-----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, VlN3iTB1Va432E6g2vGpegmWoDgYXVutday4EanpuabVHGfJOPE869yLTGkJfrki j++Lfb6ELlXby6JYc1Nt/w== 0001035002-98-000002.txt : 19980304 0001035002-98-000002.hdr.sgml : 19980304 ACCESSION NUMBER: 0001035002-98-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980302 SROS: NYSE 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-K SEC ACT: SEC FILE NUMBER: 001-13175 FILM NUMBER: 98554564 BUSINESS ADDRESS: STREET 1: 7990 WEST IH 10 CITY: SAN ANTONIO STATE: TX ZIP: 78230 BUSINESS PHONE: 210-370-2000 MAIL ADDRESS: STREET 1: 7990 WEST IH10 CITY: SAN ANTONIO STATE: TX ZIP: 78230 10-K 1 VEC DEC 1997 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 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.) 7990 West IH 10 78230 San Antonio, Texas (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code (210) 370-2000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered Common Stock, $.01 Par Value New York Stock Exchange Preferred Share Purchase Rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: NONE. 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value on January 30, 1998, of the registrant's Common Stock, $.01 par value ("Common Stock"), held by nonaffiliates of the registrant, based on the average of the high and low prices as quoted in the New York Stock Exchange Composite Transactions listing for that date, was approximately $1.75 billion. As of January 30, 1998, 55,882,057 shares of the registrant's Common Stock were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE The Company intends to file with the Securities and Exchange Commission (the "Commission") in March 1998 a definitive Proxy Statement (the "1998 Proxy Statement") for the Company's Annual Meeting of Stockholders scheduled for April 30, 1998, at which directors of the Company will be elected. Portions of the 1998 Proxy Statement are incorporated by reference in Part III of this Form 10-K and shall be deemed to be a part hereof. CROSS-REFERENCE SHEET The following table indicates the headings in the 1998 Proxy Statement where the information required in Part III of Form 10-K may be found. Form 10-K Item No. and Caption Heading in 1998 Proxy Statement 10. "Directors and Executive Officers of the Registrant" "Proposal No. 1 - Election of Directors," and "Information Concerning Nominees and Other Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" 11. "Executive Compensation" "Executive Compensation," "Stock Option Grants and Related Information," "Report of the Compensation Committee of the Board of Directors on Executive Compensation," "Retirement Benefits," "Arrangements with Certain Officers and Directors" and "Performance Graph" 12. "Security Ownership of Certain Beneficial Owners and Management" "Beneficial Ownership of Valero Securities" 13. "Certain Relationships and Related Transactions" "Transactions with Management and Others" Copies of all documents incorporated by reference, other than exhibits to such documents, will be provided without charge to each person who receives a copy of this Form 10-K upon written request to Jay D. Browning, Corporate Secretary, Valero Energy Corporation, P.O. Box 500, San Antonio, Texas 78292. CONTENTS PAGE Cross Reference Sheet PART I Item 1. Business 1997 Developments Restructuring Acquisition of Basis Petroleum, Inc. Refining Operations Corpus Christi Refinery Acquired Refineries Texas City Refinery Houston Refinery Krotz Springs Refinery Selected Operating Results Marketing Feedstock Supply Factors Affecting Operating Results Competition Environmental Matters Executive Officers of the Registrant Employees Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 8. Financial Statements Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K The following discussion contains certain estimates, predictions, projections and other "forward-looking statements" (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect the Company's current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions, or other future performance suggested herein. Some important factors (but not necessarily all factors) that could affect the Company's sales volumes, growth strategies, future profitability and operating results, or that otherwise could cause actual results to differ materially from those expressed in any forward-looking statement are discussed in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" under the heading "Forward-Looking Statements." The Company undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. PART I ITEM 1. BUSINESS Valero Energy Corporation is one of the United States' largest independent refiners and marketers, and the largest on the Gulf Coast. With the May 1, 1997 acquisition of Basis Petroleum, Inc., the Company now owns and operates four refineries in Texas and Louisiana with a combined throughput capacity of approximately 530,000 barrels per day ("BPD"). The Company principally produces premium, environmentally clean products such as reformulated gasoline, low-sulfur diesel and oxygenates. The Company also produces a substantial slate of middle distillates, jet fuel and petrochemicals. The Company markets its products in 32 states and selected export markets. Unless otherwise required by the context, the term "Valero" as used herein refers to Valero Energy Corporation, and the term "Company" refers to Valero and its consolidated subsidiaries. Valero was incorporated in Delaware in 1981 under the name Valero Refining and Marketing Company and became a publicly held corporation on July 31, 1997. Its principal executive offices are located at 7990 West I.H. 10, San Antonio, Texas, 78230 and its telephone number is (210) 370-2000. For financial and statistical information regarding the Company's operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations." For a discussion of cash flows provided by and used in the Company's operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." 1997 Developments Restructuring Prior to July 31, 1997, Valero was a wholly owned subsidiary of Valero Energy Corporation ("Energy"). Energy was a diversified energy company engaged in both the refining and marketing business and the natural gas related services business. On July 31, 1997, pursuant to an agreement and plan of distribution between Valero and Energy (the "Distribution Agreement"), Energy spun off Valero to Energy's stockholders by distributing all of Valero's $.01 par value common stock on a share for share basis to holders of record of Energy common stock at the close of business on July 31, 1997 (the "Distribution"). Immediately after the Distribution, Energy, with its remaining natural gas related services business, merged (the "Merger") with a wholly owned subsidiary of PG&E Corporation ("PG&E"). The completion of the Distribution and the Merger (collectively referred to as the "Restructuring") finalized the restructuring of Energy previously announced in January 1997. The Distribution and the Merger were approved by Energy stockholders at their annual meeting held on June 18, 1997 and, in the opinion of Energy's outside counsel, were tax-free transactions. Regulatory approval of the Merger was received from the Federal Energy Regulatory Commission on July 16, 1997. Upon completion of the Restructuring, Valero's name was changed from Valero Refining and Marketing Company to Valero Energy Corporation and its common stock was listed for trading on the New York Stock Exchange under the symbol "VLO." Immediately prior to the Distribution, the Company paid a dividend to Energy of $210 million pursuant to the Distribution Agreement. In addition, the Company paid to Energy approximately $5 million in settlement of the intercompany note balance between the Company and Energy arising from certain transactions during the period from January 1 through July 31, 1997. In connection with the Merger, PG&E issued approximately 31 million shares of its common stock in exchange for all of the issued and outstanding $1 par value common shares of Energy, and assumed $785.7 million of Energy's debt. Each Energy stockholder received .554 of one share of PG&E common stock, trading on the New York Stock Exchange under the symbol "PCG," for each Energy share owned on July 31, 1997. This fractional share amount was based on the average price of PG&E common stock during a prescribed period preceding the closing of the transaction and the number of Energy shares issued and outstanding at the time of the closing. Prior to the Restructuring, Energy, Valero and PG&E entered into a tax sharing agreement ("Tax Sharing Agreement"), which sets forth each party's rights and obligations with respect to payments and refunds, if any, of federal, state, local, or other taxes for periods before the Restructuring. In general, under the Tax Sharing Agreement, Energy and Valero are each responsible for their allocable share of the federal, state and other taxes incurred by the combined operations of Energy and Valero prior to the Distribution. Furthermore, Valero is responsible for substantially all tax liability in the event the Distribution or the Merger fails to qualify as a tax-free transaction, except that Energy would be responsible for any such tax liability attributable to certain actions by Energy and/or PG&E. The separation of the Company from the natural gas business and operations of Energy was structured as a spin-off of the Company for legal, tax and other reasons. However, the Company succeeded to certain important aspects of Energy's business, organization and affairs, namely: (i) the Company succeeded to the name "Valero Energy Corporation" and the Company retained the refining and marketing business of Energy which represented approximately one-half of the assets, revenues, and operating income of the businesses, operations and companies previously constituting Energy; (ii) the Company's Board of Directors consists of those individuals formerly comprising Energy's Board of Directors; and (iii) the Company's executive management consists primarily of those individuals formerly comprising Energy's executive management. Acquisition of Basis Petroleum, Inc. Effective May 1, 1997, Energy acquired all of the outstanding common stock of Basis Petroleum, Inc. ("Basis"), a wholly owned subsidiary of Salomon Inc ("Salomon"). The primary assets acquired with Basis include three refineries located in Texas City, Texas (the "Texas City Refinery"), Houston, Texas (the "Houston Refinery") and Krotz Springs, Louisiana (the "Krotz Springs Refinery") (these three refineries are collectively referred to as the "Acquired Refineries") and an extensive wholesale marketing business. At the time of their acquisition, the Acquired Refineries had a combined total throughput capacity in excess of 300,000 BPD. Prior to the Restructuring, Energy transferred the stock of Basis to Valero. As a result, Basis was a part of the Company at the time it was spun off to Energy's stockholders pursuant to the Restructuring. Basis' name was subsequently changed to Valero Refining Company-Texas and the Basis assets located in Louisiana were transferred to a newly-formed subsidiary of the Company, Valero Refining Company-Louisiana. Energy acquired the capital stock of Basis for approximately $470 million which includes certain post-closing adjustments and settlements. The purchase price was paid, in part, with 3,429,796 shares of Energy common stock having a fair market value of approximately $114 million with the remainder paid in cash from borrowings under Energy's bank credit facilities. In addition, Salomon is entitled to receive earn-out payments from the Company in any of the years through 2007 if certain average refining margins during any of those years are above a specified level. Any payments under this earn-out arrangement are limited to $35 million in any year and $200 million in the aggregate and are determined on May 1 of each year beginning in 1998. For additional information concerning the Company's financing activities, see Note 6 of Notes to Consolidated Financial Statements. Refining Operations The Company owns and operates four refineries located in the U.S. Gulf Coast region having a combined total refining capacity of approximately 530,000 BPD, net of inter-refinery transfers averaging approximately 35,000 BPD. The Company's largest refinery is located on 254 acres in Corpus Christi, Texas (the "Corpus Christi Refinery") along the Corpus Christi Ship Channel and has a feedstock throughput capacity of approximately 190,000 BPD. The Texas City Refinery is located on 290 acres along the Texas City Ship Channel and has a feedstock throughput capacity of approximately 180,000 BPD. The Houston Refinery is located on 250 acres along the Houston Ship Channel with a feedstock throughput capacity of approximately 115,000 BPD. The Krotz Springs Refinery is located on 260 acres in Southern Louisiana along the Atchafalaya River which has access to the Mississippi River and to the Colonial pipeline. The feedstock throughput capacity of the Krotz Springs Refinery is approximately 80,000 BPD. In addition to more than tripling the Company's throughput capacity, the Acquired Refineries have substantially diversified the Company's feedstock slate, allowing it to process both medium sour crude oils and heavy sweet crudes, both of which can typically be purchased at a discount to West Texas Intermediate ("WTI"), a benchmark crude oil. The Company's primary feedstocks are medium sour crude oil, heavy sweet crude oil and high-sulfur atmospheric residual fuel oil ("resid"). In 1998, the Company plans to begin a capital expenditure program that targets a system wide increase in total throughput capacity of approximately 140,000 BPD by early to mid-2000. The Company currently estimates the cost of this expansion to be $250-275 million in the aggregate. The majority of these capital expenditures are anticipated to be spent in 1999 on upgrades and modifications to the Acquired Refineries and will be performed during scheduled maintenance turnarounds. In addition to capital expenditures related to this expansion program, other capital expenditures are planned to improve system reliability and reduce emissions. The Company has very few turnarounds scheduled for 1998. During 1999, maintenance turnarounds for most of the Company's major refining units are planned. Such turnarounds are scheduled to occur early in the first quarter and in the fourth quarter when refining margins are historically low so as to minimize the impact on the Company's operating results. Corpus Christi Refinery The Corpus Christi Refinery specializes in processing primarily resid and heavy crude oil into premium products, such as reformulated gasoline ("RFG"). The Corpus Christi Refinery can produce approximately 117,000 BPD of gasoline and gasoline-related products, 35,000 BPD of middle distillates and 40,000 BPD of other products such as chemicals, asphalt and propane. The Corpus Christi Refinery can produce all of its gasoline as RFG and all of its diesel fuel as low-sulfur diesel. The Corpus Christi Refinery has substantial flexibility to vary its mix of gasoline products to meet changing market conditions. The Corpus Christi Refinery produces oxygenates such as MTBE (methyl tertiary butyl ether) and TAME (tertiary amyl methyl ether). MTBE is an oxygen-rich, high-octane gasoline blendstock produced by reacting methanol and isobutylene, and is used to manufacture oxygenated and reformulated gasolines. TAME, like MTBE, is an oxygen-rich, high-octane gasoline blendstock. The butane upgrade facility which produces MTBE (the "Corpus Christi MTBE Plant") is located at the Corpus Christi Refinery and can produce approximately 17,000 BPD of MTBE from butane and methanol feedstocks. The MTBE/TAME Unit at the Corpus Christi Refinery converts light olefin streams produced by the refinery's heavy oil cracker ("HOC") into MTBE and TAME. The Corpus Christi MTBE Plant and MTBE/TAME Unit enable the Corpus Christi Refinery to produce approximately 22,500 BPD of oxygenates, which are blended into the Company's own gasoline production and sold separately. Substantially all of the methanol feedstocks required for the production of oxygenates at the Corpus Christi Refinery can normally be provided by a methanol plant in Clear Lake, Texas owned by a joint venture between a Valero subsidiary and Hoechst Celanese Chemical Group, Inc. (the "Clear Lake Methanol Plant"). [FN] "Oxygenates" are liquid hydrocarbon compounds containing oxygen. Gasoline that contains oxygenates usually has lower carbon monoxide emissions than conventional gasoline. In January 1997, a mixed xylene fractionation facility ("Xylene Unit"), which recovers the mixed xylene stream from the Corpus Christi Refinery's reformate stream, was placed into service at the refinery. The fractionated xylene is sold into the petrochemical feedstock market for use in the production of paraxylene. The Corpus Christi MTBE Plant, the MTBE/TAME Unit, the Xylene Unit and related facilities diversify the Corpus Christi Refinery's operations, giving the Company the flexibility to pursue higher-margin product markets. In 1997, the Company completed a scheduled turnaround on the crude unit at the Corpus Christi Refinery. The Company also completed a scheduled turnaround of certain of the Corpus Christi Refinery's major refining units in the first quarter of 1998. Modifications made during the 1998 turnaround are expected to increase throughput by 5,000 to 10,000 BPD, depending upon the type of feedstocks utilized. In addition, the hydrodesulfurization unit ("HDS") was modified to allow for the processing of approximately 25,000 BPD of high sulfur crude oil, thereby increasing the Corpus Christi Refinery's feedstock flexibility. The Corpus Christi Refinery experienced one significant unscheduled shutdown of its HOC during the second quarter resulting in a reduction of operating income for 1997 of approximately $8 million. During this shutdown, certain debottlenecking modifications were completed which have increased the capacity of the HOC by approximately 3,000 BPD. Other than the HOC downtime, the Corpus Christi Refinery's principal refining units operated during 1997 without significant unscheduled downtime. No further turnaround activity is scheduled for the Corpus Christi Refinery during 1998. During 1999, the HOC is scheduled to be down for a maintenance turnaround and to increase the unit's capacity and the HDS is scheduled to be down for a maintenance turnaround and to replace the catalyst in the unit. Acquired Refineries The acquisition of the Acquired Refineries significantly diversified the Company's asset base and expanded and diversified its feedstock slate. At the time of their acquisition, the Acquired Refineries had a combined total throughput capacity of approximately 300,000 BPD. As a result of upgrading and reconfiguration activities undertaken by the Company, the aggregate throughput capacity of the Acquired Refineries has been increased to approximately 340,000 BPD, net of inter-refinery transfers averaging approximately 35,000 BPD. Much of this increased capacity has resulted from efforts to optimize feedstock selection in order to capitalize on the reconfiguration of the Acquired Refineries. In 1998, the Company plans to begin a capital expenditure program designed to increase total system capacity of the Acquired Refineries by converting the fluid catalytic cracking units ("FCC Units") to HOCs and increasing their capacity, expanding the crude unit capacities and various other expenditures to enhance feedstock flexibility. In addition, expenditures to upgrade instrumentation systems and modernize the control rooms at each of the Acquired Refineries will continue over the next few years to improve plant efficiency and management information systems. Texas City Refinery The Texas City Refinery is capable of refining lower-value, medium sour crudes into a slate of gasolines, low-sulfur diesels and distillates, including home heating oil, kerosene and jet fuel. The Texas City Refinery typically produces approximately 55,000 BPD of gasoline and 60,000 BPD of distillates. The Texas City Refinery also provides approximately 35,000 BPD of intermediate feedstocks such as deasphalted oil to the Corpus Christi Refinery and the Houston Refinery. The Texas City Refinery typically receives its feedstocks and ships product by tanker via deep water docking facilities along the Texas City Ship Channel, and also has access to the Colonial, Explorer and TEPPCO pipelines for distribution of its products. During the latter part of 1996, a Residfiner (which improves the cracking characteristics of the feedstocks for the FCC Unit), and a Residual Oil Supercritical Extraction ("ROSE") unit (which recovers deasphalted oil from the vacuum tower bottoms for feed to the FCC Unit) were placed in service at the Texas City Refinery, which significantly enhanced this refinery's feedstock flexibility and product diversity. Certain intermediate products produced from these units are also being utilized as feedstocks at the Corpus Christi and Houston Refineries. During 1997, the Texas City Refinery's principal refining units operated without significant unscheduled downtime. A scheduled turnaround was completed on the Residfiner in July 1997. During 1998, the Residfiner is scheduled for a maintenance turnaround. During 1999, the FCC Unit, the crude unit, Residfiner and ROSE unit are scheduled to be down for maintenance turnarounds. At that time, the FCC Unit will be converted to a heavy oil cracker and its capacity increased. The capacity of the crude unit will also be increased at that time. Houston Refinery The Houston Refinery is capable of processing heavy sweet or medium sour crude oil and produces approximately 54,000 BPD of gasoline and 37,000 BPD of distillates. The refinery typically receives its feedstocks via tanker at deep water docking facilities along the Houston Ship Channel. This facility also has access to major product pipelines, including the Colonial, Explorer and TEPPCO pipelines. The Houston Refinery experienced unplanned shutdowns of its FCC Unit during the second and fourth quarters of 1997 for approximately 11 and 14 days, respectively, in order to make certain repairs and to replace a section of its regenerator. Other than the FCC Unit repairs, the Houston Refinery's primary refining units operated during 1997 without significant unscheduled downtime. No turnaround activity is scheduled for the Houston Refinery during 1998. During 1999, the FCC Unit, the crude unit and the ROSE Unit are scheduled to be down for maintenance turnarounds. At that time, the FCC Unit will be converted to a heavy oil cracker and its capacity increased. The capacity of the crude unit will also be increased at that time. Krotz Springs Refinery The Krotz Springs Refinery processes primarily local, light Louisiana sweet crude oil and produces approximately 34,000 BPD of gasoline and 38,000 BPD of distillates. As a result of recent modifications to its FCC Unit, the Krotz Springs Refinery is also capable of processing resid. The refinery is geographically located to benefit from access to upriver markets on the Mississippi River and it has docking facilities along the Atchafalaya River sufficiently deep to allow barge and light ship access. The facility is also connected to the Colonial pipeline for product transportation to the Southeast and Northeast. This refinery was built during the 1979-1982 time period making it, like the Corpus Christi Refinery, a relatively new facility compared to other Gulf Coast refineries. This refinery also benefits from recently added MTBE/polymerization and isomerization units. The Krotz Springs Refinery's principal operating units operated during 1997 without significant unscheduled downtime. No turnaround activity is scheduled for the Krotz Springs Refinery during 1998. During 1999, the crude unit is scheduled to be down for a maintenance turnaround and to increase the unit's capacity. Selected Operating Results The following table sets forth certain consolidated operating results for the last three fiscal years. Amounts for 1997 include the results of operations of the Acquired Refineries from May 1, 1997. Average throughput margin per barrel is computed by subtracting total direct product cost of sales from product sales revenues and dividing the result by throughput volumes.
Year Ended December 31, 1997 1996 1995 Refinery Throughput Volumes (MBD) 392 170 160 Sales Volumes (MBD) 630 291 231 Average Throughput Margin per Barrel $4.64 $5.29 $6.25 Average Operating Cost per Barrel $2.78 $3.29 $3.34 For the eight months following the acquisition of Basis, refinery throughput volumes and sales volumes were 502 MBD and 780 MBD, respectively.
