any major upgrades in any of Valero's refineries could require material additional expenditures to comply with environmental laws and regulations. Although environmental costs may have a significant impact on results of operations for a single period, Valero believes that these costs will not have a material adverse effect on its financial position or liquidity. In February 2000, the EPA's "Tier II" gasoline standard was published in final form pursuant to the Clean Air Act. The standard will ultimately require the sulfur content in gasoline to be reduced from approximately 300 parts per million to 30 parts per million; the regulation will be phased in beginning in 2004. In addition, the EPA finalized its Tier II distillate standard to reduce the sulfur content of diesel fuel sold to highway consumers by 97%, from 500 parts per million to 15 parts per million, beginning June 1, 2006. The new Tier II specifications for the reduction of sulfur in both gasoline and distillates are expected to cost the refining industry as much as $16 billion to meet. Valero has determined that modifications will be required at each of its refineries as a result of the Tier II standards. Based on preliminary estimates, Valero believes that the new Tier II specifications will require approximately $270 million in capital expenditures for Valero's refineries to comply, split evenly between expenditures to meet the gasoline standard and expenditures to meet the distillate standard, but excluding the cost to install hydrogen production facilities. Valero currently plans to begin implementing the modifications in 2001 and expects all modifications to be complete by 2006. Under common stock repurchase programs approved by Valero's Board of Directors, Valero repurchases shares of its common stock from time to time for use in connection with its employee benefit plans and other general corporate purposes. During the second quarter and first six months of 2001, Valero repurchased shares of its common stock under these programs at a cost of approximately $25 million and $36 million, respectively. Thus far in the third quarter of 2001 (through July 31), Valero has repurchased additional common shares under these programs at a cost of approximately $8 million. Valero believes it has sufficient funds from operations, and to the extent necessary, from the public and private capital markets and bank markets, to fund its ongoing operating requirements. Valero expects that, to the extent necessary, it can raise additional funds from time to time through equity or debt financings. However, there can be no assurances regarding the availability of any future financings or whether such financings can be made available on terms acceptable to Valero. 36 37 On March 31, 2000, Valero filed a $1.3 billion universal shelf registration statement on Form S-3, which was declared effective by the SEC on May 30, 2000. Securities registered pursuant to this registration statement included common stock, preferred stock, debt securities and warrants. The senior notes, PEPS Units and common stock offerings issued in connection with funding the Benicia Acquisition were issued under this shelf registration statement. Proceeds from any additional issuances under this shelf registration statement, if any, are expected to be used for general corporate purposes, including acquisitions, working capital requirements, capital expenditures, repayment of debt or other business purposes. NEW ACCOUNTING PRONOUNCEMENTS As discussed in Note 8 of Notes to Consolidated Financial Statements, certain new financial accounting pronouncements have been issued by the FASB which either have already been reflected in the accompanying consolidated financial statements, or will become effective for Valero's financial statements in the future. Except for FASB Statement No. 143, "Accounting for Asset Retirement Obligations," for which the effect on Valero's consolidated financial statements has not yet been determined, and FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," the effect of which is discussed in Note 9 of Notes to Consolidated Financial Statements, the adoption of these pronouncements has not had, or is not expected to have, a material effect on Valero's consolidated financial statements. 37 38 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK COMMODITY PRICE RISK Valero is exposed to market risks related to the volatility of crude oil and refined product prices, as well as volatility in the price of natural gas used in its refining operations. In order to reduce the risks of these price fluctuations, Valero uses derivative commodity instruments to hedge a portion of its refinery feedstock and refined product inventories and a portion of its unrecognized firm commitments to purchase these inventories (fair value hedges). Valero also uses derivative commodity instruments to hedge the price risk of forecasted transactions such as forecasted feedstock and natural gas purchases and product sales (cash flow hedges). In addition, Valero uses derivative commodity instruments to manage its exposure to price volatility on a portion of its refined