For additional information regarding the Company's operating results for the three years ended December 31, 1997, see "Management's Discussion and Analysis of Financial Condition and Results of Operations." Marketing The Company's product slate is presently comprised of approximately 90% gasoline and related components, distillates, chemicals and other light products. The Company sells refined products under spot and term contracts to bulk and truck rack customers at over 170 locations in 32 states throughout the United States and selected export markets in Latin America. As a result of the Basis acquisition, total product sales volumes increased from approximately 291,000 BPD during 1996 to approximately 630,000 BPD during 1997. Sales volumes include amounts produced at the Company's refineries and amounts purchased from third parties and resold in connection with the Company's marketing activities. Currently, the Company markets approximately 170,000 BPD of gasoline and distillates through truck rack facilities. Other sales are made to large oil companies and gasoline distributors and transported by pipeline, barges and tankers. The principal purchasers of the Company's products from truck racks have been wholesalers and jobbers in the Northeast, Southeast, Midwest and Gulf Coast. No single purchaser of the Company's products accounted for more than 10% of total sales during 1997. With its access to the Gulf of Mexico, the Company's refineries are able to ship refined products to Latin American markets and the West Coast. Interconnects with common-carrier pipelines give the Company the flexibility to sell products in most major geographic regions of the United States. Approximately 40,000 BPD of the Company's RFG production is under contract to supply wholesale gasoline marketers in Texas at market-related prices. In 1997, the Company also supplied approximately 1.5 million barrels of CARB Phase II gasoline to West Coast markets in connection with the commencement of California Air Resources Board's gasoline program. The Company expects demand for RFG to continue to improve as a result of increased demand in areas currently designated as non-attainment and more cities across the United States "opting in" to the federal RFG program. For further discussion, see "Factors Affecting Operating Results" and "Outlook" under "Management's Discussion and Analysis of Financial Condition and Results of Operations." Feedstock Supply The acquisition of the Acquired Refineries expanded and diversified the slate of feedstocks which the Company can process. Prior to the Basis acquisition, the Company's primary feedstock was resid processed at the Corpus Christi Refinery. Approximately 70% of the Company's feedstock slate is now comprised of medium sour crude oil, heavy sweet crude oil and resid. The remaining feedstocks are primarily comprised of intermediates, light sweet crude oil, methanol and butane. The Company has term feedstock contracts totaling approximately 300,000 BPD, or approximately 57% of its total feedstock requirements. The remainder of its feedstock requirements are purchased on the spot market. The term agreements include contracts to purchase medium sour crude oil and resid from various foreign national oil companies, including certain Middle Eastern suppliers, and various domestic integrated oil companies. In connection with the Distribution, the Company entered into several contracts with its former affiliates, including a 10-year term contract under which a former affiliate is to supply approximately 50% of the butane required to operate the Corpus Christi MTBE Plant and natural gasoline for blending. The Company obtains approximately 80% of its total methanol requirements for all of its refineries through its 50% joint venture interest in the Clear Lake Methanol Plant. The Company owns feedstock and refined product storage facilities and leases feedstock and refined product storage facilities in various locations. The Company believes its storage facilities are generally adequate for its refining and marketing operations. Factors Affecting Operating Results The Company's earnings and cash flow from operations are primarily affected by the relationship between refined product prices and the prices for crude oil and resid. The cost to acquire feedstocks and the price for which refined products are ultimately sold depends on numerous factors beyond the Company's control, including the supply and demand for crude oil, gasoline and other refined products which in turn are dependent upon, among other things, the availability of imports, the economies and production levels of foreign suppliers, the marketing of competitive fuels, political affairs and the extent of governmental regulation. The prices received by the Company for its refined products are affected by other factors, such as product pipeline capacity, local market conditions and the operating levels of competing refineries. As a result of the geographic location of the Company's refineries, the Company's profitability is largely dependent upon Gulf Coast refining margins. A large, rapid increase in crude oil prices or a decrease in refined product prices in the Gulf Coast region could adversely affect the Company's operating margins. Crude oil costs and the price of refined products have historically been subject to wide fluctuation. Installation of additional refinery crude distillation and upgrading facilities, price volatility, international political developments and other factors beyond the control of the Company are likely to continue to play an important role in refining industry economics. The Company is aware, for example, of additional capacity of up to 200,000 BPD from a refinery in Good Hope, Louisiana which may become operational as early as late 1998. These factors can impact, among other things, the level of inventories in the market resulting in price volatility. Moreover, the industry typically experiences seasonal fluctuations in demand for refined products, such as for gasoline during the summer driving season and for home heating oil during the winter in the Northeast. A significant portion of the Company's feedstock supplies are secured under term contracts. There is no assurance of renewal of such contracts upon their expiration or that economically equivalent substitute supply contracts can be secured. The term agreements include an agreement with the Saudi Arabian Oil Company to provide an average of 36,000 BPD of resid from its Ras Tanura refinery to the Company through mid-1998. The Saudi Arabian Oil Company has advised the Company that it plans to begin operation of certain new resid conversion units in 1998 at the Ras Tanura refining complex in Saudi Arabia. As a result, the production of resid at Ras Tanura for export would be significantly reduced, which could adversely affect the price, terms or availability of high quality resid feedstocks in the future. However, the Saudi Arabian Oil Company has indicated that they are willing to provide an additional supply of resid to the Company from their other refineries although no contract has yet been negotiated. The availability of such supplies notwithstanding, the Company anticipates that lower volumes of high quality resid will be available from Saudi Arabia in the future. The Company's feedstock supplies from international producers are loaded aboard chartered vessels and are subject to the usual maritime hazards. If the Company's foreign sources of crude oil or access to the marine system for delivering crude oil were curtailed, the Company's operations could be adversely affected. In addition, the loss of, or an adverse change in the terms of, certain of its feedstock supply agreements or the loss of sources or means of delivery of its feedstock supplies, could have a material adverse effect on the Company's operating results. The volatility of prices and quantities of feedstocks that may be purchased on the spot market or pursuant to term contracts could also have a material adverse effect on operating results. Because the Company manufactures a substantial portion of its gasoline as RFG and can produce approximately 26,000 BPD of total oxygenates, certain federal and state clean-fuel programs significantly affect the operations of the Company and the markets in which it sells its refined products. In the future, the Company cannot control or with certainty predict the effect of such clean-fuel programs on the cost to manufacture, demand for or supply of refined products. Presently, the EPA's oxygenated fuel program under the Clean Air Act requires that areas designated "nonattainment" for carbon monoxide use gasoline that contains a prescribed amount of clean burning oxygenates during certain winter months. Additionally, the EPA's RFG program under the Clean Air Act requires year-round usage of RFG in areas designated "extreme" or "severe" nonattainment for ozone. In addition to these nonattainment areas, approximately 44 of the 87 areas that were designated as "serious," "moderate" or "marginal" nonattainment for ozone also "opted in" to the RFG program to decrease their emissions of hydrocarbons and toxic pollutants. In 1996, California adopted a statewide, year-round program requiring the use of gasoline that meets more restrictive emissions specifications than the federally mandated RFG. Under the California gasoline program, the entire state is required to use CARB Phase II gasoline that meets the California emissions standards which are higher than those set by the EPA. Based upon oxygenate supply and demand data, it appears most California refiners are choosing to use oxygenates to help them comply with the statewide emissions standards. In 1997, Phoenix, Arizona adopted a year-round program requiring gasoline that meets either the federal RFG standards or the CARB Phase II standards. For the first time in many years, Phoenix had no ozone exceedances in 1997. Because Phoenix previously used oxygenated gasoline only in the winter months for carbon monoxide control, the Company estimates this change will increase annualized U.S. oxygenate demand about one percent. MTBE margins are affected by the price of MTBE and its feedstocks, methanol and butane, as well as the demand for RFG, oxygenated gasoline and premium gasoline. The worldwide movement to reduce lead in gasoline is expected to increase worldwide demand for oxygenates to replace the octane provided by lead-based compounds. The general United States growth in gasoline demand as well as additional "opt-ins" by certain areas into the EPA clean fuels programs are expected to continue to increase the demand for MTBE as a component of these clean fuels. However, initiatives have been presented in California which would restrict or potentially ban the use of MTBE as a gasoline component. Based on available information, the Company believes that numerous scientific studies commissioned by the EPA, CARB and others will result in defeat of these initiatives. However, if MTBE were to be restricted or banned, the Company believes that its MTBE-producing facility could be modified to produce a product similar to alkylate or other petrochemicals. The Corpus Christi Refinery's operating results are affected by the relationship between refined product prices and resid prices, which in turn are largely determined by market forces. The price of resid is affected by the relationship between the demand for refined products (increased refined products demand increases crude oil demand, thereby increasing the supply of resid as more crude oil is processed) and worldwide additions to resid conversion capacity (which reduces the available supply of resid). The crude oil and refined products markets typically experience periods of extreme price volatility. During such periods, disproportionate changes in the prices of refined products and resid usually occur. The potential impact of changing crude oil and refined product prices on the Corpus Christi Refinery's results of operations is further affected by the fact that the Company generally buys a portion of its resid feedstocks approximately 45 to 50 days prior to processing. Because the Company's refineries are generally more complex than many conventional refineries and are designed principally to process resid and other heavy and/or sour crude oils, its operating costs per barrel are generally higher than those of most conventional refiners. But because the Company's primary feedstocks usually sell at discounts to benchmark crude oil, it has been generally able to recover its higher operating costs and generate higher margins than many conventional refiners that use lighter crude oil as their principal feedstock. Moreover, through recent improvements in technology and modifications to its operating units, the Company has improved its ability to process different types of feedstocks, including synthetic domestic heavy oil blends and heavy crude oils. The Company expects its primary feedstocks to continue to sell at a discount to benchmark crude oil, but is unable to predict future relationships between the supply of and demand for its feedstocks. In April 1995, six major oil refiners filed a lawsuit against Unocal Corporation ("Unocal") in Los Angeles, California seeking a declaratory judgment that Unocal's claimed patent on certain gasoline compositions was invalid and unenforceable. The Company is not a party to this litigation. Unocal's claimed patent covers a substantial portion of the reformulated gasoline compositions required by the CARB Phase II regulations that went into effect in March 1996. In October 1997, a federal court jury upheld the validity of Unocal's patent. In November 1997, the jury awarded Unocal royalty damages based on infringement of the patent. A final phase of the trial involving the unenforceability of Unocal's patent due to "inequitable conduct" was held in December 1997, but to date, no decision on this issue has been reached. Any adverse judgment against the six oil refiners will likely be appealed. If the Company were required to pay a royalty on the compositions claimed by Unocal's patent, such amounts could affect the operating results of the Company and alter the blending economics for compositions not covered by the patent. The Company is unable to predict the validity or effect of any claimed Unocal patent. Competition Many of the Company's competitors in the petroleum industry are fully integrated companies engaged, on a national and/or international basis, in many segments of the petroleum business, including exploration, production, transportation, refining and marketing on scales much larger than the Company's. Such competitors may have greater flexibility in responding to or absorbing market changes occurring in one or more of such segments. Substantially all of the Company's crude oil and feedstock supplies are purchased from third party sources, while some competitors have proprietary sources of crude oil available for their own refineries. The refining industry is highly competitive with respect to both feedstock supply and marketing. The Company competes with numerous other companies for available supplies of resid and other feedstocks and for outlets for its refined products. Many of the Company's competitors obtain a significant portion of their feedstocks from company-owned production and are able to dispose of refined products at their own retail outlets. The Company does not have retail gasoline operations. Competitors that have their own production or retail outlets (and brand-name recognition) may be able to offset losses from refining operations with profits from producing or retailing operations, and may be better positioned to withstand periods of depressed refining margins or feedstock shortages. The Company expects a continuation of the trend of industry restructuring and consolidation through mergers, acquisitions, divestitures, joint ventures and similar transactions, making for a more competitive business environment while providing the Company with opportunities to expand its operations. As described above, the Company expects to undertake a capital expansion program to increase the throughput capacity of its refinery facilities by approximately 140,000 BPD, and increase their operational flexibility. The Company also plans to continue evaluating and pursuing potential acquisitions to add refining capacity, in any case, depending upon the Company's assessment of an acquisition's potential for accretive earnings, creating geographic diversity, providing enhanced marketing opportunities and providing economies of scope and scale. Environmental Matters The Company's operations are subject to environmental regulation by federal, state and local authorities, including but not limited to, the EPA, the Texas Natural Resource Conservation Commission ("TNRCC") and the Louisiana Department of Environmental Quality. The regulatory requirements relate primarily to discharge of materials into the environment, waste management and pollution prevention measures. Several of the more significant federal laws applicable to the Company's operations include the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") and the Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act ("RCRA"). The Clean Air Act establishes stringent criteria for regulating conventional air pollutants as well as toxic pollutants at operating facilities in addition to requiring refiners to market cleaner-burning gasoline in specific regions of the country to reduce ozone forming pollutants and toxic emissions. CERCLA and RCRA, and related state law, subject the Company to the potential obligation to remove or mitigate the environmental impact of the disposal or release of certain pollutants at the Company's facilities and at formerly owned sites. Under CERCLA, the Company is subject to potential joint and several liability for the costs of remediation at "superfund" sites at which it has been identified as a "potentially responsible party" (a "PRP"). Pursuant to the terms of the Basis acquisition, Salomon agreed to indemnify the Company from third party claims, including "superfund" liability associated with any pre-closing activities with respect to the Acquired Refineries, subject to certain terms, conditions and limitations. As of December 31, 1997, the Company has not been designated as a PRP under CERCLA for any sites or costs not covered by Salomon's indemnity. Because the Corpus Christi Refinery was completed in 1984, it was built under more stringent environmental requirements than many existing refineries. The Corpus Christi Refinery currently meets EPA emissions standards requiring the use of "best available control technology," and is located in an area currently designated "attainment" for air quality. Accordingly, the Corpus Christi Refinery may be able to comply with the Clean Air Act and future environmental legislation more easily than older refineries, and significant additional capital expenditures for environmental compliance are not anticipated. In 1996, the Corpus Christi, Texas, area was approved as a "flexible attainment region" ("FAR") by the EPA and the TNRCC. Under the Clean Air Act, the FAR designation will allow local officials to design and implement an ozone prevention strategy customized for the community. This designation also prevents the EPA from designating the Corpus Christi area as "nonattainment" for a five-year period while agreed-upon control strategies are being initiated to reduce ozone formation. The FAR designation should provide greater flexibility with respect to possible future expansion projects at the Corpus Christi Refinery. The Company is leading an industry initiative in the State of Texas to voluntarily permit "grandfathered" emissions sources at the Houston and Texas City Refineries by utilizing a flexible permitting process. The flexible permit is a new permitting concept in Texas that allows companies that have committed to install advanced pollution control technology greater operational flexibility, including increased throughput capacities, as long as a facility-wide emissions cap is not exceeded. As part of the Company's efforts to convert all of its Texas refineries to flexible permits and utilize "best available pollution control technology" at all its refineries, the Company plans to install flue gas scrubbers on the FCC Units at the Houston and Texas City Refineries and upgrade its waste water treatment plants at the Houston and Corpus Christi Refineries. The Company anticipates spending approximately $50 million in connection with these efforts over the next two years. These expenditures are not included in the estimate of capital expenditures to increase capacity discussed above under the heading "Refining Operations." In 1997, capital expenditures for the Company attributable to compliance with environmental regulations were approximately $15 million and are currently estimated to be $21 million for 1998 (including expenditures at the Acquired Refineries). These amounts are exclusive of any amounts related to constructed facilities for which the portion of expenditures relating to compliance with environmental regulations is not determinable. Governmental regulations are complex and subject to different interpretations. Therefore, future action and regulatory initiatives could result in changes to expected operating permits, additional remedial actions or increased capital expenditures and operating costs that cannot be assessed with certainty at this time. There are no material governmental fines or corrective action requirements associated with the Company's operations and the Company believes its operations are in substantial compliance with current and applicable environmental laws and regulations. Executive Officers of the Registrant Name Age Positions Held with Valero Executive Officer Since William E. Greehey 61 Chairman of the Board and Chief Executive Officer 1982 Edward C. Benninger 55 President 1986 E. Baines Manning 57 Senior Vice President 1987 Gregory C. King 37 Vice President and General Counsel 1997 John D. Gibbons 44 Chief Financial Officer, Vice President - Finance and Treasurer 1997 Keith D. Booke 39 Vice President - Administration and Human Resources 1997 S. Eugene Edwards 41 Vice President 1998 John F. Hohnholt 45 Vice President 1998 Mr. Greehey served as Chief Executive Officer and a director of Energy from 1979, and as Chairman of the Board of Energy from 1983. He retired from his position as Chief Executive Officer in June 1996 but, upon request of the Board, resumed this position in November 1996 and continued in such positions until the Restructuring. Mr. Greehey also served as Chairman of the Board and Chief Executive Officer of Valero prior to the Restructuring when Valero was a wholly owned subsidiary of Energy. Mr. Greehey is a director of Weatherford Enterra, Inc. and Santa Fe Energy Resources, Inc. Mr. Benninger served as President and Chief Financial Officer of Energy from 1996 and as a director of Energy since 1990, in each case until the Restructuring. Prior to that, he served in various other capacities with Energy, its predecessors and subsidiaries since 1975, including Executive Vice President and Treasurer. Mr. Benninger also served as President and Chief Financial Officer of Valero prior to the Restructuring when Valero was a wholly owned subsidiary of Energy. Mr. Manning was elected Senior Vice President of the Company in 1997. He joined the Company in 1986 as senior vice president of the refining and marketing subsidiaries of Energy and held various other positions with Energy and its subsidiaries prior to the Restructuring. Mr. King was elected Vice President and General Counsel of Valero in 1997. He joined Energy in 1993 as Associate General Counsel and prior to that was a partner in the Houston law firm of Bracewell and Patterson. Mr. Gibbons was elected Chief Financial Officer of the Company in 1998. Previously, he was elected Vice President - Finance and Treasurer of Valero in 1997, and was elected Treasurer of Energy in 1992. He joined Energy in 1981 and held various other positions with Energy prior to the Restructuring. Mr. Booke was elected Vice President-Administration and Human Resources of the Company in 1998. Prior to that he served as Vice President-Administration of the Company since 1997 and Vice President-Investor Relations of Energy since 1994. He joined Energy in 1983 and held various other positions with Energy prior to the Restructuring. Mr. Edwards was elected Vice President of the Company in January 1998 and functions as head of the Marketing, Supply and Logistics department. Mr. Edwards joined Energy in 1982 and held various positions within Energy's refining operations, refining planning, business development and marketing departments prior to the Restructuring. Mr. Hohnholt was elected Vice President of the Company in January 1998 and functions as the head of the Refining Operations and Planning department. Prior to that he was General Manager of the Corpus Christi Refinery. Mr. Hohnholt joined Energy in 1982 and held various positions within Energy's refining operations department prior to the Restructuring. Employees As of January 31, 1998, the Company had 1,855 employees. ITEM 2. PROPERTIES The Company's properties include the Acquired Refineries, the Corpus Christi Refinery, and related facilities located in the States of Texas and Louisiana. See "Refining Operations" for additional information regarding properties of the Company. The Company believes that its facilities are generally adequate for their respective operations and that its facilities are maintained in a good state of repair. The Company is the lessee under a number of cancelable and non-cancelable leases for certain real properties, including office facilities and various facilities and equipment used to store, transport and produce refinery feedstocks and/or refined products. See Note 14 of Notes to Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS Litigation Relating to Operations of Basis Prior to Acquisition Basis has been named as a party to numerous claims and legal proceedings which arose prior to its acquisition by the Company. Pursuant to the Stock Purchase Agreement between Energy, the Company, Salomon, and Basis, Salomon assumed the defense of all known suits, actions, claims and investigations pending at the time of the acquisition and all obligations, liabilities and expenses related to or arising therefrom. In addition, Salomon agreed to assume all obligations, liabilities and expenses related to or resulting from all private third-party suits, actions and claims which arise out of a state of facts existing on or prior to the time of the acquisition (including "superfund" liability), but which were not pending at such time, subject to certain terms, conditions and limitations. In certain pending matters, the plaintiffs are requesting injunctive relief which, if granted, could potentially result in the operations acquired in connection with the purchase of Basis being adversely affected through required reductions in emissions, discharges or refinery throughput, which could be outside Salomon's indemnity obligations. The Company and Salomon reached an agreement in December 1997 whereby Salomon paid the Company $9.5 million in settlement of certain of Salomon's contingent environmental obligations assumed under the Stock Purchase Agreement. This settlement did not affect Salomon's other indemnity obligations described in this paragraph. Litigation Relating to Discontinued Operations Energy and certain of its natural gas related subsidiaries, as well as the Company, have been sued by Teco Pipeline Company ("Teco") regarding the operation of the 340-mile West Texas pipeline in which a subsidiary of Energy holds a 50% undivided interest. In 1985, a subsidiary of Energy sold a 50% undivided interest in the pipeline and entered into a joint venture through an ownership agreement and an operating agreement, each dated February 28, 1985, with the purchaser of the interest. In 1988, Teco succeeded to that purchaser's 50% interest. A subsidiary of Energy has at all times been the operator of the pipeline. Notwithstanding the written ownership and operating agreements, the plaintiff alleges that a separate, unwritten partnership agreement exists, and that the defendants have exercised improper dominion over such alleged partnership's affairs. The plaintiff also alleges that the defendants acted in bad faith by negatively affecting the economics of the joint venture in order to provide financial advantages to facilities or entities owned by the defendants and by allegedly usurping for the defendants' own benefit certain opportunities available to the joint venture. The plaintiff asserts causes of action for breach of fiduciary duty, fraud, tortious interference with business relationships, professional malpractice and other claims, and seeks unquantified actual and punitive damages. Energy's motion to compel arbitration was denied, but Energy has filed an appeal. Energy has also filed a counterclaim alleging that the plaintiff breached its own obligations to the joint venture and jeopardized the economic and operational viability of the pipeline by its actions. Energy is seeking unquantified actual and punitive damages. Although PG&E previously acquired Teco and now ultimately owns both Teco and Energy after the Restructuring, PG&E's Teco acquisition agreement purports to assign the benefit or detriment of this lawsuit to the former shareholders of Teco. Pursuant to the Distribution Agreement by which the Company was spun off to Energy's stockholders in connection with the Restructuring, the Company has agreed to indemnify and hold harmless Energy with respect to this lawsuit to the extent of 50% of the amount of any final judgment or settlement amount not in excess of $30 million, and 100% of that part of any final judgment or settlement amount in excess of $30 million. General The Company is also a party to additional claims and legal proceedings arising in the ordinary course of business. The Company believes it is unlikely that the final outcome of any of the claims or proceedings to which the Company is a party would have a material adverse effect on the Company's financial statements; however, due to the inherent uncertainty of litigation, the range of possible loss, if any, cannot be estimated with a reasonable degree of precision and there can be no assurance that the resolution of any particular claim or proceeding would not have an adverse effect on the Company's results of operations for the interim period in which such resolution occurred. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1997. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is listed under the symbol "VLO" on the New York Stock Exchange, which is the principal trading market for this security. As of January 30, 1998, there were approximately 6,000 holders of record and an estimated 15,000 additional beneficial owners of the Company's Common Stock. The Company's Common Stock began trading on the New York Stock Exchange on August 1, 1997 (the business day immediately following the Distribution). The following table sets forth the range of the high and low sales prices of the Common Stock as quoted in The Wall Street Journal New York Stock Exchange-Composite Transactions listing, and the amount of per-share dividends for each quarter in the preceding two years (i) for the Company after the Distribution and Merger and (ii) for Energy prior to the Distribution and Merger.
Sales Prices of the Dividends Common Stock per High Low Common Share Quarter Ended 1997: March 31 $36 3/8 $28 5/8 $.13 June 30 38 1/2 34 1/4 .13 September 30 (through 7/31/97) 43 36 1/4 - September 30 (after 7/31/97) 35 1/8 28 3/4 .08 December 31 34 26 15/16 .08 1996: March 31 $26 1/2 $22 1/8 $.13 June 30 29 24 1/2 .13 September 30 25 1/2 20 1/4 .13 December 31 30 21 7/8 .13
The Company's Board of Directors declared a quarterly dividend of $.08 per share of Common Stock at its January 29, 1998 meeting. Dividends are considered quarterly by the Company's Board of Directors and may be paid only when approved by the Board. ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below for the year ended December 31, 1997 is derived from the Company's Consolidated Financial Statements contained elsewhere herein. The selected financial data for the years ended prior to December 31, 1997 is derived from the selected financial data contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1996 except as noted below. The following summaries are in thousands of dollars except for per share amounts:
Year Ended December 31, 1997(b) 1996 1995 1994 1993 OPERATING REVENUES (a) $5,756,220 $2,757,853 $1,772,638 $1,090,497 $1,044,811 OPERATING INCOME (a) $ 211,034 $ 89,748 $ 123,755 $ 63,611 $ 60,923 INCOME FROM CONTINUING OPERATIONS (a) $ 111,768 $ 22,472 $ 58,242 $ 18,511 $ 14,032 INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES (a) $ (15,672) $ 50,229 $ 1,596 $ (1,229) $ 22,392 NET INCOME $ 96,096 $ 72,701 $ 59,838 $ 17,282 $ 36,424 Less: Preferred stock dividend requirements and redemption premium 4,592 11,327 11,818 9,490 1,262 NET INCOME APPLICABLE TO COMMON STOCK $ 91,504 $ 61,374 $ 48,020 $ 7,792 $ 35,162 EARNINGS (LOSS) PER SHARE OF COMMON STOCK: Continuing operations (a) $ 2.16 $ .51 $ 1.33 $ .43 $ .33 Discontinued operations (a) (.39) .89 (.23) (.25) .49 Total $ 1.77 $ 1.40 $ 1.10 $ .18 $ .82 EARNINGS (LOSS) PER SHARE OF COMMON STOCK - ASSUMING DILUTION: Continuing operations (a) $ 2.03 $ .44 $ 1.16 $ .38 $ .33 Discontinued operations (a) (.29) .98 .01 (.05) .49 Total $ 1.74 $ 1.42 $ 1.17 $ .33 $ .82 TOTAL ASSETS (a) $2,493,043 $1,985,631 $1,904,655 $1,869,198 $1,574,293 LONG-TERM OBLIGATIONS AND REDEEMABLE PREFERRED STOCK (a) $ 430,183 $ 354,457 $ 461,521 $ 449,717 $ 406,512 DIVIDENDS PER SHARE OF COMMON STOCK $ .42 $ .52 $ .52 $ .52 $ .46 (a) Amounts for the years ended prior to December 31, 1997 have been restated to reflect Energy's natural gas related services business as discontinued operations pursuant to the Restructuring. (b) Includes the operations of the Texas City, Houston and Krotz Springs refineries commencing May 1, 1997.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESTRUCTURING On July 31, 1997, Valero Energy Corporation ("Energy") completed the spin-off of its refining and marketing subsidiary, Valero Refining and Marketing Company, to its shareholders and the merger of its natural gas related services business with PG&E Corporation ("PG&E")(collectively referred to as the "Restructuring"). Upon completion of the Restructuring, Valero Refining and Marketing Company was renamed Valero Energy Corporation ("Valero," and together with its consolidated subsidiaries, the "Company") and is listed on the New York Stock Exchange under the symbol "VLO." The Restructuring was the result of a management recommendation announced in November 1996 to pursue strategic alternatives involving Energy's principal business activities. See Note 1 of Notes to Consolidated Financial Statements for additional information about the Restructuring. For financial reporting purposes under the federal securities laws, Valero is a "successor registrant" to Energy. As a result, the following Management's Discussion and Analysis of Financial Condition and Results of Operations, and the consolidated financial statements included elsewhere herein reflect Energy's natural gas related services business as discontinued operations of the Company. As the context requires, references to "Energy" are to (i) Valero Energy Corporation and its consolidated subsidiaries, both individually and collectively, for all periods prior to the close of business on July 31, 1997, the effective date of the Restructuring, and (ii) the natural gas related services business which was merged with PG&E for all periods subsequent to July 31, 1997. The following review of the Company's results of operations and liquidity and capital resources should be read in conjunction with the consolidated financial statements and the notes thereto of the Company presented on pages 30 to 64. EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which became effective for the Company's financial statements beginning with the period ending December 31, 1997. This statement supersedes APB Opinion No. 15, "Earnings per Share," and related interpretations and establishes new standards for computing and presenting earnings per share, requiring a dual presentation for companies with complex capital structures. In accordance with this new statement, the Company has presented basic and diluted earnings per share on the face of the accompanying Consolidated Statements of Income. References to "per share" amounts in the following discussion of Results of Operations are to basic earnings per share. FORWARD-LOOKING STATEMENTS The following discussion contains certain estimates, predictions, projections and other "forward-looking statements" (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect the Company's current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions, or other future performance suggested herein. Some important factors (but not necessarily all factors) that could affect the Company's sales volumes, growth strategies, future profitability and operating results, or that otherwise could cause actual results to differ materially from those expressed in any forward-looking statement include the following: renewal or satisfactory replacement of the Company's residual oil ("resid") feedstock arrangements as well as market, political or other forces generally affecting the pricing and availability of resid and other refinery feedstocks and refined products; accidents or other unscheduled shutdowns affecting the Company's, its suppliers' or its customers' pipelines, plants, machinery or equipment; excess industry capacity; competition from products and services offered by other energy enterprises; changes in the cost or availability of third-party vessels, pipelines and other means of transporting feedstocks and products; ability to implement the cost reductions and operational changes related to, and realize the various assumptions and efficiencies projected for, the operation of the Texas City, Houston and Krotz Springs refineries; state and federal environmental, economic, safety and other policies and regulations, any changes therein, and any legal or regulatory delays or other factors beyond the Company's control; execution of planned capital projects; weather conditions affecting the Company's operations or the areas in which the Company's products are marketed; rulings, judgments, or settlements in litigation or other legal matters, including unexpected environmental remediation costs in excess of any reserves; the introduction or enactment of federal or state legislation; and changes in the credit ratings assigned to the Company's debt securities and trade credit. Certain of these risk factors are more fully discussed in the Company's Form S-1 registration statement filed with the Securities and Exchange Commission on May 13, 1997 ("Form S-1"). The Company undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. FINANCIAL AND OPERATING HIGHLIGHTS The following are the Company's financial and operating highlights for each of the three years in the period ended December 31, 1997. Amounts for 1996 and 1995 have been restated to reflect Energy's natural gas related services business as discontinued operations pursuant to the Restructuring. The amounts in the following table are in thousands of dollars, unless otherwise noted:
Year Ended December 31, 1997 (1) 1996 1995 Operating revenues $5,756,220 $2,757,853 $1,772,638 Operating income (loss): Refining and marketing $ 254,896 $ 118,192 $ 150,300 Administrative expenses (43,862) (28,444) (26,545) Total $ 211,034 $ 89,748 $ 123,755 Loss on investment in Proesa joint venture $ - $ (19,549) $ - Other income, net $ 6,978 $ 7,418 $ 5,876 Interest and debt expense, net $ (42,455) $ (38,534) $ (40,935) Income from continuing operations $ 111,768 $ 22,472 $ 58,242 Income (loss) from discontinued operations, net of income taxes $ (15,672) $ 50,229 $ 1,596 Net income $ 96,096 $ 72,701 $ 59,838 Net income applicable to common stock $ 91,504 $ 61,374 $ 48,020 Earnings (loss) per share of common stock: Continuing operations $ 2.16 $ .51 $ 1.33 Discontinued operations (.39) .89 (.23) Total $ 1.77 $ 1.40 $ 1.10 Earnings (loss) per share of common stock - assuming dilution: Continuing operations $ 2.03 $ .44 $ 1.16 Discontinued operations (.29) .98 .01 Total $ 1.74 $ 1.42 $ 1.17 Earnings before interest, taxes, depreciation and amortization ("EBITDA") $ 313,025 $ 164,958 $ 214,318 Ratio of EBITDA to interest expense (2) 7.1x 4.0x 4.8x Operating statistics: Corpus Christi refinery: Throughput volumes (Mbbls per day) 180 170 160 Operating cost per barrel $ 3.34 $ 3.29 $ 3.34 Texas City/Houston/Krotz Springs refineries: Throughput volumes (Mbbls per day) (3) 315 N/A N/A Operating cost per barrel (3) $ 2.30 N/A N/A Sales volumes (Mbbls per day) 630 291 231 Average throughput margin per barrel $ 4.64 $ 5.29 $ 6.25 (1) Includes the operations of the Texas City, Houston and Krotz Springs refineries commencing May 1, 1997. (2) Interest expense includes $18,164, $30,642 and $34,362 for 1997, 1996 and 1995, respectively, of interest on corporate debt that was allocated to continuing operations (see Note 3 of Notes to Consolidated Financial Statements). (3) 1997 amounts are for the eight months ended December 31, 1997.
RESULTS OF OPERATIONS 1997 COMPARED TO 1996 General The Company reported income from continuing operations of $111.8 million, or $2.16 per share, for the year ended December 31, 1997 compared to $22.5 million, or $.51 per share, for the year ended December 31, 1996. For the fourth quarter of 1997, income from continuing operations was $12.4 million, or $.22 per share, compared to a loss from continuing operations of $5.3 million, or $.12 per share, for the fourth quarter of 1996. Results from discontinued operations were a loss of $15.7 million, or $.39 per share, for the seven months ended July 31, 1997, and income of $24.1 million, or $.49 per share, and $50.2 million, or $.89 per share, for the quarter and year ended December 31, 1996, respectively. In determining earnings per share, dividends on Energy's preferred stock were deducted from income from discontinued operations as such preferred stock was issued in connection with Energy's natural gas related services business. The May 1, 1997 acquisition of the Texas City, Houston and Krotz Springs refineries (individually, the "Texas City Refinery," the "Houston Refinery" and the "Krotz Springs Refinery"), which were acquired from Salomon Inc in connection with the purchase of Basis Petroleum, Inc. ("Basis")(see Note 4 of Notes to Consolidated Financial Statements), added significantly to the Company's 1997 results. Income from continuing operations and related earnings per share increased significantly during 1997 compared to 1996 due primarily to an increase in operating income, partially offset by an increase in income tax expense. In addition, fourth quarter and total year results for 1996 were negatively impacted by a $19.5 million pre-tax loss resulting from the write-off of the Company's investment in its joint venture project to design, construct and operate a plant in Mexico to produce methyl tertiary butyl ether ("MTBE"). This loss reduced results from continuing operations for such periods by approximately $.29 per share. Operating Revenues Operating revenues increased $3 billion, or 109%, to $5.8 billion during 1997 compared to 1996 due to a 116% increase in average daily sales volumes resulting primarily from additional throughput volumes attributable to the May 1, 1997 acquisition of the Texas City, Houston and Krotz Springs refineries. Also contributing, to a lesser extent, to the increase in sales volumes was an increase in marketing activities and a 6% increase in throughput volumes at the Company's Corpus Christi refinery ("Corpus Christi Refinery") resulting from, among other things, various unit capacity expansions completed in late 1996 and 1997 and less unit downtime experienced in 1997 compared to 1996. Operating Income Operating income increased $121.3 million, or 135%, to $211 million during 1997 compared to 1996 due to an approximate $84 million contribution from the operations related to the Texas City, Houston and Krotz Springs refineries, and to an approximate $67 million increase in total throughput margins for the operations related to the Corpus Christi Refinery. Partially offsetting these increases in operating income were an approximate $15 million increase in operating costs at the Corpus Christi Refinery (explained below) and an approximate $15 million increase in administrative expenses resulting primarily from higher employee-related costs, including the effect of additional personnel resulting from the acquisition of Basis in May 1997. Total throughput margins for the operations related to the Corpus Christi Refinery increased during 1997 compared to 1996 due to a substantial improvement in the price differential between conventional gasoline and crude oil, higher oxygenate margins resulting primarily from a decrease in methanol feedstock costs as a result of lower production costs at the Company's joint venture methanol plant in Clear Lake, Texas ("Clear Lake Methanol Plant"), and higher premiums on sales of reformulated gasoline and petrochemical feedstocks, including a substantial benefit from the sale of mixed xylenes produced from the xylene fractionation unit that was placed in service at the Corpus Christi Refinery in January 1997. Total throughput margins for the operations related to the Corpus Christi Refinery were also higher in 1997 due to less unit downtime compared to 1996 as described below. The increases resulting from these factors were partially offset by lower discounts on purchases of resid feedstocks during the last nine months of the year due to high demand for resid in the Far East and a decrease in crude oil prices. The $15 million, or 7%, increase in operating costs at the Corpus Christi Refinery was due primarily to increases in maintenance and employee-related costs, incremental costs associated with the xylene fractionation unit, and higher variable costs resulting from the above noted increase in throughput volumes. However, due to such increase in throughput volumes, operating costs per barrel at the Corpus Christi Refinery increased only 2%. At the Corpus Christi Refinery, turnarounds of the crude and vacuum units were completed in April 1997 which increased the crude unit's capacity by approximately 8,000 barrels per day. Also, in the second quarter of 1997, the heavy oil cracking unit ("HOC") was shut down for approximately 14 days as a result of various unit malfunctions. In 1996, a maintenance turnaround and a catalyst change for the hydrodesulfurization ("HDS") unit were completed in July, a turnaround of the MTBE Plant was completed in September during which its capacity was increased by approximately 1,500 barrels per day, and turnarounds of the hydrocracker and naphtha reformer units were completed in December. Also, in the 1996 second quarter, two power outages resulted in reduced run rates for several units. In addition, the Clear Lake Methanol Plant was out of service for approximately three months beginning in December 1996 as a result of an explosion that occurred as the plant was being shut down for repairs. At the Texas City Refinery, a turnaround and catalyst change for the residfiner unit was completed in July 1997. At the Houston Refinery, the fluid catalytic cracking unit ("FCC Unit") was shut down for repairs for approximately 11 days in the 1997 second quarter and approximately 14 days in December 1997, during which times minor turnarounds were completed. See "Outlook" for a discussion of maintenance turnarounds scheduled at the Company's refineries in 1998. The Company enters into various exchange-traded and over-the-counter financial instrument contracts with third parties to manage price risk associated with refining feedstock and fuel purchases, refined product inventories and refining operating margins. Although such activities are intended to limit the Company's exposure to loss during periods of declining margins, such activities could tend to reduce the Company's participation in rising margins. In 1997 and 1996, the effect of hedging activities on refining throughput margins was not significant. In 1996, the Company reduced its operating costs by approximately $2.8 million as a result of hedges on refining natural gas fuel requirements. The effect of such hedging activities on operating costs in 1997 was not significant. See Note 2 under "Price Risk Management Activities" and Note 7 of Notes to Consolidated Financial Statements. Net Interest and Debt Expense Net interest and debt expense increased $3.9 million, or 10%, to $42.4 million during 1997 compared to 1996 due primarily to interest on bank borrowings related to the acquisition of Basis and to the special pre-Distribution dividend paid to Energy described in Note 1 of Notes to Consolidated Financial Statements. The increase in net interest and debt expense resulting from these factors was partially offset by a $12.5 million decrease in interest expense on allocated corporate debt (see Notes 3 and 6 of Notes to Consolidated Financial Statements), and by a reduction in bank borrowings resulting from cash provided by operations subsequent to the Restructuring. Income Tax Expense Income tax expense increased $47.2 million to $63.8 million during 1997 compared to 1996 due primarily to higher pre-tax income from continuing operations. Discontinued Operations The loss from discontinued operations in 1997 of $15.7 million (net of an income tax benefit of $8.9 million), or $.39 per share, reflected the net loss of Energy's natural gas related services business for the seven months ended July 31, 1997, prior to consummation of the Restructuring. Income from discontinued operations in 1996 of $50.2 million (net of income tax expense of $24.4 million), or $.89 per share, reflected the net income of Energy's natural gas related services business for all of such year. See Note 3 of Notes to Consolidated Financial Statements for additional information. 1996 COMPARED TO 1995 General The Company reported income from continuing operations of $22.5 million, or $.51 per share, for the year ended December 31, 1996 compared to $58.2 million, or $1.33 per share, for the year ended December 31, 1995. For the fourth quarter of 1996, the Company reported a loss from continuing operations of $5.3 million, or $.12 per share, compared to income from continuing operations of $11.1 million, or $.25 per share, for the fourth quarter of 1995. Results from discontinued operations were income of $24.1 million, or $.49 per share, and $50.2 million, or $.89 per share, for the quarter and year ended December 31, 1996, respectively, and income (loss) of $1.8 million, or $(.02) per share, and $1.6 million, or $(.23) per share, for the quarter and year ended December 31, 1995. In determining earnings per share for the 1996 and 1995 periods, dividends on Energy's preferred stock were deducted from income from discontinued operations as such preferred stock was issued in connection with Energy's natural gas related services business. Income from continuing operations and related earnings per share decreased during the 1996 fourth quarter and total year compared to the same periods in 1995 due primarily to a decrease in refining and marketing operating income, and a $19.5 million pre-tax loss recorded in the fourth quarter of 1996 resulting from the write-off of the Company's investment in its Mexico MTBE project which reduced results from continuing operations by approximately $.29 per share. Operating Revenues Operating revenues increased $807.1 million, or 41%, to $2.8 billion during 1996 compared to 1995 due primarily to a 26% increase in sales volumes and a 12% increase in the average sales price per barrel. The increase in sales volumes was due primarily to increased volumes from trading and rack marketing activities, and a 6% increase in average daily throughput volumes at the Corpus Christi Refinery resulting from various unit improvements and enhancements made during 1995 and a reduced impact on production due to unit turnarounds which occurred in 1996 compared to 1995, partially offset by the effects of two second quarter 1996 power outages. The average sales price per barrel increased due primarily to higher gasoline and distillate prices which generally followed an increase in crude oil prices during 1996. Operating Income Operating income decreased $34 million, or 27%, to $89.7 million during 1996 compared to 1995 due primarily to a decrease in total throughput margins and higher operating costs. The decrease in total throughput margins was due primarily to lower oxygenate margins resulting from higher butane feedstock costs, particularly in the fourth quarter, lower margins on sales of petrochemical feedstocks, and decreased results from price risk management activities. These decreases in throughput margins were partially offset by the increase in throughput volumes noted above in the discussion of operating revenues, higher distillate margins, and an improvement in discounts on purchases of resid feedstocks. Operating expenses increased due primarily to costs associated with the Clear Lake Methanol Plant which was placed in service in late August 1995 and higher variable costs resulting from increased throughput at the Corpus Christi Refinery. In 1996, refining throughput margins were reduced by $1.2 million as a result of hedging activities compared to a $12.8 million benefit in 1995. The 1995 benefit resulted primarily from favorable price swap contracts on methanol, as methanol prices dropped by over 70% during that year. In 1996 and 1995, the Company reduced its operating costs by $2.8 million and $1 million, respectively, as a result of hedges on refining natural gas fuel requirements. Net Interest and Debt Expense Net interest and debt expense decreased $2.4 million to $38.5 million during 1996 compared to 1995 due primarily to a decrease in bank borrowings. Income Tax Expense Income tax expense decreased $13.8 million in 1996 compared to 1995 due primarily to lower pre-tax income. Discontinued Operations Income from discontinued operations in 1996 of $50.2 million (net of income tax expense of $24.4 million), or $.89 per share, and in 1995 of $1.6 million (net of income tax expense of $4.8 million), or a loss of $.23 per share, reflected the net income of Energy's natural gas related services business for all of such years. See Note 3 of Notes to Consolidated Financial Statements for additional information. OUTLOOK Over the next few years, the Company anticipates a moderate improvement in refining margins due to tightening refining capacity. Increased demand for light products is expected to outpace capacity additions due to slow growth in capacity additions resulting from poor margins experienced in recent years. Excess conversion capacity triggered by enhanced conversion capacity projects in the early to mid-1990's has now been fully absorbed, and any such projects currently planned will not keep pace with an expected increase in the supply of heavy crudes resulting from increased Middle East and Latin American production. As a result, the spread between light and heavy crudes is expected to increase. The quantity and quality of resid feedstock is expected to decrease as conversion capacity expansions come on-line in the Middle East and Asia. Domestic gasoline demand, which increased 2.5% in 1997 versus only 1% in 1996, is expected to continue to improve due to a strong economy and the trend in recent years toward less fuel-efficient vehicles. Demand for clean-burning fuels, such as RFG, is expected to continue to increase resulting from the worldwide movement to reduce lead in gasoline. The demand for RFG increased to 32.5% of the total demand for gasoline in the U.S. in 1997, up from 30.3% in 1996, primarily due to the full-year effect of the implementation in 1996 of the requirement for the use of Phase II RFG in California and the opt-in to RFG by Phoenix in the summer of 1997. The increasing demand for clean-burning fuels should sustain a strong demand for oxygenates such as MTBE. Certain initiatives have been presented in California which would restrict or potentially ban the use of MTBE as a gasoline component. Based on available information, the Company believes that numerous scientific studies commissioned by the EPA, CARB, and others will result in defeat of these initiatives. However, if MTBE were to be restricted or banned, the Company believes that its MTBE-producing facility could be modified to produce a product similar to alkylate or other petrochemicals. The Company expects a continuation of the recent industry consolidations through mergers and acquisitions, making for a more competitive business environment while providing the Company with opportunities to expand its operations. Beginning in 1998, the Company expects to undertake a capital expansion program to increase the throughput capacity of its refinery facilities by approximately 140,000 barrels per day, and increase the operational flexibility of the refineries. The majority of such program is anticipated to be performed in 1999 during scheduled maintenance turnarounds. The Company's turnaround schedule for 1998 is light. During January 1998, catalyst change-outs in the HDS unit and the hydrocracker/reformer complex, as well as a maintenance turnaround of the MTBE Plant, were completed at the Corpus Christi Refinery. A catalyst change in the residfiner at the Texas City Refinery is currently scheduled to begin in late March 1998. During 1999, maintenance turnarounds for most of the Company's major refining units are planned. Such turnarounds are scheduled to occur early in the first quarter and in the fourth quarter when refining margins are historically low so as to minimize the impact on the Company's operating results. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by continuing operations increased $76.2 million to $196.6 million during 1997 compared to 1996 due to the increase in income from continuing operations discussed above under "Results of Operations," partially offset by the changes in current assets and current liabilities detailed in Note 2 of Notes to Consolidated Financial Statements under "Statements of Cash Flows." Included in the changes in current assets and current liabilities for 1997 was a substantial decrease in accounts payable offset to a large extent by decreases in accounts receivable and inventories. Accounts payable and accounts receivable decreased in 1997 due to lower commodity prices. In 1996, inventories increased due to increased wholesale marketing activities for the operations related to the Corpus Christi Refinery. The inventory increase in 1996 was almost entirely offset by the net change in accounts receivable and accounts payable, both of which increased due to higher commodity prices and increased purchase and sales volumes. During 1997, cash provided by operating activities, along with net proceeds from bank and other borrowings (see Note 6 of Notes to Consolidated Financial Statements), and issuances of common stock related to Energy's benefit plans totaled approximately $748 million. These funds were utilized to acquire Basis, fund capital expenditures and deferred turnaround and catalyst costs, pay common and preferred stock dividends, pay a special dividend to Energy and settle the intercompany note balance with Energy pursuant to the Distribution Agreement (see Note 1 of Notes to Consolidated Financial Statements), purchase treasury stock, and redeem the remaining outstanding shares of Energy's Series A Preferred Stock (see Note 8 of Notes to Consolidated Financial Statements). The Company currently maintains a five-year, unsecured $835 million revolving bank credit and letter of credit facility that matures in November 2002 and is available for general corporate purposes including working capital needs and letters of credit. Borrowings under this facility bear interest at either LIBOR plus a margin, a base rate or a money market rate. The Company is also charged various fees and expenses, including a facility fee and various letter of credit fees. The interest rate and fees under the credit facility are subject to adjustment based upon the credit ratings assigned to the Company's long-term debt. The credit facility includes certain restrictive covenants including a coverage ratio, a capitalization ratio, and a minimum net worth test, none of which are expected to limit the Company's ability to operate in the ordinary course of business. As of December 31, 1997, the Company had approximately $558 million available under this committed bank credit facility for additional borrowings and letters of credit. The Company also has numerous uncommitted short-term bank credit facilities, along with several uncommitted letter of credit facilities. As of December 31, 1997, a minimum of $120 million and a maximum of $313 million were available for additional borrowings under the short-term bank credit facilities, and approximately $232 million was available for additional letters of credit under the uncommitted letter of credit facilities. As of December 31, 1997, the Company's debt to capitalization ratio was 32.3%. The Company was in compliance with all covenants contained in its bank credit and letter of credit facilities, and other debt facilities noted below, as of December 31, 1997. See Notes 5 and 6 of Notes to Consolidated Financial Statements. During 1997, the Company undertook various initiatives to lower its future interest payments and increase its financial flexibility. In April 1997, the Company refinanced $98.5 million principal amount of 10 1/4% to 10 5/8% tax-exempt industrial revenue bonds, which had due dates ranging from 2008 to 2017, with $98.5 million of variable rate tax-exempt industrial revenue bonds which have due dates ranging from 2009 to 2027. These bonds bore interest at rates ranging from 3.65% to 3.95% as of December 31, 1997. In May 1997, the Company issued $25 million of new variable rate tax-exempt industrial revenue bonds due in 2031 and used the proceeds to reduce bank borrowings. These bonds bore interest at 3.8% as of December 31, 1997. In addition, in December 1997, the Company issued $150 million principal amount of notes ("Notes") at an effective interest rate of 5.86% over the initial five years of their term, also using the proceeds to reduce bank borrowings. If the 30-year Treasury rate has decreased below 6.13% at the end of five years from the date of issuance of the Notes, a third party will likely exercise its option to purchase the Notes and the term of the Notes will be extended thirty years at 6.13% plus the Company's prevailing credit spread. If at the end of five years from the date of issuance of the Notes, the 30-year Treasury rate is higher than 6.13% and as a result the third party does not exercise its purchase option, then the Company will be required to repurchase the Notes at par. See Note 6 of Notes to Consolidated Financial Statements. In order to reduce the Company's exposure to increases in interest rates, in January 1998, the Company's Board of Directors approved the commencement of efforts to convert the interest rates on the Company's $123.5 million of outstanding industrial revenue bonds from variable rates to fixed rates. At the same time, the Board approved the issuance of an additional $25 million of tax-exempt industrial revenue bonds at a fixed interest rate and the issuance of up to $43.5 million of taxable industrial revenue bonds at variable interest rates, both of which are expected to mature in the year 2032. The $43.5 million of variable rate bonds will be supported by a letter of credit issued under the Company's $835 million revolving bank credit facility. The letters of credit issued under such facility and associated with the above noted $123.5 million of outstanding tax-exempt bonds will be released upon conversion of the interest rates from variable to fixed. The interest rate conversion of the outstanding bonds and the issuance of the new bonds are expected to be completed by the end of the first quarter of 1998. As described in Note 4 of Notes to Consolidated Financial Statements, Energy acquired the outstanding common stock of Basis on May 1, 1997 for approximately $356 million in cash, funded with borrowings under Energy's bank credit facilities, and Energy common stock which had a fair market value of $114 million on the date of issuance. Although Basis incurred significant operating losses during 1995 and 1996, the Texas City, Houston and Krotz Springs refineries and related marketing operations were able to contribute approximately $84 million to the Company's operating income for the months of May through December 1997, as described above under "Results of Operations." The achievement of such results was due to, among other things, refinery upgrading projects completed both prior to and after the acquisition, favorable market conditions which existed throughout much of the year, a reduction in depreciation and amortization expense due to the acquisition cost of Basis being less than its net book value, and a reduction in operating and overhead costs through various operational and personnel-related changes implemented by the Company. The Company believes that the operations related to the Texas City, Houston and Krotz Springs refineries will continue to benefit the Company's consolidated cash flow and earnings. During 1997, the Company expended, exclusive of the Basis acquisition cost, approximately $133 million for capital investments, including capital expenditures of $122 million and deferred turnaround and catalyst costs of $11 million. Of the total capital investment amount, $80 million related to continuing refining and marketing operations while $53 million related to the discontinued natural gas related services operations. Included in the refining and marketing amount was approximately $21 million related to the Texas City, Houston and Krotz Springs refineries for expenditures during the months of May through December. For 1998, the Company currently expects to incur approximately $175 to $225 million for capital investments, including approximately $40 to $50 million for deferred turnaround and catalyst costs. Dividends on the Company's Common Stock are considered quarterly by the Company's Board of Directors, and may be paid only when approved by the Board. Prior to the Restructuring, Energy declared dividends on its common stock of $.13 per share during each of the first two quarters of 1997. Following the Restructuring, the Company declared dividends of $.08 per common share during each of the last two quarters of 1997 and the first quarter of 1998. Because appropriate levels of dividends are determined by the Board on the basis of earnings and cash flows, the Company cannot assure the continuation of Common Stock dividends at any particular level. The Company believes it has sufficient funds from operations, and to the extent necessary, from the public and private capital markets and bank markets, to fund its ongoing operating requirements. The Company expects that, to the extent necessary, it can raise additional funds from time to time through equity or debt financings; however, except for the new issuances of industrial revenue bonds described above and borrowings under bank credit agreements, the Company has no specific financing plans as of the date hereof to increase the amount of debt outstanding. The Company's refining and marketing operations have a concentration of customers in the oil refining industry and spot and retail gasoline markets. These concentrations of customers may impact the Company's overall exposure to credit risk, either positively or negatively, in that the customers in such industry and markets may be similarly affected by changes in economic or other conditions. However, the Company believes that its portfolio of accounts receivable is sufficiently diversified to the extent necessary to minimize potential credit risk. Historically, the Company has not had any significant problems collecting its accounts receivable. The Company's accounts receivable are not collateralized. The Company's refining and marketing operations are subject to environmental regulation at the federal, state and local levels. Capital expenditures for environmental control and protection for its refining and marketing operations totaled approximately $15 million in 1997 and are expected to be approximately $21 million in 1998. These amounts are exclusive of any amounts related to constructed facilities for which the portion of expenditures relating to environmental requirements is not determinable. The Corpus Christi Refinery was completed in 1984 under more stringent environmental requirements than many existing United States refineries, which are older and were built before such environmental regulations were enacted. As a result, the Company believes that it will be able to more easily comply with present and future environmental legislation with respect to such facility. Within the next several years, all U.S. refineries must obtain federal operating permits under provisions of the Clean Air Act Amendments of 1990 (the "Clean Air Act"). As new rules are promulgated under the Clean Air Act, the recently acquired Texas City, Houston and Krotz Springs refineries will require additional capital investments to upgrade some of their pollution control technology. The Refinery MACT II (Maximum Available Control Technology) standards are anticipated to be published in proposed form during the second quarter of 1998. These rules will require refiners to control toxic emissions from fluid catalytic crackers, sulfur recovery units, and reformers. Once the proposed rules are published, the Company will be able to determine what, if any, capital improvements will be required at the Texas City, Houston and Krotz Springs refineries. The final MACT II rules are anticipated to be published in late 1998 with a three year compliance schedule to install pollution control technology. The estimated amount of 1998 environmental expenditures noted above includes amounts for pollution control equipment installation at the Texas City, Houston and Krotz Springs refineries. Sulfur plant modifications are not anticipated for the Corpus Christi or Texas City refineries; however, depending on the outcome of the MACT II rules, sulfur plant control may be necessary for the Houston and Krotz Springs refineries. The Clean Air Act is not expected to have any significant adverse impact on the Company's operations and the Company does not anticipate that it will be necessary to expend any material amounts in 1998 in addition to those mentioned above for environmental control and protection. The Company is not aware of any material environmental remediation costs related to its operations. See Notes 4 and 15 of Notes to Consolidated Financial Statements for information regarding the settlement of certain of Salomon's contingent environmental obligations for which it was liable in connection with the Company's acquisition of Basis. NEW ACCOUNTING STANDARDS In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements and requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement requires that an enterprise classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Reclassification of prior period financial statements presented for comparative purposes is required. This statement becomes effective for the Company's financial statements beginning in 1998 and requires that a total for comprehensive income be reported in interim period financial statements issued to shareholders. Based on current accounting standards, the adoption of this statement is not expected to impact the Company's consolidated financial statements. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes new standards for reporting information about operating segments in annual financial statements and requires selected operating segment information to be reported in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement becomes effective for the Company's financial statements beginning with the year ended December 31, 1998 at which time restatement of prior period segment information presented for comparative purposes is required. Interim period information is not required until the second year of application, at which time comparative information is required. The adoption of this statement is not expected to impact the Company's consolidated financial statement disclosures. In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets, and eliminates certain disclosures that are no longer useful. This statement becomes effective for the Company's financial statement disclosures beginning in 1998 and requires restatement of prior period disclosures presented for comparative purposes unless the information is not readily available. The FASB had previously issued in February 1997 SFAS No. 128, "Earnings per Share," (discussed above) and SFAS No. 129, "Disclosure of Information about Capital Structure," both of which became effective for the Company's financial statements beginning with the period ending December 31, 1997. As the purpose of SFAS No. 129 was primarily to consolidate certain disclosure requirements previously contained in other pronouncements with which the Company was already in compliance, the adoption of this statement had no effect on the Company's accompanying consolidated financial statements. YEAR 2000 COMPUTER ISSUES Historically, certain computer programs have been written using two digits rather than four to define the applicable year, which could result in the computer recognizing a date using "00" as the year 1900 rather than the year 2000. This, in turn, could result in major system failures or miscalculations, and is generally referred to as the "Year 2000" problem. In late 1996, the Company began the implementation of new client/server based systems which will run substantially all of the Company's principal data processing and financial reporting software applications. These new systems are Year 2000 compliant and are expected to be completed by the end of 1998. The Company is also currently evaluating the computerized production equipment at its refineries to ensure that the transition to the Year 2000 will not disrupt the Company's processing capabilities. In addition, the Company intends to communicate with, and evaluate the systems of, its customers, suppliers, financial institutions and others with which it does business to identify any Year 2000 issues. Presently, the Company does not believe that Year 2000 compliance will result in material investments by the Company, nor does the Company anticipate that the Year 2000 problem will have a material adverse effect on the operations or financial performance of the Company. There can be no assurance, however, that the Year 2000 problem will not adversely affect the Company and its business. ITEM 8. FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of Valero Energy Corporation: We have audited the accompanying consolidated balance sheets of Valero Energy Corporation (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, common stock and other stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valero Energy Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Antonio, Texas February 14, 1998
VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Thousands of Dollars) December 31, 1997 1996 A S S E T S CURRENT ASSETS: Cash and temporary cash investments $ 9,935 $ 10 Receivables, less allowance for doubtful accounts of $1,275 (1997) and $975 (1996) 366,315 162,457 Inventories 369,355 159,871 Current deferred income tax assets 17,155 17,587 Prepaid expenses and other 26,265 11,924 789,025 351,849 PROPERTY, PLANT AND EQUIPMENT - including construction in progress of $66,636 (1997) and $21,728 (1996), at cost 2,132,489 1,712,334 Less: Accumulated depreciation 539,956 480,124 1,592,533 1,232,210 NET ASSETS OF DISCONTINUED OPERATIONS - 280,515 DEFERRED CHARGES AND OTHER ASSETS 111,485 121,057 $2,493,043 $1,985,631 L I A B I L I T I E S A N D S T O C K H O L D E R S' E Q U I T Y CURRENT LIABILITIES: Short-term debt $ 122,000 $ 57,728 Current maturities of long-term debt - 26,037 Accounts payable 414,305 191,555 Accrued expenses 60,979 25,264 597,284 300,584 LONG-TERM DEBT, less current maturities 430,183 353,307 DEFERRED INCOME TAXES 256,858 224,548 DEFERRED CREDITS AND OTHER LIABILITIES 49,877 30,217 REDEEMABLE PREFERRED STOCK, SERIES A, issued 1,150,000 shares, outstanding -0- (1997) and 11,500 (1996) shares - 1,150 COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY: Preferred stock, $.01 (1997) and $1 (1996) par value - 20,000,000 shares authorized including redeemable preferred shares: $3.125 Convertible Preferred Stock, issued and outstanding -0- (1997) and 3,450,000 (1996) shares - 3,450 Common stock, $.01 (1997) and $1 (1996) par value - 150,000,000 shares authorized; issued 56,136,032 (1997) and 44,185,513 (1996) shares 561 44,186 Additional paid-in capital 1,110,654 540,133 Unearned Valero Employees' Stock Ownership Plan Compensation - (8,783) Retained earnings 47,626 496,839 1,158,841 1,075,825 $2,493,043 $1,985,631
VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Thousands of Dollars, Except Per Share Amounts) Year Ended December 31, 1997 1996 1995 OPERATING REVENUES $5,756,220 $2,757,853 $1,772,638 COSTS AND EXPENSES: Cost of sales and operating expenses 5,426,438 2,581,836 1,560,324 Selling and administrative expenses 53,573 31,248 31,392 Depreciation expense 65,175 55,021 57,167 Total 5,545,186 2,668,105 1,648,883 OPERATING INCOME 211,034 89,748 123,755 LOSS ON INVESTMENT IN PROESA JOINT VENTURE - (19,549) - OTHER INCOME, NET 6,978 7,418 5,876 INTEREST AND DEBT EXPENSE: Incurred (44,150) (41,418) (45,052) Capitalized 1,695 2,884 4,117 INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 175,557 39,083 88,696 INCOME TAX EXPENSE 63,789 16,611 30,454 INCOME FROM CONTINUING OPERATIONS 111,768 22,472 58,242 INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAX EXPENSE (BENEFIT) OF $(8,889), $24,389 AND $4,846, RESPECTIVELY (15,672) 50,229 1,596 NET INCOME 96,096 72,701 59,838 Less: Preferred stock dividend requirements and redemption premium 4,592 11,327 11,818 NET INCOME APPLICABLE TO COMMON STOCK $ 91,504 $ 61,374 $ 48,020 EARNINGS (LOSS) PER SHARE OF COMMON STOCK: Continuing operations $ 2.16 $ .51 $ 1.33 Discontinued operations (.39) .89 (.23) Total $ 1.77 $ 1.40 $ 1.10 Weighted average common shares outstanding (in thousands) 51,662 43,926 43,652 EARNINGS (LOSS) PER SHARE OF COMMON STOCK - ASSUMING DILUTION: Continuing operations $ 2.03 $ .44 $ 1.16 Discontinued operations (.29) .98 .01 Total $ 1.74 $ 1.42 $ 1.17 Weighted average common shares outstanding (in thousands) 55,129 50,777 50,243 DIVIDENDS PER SHARE OF COMMON STOCK $ .42 $ .52 $ .52
VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY (Thousands of Dollars) Convertible Number of Additional Unearned Preferred Common Common Paid-in VESOP Retained Treasury Stock Shares Stock Capital Compensation Earnings Stock BALANCE, December 31, 1994 $3,450 43,463,869 $43,464 $ 536,613 $(13,706) $433,059 $ - Net income - - - - - 59,838 - Dividends on Series A Preferred Stock - - - - - (1,075) - Dividends on Convertible Preferred Stock - - - - - (10,781) - Dividends on Common Stock - - - - - (22,698) - Valero Employees' Stock Ownership Plan compensation earned - - - - 2,388 - - Deficiency payment tax effect - - - (9,106) - - - Shares repurchased and shares issued pursuant to employee stock plans and other - 275,511 275 2,670 - - (178) BALANCE, December 31, 1995 3,450 43,739,380 43,739 530,177 (11,318) 458,343 (178) Net income - - - - - 72,701 - Dividends on Series A Preferred Stock - - - - - (587) - Dividends on Convertible Preferred Stock - - - - - (10,781) - Dividends on Common Stock - - - - - (22,837) - Valero Employees' Stock Ownership Plan compensation earned - - - - 2,535 - - Shares repurchased and shares issued pursuant to employee stock plans and other - 446,133 447 9,956 - - 178 BALANCE, December 31, 1996 3,450 44,185,513 44,186 540,133 (8,783) 496,839 - Net income - - - - - 96,096 - Dividends on Series A Preferred Stock - - - - - (32) - Dividends on Convertible Preferred Stock - - - - - (5,387) - Dividends on Common Stock - - - - - (21,031) - Redemption/conversion of Convertible Preferred Stock (3,450) 6,377,432 6,377 (3,116) - - - Special spin-off dividend to Energy - - - (210,000) - - - Recapitalization pursuant to the Restructuring - - (55,533) 622,500 - (518,859) - Issuance of Common Stock in connection with acquisition of Basis Petroleum, Inc. - 3,429,796 3,430 110,570 - - - Valero Employees' Stock Ownership Plan compensation earned - - - - 8,783 - - Shares repurchased and shares issued pursuant to employee stock plans and other - 2,143,291 2,101 50,567 - - - BALANCE, December 31, 1997 $ - 56,136,032 $ 561 $1,110,654 $ - $ 47,626 $ -
VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars) Year Ended December 31, 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations $ 111,768 $ 22,472 $ 58,242 Adjustments to reconcile income from continuing operations to net cash provided by continuing operations: Depreciation expense 65,175 55,021 57,167 Loss on investment in Proesa joint venture - 19,549 - Amortization of deferred charges and other, net 27,252 28,485 25,426 Changes in current assets and current liabilities (32,113) (7,796) 2,358 Deferred income tax expense 32,827 8,969 29,217 Changes in deferred items and other, net (8,264) (6,246) (6,479) Net cash provided by continuing operations 196,645 120,454 165,931 Net cash provided by discontinued operations 24,452 126,054 792 Net cash provided by operating activities 221,097 246,508 166,723 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures: Continuing operations (69,284) (59,412) (89,395) Discontinued operations (52,674) (69,041) (35,224) Deferred turnaround and catalyst costs (10,860) (36,389) (35,590) Acquisition of Basis Petroleum, Inc. (355,595) - - Investment in and advances to joint ventures, net 1,400 1,197 (2,018) Dispositions of property, plant and equipment 28 93 49 Other, net 265 1,388 (1,226) Net cash used in investing activities (486,720) (162,164) (163,404) CASH FLOWS FROM FINANCING ACTIVITIES: Increase in short-term debt, net 155,088 57,728 - Long-term borrowings 1,530,809 44,427 366,095 Long-term debt reduction (1,217,668) (153,772) (335,816) Special spin-off dividend, including intercompany note settlement (214,653) - - Common stock dividends (21,031) (22,837) (22,698) Preferred stock dividends (5,419) (11,368) (11,856) Issuance of common stock 59,054 11,225 6,129 Purchase of treasury stock (9,293) (4,000) (4,445) Redemption of preferred stock (1,339) (5,750) (5,750) Net cash provided by (used in) financing activities 275,548 (84,347) (8,341) NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS 9,925 (3) (5,022) CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD 10 13 5,035 CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD $ 9,935 $ 10 $ 13
VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. RESTRUCTURING In the discussion below and Notes that follow, the "Company" refers to Valero Energy Corporation ("Valero") and its consolidated subsidiaries. Valero was formerly known as Valero Refining and Marketing Company prior to the Restructuring described below. Upon completion of the Restructuring, Valero Refining and Marketing Company was renamed Valero Energy Corporation. "Energy" refers to Valero Energy Corporation and its consolidated subsidiaries, both individually and collectively, for periods prior to the Restructuring, and to the natural gas related services business of Energy for periods subsequent to the Restructuring. On July 31, 1997, pursuant to an agreement and plan of distribution between Energy and Valero (the "Distribution Agreement"), Energy spun off Valero to Energy's stockholders by distributing all of Valero's $.01 par value common stock ("Common Stock") on a share for share basis to holders of record of Energy common stock at the close of business on such date (the "Distribution"). Immediately after the Distribution, Energy merged its natural gas related services business with a wholly owned subsidiary of PG&E Corporation ("PG&E") (the "Merger"). The Distribution and the Merger (collectively referred to as the "Restructuring") were approved by Energy's stockholders at Energy's annual meeting of stockholders held on June 18, 1997 and, in the opinion of Energy's outside counsel, were tax-free transactions. Regulatory approval of the Merger was received from the Federal Energy Regulatory Commission (the "FERC") on July 16, 1997. Upon completion of the Restructuring, Valero Refining and Marketing Company was renamed Valero Energy Corporation and is listed on the New York Stock Exchange under the symbol "VLO." Immediately prior to the Distribution, the Company paid to Energy a $210 million dividend pursuant to the Distribution Agreement. In addition, the Company paid to Energy approximately $5 million in settlement of the intercompany note balance between the Company and Energy arising from certain transactions during the period from January 1 through July 31, 1997. In connection with the Merger, PG&E issued approximately 31 million shares of its common stock in exchange for the outstanding $1 par value common shares of Energy, and assumed $785.7 million of Energy's debt. Each Energy stockholder received .554 of a share of PG&E common stock (trading on the New York Stock Exchange under the symbol "PCG") for each Energy share owned. This fractional share amount was based on the average price of PG&E common stock during a prescribed period preceding the closing of the transaction and the number of Energy shares issued and outstanding at the time of the closing. Prior to the Restructuring, Energy, Valero, and PG&E entered into a tax sharing agreement ("Tax Sharing Agreement"), which sets forth each party's rights and obligations with respect to payments and refunds, if any, of federal, state, local or other taxes for periods before the Restructuring. In general, under the Tax Sharing Agreement, Energy and Valero are each responsible for its allocable share of the federal, state and other taxes incurred by the combined operations of Energy and Valero prior to the Distribution. Furthermore, Valero is responsible for substantially all tax liability resulting from the failure of the Distribution or the Merger to qualify as a tax-free transaction, except that Energy will be responsible for any such tax liability attributable to certain actions taken by Energy and/or PG&E. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Basis of Presentation Prior to the Restructuring, Valero was a wholly owned subsidiary of Energy. For financial reporting purposes under the federal securities laws, Valero is a "successor registrant" to Energy. As a result, for periods prior to the Restructuring, the accompanying consolidated financial statements include the accounts of Energy restated to reflect Energy's natural gas related services business as discontinued operations. For periods subsequent to the Restructuring, the accompanying consolidated financial statements include the accounts of Valero and its consolidated subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition Revenues generally are recorded when products have been delivered. Price Risk Management Activities The Company enters into price swaps, options and futures contracts with third parties to hedge refinery feedstock purchases and refined product inventories in order to reduce the impact of adverse price changes on these inventories before the conversion of the feedstock to finished products and ultimate sale. Hedges of inventories are accounted for under the deferral method with gains and losses included in the carrying amounts of inventories and ultimately recognized in cost of sales as those inventories are sold. The Company also hedges anticipated transactions. Price swaps, options and futures contracts with third parties are used to hedge feedstock and product purchases, product sales and refining operating margins by locking in purchase or sales prices or components of the margins, including feedstock discounts, the conventional crack spread and premium product differentials. Hedges of anticipated transactions are also accounted for under the deferral method with gains and losses on these transactions recognized in cost of sales when the hedged transaction occurs. The above noted contracts are designated at inception as a hedge when there is a direct relationship to the price risk associated with the Company's inventories, future purchases and sales of commodities used in the Company's operations, or components of the Company's refining operating margins. If such direct relationship ceases to exist, the related contract is designated "for trading purposes" and accounted for as described below. Gains and losses on early terminations of financial instrument contracts designated as hedges are deferred and included in cost of sales in the measurement of the hedged transaction. When an anticipated transaction being hedged is no longer likely to occur, the related derivative contract is accounted for similar to a contract entered into for trading purposes. The Company also enters into price swaps, options, and futures contracts with third parties for trading purposes using its fundamental and technical analysis of market conditions to earn additional revenues. Contracts entered into for trading purposes are accounted for under the fair value method. Changes in the fair value of these contracts are recognized as gains or losses in cost of sales currently and are recorded in the Consolidated Balance Sheets in "Prepaid expenses and other" and "Accounts payable" at fair value at the reporting date. The Company determines the fair value of its exchange-traded contracts based on the settlement prices for open contracts, which are established by the exchange on which the instruments are traded. The fair value of the Company's over-the-counter contracts is determined based on market-related indexes or by obtaining quotes from brokers. The Company's derivative contracts and their related gains and losses are reported in the Consolidated Balance Sheets and Consolidated Statements of Income as discussed above, depending on whether they are designated as a hedge or for trading purposes. In the Consolidated Statements of Cash Flows, cash transactions related to derivative contracts are included in changes in current assets and current liabilities. Inventories Refinery feedstocks and refined products and blendstocks are carried at the lower of cost or market, with the cost of feedstocks purchased for processing and produced products determined primarily under the last-in, first-out ("LIFO") method of inventory pricing and the cost of feedstocks and products purchased for resale determined primarily under the weighted average cost method. The replacement cost of the Company's LIFO inventories approximated their LIFO values at December 31, 1997. Materials and supplies are carried principally at weighted average cost not in excess of market. Inventories as of December 31, 1997 and 1996 were as follows (in thousands):
December 31, 1997 1996 Refinery feedstocks $102,677 $ 42,744 Refined products and blendstocks 210,196 99,398 Materials and supplies 56,482 17,729 $369,355 $159,871
Refinery feedstock and refined product and blendstock inventory volumes totaled 15.7 million barrels ("MMbbls") and 7.4 MMbbls as of December 31, 1997 and 1996, respectively. See Note 7 for information concerning the Company's hedging activities related to its refinery feedstock purchases and refined product inventories. Property, Plant and Equipment Property additions and betterments include capitalized interest and acquisition costs allocable to construction and property purchases. The costs of minor property units (or components of property units), net of salvage, retired or abandoned are charged or credited to accumulated depreciation under the composite method of depreciation. Gains or losses on sales or other dispositions of major units of property are credited or charged to income.