product inventories and on certain forecasted feedstock and refined product purchases that do not receive hedge accounting treatment under FASB 133. These derivative instruments are considered economic hedges for which changes in their fair value are reported currently in earnings. Finally, Valero uses derivative commodity instruments for trading purposes using its fundamental and technical analysis of market conditions to earn additional income. The types of instruments used in Valero's hedging and trading activities described above include swaps, futures and options. Valero's positions in derivative commodity instruments are monitored and managed on a daily basis by a risk control group to ensure compliance with Valero's stated risk management policy which has been approved by Valero's Board of Directors. In the tables below detailing Valero's open derivative commodity instruments as of June 30, 2001, the total gain or (loss) on swaps is the net of the fixed price payor and receiver fair value amounts, while the total gain or (loss) on futures is (i) the excess of the fair value amount over the contract amount for fixed price payor positions, combined with (ii) the excess of the contract amount over the fair value amount for fixed price receiver positions. See Note 9 of Notes to Consolidated Financial Statements for a discussion of Valero's accounting policies related to its derivative commodity instrument transactions, including Valero's adoption of FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," effective January 1, 2001. HEDGING ACTIVITIES The following table provides information about Valero's derivative commodity instruments (i) designated and qualifying as fair value hedges and held to hedge refining inventories and unrecognized firm commitments, and (ii) used in economic hedging relationships and held to manage price volatility in refined product inventories, as of June 30, 2001 (which mature in 2001 and 2002) (dollars in thousands, except amounts per barrel, or bbl). 38 39
Mature in 2001 Mature in 2002 Fixed Price Fixed Price ------------------------- ------------------------- Payor Receiver Payor Receiver -------- -------- -------- -------- Futures: Volumes (Mbbls) .................... 18,920 23,107 34 1 Weighted average price (per bbl) ... $ 27.62 $ 27.42 $ 31.03 $ 33.26 Contract amount .................... $522,579 $633,588 $ 1,055 $ 33 Fair value ......................... $510,160 $617,381 $ 1,033 $ 31
The following table provides information about Valero's derivative commodity instruments (i) designated and qualifying as cash flow hedges and held to hedge forecasted feedstock purchases and product sales, and (ii) used in economic hedging relationships and held to manage price volatility in forecasted feedstock and refined product purchases, as of June 30, 2001 (which mature in 2001 and 2002) (dollars in thousands, except amounts per barrel or per million British thermal units, or MMBtus). Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements.
Mature in 2001 Mature in 2002 Fixed Price Fixed Price ---------------------------- ----------------------- Payor Receiver Payor Receiver --------- --------- --------- --------- Swaps: Notional volumes (Mbbls) ..................... 1,600 6,875 -- -- Weighted average pay price (per bbl) ......... $ 1.36 $ 3.29 -- -- Weighted average receive price (per bbl) ..... $ 1.47 $ 3.49 -- -- Fair value (gain) ............................ $ 187 $ 1,402 -- -- Notional volumes (BBtus) ..................... 1,075 920 -- -- Weighted average pay price (per MMBtu) ....... $ 4.47 $ 1.77 -- -- Weighted average receive price (per MMBtu) ... $ 3.33 $ 2.36 -- -- Fair value (gain (loss)) ..................... $ (1,229) $ 1,124 -- -- Futures: Volumes (Mbbls) .............................. 6,413 7,255 60 -- Weighted average price (per bbl) ............. $ 28.94 $ 30.83 31.75 -- Contract amount .............................. $ 185,609 $ 223,651 1,905 -- Fair value ................................... $ 180,670 $ 214,026 1,857 -- Options: Volumes (BBtus) .............................. -- 5,720 -- -- Weighted average strike price (per MMBtu) .... -- $ 4.51 -- -- Contract amount .............................. -- $ 2,930 -- -- Fair value ................................... -- $ 6,932 -- --
In addition to the above, as of June 30, 2001, Valero was the fixed price payor under certain swap contracts held to hedge forecasted purchases of refinery feedstocks and refined products that mature 39 40 in 2002, have notional volumes totaling approximately 7.5 million barrels, and have a weighted average pay price of $20.11 per barrel. As of June 30, 2001, these swaps had a weighted average receive price of $24.97 per barrel and a net after-tax gain recorded in other comprehensive income of approximately $38.7 million. TRADING ACTIVITIES The following table provides information about Valero's derivative commodity instruments held or issued for trading purposes as of June 30, 2001 (which mature in 2001 or 2002) (dollars in thousands, except amounts per barrel or per million British thermal units). Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements.