Major classes of property, plant and equipment as of December 31, 1997 and 1996 were as follows (in thousands): December 31, 1997 1996 Crude oil processing facilities $1,522,409 $1,329,386 Butane processing facilities 351,594 233,457 Other processing facilities 80,197 80,000 Other 111,653 47,763 Construction in progress 66,636 21,728 $2,132,489 $1,712,334
Provision for depreciation of property, plant and equipment is made primarily on a straight-line basis over the estimated useful lives of the depreciable facilities. During 1996, a detailed study of the Company's fixed asset lives was completed by a third-party consultant for the majority of the Company's then-existing processing facilities. As a result of such study, the Company adjusted the weighted-average remaining lives of the assets subject to the study, utilizing the composite method of depreciation, to better reflect the estimated periods during which such assets are expected to remain in service. The effect of this change in accounting estimate was an increase in income from continuing operations for 1996 of approximately $3.6 million, or $.08 per share. A summary of the principal rates used in computing the annual provision for depreciation, primarily utilizing the composite method and including estimated salvage values, is as follows:
Weighted Range Average Crude oil processing facilities 3.6% - 4.9% 4.6% Butane processing facilities 3.7% 3.7% Other processing facilities 3.6% 3.6% Other 2.25% - 45% 22.5%
Deferred Charges and Other Assets Catalyst and Refinery Turnaround Costs Catalyst costs are deferred when incurred and amortized over the estimated useful life of that catalyst, normally one to three years. Refinery turnaround costs are deferred when incurred and amortized over that period of time estimated to lapse until the next turnaround occurs. Technological Royalties and Licenses Technological royalties and licenses are deferred when incurred and amortized over the estimated useful life of each particular royalty or license. Other Deferred Charges and Other Assets Other deferred charges and other assets include the Company's 20% interest in Javelina Company ("Javelina"), a general partnership that owns a refinery off-gas processing plant in Corpus Christi. The Company accounts for its interest in Javelina on the equity method of accounting. Also included in other deferred charges and other assets are prefunded benefit costs and certain other costs. Accrued Expenses
Accrued expenses as of December 31, 1997 and 1996 were as follows (in thousands): December 31, 1997 1996 Accrued interest expense $ 1,766 $ 5,088 Accrued taxes 36,712 11,938 Accrued employee benefit costs (see Note 13) 18,122 93 Current portion of accrued pension cost (see Note 13) 1,115 4,265 Other 3,264 3,880 $60,979 $25,264
Fair Value of Financial Instruments The carrying amounts of the Company's financial instruments approximate fair value, except for certain long-term debt as of December 31, 1996 and financial instruments used in price risk management activities. See Notes 6 and 7. Stock-Based Compensation The Company accounts for its employee stock compensation plans using the "intrinsic value" method of accounting set forth in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of the grant over the amount an employee must pay to acquire the stock. Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," issued by the Financial Accounting Standards Board ("FASB") in October 1995, encourages, but does not require companies to measure and recognize in their financial statements a compensation cost for stock-based employee compensation plans based on the "fair value" method of accounting set forth in the statement. See Note 13 for the pro forma effects on net income and earnings per share had compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS No. 123. Earnings Per Share In February 1997, the FASB issued SFAS No. 128, "Earnings per Share," which became effective for the Company's financial statements beginning with the period ending December 31, 1997. This statement supersedes APB Opinion No. 15, "Earnings per Share," and related interpretations and establishes new standards for computing and presenting earnings per share, requiring a dual presentation for companies with complex capital structures. In accordance with this new statement, the Company has presented basic and diluted earnings per share on the face of the accompanying income statements. Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of the Company's Convertible Preferred Stock (see Note 9) and outstanding stock options and performance awards granted to employees in connection with the Company's stock compensation plans (see Note 13). In determining basic earnings per share for the years ended December 31, 1997, 1996 and 1995, dividends on Energy's preferred stock were deducted from income from discontinued operations as such preferred stock was issued in connection with Energy's natural gas related services business. The weighted average number of common shares outstanding for the years ended December 31, 1997, 1996 and 1995 was 51,662,449, 43,926,026 and 43,651,914, respectively. A reconciliation of the numerators and denominators of the basic and diluted per-share computations for income from continuing operations is as follows (dollars and shares in thousands, except per share amounts):
Year Ended December 31, 1997 1996 1995 Per- Per- Per- Share Share Share Income Shares Amt. Income Shares Amt. Income Shares Amt. Income from continuing operations $111,768 $22,472 $58,242 Basic earnings per share: Income available to common stockholders $111,768 51,662 $2.16 $22,472 43,926 $.51 $58,242 43,652 $1.33 Effect of dilutive securities: Stock options - 881 - 425 - 209 Performance awards - 91 - 44 - - Convertible preferred stock - 2,495 - 6,382 - 6,382 Diluted earnings per share: Income available to common stockholders plus assumed conversions $111,768 55,129 $2.03 $22,472 50,777 $.44 $58,242 50,243 $1.16
Statements of Cash Flows In order to determine net cash provided by continuing operations, income from continuing operations has been adjusted by, among other things, changes in current assets and current liabilities, excluding changes in cash and temporary cash investments, current deferred income tax assets, short-term debt and current maturities of long-term debt. The changes in the Company's current assets and current liabilities, excluding the items noted above, are shown in the following table as an (increase)/decrease in current assets and an increase/(decrease) in current liabilities. The Company's temporary cash investments are highly liquid, low-risk debt instruments which have a maturity of three months or less when acquired. (Dollars in thousands.)
Year Ended December 31, 1997 1996 1995 Receivables, net $ 36,287 $(33,653) $(51,120) Inventories 37,007 (58,089) 40,723 Prepaid expenses and other (12,703) 3,243 (307) Accounts payable (95,318) 88,182 4,132 Accrued expenses 2,614 (7,479) 8,930 Total $(32,113) $ (7,796) $ 2,358
Cash interest and income taxes paid, including amounts related to discontinued operations for periods up to and including July 31, 1997, were as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Interest (net of amount capitalized) $66,008 $105,519 $86,553 Income taxes 24,526 19,043 23,935
Noncash investing and financing activities for 1997 included the issuance of Energy common stock to Salomon Inc ("Salomon") as partial consideration for the acquisition of the stock of Basis Petroleum, Inc. ("Basis"), and an $18.3 million accrual as of December 31, 1997 related to the Company's estimate of a contingent earn-out payment in 1998 in conjunction with such acquisition. See Note 4. In addition, noncash investing and financing activities for 1997 included various adjustments to debt and equity, including the assumption of certain debt by PG&E that was previously allocated to the Company, resulting from the Merger discussed in Note 1. New Accounting Standards In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements and requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement requires that an enterprise classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Reclassification of prior period financial statements presented for comparative purposes is required. This statement becomes effective for the Company's financial statements beginning in 1998 and requires that a total for comprehensive income be reported in interim period financial statements issued to shareholders. Based on current accounting standards, the adoption of this statement is not expected to impact the Company's consolidated financial statements. Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes new standards for reporting information about operating segments in annual financial statements and requires selected operating segment information to be reported in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement becomes effective for the Company's financial statements beginning with the year ended December 31, 1998 at which time restatement of prior period segment information presented for comparative purposes is required. Interim period information is not required until the second year of application, at which time comparative information is required. The adoption of this statement is not expected to impact the Company's consolidated financial statement disclosures. In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets, and eliminates certain disclosures that are no longer useful. This statement becomes effective for the Company's financial statement disclosures beginning in 1998 and requires restatement of prior period disclosures presented for comparative purposes unless the information is not readily available. The FASB had previously issued in February 1997 SFAS No. 128, "Earnings per Share," (discussed above) and SFAS No. 129, "Disclosure of Information about Capital Structure," both of which became effective for the Company's financial statements beginning with the period ending December 31, 1997. As the purpose of SFAS No. 129 was primarily to consolidate certain disclosure requirements previously contained in other pronouncements with which the Company was already in compliance, the adoption of this statement had no effect on the Company's accompanying consolidated financial statements. 3. DISCONTINUED OPERATIONS Energy's historical practice was to utilize a centralized cash management system and to incur certain indebtedness for its consolidated group at the parent company level rather than at the operating subsidiary level. Therefore, the accompanying consolidated financial statements reflect, for periods prior to the Restructuring, the allocation of a portion of the borrowings under Energy's various bank credit facilities, as well as a portion of other corporate debt of Energy, to the discontinued natural gas related services business based upon the ratio of such business' net assets, excluding the amounts of intercompany notes receivable or payable, to Energy's consolidated net assets. Interest expense related to corporate debt was also allocated to the discontinued natural gas related services business for periods prior to the Restructuring based on the same net asset ratio. Total interest expense allocated to discontinued operations in the accompanying Consolidated Statements of Income, including a portion of interest on corporate debt allocated pursuant to the methodology described above plus interest specifically attributed to discontinued operations, was $32.7 million for the seven months ended July 31, 1997, and $58.1 million and $60.9 million for the years ended December 31, 1996 and 1995, respectively. Revenues of the discontinued natural gas related services business were $1.7 billion for the seven months ended July 31, 1997, and $2.4 billion and $1.4 billion for the years ended December 31, 1996 and 1995, respectively. These amounts are not included in operating revenues as reported in the accompanying Consolidated Statements of Income. 4. ACQUISITION OF BASIS PETROLEUM, INC. Effective May 1, 1997, Energy acquired the outstanding common stock of Basis, a wholly owned subsidiary of Salomon. Prior to the Restructuring, Energy transferred the stock of Basis to Valero. As a result, Basis was a part of the Company at the time it was spun off to Energy's stockholders pursuant to the Restructuring. The primary assets acquired in the Basis acquisition included petroleum refineries located in Texas at Texas City and Houston and in Louisiana at Krotz Springs, and an extensive wholesale marketing business. The acquisition has been accounted for using the purchase method of accounting and the purchase price was allocated to the assets acquired and liabilities assumed based on estimated fair values, pending the completion of an independent appraisal. The accompanying Consolidated Statements of Income of the Company include the results of the operations acquired in connection with the purchase of Basis for the months of May through December 1997. Energy acquired the stock of Basis for approximately $470 million. This amount includes certain costs incurred in connection with the acquisition and is net of $9.5 million received from Salomon in December 1997 representing a final resolution between the parties relating to certain contingent environmental obligations for which Salomon was liable pursuant to the purchase agreement. The purchase price was paid, in part, with 3,429,796 shares of Energy common stock having a fair market value of $114 million, with the remainder paid in cash from borrowings under Energy's bank credit facilities (see Note 6). Pursuant to the purchase agreement, Salomon is also entitled to receive payments in any of the next 10 years if certain average refining margins during any of such years exceed a specified level. Any payments under this earn-out arrangement, which will be determined as of May 1 of each year beginning in 1998, are limited to $35 million in any year and $200 million in the aggregate and will be accounted for by the Company as an additional cost of the acquisition and depreciated over the remaining lives of the assets to which the additional cost is allocated. As of December 31, 1997, the Company accrued $18.3 million related to its estimate of the contingent earn-out payment due in 1998. The following unaudited pro forma financial information of the Company assumes that the acquisition of Basis occurred at the beginning of each period presented. Such pro forma information is not necessarily indicative of the results of future operations. (Dollars in thousands, except per share amounts.)
Year Ended December 31, 1997 1996 Operating revenues $7,576,676 $10,125,626 Operating income 149,847 8,362 Income (loss) from continuing operations 73,268 (35,821) Income (loss) from discontinued operations (15,672) 50,229 Net income 57,596 14,408 Earnings (loss) per common share: Continuing operations 1.42 (.82) Discontinued operations (.39) .89 Total 1.03 .07 Earnings (loss) per common share - assuming dilution: Continuing operations 1.33 (.82) Discontinued operations (.29) .89 Total 1.04 .07
5. SHORT-TERM DEBT The Company currently maintains seven separate short-term bank credit facilities under which amounts ranging from $160 million to $435 million may be borrowed. As of December 31, 1997, $122 million was outstanding under these short-term bank credit facilities at a weighted average interest rate of approximately 7.7%. Four of these credit facilities are cancelable on demand, and the others expire at various times in 1998. These short-term credit facilities bear interest at each respective bank's quoted money market rate, have no commitment or other fees or compensating balance requirements and are unsecured and unrestricted as to use. 6. LONG-TERM DEBT AND BANK CREDIT FACILITIES Long-term debt balances as of December 31, 1997 and 1996 were as follows (in thousands):
December 31, 1997 1996 Industrial revenue bonds: Variable rate Revenue Refunding Bonds: Series 1997A, 3.85% at December 31, 1997, due April 1, 2027 $ 24,400 $ - Series 1997B, 3.7% at December 31, 1997, due April 1, 2018 32,800 - Series 1997C, 3.65% at December 31, 1997, due April 1, 2018 32,800 - Series 1997D, 3.95% at December 31, 1997, due April 1, 2009 8,500 - Variable rate Waste Disposal Revenue Bonds, 3.8% at December 31, 1997, due December 1, 2031 25,000 - Marine terminal and pollution control revenue bonds, Series 1987A, 10 1/4% - 90,000 Marine terminal revenue bonds, Series 1987B , 10 5/8% - 8,500 6.75% notes, due December 15, 2032 (notes are callable or putable on December 15, 2002) 150,000 - $835 million revolving bank credit and letter of credit facility, approximately 6.25% at December 31, 1997, due November 28, 2002 150,000 - Allocated corporate debt obligations of Energy, weighted average interest rate of approximately 8.97% at December 31, 1996 - 280,844 Unamortized premium 6,683 - Total long-term debt 430,183 379,344 Less current maturities - 26,037 $ 430,183 $ 353,307
Effective May 1, 1997, Energy replaced its existing unsecured $300 million revolving bank credit and letter of credit facility with a new five-year, unsecured $835 million revolving bank credit and letter of credit facility. The new credit facility was used to finance a portion of the acquisition cost of Basis (see Note 4) and to fund a $210 million dividend paid by the Company to Energy immediately prior to the Distribution (see Note 1). The facility also provides continuing credit enhancement for the Company's Refunding Bonds and Revenue Bonds as discussed below, and can be used to provide financing for other general corporate purposes. Energy was the borrower under the facility until the completion of the Restructuring on July 31, 1997, at which time all obligations of Energy under the facility were assumed by the Company. In November 1997, the facility was amended to further enhance the Company's financial flexibility. Among other things, the amendment extended the maturity to November 2002, eliminated provisions restricting availability under the facility, and eliminated several restrictive covenants. Borrowings under the credit facility bear interest at either LIBOR plus a margin, a base rate, or a money market rate. In addition, various fees and expenses are required to be paid in connection with the credit facility, including a facility fee, a letter of credit issuance fee and a fee based on letters of credit outstanding. The interest rate and fees under the credit facility are subject to adjustment based upon the credit ratings assigned to the Company's long-term debt. The credit facility includes certain restrictive covenants including a coverage ratio, a capitalization ratio, and a minimum net worth test. As of December 31, 1997, the Company had approximately $558 million available under this revolving bank credit facility for additional borrowings and letters of credit. The Company also has several uncommitted bank letter of credit facilities. As of December 31, 1997, such facilities totaled $305 million of which approximately $73 million was outstanding. In April 1997, the Industrial Development Corporation of the Port of Corpus Christi issued and sold, for the benefit of the Company, $98.5 million of tax-exempt Revenue Refunding Bonds (the "Refunding Bonds"), with credit enhancement provided through a letter of credit issued under the revolving bank credit facility described above. The Refunding Bonds were issued in four series with due dates ranging from 2009 to 2027. The Refunding Bonds bear interest at variable rates determined weekly, with the Company having the right to convert such rates to a daily, weekly or commercial paper rate, or to a fixed rate. The Refunding Bonds were issued to refund the Company's $98.5 million principal amount of tax-exempt bonds which were issued in 1987. In May 1997, the Gulf Coast Industrial Development Authority issued and sold, for the benefit of the Company, $25 million of new Waste Disposal Revenue Bonds (the "Revenue Bonds") which mature on December 1, 2031, with credit enhancement provided through a letter of credit issued under the Company's revolving bank credit facility. Other terms and conditions of these bonds are similar to those of the Refunding Bonds. In January 1998, the Company's Board of Directors approved the commencement of efforts to convert the interest rates on the Refunding Bonds and Revenue Bonds from variable rates to fixed rates. At the same time, the Board approved the issuance of an additional $25 million of tax-exempt industrial revenue bonds at a fixed interest rate and the issuance of up to $43.5 million of taxable industrial revenue bonds at variable interest rates, both of which are expected to mature in the year 2032. The $43.5 million of variable rate bonds will be supported by a letter of credit issued under the Company's revolving bank credit facility. The above noted letters of credit associated with the $123.5 million of outstanding Refunding Bonds and Revenue Bonds will be released upon conversion of the interest rates from variable to fixed. The interest rate conversion of the outstanding bonds and the issuance of the new bonds are expected to be completed by the end of the first quarter of 1998. In December 1997, the Company issued $150 million principal amount of 6.75% notes (the "Notes") for net proceeds of approximately $156 million. The Notes are unsecured and unsubordinated and rank equally with all other unsecured and unsubordinated obligations of the Company. The Notes were issued to the Valero Pass-Through Asset Trust 1997-1 (the "Trust"), which funded the acquisition of the Notes through a private placement of $150 million principal amount of 6.75% Pass-Through Asset Trust Securities ("PATS"). The PATS represent a fractional undivided beneficial interest in the Trust. In exchange for certain consideration paid to the Trust, a third party has an option to purchase the Notes under certain circumstances at par on December 15, 2002, at which time the term of the Notes would be extended 30 years to December 15, 2032. If the third party does not exercise its purchase option, then under the terms of the Notes, the Company would be required to repurchase the Notes at par on December 15, 2002. The Company was in compliance with all covenants contained in its various debt facilities as of December 31, 1997. Based on long-term debt outstanding at December 31, 1997, the Company has no maturities of long-term debt during the next five years except for $150 million due in November 2002 under its revolving bank credit and letter of credit facility. See above for maturities under the terms of the Notes. The carrying amounts of the Company's variable-rate industrial revenue bonds and revolving bank credit and letter of credit facility approximate fair value at December 31, 1997. The carrying amount of the Company's 6.75% Notes also approximates fair value at December 31, 1997 due to their issuance on December 12, 1997. As of December 31, 1996, based on the borrowing rates available to the Company for long-term debt with similar terms and average maturities, the estimated fair value of the Company's long-term debt, including current maturities, was $412.7 million. 7. PRICE RISK MANAGEMENT ACTIVITIES Hedging Activities The Company uses price swaps, options and futures to hedge refinery feedstock purchases and refined product inventories in order to reduce the impact of adverse price changes on these inventories before the conversion of the feedstock to finished products and ultimate sale. Swaps, options and futures contracts held to hedge refining inventories at the end of 1997 and 1996 had remaining terms of less than one year. As of December 31, 1997 and 1996, 14% and 13%, respectively, of the Company's refining inventory position was hedged. As of December 31, 1997, $2.1 million of deferred hedge gains were included as a reduction of refining inventories, while as of December 31, 1996, $.8 million of deferred hedge losses were included as an increase to refining inventories. The following table is a summary of the volumes and range of prices for the Company's contracts held or issued to hedge refining inventories as of December 31, 1997 and 1996. Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements and do not represent volumes exchanged.
1997 1996 Payor Receiver Payor Receiver Swaps: Volumes (Mbbls) - 75 497 497 Price (per bbl) - $31.82 $17.50-$17.57 $17.31-$17.38 Options: Volumes (Mbbls) 420 250 - - Price (per bbl) $.38-$1.32 $.53-$.67 - - Futures: Volumes (Mbbls) 315 2,657 - 981 Price (per bbl) $20.87-$24.78 $17.64-$23.90 - $24.87-$29.65
The Company also hedges anticipated transactions. Price swaps, options and futures are used to hedge feedstock and product purchases, product sales and refining operating margins for periods up to five years by locking in purchase or sales prices or components of the margins, including the resid discount, the conventional crack spread and premium product differentials. There were no significant explicit deferrals of hedging gains or losses related to these anticipated transactions as of either year end. The following table is a summary of the volumes and range of prices for the Company's contracts held or issued to hedge feedstock and product purchases, product sales and refining margins as of December 31, 1997 and 1996. Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements and do not represent volumes exchanged.
1997 1996 Payor Receiver Payor Receiver Swaps: Volumes (Mbbls) 8,856 1,350 6,000 28,300 Price (per bbl) $.17-$25.23 $.29-$3.76 $.53 -$4.90 $.74-$3.55 Options: Volumes (Mbbls) - - 750 - Price (per bbl) - - $25.00-$32.76 - Futures: Volumes (Mbbls) 146 90 1,312 1,410 Price (per bbl) $17.60-$19.33 $19.22-$19.23 $26.46-$30.87 $21.74-$30.39
The following table discloses the carrying amount and fair value of the Company's contracts held or issued for non-trading purposes as of December 31, 1997 and 1996 (dollars in thousands):
1997 1996 Assets (Liabilities) Assets (Liabilities) Carrying Fair Carrying Fair Amount Value Amount Value Swaps $ - $(4,021) $7,184 $6,390 Options - (1) (784) 617 Futures 1,849 1,849 (859) (859) Total $ 1,849 $(2,173) $5,541 $6,148
Trading Activities The Company enters into transactions for trading purposes using its fundamental and technical analysis of market conditions to earn additional revenues. The types of instruments used include price swaps, over-the-counter and exchange-traded options, and futures. These contracts run for periods of up to 12 months. As a result, contracts outstanding as of December 31, 1997 will mature in 1998. The following table is a summary of the volumes and range of prices for the Company's contracts held or issued for trading purposes as of December 31, 1997 and 1996. Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements and do not represent volumes exchanged.
1997 1996 Payor Receiver Payor Receiver Swaps: Volumes (Mbbls) 4,475 2,175 400 400 Price (per bbl) $1.79-$27.51 $1.18-$19.02 $4.25-$4.55 $4.20-$4.72 Options: Volumes (Mbbls) - - - 275 Price (per bbl) - - - $25.20 Futures: Volumes (Mbbls) 653 544 - - Price (per bbl) $17.63-$25.20 $18.10-$24.61 - -
The following table discloses the fair values of contracts held or issued for trading purposes and net gains (losses) from trading activities as of or for the periods ended December 31, 1997 and 1996 (dollars in thousands):
Fair Value of Assets (Liabilities) Average Ending Net Gains(Losses) 1997 1996 1997 1996 1997 1996 Swaps $ (95) $ 204 $ (235) $ 58 $(1,143) $ 94 Options (76) (37) (963) 7 (109) 131 Futures 7,292 910 3,965 - 661 (1,656) Total $ 7,121 $ 1,077 $ 2,767 $ 65 $ (591) $(1,431)
Market and Credit Risk The Company's price risk management activities involve the receipt or payment of fixed price commitments into the future. These transactions give rise to market risk, the risk that future changes in market conditions may make an instrument less valuable. The Company closely monitors and manages its exposure to market risk on a daily basis in accordance with policies limiting net open positions. Concentrations of customers in the refining industry may impact the Company's overall exposure to credit risk, in that the customers in such industry may be similarly affected by changes in economic or other conditions. The Company believes that its counterparties will be able to satisfy their obligations under contracts. 8. REDEEMABLE PREFERRED STOCK On March 30, 1997, Energy redeemed the remaining 11,500 outstanding shares of its Cumulative Preferred Stock, $8.50 Series A ("Series A Preferred Stock"). The redemption price was $104 per share, plus dividends accrued to the redemption date of $.685 per share. 9. CONVERTIBLE PREFERRED STOCK In April 1997, Energy called all of its outstanding $3.125 convertible preferred stock ("Convertible Preferred Stock") for redemption on June 2, 1997. The total redemption price for the Convertible Preferred Stock was $52.1966 per share (representing a per-share redemption price of $52.188, plus accrued dividends in the amount of $.0086 per share for the one-day period from June 1, 1997 to the June 2, 1997 redemption date). The Convertible Preferred Stock was convertible into Energy common stock at a conversion price of $27.03 per share (equivalent to a conversion rate of approximately 1.85 shares of common stock for each share of Convertible Preferred Stock). Prior to the redemption, substantially all of the outstanding shares of Convertible Preferred Stock were converted into shares of Energy common stock. 10. PREFERRED SHARE PURCHASE RIGHTS In connection with the Distribution, the Company's Board of Directors declared a dividend distribution of one Preferred Share Purchase Right ("Right") for each outstanding share of the Company's Common Stock distributed to Energy stockholders pursuant to the Distribution. Except as set forth below, each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of the Company's Junior Participating Preferred Stock, Series I, ("Junior Preferred Stock") at a price of $100 per one one-hundredth of a share, subject to adjustment. Until the earlier to occur of (i) 10 days following a public announcement that a person or group of affiliated or associated persons (an "Acquiring Person") has acquired beneficial ownership of 15% or more of the outstanding shares of the Company's Common Stock, (ii) 10 business days (or such later date as may be determined by action of the Company's Board of Directors) following the initiation of a tender offer or exchange offer which would result in the beneficial ownership by an Acquiring Person of 15% or more of such outstanding Common Stock (the earlier of such dates being called the "Rights Separation Date"), or (iii) the earlier redemption or expiration of the Rights, the Rights will be transferred only with the Common Stock. The Rights are not exercisable until the Rights Separation Date. At any time prior to the acquisition by an Acquiring Person of beneficial ownership of 15% or more of the outstanding Common Stock, the Company's Board of Directors may redeem the Rights at a price of $.01 per Right. The Rights will expire on June 30, 2007, unless such date is extended or unless the Rights are earlier redeemed or exchanged by the Company. In the event that after the Rights Separation Date, the Company is acquired in a merger or other business combination transaction, or if 50% or more of its consolidated assets or earning power are sold, each holder of a Right will have the right to receive, upon the exercise thereof at the then current exercise price of the Right, that number of shares of common stock of the acquiring company which at the time of such transaction will have a market value of two times the exercise price of the Right. In the event that any person or group of affiliated or associated persons becomes the beneficial owner of 15% or more of the outstanding Common Stock, each holder of a Right, other than Rights beneficially owned by the Acquiring Person (which will thereafter be void), will thereafter have the right to receive upon exercise that number of shares of Common Stock having a market value of two times the exercise price of the Right. At any time after the acquisition by an Acquiring Person of beneficial ownership of 15% or more of the outstanding Common Stock and prior to the acquisition by such Acquiring Person of 50% or more of the outstanding Common Stock, the Company's Board of Directors may exchange the Right (other than Rights owned by such Acquiring Person which have become void), at an exchange ratio of one share of Common Stock, or one one-hundredth of a share of Junior Preferred Stock, per Right (subject to adjustment). Until a Right is exercised, the holder will have no rights as a stockholder of the Company including, without limitation, the right to vote or to receive dividends. The Rights may have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Company's Board of Directors, except pursuant to an offer conditioned on a substantial number of Rights being acquired. The Rights should not interfere with any merger or other business combination approved by the Company's Board of Directors since the Rights may be redeemed by the Company prior to the time that a person or group has acquired beneficial ownership of 15% or more of the Common Stock. 11. INDUSTRY SEGMENT INFORMATION Subsequent to the Restructuring, the Company operates in one industry segment encompassing the refining and marketing of premium, environmentally clean products such as reformulated gasoline, CARB Phase II gasoline, low-sulfur diesel and oxygenates. The Company also produces a substantial slate of middle distillates, jet fuel and petrochemicals. The Company's operations consist primarily of four petroleum refineries located in Texas at Corpus Christi, Texas City and Houston, and in Louisiana at Krotz Springs which have a combined throughput capacity of approximately 530,000 BPD. The Company also has certain marketing operations located in Houston. The Company currently markets its products to wholesale customers in 32 states, including California and other states located in the Northeast, Midwest, Southeast and Gulf Coast, and selected export markets in Latin America. In 1997, 1996 and 1995, the Company had no significant amount of export sales and no significant foreign operations. In 1997, no single customer accounted for more than 10% of the Company's consolidated operating revenues, while in 1996 and 1995, approximately 11% and 17%, respectively, of the Company's consolidated operating revenues were derived from a major domestic oil company. 12. INCOME TAXES Components of income tax expense applicable to continuing operations were as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Current: Federal $29,501 $ 7,902 $ 425 State 1,461 (260) 812 Total current 30,962 7,642 1,237 Deferred: Federal 32,827 8,969 29,217 Total income tax expense $63,789 $16,611 $30,454
The following is a reconciliation of total income tax expense to income taxes computed by applying the statutory federal income tax rate (35% for all years presented) to income before income taxes (in thousands):
Year Ended December 31, 1997 1996 1995 Federal income tax expense at the statutory rate $61,445 $13,679 $31,044 State income taxes, net of federal income tax benefit 950 (169) 528 Other - net 1,394 3,101 (1,118) Total income tax expense $63,789 $16,611 $30,454
The tax effects of significant temporary differences representing deferred income tax assets and liabilities are as follows (in thousands):
December 31, 1997 1996 Deferred income tax assets: Tax credit carryforwards $ 14,287 $ 15,540 Other 19,627 26,915 Total deferred income tax assets $ 33,914 $ 42,455 Deferred income tax liabilities: Depreciation $(257,102) $(234,031) Other (16,515) (15,385) Total deferred income tax liabilities $(273,617) $(249,416)
At December 31, 1997, the Company had an alternative minimum tax ("AMT") credit carryforward of approximately $14.3 million which is available to reduce future federal income tax liabilities. The AMT credit carryforward has no expiration date. The Company has not recorded any valuation allowances against deferred income tax assets as of December 31, 1997. The Company's taxable years through 1993 are closed to adjustment by the Internal Revenue Service. The Company believes that adequate provisions for income taxes have been reflected in its consolidated financial statements. 13. EMPLOYEE BENEFIT PLANS Pension Plans Prior to the Restructuring, Energy maintained a defined benefit pension plan. Pursuant to an "Employee Benefits Agreement" entered into between the Company and Energy in connection with the Restructuring, effective at the time of the Distribution, the Company became the sponsor of Energy's pension plan and became solely responsible for (i) pension liabilities existing immediately prior to the time of the Distribution to, or relating to, individuals employed by Energy which became employees of PG&E after the Distribution, which liabilities will become payable upon the retirement of such individuals, (ii) all liabilities to, or relating to, former employees of Energy and the Company, and (iii) all liabilities to, or relating to, current employees of the Company. Also pursuant to the Employee Benefits Agreement, the Company became the sponsor of Energy's nonqualified Supplemental Executive Retirement Plan ("SERP"), which provided additional pension benefits to executive officers and certain other employees, and assumed all liabilities with respect to current and former employees of both Energy and the Company under such plan. The Company's pension plan, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, is designed to provide eligible employees with retirement income. Participation in the plan commences upon attaining age 21 and the completion of one year of continuous service. A participant vests in plan benefits after five years of vesting service or upon reaching normal retirement date. Employees of the Company who were formerly employees of Basis commenced participation in the plan effective January 1, 1998 under the same service requirements as required for other Company employees. For such employees, prior employment with Basis is considered in determining vesting service, but credited service for the accrual of benefits did not begin until January 1, 1998. The pension plan provides a monthly pension payable upon normal retirement of an amount equal to a set formula which is based on the participant's 60 consecutive highest months of compensation during the latest 10 years of credited service under the plan. Contributions to the plan by the Company, when permitted, are actuarially determined in an amount sufficient to fund the currently accruing benefits and amortize any prior service cost over the expected life of the then current work force. The Company's contributions to the pension plan and SERP in 1997, 1996 and 1995 were approximately $8.8 million, $14.2 million and $4.3 million, respectively, and are currently estimated to be $1.1 million in 1998. In connection with the Restructuring, Energy approved the establishment of a supplement to the pension plan (the "1997 Window Plan") which permitted certain employees to retire from employment during 1997. The following table sets forth for the pension plans of the Company, including the SERP, the funded status and amounts recognized in the Company's consolidated financial statements at December 31, 1997 and 1996 (in thousands):
December 31, 1997 1996 Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $112,411 (1997) and $76,448 (1996) $114,296 $78,441 Projected benefit obligation for services rendered to date $129,430 $99,435 Plan assets at fair value 121,393 92,486 Projected benefit obligation in excess of plan assets 8,037 6,949 Unrecognized net gain (loss) from past experience different from that assumed (1,442) 5,700 Prior service cost not yet recognized in net periodic pension cost (4,985) (5,305) Unrecognized net asset at beginning of year 1,199 1,341 Accrued pension cost $ 2,809 $ 8,685 Net periodic pension cost for the years ended December 31, 1997, 1996 and 1995 included the following components (in thousands):
Year Ended December 31, 1997 1996 1995 Service cost - benefits earned during the period $ 3,710 $ 4,622 $ 3,465 Interest cost on projected benefit obligation 7,298 6,309 5,455 Actual (return) loss on plan assets (24,698) (12,424) (14,376) Net amortization and deferral 15,542 6,651 9,637 Net periodic pension cost 1,852 5,158 4,181 Additional expense resulting from 1997 Window Plan 3,168 - - Curtailment gain resulting from Restructuring (see Note 1) (2,083) - - Total pension expense $ 2,937 $ 5,158 $ 4,181
The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation was 7% and 7.25% as of December 31, 1997 and 1996, respectively. The rate of increase in future compensation levels used in determining the projected benefit obligation as of December 31, 1997 and 1996 was 4% for nonexempt personnel and 4% and 3%, respectively, for exempt personnel. The expected long-term rate of return on plan assets was 9.25% as of December 31, 1997 and 1996. Postretirement Benefits Other Than Pensions The Company provides certain health care and life insurance benefits for retired employees, referred to herein as "postretirement benefits other than pensions." Substantially all of the Company's employees may become eligible for those benefits if, while still working for the Company, they either reach normal retirement age or take early retirement. Health care benefits are offered by the Company through a self-insured plan and a health maintenance organization while life insurance benefits are provided through an insurance company. The Company funds its postretirement benefits other than pensions on a pay-as-you-go basis. Pursuant to the Employee Benefits Agreement, effective at the time of the Distribution, the Company became responsible for all liabilities to former employees of both Energy and the Company as well as current employees of the Company arising under Energy's health care and life insurance programs. Employees of the Company who were formerly employees of Basis became eligible for postretirement benefits other than pensions under the Company's plan effective January 1, 1998. The following table sets forth for the Company's postretirement benefits other than pensions, the funded status and amounts recognized in the Company's consolidated financial statements at December 31, 1997 and 1996 (in thousands):
December 31, 1997 1996 Accumulated benefit obligation: Retirees $14,256 $11,930 Other fully eligible plan participants 848 390 Other active plan participants 17,617 17,571 Total accumulated benefit obligation 32,721 29,891 Unrecognized loss (2,918) (4,498) Unrecognized prior service cost (1,786) (3,909) Unrecognized transition obligation (4,705) (10,334) Accrued postretirement benefit cost $23,312 $11,150
Net periodic postretirement benefit cost for the years ended December 31, 1997, 1996 and 1995 included the following components (in thousands):
December 31, 1997 1996 1995 Service cost - benefits attributed to service during the period $1,028 $1,091 $ 860 Interest cost on accumulated benefit obligation 1,842 1,716 1,769 Amortization of unrecognized transition obligation 513 653 766 Amortization of prior service cost 184 - - Amortization of unrecognized net loss 46 110 - Net periodic postretirement benefit cost 3,613 3,570 3,395 Additional expense resulting from 1997 Window Plan 171 - - Curtailment loss resulting from Restructuring (see Note 1) 576 - - Total postretirement benefit cost $4,360 $3,570 $3,395
For measurement purposes, the assumed health care cost trend rate was 5% in 1997, remaining level thereafter. The health care cost trend rate assumption has a significant effect on the amount of the obligation and periodic cost reported. An increase in the assumed health care cost trend rate by 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $5.8 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $.8 million. The weighted average discount rate used in determining the accumulated postretirement benefit obligation as of December 31, 1997 and 1996 was 7% and 7.25%, respectively. Profit-Sharing/Savings Plans Prior to the Restructuring, Energy maintained a qualified profit-sharing plan (the "Thrift Plan"). Effective at the time of the Distribution, the Company became the sponsor of the Thrift Plan and became solely responsible for all liabilities arising under the Thrift Plan after the time of the Distribution with respect to current Company employees and former employees of both Energy and the Company. Each Energy employee participating in the Thrift Plan prior to the Distribution who became a PG&E employee subsequent to the Distribution transferred their account balance to the PG&E thrift plan. The purpose of the Thrift Plan is to provide a program whereby contributions of participating employees and their employers are systematically invested to provide the employees an interest in the Company and to further their financial independence. Participation in the Thrift Plan is voluntary and is open to employees of the Company who become eligible to participate upon attaining age 21 and the completion of one year of continuous service. Employees of the Company who were formerly Basis employees became eligible to participate in the Thrift Plan on January 1, 1998 under the same service requirements as required for other Company employees, with service including prior employment with Basis. Basis's previously existing 401(k) profit-sharing and retirement savings plan was maintained for such employees through December 31, 1997 and was merged into the Company's Thrift Plan effective January 1, 1998. Participating employees may contribute from 2% up to 22% of their total annual compensation, subject to certain limitations, to the Thrift Plan. Participants may elect to make such contributions on either a before-tax or after-tax basis, with federal income taxes on before-tax contributions being deferred until such time as a distribution is made to the participant. Participants' contributions to the Thrift Plan of up to 8% of their base annual compensation are matched 75% by the Company, with an additional match of up to 25% subject to certain conditions. Participants' contributions in excess of 8% of their base annual compensation are not matched by the Company. Up until termination of the VESOP (see below) in 1997, the Company made contributions to the Thrift Plan to the extent 75% of participants' base contributions (from 2% up to 8% of total base salary) exceeded the amount of the Company's contribution to the VESOP for debt service. Subsequent to the VESOP termination, all Company contributions were made to the Thrift Plan. Company contributions to the Thrift Plan were $2,253,000 in 1997. There were no Company contributions to the Thrift Plan in 1996 or 1995. In 1989, Energy established the Valero Employees' Stock Ownership Plan ("VESOP") which was a leveraged employee stock ownership plan. Pursuant to a private placement in 1989, the VESOP issued notes in the principal amount of $15 million. The net proceeds from this private placement were used by the VESOP trustee to fund the purchase of Energy common stock. During 1991, Energy made an additional loan of $8 million to the VESOP which was also used by the trustee to purchase Energy common stock. The 1989 and 1991 VESOP loans are referred to herein as the "VESOP Notes." In connection with effecting the Restructuring, on April 11, 1997, Energy's Board of Directors approved the termination of the VESOP and subsequently directed the VESOP trustee to sell a sufficient amount of Energy common stock held in the VESOP suspense account to repay the outstanding amount of VESOP Notes and allocate the remaining stock in the suspense account to the accounts of the VESOP participants. The VESOP Notes were repaid in full in May 1997, after which 226,198 remaining shares of Energy common stock were allocated to all VESOP participants. As noted above, prior to termination of the VESOP, the Company's annual contribution to the Thrift Plan was reduced by the Company's contribution to the VESOP for debt service. During 1997, 1996 and 1995, the Company contributed $586,000, $3,372,000 and $3,170,000, respectively, to the VESOP, comprised of $58,000, $525,000 and $678,000, respectively, of interest on the VESOP Notes and $541,000, $3,072,000 and $2,918,000, respectively, of compensation expense. Compensation expense was based on the VESOP debt principal payments for the portion of the VESOP established in 1989 and on the cost of the shares allocated to participants for the portion of the VESOP established in 1991. Dividends on VESOP shares of common stock were recorded as a reduction of retained earnings. Dividends on allocated shares of common stock were paid to participants. Dividends paid on unallocated shares were used to reduce the Company's contributions to the VESOP during 1997, 1996 and 1995 by $13,000, $225,000 and $426,000, respectively. VESOP shares of common stock were considered outstanding for earnings per share computations. As of December 31, 1996 and 1995, the number of allocated shares was 1,052,454 and 940,470, respectively, the number of committed-to-be-released shares was 62,918 for both years, and the number of suspense shares was 583,301 and 772,055, respectively. Stock Compensation Plans Prior to the Restructuring, Energy maintained various stock compensation plans. In connection with the Restructuring, all stock options held by Energy employees under any of such stock compensation plans that were granted prior to January 1, 1997 became 100% vested and immediately exercisable upon the approval of the Restructuring by Energy's stockholders on June 18, 1997. For all options still outstanding at the time of the Distribution, pursuant to the Employee Benefits Agreement, each option to purchase Energy Common Stock held by a current or former employee of the Company was converted into an option to acquire shares of Company Common Stock, and each option held by a current or former employee of Energy's natural gas related services business was converted into an option to acquire shares of PG&E common stock. In each case, the number of options and related exercise prices were converted in such a manner so that the aggregate option value for each holder immediately after the Restructuring was equal to the aggregate option value immediately prior to the Restructuring. The other terms and conditions of any such converted option remained essentially unchanged. All restricted stock issued pursuant to Energy's stock compensation plans became fully vested either upon the approval of the Restructuring by Energy's stockholders on June 18, 1997 or upon the completion of the Restructuring on July 31, 1997. As of December 31, 1997, the Company had various fixed and performance-based stock compensation plans. The Company's Executive Stock Incentive Plan (the "ESIP"), which was maintained by Energy prior to the Restructuring, authorizes the grant of various stock and stock-related awards to executive officers and other key employees. Awards available under the ESIP include options to purchase shares of Common Stock, restricted stock which vests over a period determined by the Company's compensation committee, and performance shares which vest upon the achievement of an objective performance goal. A total of 2,500,000 shares of Company Common Stock may be issued under the ESIP, of which no more than 1,000,000 shares may be issued as restricted stock. Under the ESIP, 6,250 shares of restricted stock were granted during the period August 1, 1997 through December 31, 1997 at a weighted average grant-date fair value of $31.78 per share and 24,563 performance shares were granted during the period January 1, 1997 through July 31, 1997 at a weighted average grant-date fair value of $34.58 per share. The Company also has a non-qualified stock option plan (the "Stock Option Plan") which, at the date of the Restructuring, replaced three non-qualified stock option plans previously maintained by Energy. Awards under the Stock Option Plan are granted to key officers, employees and prospective employees of the Company. A total of 2,000,000 shares of Company Common Stock may be issued under the Stock Option Plan. The Company also maintains an Executive Incentive Bonus Plan, under which 200,000 shares of Company Common Stock may be issued, that provides bonus compensation to key employees of the Company based on individual contributions to Company profitability. Bonuses are payable either in cash or in whole or in part in Company Common Stock. No grants of Common Stock were made under this plan in 1997. The Company also has a non-employee director stock option plan, under which 200,000 shares of Company Common Stock may be issued, and a non-employee director restricted stock plan, under which 100,000 shares of Company Common Stock may be issued. During the period August 1, 1997 through December 31, 1997, 9,336 shares were granted under the non-employee director restricted stock plan at a weighted average grant-date fair value of $28.94 per share. Under the terms of the ESIP, the Stock Option Plan and the non-employee director stock option plan, the exercise price of the options granted will not be less than the fair market value of Common Stock at the date of grant. Stock options become exercisable pursuant to the individual written agreements between the Company and the participants, generally in three equal annual installments beginning one year after the date of grant, with unexercised options expiring ten years from the date of grant. A summary of the status of the Company's stock option plans, including options granted under the ESIP, the Stock Option Plan, the non-employee director stock option plan and Energy's previously existing stock compensation plans, as of December 31, 1997, 1996, and 1995, and changes during the years then ended is presented in the table below. (Note: Shares outstanding at July 31, 1997 prior to the Restructuring differs from shares outstanding at August 1, 1997 after the Restructuring because the August 1 amount: (i) excludes options held by current or former employees of Energy's natural gas related services business which were converted to PG&E options and (ii) reflects the conversion of Energy options held by current or former employees of the Company to an equivalent number of Company options.)