Mature in 2001 Mature in 2002 Fixed Price Fixed Price ---------------------------- --------------------------- Payor Receiver Payor Receiver --------- --------- --------- --------- Swaps: Notional volumes (Mbbls) ..................... 5,365 4,975 900 1,125 Weighted average pay price (per bbl) ......... $ 4.50 $ 3.12 $ 3.52 $ 3.83 Weighted average receive price (per bbl) ..... $ 3.84 $ 3.47 $ 4.71 $ 4.42 Fair value (gain) ............................ $ (3,515) $ 1,605 $ 282 $ (323) Notional volumes (BBtus) ..................... 4,190 4,190 -- -- Weighted average pay price (per MMBtu) ....... $ 3.96 $ 2.90 -- -- Weighted average receive price (per MMBtu) ... $ 2.90 $ 3.95 -- -- Fair value (gain (loss)) ..................... $ (4,465) $ 4,433 -- -- Futures: Volumes (Mbbls) .............................. 8,547 8,668 558 550 Weighted average price (per bbl) ............. $ 28.57 $ 28.54 $ 29.05 $ 27.46 Contract amount .............................. $ 244,155 $ 247,372 $ 16,210 $ 15,105 Fair value ................................... $ 239,439 $ 242,518 $ 15,673 $ 14,750 Volumes (BBtus) .............................. 2,600 2,600 -- -- Weighted average price (per MMBtu) ........... $ 5.21 $ 5.22 -- -- Contract amount .............................. $ 13,558 $ 13,575 -- -- Fair value ................................... $ 8,776 $ 8,776 -- --
INTEREST RATE RISK Valero's primary market risk exposure for changes in interest rates relates to its long-term debt obligations. Valero manages its exposure to changing interest rates principally through the use of a combination of fixed and floating rate debt and currently does not use derivative financial instruments to manage such risk. 40 41 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. City of Dallas v. Explorer Pipeline Company, Inc., Valero Energy Corporation, et al., 160th State District Court, Dallas County, Texas (filed May 14, 2001). On May 14, 2001, the City of Dallas added Valero as a named defendant in a suit filed previously against Explorer Pipeline Company, Inc. and certain other refiners and suppliers who transport gasoline through Explorer's petroleum products pipeline in North Texas. On March 9, 2000, Explorer's pipeline ruptured and discharged gasoline into East Caddo Creek in Hunt County, Texas. The plaintiff alleges that its source of water supply from Lake Tawakoni (located approximately 28 miles from the site of the pipeline rupture) was contaminated by gasoline containing MTBE causing the plaintiff to discontinue the use of water from Lake Tawakoni as a source of water supply, and requiring the construction of an emergency water supply pipeline from another source. The plaintiff asserts causes of action for negligence, nuisance, strict product liability, and gross negligence, and seeks the recovery of an unspecified amount of actual and punitive damages, including costs for the construction of the alternate supply pipeline. In a related matter, on July 3, 2001, Valero received a notice from several residents of Hunt County, Texas, of their intent to commence a citizen's suit under the Resource Conservation and Recovery Act to require an investigation and remediation of the rupture site. Valero has not been served with a citation in the proposed citizen's suit. Environmental Proceedings: Texas Natural Resource Conservation Commission (TNRCC). Valero received the following notices of enforcement from the TNRCC for Valero's Texas refineries, but the TNRCC has not yet issued any enforcement order related to these notices. The notices pertain to various inspections of Valero's Texas refineries conducted earlier in 2001. The notices of enforcement do not assess any fines or penalties. (i) Notice of Enforcement for a Comprehensive Compliance Investigation at the Houston refinery, TNRCC ID No. HG-0130-C, served on May 8, 2001, for alleged noncompliance with certain air emission and record keeping requirements, (ii) Notice of Enforcement for an Upset Maintenance Notification Investigation at the Houston refinery, TNRCC ID No. HG-0130-C, served on July 17, 2001, for an alleged violation of TNRCC upset/maintenance