1997 1996 1995 August 1-December 31 January 1-July 31 Weighted- Weighted- Weighted- Weighted- Average Average Average Average Exercise Exercise Exercise Exercise Shares Price Shares Price Shares Price Shares Price Outstanding at beginning of period 3,802,584 $19.05 4,229,092 $22.02 3,928,267 $20.69 2,575,902 $21.51 Granted 36,550 29.35 1,365,875 33.71 757,920 27.44 1,599,463 18.99 Exercised (44,144) 17.21 (2,925,687) 21.81 (418,117) 19.28 (171,604) 17.08 Forfeited (14,572) 23.07 (17,028) 25.84 (38,978) 22.17 (74,428) 21.12 Expired - - - - - - (1,066) 18.36 Outstanding at end of period 3,780,418 19.15 2,652,252 28.25 4,229,092 22.02 3,928,267 20.69 Exercisable at end of period 1,758,479 15.08 1,288,977 22.47 2,525,957 21.71 1,531,718 22.30 Weighted-average fair value of options granted $ 6.86 $ 8.09 $ 6.25 $ 4.50
The following table summarizes information about stock options outstanding under the ESIP, the Stock Option Plan and the non-employee director stock option plan as of December 31, 1997:
Options Outstanding Options Exercisable Range Number Weighted-Avg. Number of Outstanding Remaining Weighted-Avg. Exercisable Weighted-Avg. Exercise Prices at 12/31/97 Contractual Life Exercise Price at 12/31/97 Exercise Price $11.47-$16.95 1,246,320 6.4 years $13.42 1,245,691 $13.43 $18.45-$33.81 2,534,098 8.9 21.97 512,788 19.11 $11.47-$33.81 3,780,418 8.1 19.15 1,758,479 15.08
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of 6.3 percent, 6.4 percent and 6.7 percent; expected dividend yields of 1.5 percent, 1.9 percent and 2.8 percent; expected lives of 3.2 years, 3.1 years and 3.2 years; and expected volatility of 26.2 percent, 25.5 percent and 29.5 percent. For each share of stock that can be purchased thereunder pursuant to a stock option, the Stock Option Plan provides, and the predecessor stock option plans of Energy provided, that a SAR may also be granted. A SAR is a right to receive a cash payment equal to the difference between the fair market value of Common Stock on the exercise date and the option price of the stock to which the SAR is related. SARs are exercisable only upon the exercise of the related stock options. At the end of each reporting period within the exercise period, the Company recorded an adjustment to compensation expense based on the difference between the fair market value of Common Stock at the end of each reporting period and the option price of the stock to which the SAR was related. During the January 1, 1997 through July 31, 1997 period prior to the Restructuring, 88,087 SARs were exercised at a weighted-average exercise price of $14.52 per share, and no SARs related to Company Common Stock remained outstanding as of July 31, 1997. During the August 1, 1997 through December 31, 1997 period subsequent to the Restructuring, no SARs were granted. The Company applies APB Opinion No. 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. The after-tax compensation cost reflected in net income for stock-based compensation plans was $4.6 million, $2.6 million and $1.7 million for 1997, 1996 and 1995, respectively. Of these amounts, $2.1 million, $1.4 million and $.9 million related to the discontinued natural gas related services business. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for 1997, 1996 and 1995 awards under those plans consistent with the method of SFAS No. 123, the Company's net income and earnings per share for the years ended December 31, 1997, 1996 and 1995 would have been reduced to the pro forma amounts indicated below:
Year Ended December 31, 1997 1996 1995 Net Income As Reported $96,096 $72,701 $59,838 Pro Forma $92,304 $70,427 $58,373 Earnings per share As Reported $ 1.77 $ 1.40 $ 1.10 Pro Forma $ 1.70 $ 1.35 $ 1.07 Earnings per share - assuming dilution As Reported $ 1.74 $ 1.42 $ 1.17 Pro Forma $ 1.67 $ 1.38 $ 1.14
Because the SFAS No. 123 method of accounting has not been applied to awards granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. 14. LEASE AND OTHER COMMITMENTS The Company has long-term operating lease commitments in connection with land, office facilities and equipment, and various facilities and equipment used in the storage, transportation and production of refinery feedstocks and/or refined products. Long-term leases for land have remaining primary terms of up to 26.7 years, while long-term leases for office facilities have remaining primary terms of up to 4.5 years. The Company's long-term leases for production equipment, feedstock and refined product storage facilities and transportation assets have remaining primary terms of up to 14.1 years and in certain cases provide for various contingent payments based on, among other things, throughput volumes in excess of a base amount. Future minimum lease payments and minimum rentals to be received under subleases as of December 31, 1997 for operating leases having initial or remaining noncancelable lease terms in excess of one year are as follows (in thousands): 1998 $23,779 1999 22,654 2000 16,492 2001 11,924 2002 4,438 Remainder 18,843 98,130 Less future minimum rentals to be received under subleases 1,354 $96,776
Consolidated rental expense under operating leases for continuing operations amounted to approximately $39,805,000, $26,739,000, and $24,177,000 for 1997, 1996 and 1995, respectively. Such amounts are included in the accompanying Consolidated Statements of Income in cost of sales and operating expenses and in selling and administrative expenses and include various month-to-month and other short-term rentals in addition to rents paid and accrued under long-term lease commitments. The Company has a product supply arrangement which requires the payment of a reservation fee of approximately $10.4 million annually through August 2002. 15. LITIGATION AND CONTINGENCIES Litigation Relating to Operations of Basis Prior to Acquisition Basis was named as a party to numerous claims and legal proceedings which arose prior to its acquisition by the Company. Pursuant to the stock purchase agreement between Energy, the Company, Salomon, and Basis, Salomon assumed the defense of all known suits, actions, claims and investigations pending at the time of the acquisition and all obligations, liabilities and expenses related to or arising therefrom. In addition, Salomon agreed to assume all obligations, liabilities and expenses related to or resulting from all private third-party suits, actions and claims which arise out of a state of facts existing on or prior to the time of the acquisition (including "superfund" liability), but which were not pending at such time, subject to certain terms, conditions and limitations. In certain pending matters, the plaintiffs are requesting injunctive relief which, if granted, could potentially result in the operations acquired in connection with the purchase of Basis being adversely affected through required reductions in emissions, discharges, or refinery throughput, which could be outside Salomon's indemnity obligations. As discussed in Note 4, the Company and Salomon reached an agreement in December 1997 whereby Salomon paid the Company $9.5 million in settlement of certain of Salomon's contingent environmental obligations assumed under the stock purchase agreement. This settlement did not affect Salomon's other indemnity obligations described in this paragraph. Litigation Relating to Discontinued Operations Energy and certain of its natural gas related subsidiaries, as well as the Company, have been sued by Teco Pipeline Company ("Teco") regarding the operation of the 340-mile West Texas pipeline in which a subsidiary of Energy holds a 50% undivided interest. In 1985, a subsidiary of Energy sold a 50% undivided interest in the pipeline and entered into a joint venture through an ownership agreement and an operating agreement, each dated February 28, 1985, with the purchaser of the interest. In 1988, Teco succeeded to that purchaser's 50% interest. A subsidiary of Energy has at all times been the operator of the pipeline. Notwithstanding the written ownership and operating agreements, the plaintiff alleges that a separate, unwritten partnership agreement exists, and that the defendants have exercised improper dominion over such alleged partnership's affairs. The plaintiff also alleges that the defendants acted in bad faith by negatively affecting the economics of the joint venture in order to provide financial advantages to facilities or entities owned by the defendants and by allegedly usurping for the defendants' own benefit certain opportunities available to the joint venture. The plaintiff asserts causes of action for breach of fiduciary duty, fraud, tortious interference with business relationships, professional malpractice and other claims, and seeks unquantified actual and punitive damages. Energy's motion to compel arbitration was denied, but Energy has filed an appeal. Energy has also filed a counterclaim alleging that the plaintiff breached its own obligations to the joint venture and jeopardized the economic and operational viability of the pipeline by its actions. Energy is seeking unquantified actual and punitive damages. Although PG&E previously acquired Teco and now ultimately owns both Teco and Energy after the Restructuring, PG&E's Teco acquisition agreement purports to assign the benefit or detriment of this lawsuit to the former shareholders of Teco. Pursuant to the Distribution Agreement by which the Company was spun off to Energy's stockholders in connection with the Restructuring, the Company has agreed to indemnify and hold harmless Energy with respect to this lawsuit to the extent of 50% of the amount of any final judgment or settlement amount not in excess of $30 million, and 100% of that part of any final judgment or settlement amount in excess of $30 million. General The Company is also a party to additional claims and legal proceedings arising in the ordinary course of business. The Company believes it is unlikely that the final outcome of any of the claims or proceedings to which the Company is a party would have a material adverse effect on the Company's financial statements; however, due to the inherent uncertainty of litigation, the range of possible loss, if any, cannot be estimated with a reasonable degree of precision and there can be no assurance that the resolution of any particular claim or proceeding would not have an adverse effect on the Company's results of operations for the interim period in which such resolution occurred. 16. QUARTERLY RESULTS OF OPERATIONS (Unaudited) The results of operations by quarter for the years ended December 31, 1997 and 1996 were as follows (in thousands of dollars, except per share amounts):
1997 - Quarter Ended (a) March 31 June 30 (b) September 30(b) December 31 (b) Total Operating revenues $821,802 $1,362,624 $1,975,665 $1,596,129 $5,756,220 Operating income 38,413 55,800 94,107 22,714 211,034 Income from continuing operations 19,811 27,598 51,993 12,366 111,768 Income (loss) from discontinued operations (4,371) (10,869) (432) - (15,672) Net income 15,440 16,729 51,561 12,366 96,096 Earnings (loss) per common share: Continuing operations .45 .55 .93 .22 2.16 Discontinued operations (.16) (.26) (.01) - (.39) Total .29 .29 .92 .22 1.77 Earnings (loss) per common share - assuming dilution: Continuing operations .38 .50 .91 .22 2.03 Discontinued operations (.08) (.20) (.01) - (.29) Total .30 .30 .90 .22 1.74
1996 - Quarter Ended (a) March 31 June 30 September 30 December 31 Total Operating revenues $574,522 $675,009 $678,059 $830,263 $2,757,853 Operating income 10,105 36,534 23,060 20,049 89,748 Income from continuing operations 2,963 18,164 6,630 (5,285) 22,472 Income (loss) from discontinued operations 16,951 2,677 6,516 24,085 50,229 Net income 19,914 20,841 13,146 18,800 72,701 Earnings (loss) per common share: Continuing operations .07 .41 .15 (.12) .51 Discontinued operations .32 - .08 .49 .89 Total .39 .41 .23 .37 1.40 Earnings (loss) per common share - assuming dilution: Continuing operations .06 .36 .13 (.12) .44 Discontinued operations .33 .05 .13 .49 .98 Total .39 .41 .26 .37 1.42 (a) Amounts reflect Energy's natural gas related services business as discontinued operations pursuant to the Restructuring. (b) Includes the operations of the Texas City, Houston and Krotz Springs refineries commencing May 1, 1997.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information on directors required by Items 401 and 405 of Regulation S-K is incorporated herein by reference to the Company's definitive Proxy Statement which will be filed with the Commission by April 30, 1998. Information concerning the Company's executive officers appears in Part I of this Annual Report on Form 10-K. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1. Financial Statements. The following Consolidated Financial Statements of Valero Energy Corporation and its subsidiaries are included in Part II, Item 8 of this Form 10-K: Page Report of independent public accountants Consolidated balance sheets as of December 31, 1997 and 1996 Consolidated statements of income for the years ended December 31, 1997, 1996 and 1995 Consolidated statements of common stock and other stockholders' equity for the years ended December 31, 1997, 1996 and 1995 Consolidated statements of cash flows for the years ended December 31, 1997, 1996 and 1995 Notes to consolidated financial statements 2. Financial Statement Schedules and Other Financial Information. No financial statement schedules are submitted because either they are inapplicable or because the required information is included in the Consolidated Financial Statements or notes thereto. 3. Exhibits. Filed as part of this Form 10-K are the following exhibits: 2.1 -- Agreement and Plan of Merger, dated as of January 31, 1997, as amended, by and among Valero Energy Corporation, PG&E Corporation, and PG&E Acquisition Corporation--incorporated by reference from Exhibit 2.1 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 2.2 -- Form of Agreement and Plan of Distribution between Valero Energy Corporation and Valero Refining and Marketing Company-- incorporated by reference from Exhibit 2.2 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 2.3 -- Form of Tax Sharing Agreement among Valero Energy Corporation, Valero Refining and Marketing Company and PG&E Corporation-- incorporated by reference from Exhibit 2.3 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 2.4 -- Form of Employee Benefits Agreement between Valero Energy Corporation and Valero Refining and Marketing Company-- incorporated by reference from Exhibit 2.4 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 2.5 -- Form of Interim Services Agreement between Valero Energy Corporation and Valero Refining and Marketing Company-- incorporated by reference from Exhibit 2.5 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 2.6 -- Stock Purchase Agreement dated as of April 22, 1997, among Valero Energy Corporation, Valero Refining and Marketing Company, Salomon Inc and Basis Petroleum, Inc.--incorporated by reference from Exhibit 2.1 to the Company's Current Report on Form 8-K. 3.1 -- Amended and Restated Certificate of Incorporation of Valero Energy Corporation (formerly known as Valero Refining and Marketing Company)--incorporated by reference from Exhibit 3.1 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 3.2 -- By-Laws of Valero Energy Corporation (formerly known as Valero Refining and Marketing Company)--incorporated by reference from Exhibit 3.2 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). 4.1 -- Rights Agreement between Valero Refining and Marketing Company and Harris Trust and Savings Bank, as Rights Agent--incorporated by reference from Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No. 333-31709, filed July 21, 1997). *4.2 -- Amended and Restated Credit Agreement dated as of November 28, 1997, among Valero Energy Corporation, the Banks listed therein, Morgan Guaranty Trust Company of New York, as Administrative Agent, and Bank of Montreal, as Syndicating Agent and Issuing Bank. +10.1 -- Valero Energy Corporation Executive Incentive Bonus Plan, as amended, dated as of April 23, 1997--incorporated by reference from Exhibit 10.1 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.2 -- Valero Energy Corporation Executive Stock Incentive Plan, as amended, dated as of April 23, 1997--incorporated by reference from Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.3 -- Valero Energy Corporation Stock Option Plan, as amended, dated as of April 23, 1997--incorporated by reference from Exhibit 10.3 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.4 -- Valero Energy Corporation Restricted Stock Plan for Non-Employee Directors, as amended, dated as of April 23, 1997--incorporated by reference from Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.5 -- Valero Energy Corporation Non-Employee Director Stock Option Plan, as amended, dated as of April 23, 1997--incorporated by reference from Exhibit 10.5 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.6 -- Executive Severance Agreement between Valero Energy Corporation and William E. Greehey, dated as of December 15, 1982, as adopted and ratified by Valero Refining and Marketing Company--incorporated by reference from Exhibit 10.6 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.7 -- Schedule of Executive Severance Agreements--incorporated by reference from Exhibit 10.7 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.8 -- Form of Indemnity Agreement between Valero Refining and Marketing Company and William E. Greehey--incorporated by reference from Exhibit 10.8 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.9 -- Schedule of Indemnity Agreements--incorporated by reference from Exhibit 10.9 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.10 -- Form of Incentive Bonus Agreement between Valero Refining and Marketing Company and Gregory C. King--incorporated by reference from Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). +10.11 -- Schedule of Incentive Bonus Agreements--incorporated by reference from Exhibit 10.11 to the Company's Registration Statement on Form S-1 (File No. 333-27013, filed May 13, 1997). *+10.12 -- Employment Agreement between Valero Refining and Marketing Company and William E. Greehey, dated as of June 18, 1997. *+10.13 -- Employment Agreement between Valero Refining and Marketing Company and Edward C. Benninger, dated as of June 18, 1997. *+10.14 -- Form of Management Stability Agreement between Valero Energy Corporation and Gregory C. King. *+10.15 -- Schedule of Management Stability Agreements. *11.1 -- Computation of Earnings Per Share. *21.1 -- Valero Energy Corporation subsidiaries, including state or other jurisdiction of incorporation or organization. *23.1 -- Consent of Arthur Andersen LLP, dated February 26, 1998. *24.1 -- Power of Attorney, dated February 26, 1998 (set forth on the signatures page of this Form 10-K). **27.1 -- Financial Data Schedule (reporting financial information as of and for the year ended December 31, 1997). **27.2 -- Restated Financial Data Schedule (reporting financial information as of and for the year ended December 31, 1996). **27.3 -- Restated Financial Data Schedule (reporting financial information as of and for the year ended December 31, 1995). ______________ * Filed herewith + Identifies management contracts or compensatory plans or arrangements required to be filed as an exhibit hereto pursuant to Item 14(c) of Form 10-K. ** The Financial Data Schedule and Restated Financial Data Schedule shall not be deemed "filed" for purposes of Section 11 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and are included as exhibits only to the electronic filing of this Form 10-K in accordance with Item 601(c) of Regulation S-K and Section 401 of Regulation S-T. Copies of exhibits filed as a part of this Form 10-K may be obtained by stockholders of record at a charge of $.15 per page, minimum $5.00 each request. Direct inquiries to Jay D. Browning, Corporate Secretary, Valero Energy Corporation, P.O. Box 500, San Antonio, Texas 78292. Pursuant to paragraph 601(b)(4)(iii)(A) of Regulation S-K, the registrant has omitted from the foregoing listing of exhibits, and hereby agrees to furnish to the Commission upon its request, copies of certain instruments, each relating to long-term debt not exceeding 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. (b) Reports on Form 8-K. The Company did not file any Current Reports on Form 8-K during the quarter ended December 31, 1997. For the purposes of complying with the rules governing Form S-8 under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 No. 333-31709 (filed July 21, 1997), No. 333-31721 (filed July 21, 1997), No. 333-31723 (filed July 21, 1997) and No. 333-31727 (filed July 21, 1997): Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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/ William E. Greehey (William E. Greehey) Chairman of the Board and Chief Executive Officer Date: February 26, 1998 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints William E. Greehey, Edward C. Benninger and Jay D. Browning, or any of them, each with power to act without the other, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all subsequent amendments and supplements to this Annual Report on Form 10-K, and to file the same, or cause to be filed the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto each said attorney-in-fact and agent full power to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby qualifying and confirming all that said attorney-in-fact and agent or his substitute or substitutes may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date Director, Chairman of the Board and Chief Executive Officer (Principal /s/ William E. Greehey Executive Officer) February 26, 1998 (William E. Greehey) Chief Financial Officer (Principal Financial and /s/ John D. Gibbons Accounting Officer) February 26, 1998 (John D. Gibbons) /s/ Edward C. Benninger Director and President February 26, 1998 (Edward C. Benninger) /s/ Ronald K. Calgaard Director February 26, 1998 (Ronald K. Calgaard) /s/ Robert G. Dettmer Director February 26, 1998 (Robert G. Dettmer) /s/ Ruben M. Escobedo Director February 26, 1998 (Ruben M. Escobedo) /s/ James L. Johnson Director February 26, 1998 (James L. Johnson) /s/ Lowell H. Lebermann Director February 26, 1998 (Lowell H. Lebermann) /s/ Susan Kaufman Purcell Director February 26, 1998 (Susan Kaufman Purcell) EX-4.2 2 AMENDED AND RESTATED CREDIT AGREEMENT CONFORMED COPY $835,000,000 AMENDED AND RESTATED CREDIT AGREEMENT dated as of November 28, 1997 among Valero Energy Corporation, The Banks Listed Herein, Morgan Guaranty Trust Company of New York, as Administrative Agent, and Bank of Montreal, as Syndication Agent and Issuing Bank TABLE OF CONTENTS Page ARTICLE 1 Definitions Section 1.01. Definitions . . . . . . . . . . . . . . . . . . .1 Section 1.02. Accounting Terms and Determinations . . . . . . 15 Section 1.03. Types of Borrowings . . . . . . . . . . . . . . 15 Section 1.04. Other Definitional Provisions . . . . . . . . . 16 Section 2.01. Commitments to Lend . . . . . . . . . . . . . . 16 Section 2.02. Notice of Committed Borrowing . . . . . . . . . 17 Section 2.03. Money Market Borrowings . . . . . . . . . . . . 17 Section 2.04. Notice to Banks; Funding of Loans . . . . . . . 21 Section 2.05. Notes . . . . . . . . . . . . . . . . . . . . . 22 Section 2.06. Maturity of Loans . . . . . . . . . . . . . . . 23 Section 2.07. Interest Rates. . . . . . . . . . . . . . . . . 23 Section 2.09. Optional Termination or Reduction of Commitments . . . . . . . . . . . . . . . . . 26 Section 2.10. Scheduled Termination of Commitments. . . . . . 26 Section 2.11. Optional Prepayments. . . . . . . . . . . . . . 26 Section 2.14. Computation of Interest and Fees. . . . . . . . 28 ARTICLE 3 Letters of Credit Section 3.01. Letter of Credit Commitment . . . . . . . . . . 28 Section 3.02. Letter of Credit Requests . . . . . . . . . . . 29 Section 3.04. Agreement to Repay Letter of Credit Drawings. . 30 Section 3.05. Indemnity . . . . . . . . . . . . . . . . . . . 32 ARTICLE 4 Conditions Section 4.01. Effectiveness . . . . . . . . . . . . . . . . . 32 Section 4.02. Borrowings. . . . . . . . . . . . . . . . . . . 34 ARTICLE 5 Representations and Warranties Section 5.02. Corporate and Governmental Authorization; No Contravention . . . . . . . . . . . . . . 35 Section 5.03. Binding Effect. . . . . . . . . . . . . . . . . 35 Section 5.04. Financial Information . . . . . . . . . . . . . 35 Section 5.05. Litigation. . . . . . . . . . . . . . . . . . . 36 Section 5.06. Compliance with ERISA . . . . . . . . . . . . . 36 Section 5.07. Environmental Matters . . . . . . . . . . . . . 37 Section 5.08. Taxes . . . . . . . . . . . . . . . . . . . . . 37 Section 5.09. Subsidiaries. . . . . . . . . . . . . . . . . . 37 Section 5.10. Not an Investment Company . . . . . . . . . . . 38 Section 5.11. Full Disclosure . . . . . . . . . . . . . . . . 38 Section 5.12. Representations in Subsidiary Guarantee Agreement . . . . . . . . . . . . . . . . . . 38 ARTICLE 6 Covenants Section 6.01. Information . . . . . . . . . . . . . . . . . . 38 Section 6.02. Payment of Obligations. . . . . . . . . . . . . 40 Section 6.03. Maintenance of Property; Insurance. . . . . . . 40 Section 6.04. Conduct of Business and Maintenance of Existence . . . . . . . . . . . . . . . . . . 41 Section 6.05. Compliance with Laws. . . . . . . . . . . . . . 41 Section 6.06. Inspection of Property, Books and Records . . . 41 Section 6.07. Fixed Charge Coverage . . . . . . . . . . . . . 41 Section 6.08. Debt. . . . . . . . . . . . . . . . . . . . . . 42 Section 6.09. Minimum Consolidated Net Worth. . . . . . . . . 42 Section 6.10. Negative Pledge-Liens . . . . . . . . . . . . . 43 Section 6.11. Subsidiary Debt . . . . . . . . . . . . . . . . 45 Section 6.12. Guarantors. . . . . . . . . . . . . . . . . . . 45 Section 6.13. Consolidations, Mergers and Transfers of Assets 46 Section 6.14. Use of Proceeds . . . . . . . . . . . . . . . . 47 Section 6.15. Restriction on Other Agreements . . . . . . . . 47 ARTICLE 7 Defaults Section 7.01. Events of Default . . . . . . . . . . . . . . . 47 Section 7.02. Cash Cover. . . . . . . . . . . . . . . . . . . 49 Section 7.03. Notice of Default . . . . . . . . . . . . . . . 50 ARTICLE 8 The Administrative Agent Section 8.01. Appointment and Authorization . . . . . . . . . 50 Section 8.02. Administrative Agent and Agent. . . . . . . . . 50 Section 8.03. Action by Administrative Agent. . . . . . . . . 50 Section 8.04. Consultation with Experts . . . . . . . . . . . 50 Section 8.05. Liability of Administrative Agent . . . . . . . 51 Section 8.06. Indemnification . . . . . . . . . . . . . . . . 51 Section 8.07. Credit Decision . . . . . . . . . . . . . . . . 51 Section 8.08. Successor Administrative Agent. . . . . . . . . 52 Section 8.09. Administrative Agent's Fee. . . . . . . . . . . 52 Section 8.10. Syndication Agent . . . . . . . . . . . . . . . 52 ARTICLE 9 Change in Circumstances Section 9.01. Basis for Determining Interest Rate Inadequate or Unfair. . . . . . . . . . . . . 52 Section 9.02. Illegality. . . . . . . . . . . . . . . . . . . 53 Section 9.03. Increased Cost and Reduced Return . . . . . . . 54 Section 9.04. Taxes . . . . . . . . . . . . . . . . . . . . . 55 Section 9.05. Base Rate Loans Substituted for Affected Fixed Rate Loans. . . . . . . . . . . . . . . 57 Section 9.06. Borrower's Right to Replace Banks . . . . . . . 58 ARTICLE 10 Miscellaneous Section 10.01. Notices. . . . . . . . . . . . . . . . . . . . 58 Section 10.02. No Waivers . . . . . . . . . . . . . . . . . . 59 Section 10.03. Expenses; Indemnification. . . . . . . . . . . 59 Section 10.04. Sharing of Set-Offs. . . . . . . . . . . . . . 60 Section 10.05. Amendments and Waivers . . . . . . . . . . . . 60 Section 10.06. Successors and Assigns . . . . . . . . . . . . 61 Section 10.07. Collateral . . . . . . . . . . . . . . . . . . 62 Section 10.08. Governing Law; Submission to Jurisdiction. . . 62 Section 10.09. Counterparts; Integration. . . . . . . . . . . 63 Section 10.10. WAIVER OF JURY TRIAL . . . . . . . . . . . . . 