regulations, (iii) Notice of Enforcement for the Compliance Certification Inspection at the Texas City refinery, TNRCC Account No. GB-0073-P, served on July 10, 2001, for alleged noncompliance with certain air emission and record keeping requirements, and (iv) Notice of Enforcement for Upset Report Reviews at the Corpus Christi refinery (Up River Road), TNRCC Air Account No. NE-0112-G, served on May 1, 2001, for alleged noncompliance with certain air emission and record keeping requirements. California Environmental Protection Agency Department of Toxic Substances Control. Valero received a Draft Enforcement Order on July 17, 2001 pertaining to its Benicia, California refinery. The Order alleges noncompliance with several state and federal waste management requirements, and seeks penalties of $226,500 and compliance. Valero disagrees with many of the Order's allegations, and has entered into discussions with the agency to resolve the matter. New Jersey Department of Environmental Protection (NJDEP). Valero disclosed in its Annual Report on Form 10-K for the year ended December 31, 2000, that on July 17, 2000, Valero Refining Company-New Jersey had received an Administrative Order (EA ID No. PEA000002-55006) from the 41 42 New Jersey Department of Environmental Protection related to alleged excess emissions from the Paulsboro Refinery. Valero recently reached a settlement agreement with the NJDEP relating to this order pursuant to which Valero will pay $286,680 in penalties in the third quarter of 2001. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Company's annual meeting of stockholders was held May 10, 2001. Matters voted on at the meeting and the results thereof were (i) a proposal to elect three Class I directors to serve until the 2004 annual meeting: Ruben M. Escobedo (approved with 55,243,656 affirmative votes, and 1,093,835 abstentions), Lowell H. Lebermann (approved with 55,249,610 affirmative votes, and 1,087,880 abstentions), and William B. Richardson (approved with 55,247,000 affirmative votes, and 1,090,490 abstentions); (ii) a proposal to approve the 2001 Executive Stock Incentive Plan for executive officers and employees (approved with 38,722,295 affirmative votes, 17,246,799 negative votes, and 368,397 abstentions), and (iii) a proposal to ratify the appointment of Arthur Andersen LLP as independent public accountants (approved with 55,593,336 affirmative votes, 476,560 negative votes, and 267,594 abstentions). Directors whose terms of office continued after the meeting were: Ronald K. Calgaard, Donald M. Carlton, Jerry D. Choate, Robert G. Dettmer, William E. Greehey, and Susan Kaufman Purcell. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. 2.1 Agreement and Plan of Merger, dated as of May 6, 2001, by and between Valero Energy Corporation and Ultramar Diamond Shamrock Corporation -- incorporated by reference from Exhibit 2.1 to Valero's Current Report on Form 8-K dated May 6, 2001, and filed May 10, 2001. (b) Reports on Form 8-K. (i) On May 10, 2001, Valero filed a Current Report on Form 8-K dated May 6, 2001, reporting Item 5 (Other Events) in connection with the announcement that Valero and UDS had entered into an agreement and plan of merger dated May 6, 2001, pursuant to which UDS will merge with and into Valero. Financial statements were not filed with this report. (ii) On June 4, 2001, Valero filed a Current Report on Form 8-K dated June 4, 2001, reporting Item 5 (Other Events) in connection with the announcement that certain subsidiaries of Valero had executed lease agreements with purchase options for a 115,000 BPD refinery in Corpus Christi and certain refined product pipelines and terminals in Texas owned and operated by subsidiaries of El Paso Corporation. Financial statements were not filed with this report. 42 43 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VALERO ENERGY CORPORATION (Registrant) By: /s/ John D. Gibbons ----------------------------------------- John D. Gibbons Executive Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) Date: August 13, 2001 43 -----END PRIVACY-ENHANCED MESSAGE-----