63 Schedule I - Pricing Schedule Schedule II - Commitment Schedule Exhibit A - Note Exhibit B - Money Market Quote Request Exhibit C - Invitation for Money Market Quotes Exhibit D - Money Market Quote Exhibit E - Opinion of Counsel for the Borrower Exhibit F - Opinion of Special Counsel for the Administrative Agent Exhibit G - Assignment and Assumption Agreement Exhibit H - Notice of Borrowing Exhibit I - Subsidiary Guarantee Agreement Exhibit J - Form of Guarantor Counsel Opinion AMENDED AND RESTATED CREDIT AGREEMENT AGREEMENT dated as of November 28, 1997, among VALERO ENERGY CORPORATION, the BANKS listed on the signature pages hereof, MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Administrative Agent, and BANK OF MONTREAL, as Syndication Agent and Issuing Bank. W I T N E S S E T H: WHEREAS, the Borrower, the banks referred to therein, Morgan Guaranty Trust Company of New York, as administrative agent for such banks and Bank of Montreal as syndication agent and issuing bank, are parties to a Credit Agreement dated as of May 1, 1997 (the "Existing Credit Agreement"); WHEREAS, the parties thereto desire to amend and restate the Existing Credit Agreement as provided in this Agreement and, upon satisfaction of the conditions specified in Section 4.01, said Credit Agreement will be so amended and restated; NOW, THEREFORE, the parties hereto hereby agree as follows: ARTICLE I Definitions Section 1.01. Definitions. The following terms, as used herein, have the following meanings: "Absolute Rate Auction" means a solicitation of Money Market Quotes setting forth Money Market Absolute Rates pursuant to Section 2.03. "Additional IDB" means up to $25,000,000 aggregate principal amount of industrial development bonds to be issued for the account of the Borrower or a Subsidiary and supported by a Letter of Credit to be issued under this Agreement. "Adjusted London Interbank Offered Rate" has the meaning set forth in Section 2.07(b). "Administrative Agent" means Morgan Guaranty in its capacity as administrative agent and documentation agent for the Banks under the Financing Documents, and its successors in such capacity. "Administrative Questionnaire" means, with respect to each Bank, an administrative questionnaire in the form prepared by the Administrative Agent and submitted to the Administrative Agent (with a copy to the Borrower) duly completed by such Bank. "Agreement" means the Existing Credit Agreement as amended and restated by this Amended Agreement and as the same may be further amended or restated from time to time in accordance with the terms hereof. "Amended Agreement" means this Amended and Restated Credit Agreement dated as of November 28, 1997 among the Borrower, the Banks, the Administrative Agent and BMO as Syndication Agent and Issuing Bank. "Applicable Lending Office" means, with respect to any Bank, (i) in the case of its Base Rate Loans, its Domestic Lending Office, (ii) in the case of its Euro-Dollar Loans, its Euro-Dollar Lending Office and (iii) in the case of its Money Market Loans, its Money Market Lending Office. "Assignee" has the meaning set forth in Section 10.06(c). "Bank" means each bank listed on the signature pages hereof, each Assignee which becomes a Bank pursuant to Section 10.06(c), and their respective successors. "Base Rate" means, for any day, a rate per annum equal to the higher of (i) the Prime Rate for such day and (ii) the sum of 1/2 of 1% plus the Federal Funds Rate for such day. "Base Rate Loan" means a Committed Loan to be made by a Bank as a Base Rate Loan in accordance with the applicable Notice of Borrowing or pursuant to Article 9. "Benefit Arrangement" means at any time an employee benefit plan within the meaning of Section 3(3) of ERISA which is not a Plan or a Multi-employer Plan and which is maintained or otherwise contributed to by any member of the ERISA Group. "BMO" means Bank of Montreal. "Bond Letters of Credit" means (i) the letter of credit issued by BMO and outstanding under the Existing Credit Agreement supporting payment of up to $98,500,000 principal amount of Industrial Development Corporation of Port of Corpus Christi Revenue Refunding Bonds (Valero Refining and Marketing Company Project) and specified amounts of accrued interest thereon and (ii) the letter of credit issued by BMO and outstanding under the Existing Credit Agreement supporting payment of up to $25,000,000 principal amount of Gulf Coast Industrial Development Authority Waste Disposal Revenue Bonds (Valero Refining and Marketing Company Project) and specified amounts of accrued interest thereon. The amount available under each Bond Letter of Credit shall include, for all purposes of this Agreement, any amounts not currently available thereunder but subject to reinstatement in accordance with the terms thereof. "Borrower" means Valero Energy Corporation, a Delaware corporation. "Borrowing" has the meaning set forth in Section 1.03. "Commitment" means, with respect to each Bank, the amount set forth opposite the name of such Bank on the Commitment Schedule, as such amount may be reduced from time to time pursuant to Section 2.09 or 2.10 or increased or reduced from time to time pursuant to Section 10.06(c), or the obligation of such Bank to make Committed Loans and to participate in Letters of Credit hereunder in an aggregate amount at any time outstanding not to exceed such amount, as the context may require. "Commitment Schedule" means the Schedule attached hereto and identified as such. "Committed Borrowings" has the meaning given such term in Section 1.03. "Committed Loan" means a loan made by a Bank pursuant to Section 2.01. "Consolidated Debt" means for any Person at any date the Debt of such Person and its Consolidated Subsidiaries as of such date, determined on a consolidated basis in accordance with generally accepted accounting principles. "Consolidated Net Income" means, for any Person for any period, the net income of such Person and its Consolidated Subsidiaries for such period determined on a consolidated basis in accordance with generally accepted accounting principles. "Consolidated Net Income Applicable to Common Stock" means, for any Person for any period, the net income to common shareholders of such Person and its Consolidated Subsidiaries for such period determined on a consolidated basis in accordance with generally accepted accounting principles. "Consolidated Net Worth" means for any Person at any date the Net Worth of such Person and its Consolidated Subsidiaries as of such date determined on a consolidated basis in accordance with generally accepted accounting principles. "Consolidated Subsidiary" means for any Person at any date any Subsidiary or other entity the accounts of which would be consolidated with those of such Person in its consolidated financial statements if such statements were prepared as of such date. "Consolidated Total Assets" means for any Person at any date the total assets of such Person and its Consolidated Subsidiaries, determined on a consolidated basis as of such date in accordance with generally accepted accounting principles. "Debt" of any Person means at any date, without duplication, (i) all items of indebtedness or liability which, in accordance with generally accepted accounting principles, would be included in determining total liabilities as shown on the liability side of a balance sheet at the date as of which indebtedness is to be determined, but excluding Net Worth, preferred stock, deferred credits, deferred taxes, accounts payable (not more than 120 days past due), accrued expenses and taxes payable, (ii) all obligations under leases which, in accordance with generally accepted accounting principles, would at such time (and assuming that the Person was not a regulated enterprise) be required to be capitalized on a balance sheet of such Person, (iii) all non-contingent obligations (and, solely for purposes of Sections 6.10 and the definitions of Material Debt and Material Financial Obligations, all contingent obligations) of such Person to reimburse any bank or other Person in respect of amounts paid under a letter of credit or similar instrument, (iv) all indebtedness, liabilities or obligations of others of the type described in clause (i), (ii) or (iii) that are Guaranteed by such Person and (v) all indebtedness, liabilities or obligations of others of the type described in clause (i), (ii), (iii) or (iv) that are secured by any Lien upon the properties or assets of such Person, provided that the amount of any Debt of such Person which constitutes Debt of such Person solely by reason of this clause (v) shall not for purposes of this Agreement exceed the greater of the book value or the fair market value of the properties or assets subject to such Lien. "Default" means any condition or event which constitutes an Event of Default or which with the giving of notice or lapse of time or both would, unless cured or waived, become an Event of Default. "Deferred Turnaround and Catalyst Cost" means, for any period, the amount of capital expenditures of the Borrower and its Consolidated Subsidiaries during such period in respect of scheduled or periodic maintenance of refineries where such scheduled or periodic maintenance requires the shutdown of a refinery for a period in excess of 14 days; provided that Deferred Turnaround and Catalyst Cost shall not for purposes of calculations of compliance under Section 6.07 exceed $40,000,000 for any period of four consecutive fiscal quarters. "Derivatives Obligations" of any Person means all obligations of such Person in respect of any rate swap transaction, basis swap, forward rate transaction, commodity swap, commodity option, equity or equity index swap, equity or equity index option, bond option, interest rate option, foreign exchange transaction, cap transaction, floor transaction, collar transaction, currency swap transaction, cross-currency rate swap transaction, currency option or any other similar transaction (including any option with respect to any of the foregoing transactions) or any combination of the foregoing transactions. "Domestic Business Day" means any day except a Saturday, Sunday or other day on which commercial banks in New York City are authorized by law to close. "Domestic Lending Office" means, as to each Bank, its office located at its address set forth in its Administrative Questionnaire (or identified in its Administrative Questionnaire as its Domestic Lending Office) or such other office as such Bank may hereafter designate as its Domestic Lending Office by notice to the Borrower and the Administrative Agent. "Effective Date" means the date this Amended Agreement becomes effective in accordance with Section 4.01. "Environmental Laws" means any and all federal, state, local and foreign statutes, laws, judicial decisions, regulations, ordinances, rules, judgments, orders, decrees, plans, injunctions, permits, concessions, grants, franchises, licenses, agreements and other governmental restrictions relating to the environment, the effect of the environment on human health or to emissions, discharges or releases of pollutants, contaminants, Hazardous Substances or wastes into the environment including, without limitation, ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, Hazardous Substances or wastes or the clean-up or other remediation thereof. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, or any successor statute. "ERISA Group" means the Borrower, any Subsidiary and all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower or any Subsidiary, are treated as a single employer under Section 414 of the Internal Revenue Code. "Euro-Dollar Business Day" means any Domestic Business Day on which commercial banks are open for international business (including dealings in dollar deposits) in London. "Euro-Dollar Lending Office" means, as to each Bank, its office, branch or affiliate located at its address set forth in its Administrative Questionnaire (or identified in its Administrative Questionnaire as its Euro-Dollar Lending Office) or such other office, branch or affiliate of such Bank as it may hereafter designate as its Euro-Dollar Lending Office by notice to the Borrower and the Administrative Agent. "Euro-Dollar Loan" means a Committed Loan to be made by a Bank as a Euro-Dollar Loan in accordance with the applicable Notice of Committed Borrowing. "Euro-Dollar Margin" has the meaning set forth in Section 2.07(c). "Euro-Dollar Reserve Percentage" has the meaning set forth in Section 2.07(c). "Event of Default" has the meaning set forth in Section 7.01. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Existing Credit Agreement" has the meaning set forth in the recitals hereto. "Existing Letter of Credit" means each Letter of Credit outstanding under the Existing Credit Agreement on the Effective Date, including the Bond Letters of Credit. "Federal Funds Rate" means, for any day, the rate per annum (rounded upward, if necessary, to the nearest 1/100th of 1%) equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Domestic Business Day next succeeding such day, provided that (i) if such day is not a Domestic Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Domestic Business Day as so published on the next succeeding Domestic Business Day, and (ii) if no such rate is so published on such next succeeding Domestic Business Day, the Federal Funds Rate for such day shall be the average rate quoted to Morgan Guaranty on such day on such transactions as determined by the Administrative Agent. "Fee Letters" means the letter agreements entered into from time to time by the Borrower and Morgan Guaranty and/or BMO establishing fees payable by the Borrower. "Financial Letter of Credit" means the Bond Letters of Credit and any other Letter of Credit which is not a Performance Letter of Credit. "Financial Officer" means the chief financial officer, vice president-finance or other financial vice president, controller, treasurer or assistant treasurer of the Borrower. "Financing Documents" means this Agreement, the Notes and each Subsidiary Guarantee Agreement. "Fixed Rate Borrowing" has the meaning set forth in Section 1.03. "Fixed Rate Loans" means Euro-Dollar Loans or Money Market Loans (excluding Money Market LIBOR Loans bearing interest at the Base Rate pursuant to Section 9.01) or any combination of the foregoing. "Guarantee" by any Person means any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Debt of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt (whether arising by virtue of partnership arrangements, by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for the purpose of assuring in any other manner the holder of such Debt of the payment thereof or to protect such holder against loss in respect thereof (in whole or in part), provided that the term Guarantee shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. "Guarantor" means, at any time, a Subsidiary which at or prior to such time shall have delivered to the Administrative Agent (i) a Subsidiary Guarantee Agreement in substantially the form of Exhibit I, duly executed by such Subsidiary, which Subsidiary Guarantee Agreement has not been terminated in accordance with its terms, (ii) an opinion of counsel for such Subsidiary (which counsel may be an employee of the Borrower or such Subsidiary) reasonably satisfactory to the Administrative Agent with respect to such Subsidiary Guarantee Agreement, substantially in the form of Exhibit J hereto and covering such additional matters relating to such Subsidiary Guarantee Agreement as the Required Banks may reasonably request and (iii) all documents the Administrative Agent may reasonably request relating to the existence of such Subsidiary, the corporate authority for and the validity of such Subsidiary Guarantee Agreement, and any other matters reasonably determined by the Administrative Agent to be relevant thereto, all in form and substance reasonably satisfactory to the Administrative Agent. "Hazardous Substances" means any toxic, radioactive, caustic or otherwise hazardous substance, including petroleum, its derivatives, by-products and other hydrocarbons, or any substance having any constituent elements displaying any of the foregoing characteristics. "Indemnitee" has the meaning set forth in Section 10.03(b). "Interest Period" means: (1) with respect to each Euro-Dollar Borrowing, the period commencing on the date of such Borrowing and ending one, two, three or six months thereafter, as the Borrower may elect in the applicable Notice of Borrowing; provided that: (a) any Interest Period which would otherwise end on a day which is not a Euro-Dollar Business Day shall, subject to clause (c) below, be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Euro-Dollar Business Day; (b) any Interest Period which begins on the last Euro-Dollar Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall, subject to clause (c) below, end on the last Euro-Dollar Business Day of a calendar month; and (c) any interest Period which would otherwise end after the Termination Date shall end on the Termination Date. (2) with respect to each Base Rate Borrowing, the period commencing on the date of such Borrowing and ending on the Termination Date; (3) with respect to each Money Market LIBOR Borrowing, the period commencing on the date of such Borrowing and ending such whole number of months thereafter as the Borrower may elect in accordance with Section 2.03; provided that: (a) any Interest Period which would otherwise end on a day which is not a Euro-Dollar Business Day shall, subject to clause (c) below, be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Euro-Dollar Business Day; (b) any Interest Period which begins on the last Euro-Dollar Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall, subject to clause (c) below, end on the last Euro-Dollar Business Day of a calendar month; and (c) any interest Period which would otherwise end after the Termination Date shall end on the Termination Date. (4) with respect to each Money Market Absolute Rate Borrowing, the period commencing on the date of such Borrowing and ending such number of days thereafter (but not less than 7 days) as the Borrower may elect in accordance with Section 2.03; provided that: (a) any Interest Period which would otherwise end on a day which is not a Euro-Dollar Business Day shall, subject to clause (b) below, be extended to the next succeeding Euro-Dollar Business Day; and (b) any interest Period which would otherwise end after the Termination Date shall end on the Termination Date. "Internal Revenue Code" means the Internal Revenue Code of 1986, as amended, or any successor statute. "Investment Grade Rating" means a rating of senior long-term unsecured debt securities of the Borrower without any third-party credit enhancement of (i) BBB- or higher by S&P or (ii) Baa3 or higher by Moody's. "Issuing Bank" means BMO. "Letters of Credit" has the meaning set forth in Section 3.01. "Letter of Credit Outstandings" means, at any time, the sum (without duplication) of the aggregate Stated Amount of all outstanding Letters of Credit and the aggregate amount of all Unpaid Drawings in respect of Letters of Credit. "Letter of Credit Termination Date" means the date falling ten days prior to the Termination Date. "LIBOR Auction" means a solicitation of Money Market Quotes setting forth Money Market Margins based on the London Interbank Offered Rate pursuant to Section 2.03. "Lien" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind, or any other type of preferential arrangement that has the practical effect of creating a security interest, in respect of such asset. For the purposes of this Agreement, the Borrower or any Subsidiary shall be deemed to own subject to a Lien any asset which it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement relating to such asset. "Loan" means a Base Rate Loan or a Euro-Dollar Loan or a Money Market Loan and "Loans" means Base Rate Loans or Euro-Dollar Loans or Money Market Loans or any combination of the foregoing. "London Interbank Offered Rate" has the meaning set forth in Section 2.07(c). "Material Debt" means Debt (other than the Notes) of the Borrower and/or one or more of its Subsidiaries, arising in one or more related or unrelated transactions, in an aggregate principal or face amount exceeding $25,000,000. "Material Financial Obligations" means a principal or face amount of Debt and/or payment obligations in respect of Derivatives Obligations of the Borrower and/or one or more of its Subsidiaries, arising in one or more related or unrelated transactions, exceeding in the aggregate $25,000,000. "Material Plan" means at any time a Plan or Plans having aggregate Unfunded Liabilities in excess of $25,000,000. "Material Subsidiary" means Valero Refining Company, Valero Marketing and Supply Company, Valero Refining Company-Texas and Valero Refining Company-Louisiana and (ii) each other Subsidiary of the Borrower that would be a "significant subsidiary" as such term is defined in Regulation S-X promulgated pursuant to the Securities Exchange Act of 1934, as amended to the date hereof, and their respective successors. "Moody's" means Moody's Investors Service, Inc. "Money Market Absolute Rate" has the meaning set forth in Section 2.03(d). "Money Market Absolute Rate Loan" means a loan to be made by a Bank pursuant to an Absolute Rate Auction. "Money Market Lending Office" means, as to each Bank, its Domestic Lending Office or such other office, branch or affiliate of such Bank as it may hereafter designate as its Money Market Lending Office by notice to the Borrower and the Administrative Agent; provided that any Bank may from time to time by notice to the Borrower and the Administrative Agent designate separate Money Market Lending Offices for its Money Market LIBOR Loans, on the one hand, and its Money Market Absolute Rate Loans, on the other hand, in which case all references herein to the Money Market Lending Office of such Bank shall be deemed to refer to either or both of such offices, as the context may require. "Money Market LIBOR Loan" means a loan to be made by a Bank pursuant to a LIBOR Auction (including such a loan bearing interest at the Base Rate pursuant to Section 9.01). "Money Market Loan" means a Money Market LIBOR Loan or a Money Market Absolute Rate Loan. "Money Market Margin" has the meaning set forth in Section 2.03(d). "Money Market Quote" means an offer by a Bank to make a Money Market Loan in accordance with Section 2.03. "Morgan Guaranty" means Morgan Guaranty Trust Company of New York. "Multiemployer Plan" means at any time an employee pension benefit plan within the meaning of Section 4001(a)(3) of ERISA to which any member of the ERISA Group is then making or accruing an obligation to make contributions or has within the preceding five plan years made contributions, including for these purposes any Person which ceased to be a member of the ERISA Group during such five year period. "Net Worth" of a Person means at any time the sum of its capital stock, additional paid in capital, retained earnings, and any other account which, in accordance with generally accepted accounting principles, constitutes stockholders' equity, less treasury stock; provided that "Net Worth" shall not include the liquidation value of any preferred stock classified as redeemable preferred stock in accordance with generally accepted accounting principles. "Notes" means promissory notes of the Borrower, substantially in the form of Exhibit A hereto, evidencing the obligation of the Borrower to repay the Loans, and "Note" means any one of such promissory notes issued hereunder. "Notice of Borrowing" means a notice of borrowing in substantially the form of Exhibit H. "Parent" means, with respect to any Bank, any Person controlling such Bank. "Participant" has the meaning set forth in Section 10.06(b). "PBGC" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. "Percentage Participation" means, for each Bank, the percentage obtained by dividing the amount of such Bank's Commitment by the aggregate amount of the Commitments. "Performance Letter of Credit" means a Letter of Credit to back performance of non-financial or commercial contracts or undertakings of the Borrower and its Subsidiaries of the type which qualifies for a 50% conversion factor for purposes of risk-based capital adequacy regulations applicable to the Banks. "Person" means an individual, a corporation, a partnership, an association, a trust or any other entity or organization, including a government or political subdivision or an agency or instrumentality thereof. "Plan" means at any time an employee pension benefit plan (other than a Multi-employer Plan) which is covered by Title IV of ERISA or subject to the minimum funding standards under Section 412 of the Internal Revenue Code and either (i) is maintained, or contributed to, by any member of the ERISA Group for employees of any member of the ERISA Group or (ii) has at any time within the preceding five years been maintained, or contributed to, by any Person which was at such time a member of the ERISA Group for employees of any Person which was at such time a member of the ERISA Group. "Pricing Schedule" means the Schedule attached hereto identified as such. "Prime Rate" means the rate of interest publicly announced by Morgan Guaranty in New York City from time to time as its Prime Rate. "Reference Banks" means the principal London offices of BMO and Morgan Guaranty. "Refunding Borrowing" means a Committed Borrowing which, after application of the proceeds thereof, results in no net increase in the outstanding principal amount of Committed Loans made by any Bank. "Regulation G" means Regulation G of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Regulation U" means Regulation U of the Board of Governors of the Federal Reserve System, as in effect from time to time. "Required Banks" means at any time Banks having at least 51% of the aggregate amount of the Commitments or, if the Commitments shall have been terminated, holding at least 51% of the sum of the aggregate unpaid principal amount of the Loans and the Letter of Credit Outstandings. "Revolving Credit Period" means the period from and including the Effective Date to but excluding the Termination Date. "S&P" shall mean Standard & Poor's Ratings Services. "Stated Amount" means, as to any Letter of Credit at any time, the maximum amount then available to be drawn thereunder (without regard to whether any conditions to drawing could then be met). "Subsidiary" means, as to any Person, (i) any corporation more than 50% of whose stock of any class or classes having by the terms thereof ordinary voting power to elect a majority of the directors of such corporation (irrespective of whether or not at the time stock of any class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time owned by such Person directly or indirectly through one or more other Subsidiaries and (ii) any partnership, association, joint venture or other entity in which such Person, directly or indirectly through one or more other Subsidiaries, has a greater than 50% equity interest at the time. "Subsidiary Guarantee Agreement" means a Guarantee which may be entered into by a Subsidiary substantially in the form of Exhibit I hereto. "Syndication Agent" means BMO in its capacity as syndication agent hereunder. "Termination Date" means November 28, 2002, or, if such day is not a Euro-Dollar Business Day, the next preceding Euro-Dollar Business Day. "Unfunded Liabilities" means, with respect to any Plan at any time, the amount (if any) by which (i) the value of all benefit liabilities under such Plan, determined on a plan termination basis using the assumptions prescribed by the PBGC for purposes of Section 4044 of ERISA, exceeds (ii) the fair market value of all Plan assets allocable to such liabilities under Title IV of ERISA (excluding any accrued but unpaid contributions), all determined as of the then most recent valuation date for such Plan, but only to the extent that such excess represents a potential liability of a member of the ERISA Group to the PBGC or any other Person under Title IV of ERISA. "United States" means the United States of America, including the States and the District of Columbia, but excluding its territories and possessions. "Unpaid Drawing" has the meaning set forth in Section 3.04(a). "Valero S-1" means the Registration Statement on Form S-1 filed by the Borrower with the Securities and Exchange Commission on May 13, 1997 pursuant to the Securities Act of 1933, as amended. "Valero 10-Q" means the Borrower's quarterly report on Form 10-Q for the fiscal period ended September 30, 1997, as filed with the Securities and Exchange Commission pursuant to the Exchange Act. "Wholly-Owned Consolidated Subsidiary" means, as to any Person, any Consolidated Subsidiary all of the shares of capital stock or other ownership interests of which (except directors' qualifying shares) are at the time directly or indirectly owned by such Person. Section 1.02. Accounting Terms and Determinations. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all accounting determinations hereunder shall be made, and all financial statements required to be delivered hereunder shall be prepared in accordance with generally accepted accounting principles as in effect from time to time, applied on a basis consistent (except for changes concurred in by the Borrower's independent public accountants) with the most recent audited consolidated financial statements of the Borrower and its Consolidated Subsidiaries delivered to the Banks; provided that, if the Borrower notifies the Administrative Agent that the Borrower wishes to amend any covenant in Article 6 to eliminate the effect of any change in generally accepted accounting principles on the operation of such covenant (or if the Administrative Agent notifies the Borrower that the Required Banks wish to amend Article 6 for such purpose), then the Borrower's compliance with such covenant shall be determined on the basis of generally accepted accounting principles in effect immediately before the relevant change in generally accepted accounting principles became effective, until either such notice is withdrawn or such covenant is amended in a manner satisfactory to the Borrower and the Required Banks. Section 1.03. Types of Borrowings. The term "Borrowing" denotes the aggregation of Loans of one or more Banks to be made to the Borrower pursuant to Article 2 on a single date and for a single Interest Period. Borrowings are classified for purposes of this Agreement either by reference to the pricing of Loans comprising such Borrowing (e.g., a "Euro-Dollar Borrowing" is a Borrowing comprised of Euro-Dollar Loans and a "Fixed Rate Borrowing" is a Borrowing comprised of Fixed Rate Loans) or by reference to the provisions of Article 2 under which participation therein is determined (i.e., a "Committed Borrowing" is a Borrowing under Section 2.01 in which all Banks participate in proportion to their Commitments, while a "Money Market Borrowing" is a Borrowing under Section 2.03 in which the Bank participants are determined on the basis of their bids in accordance therewith). Section 1.04. Other Definitional Provisions. References in this Agreement to "Articles", "Sections", "Schedules" or "Exhibits" shall be to Articles, Sections, Schedules or Exhibits of or to this Agreement unless otherwise specifically provided. Any of the terms defined in Section 1.01 may, unless the context otherwise requires, be used in the singular or plural depending on the reference. "Include" or "includes" and "including" shall be deemed to be followed by "without limitation" whether or not they are in fact followed by such words or words of like import. "Writing", "written" and comparable terms refer to printing, typing and other means of reproducing words in a visible form. References to any agreement or contract are to such agreement or contract as amended, modified or supplemented from time to time in accordance with the terms hereof and thereof. Reference to any Person include the successors and permitted assigns of such Person. References "from" or "through" any date mean, unless otherwise specified, "from and including" or "through and including", respectively. ARTICLE 2 The Credits Section 2.01. Commitments to Lend. During the Revolving Credit Period each Bank severally agrees, on the terms and conditions set forth in this Agreement, to make loans to the Borrower pursuant to this Section from time to time in amounts requested by the Borrower, provided that the sum of the aggregate principal amount of Committed Loans by such Bank at any one time outstanding and such Bank's ratable share of the Letter of Credit Outstandings at such time shall not exceed the amount of its Commitment. Each Borrowing under this Section shall be in an aggregate principal amount of $1,000,000 or any larger multiple of $1,000,000 (except that any such Borrowing may be in the aggregate amount available in accordance with Section 4.02(b)) and shall be made from the several Banks ratably in proportion to their respective Commitments. Within the foregoing limits, the Borrower may borrow under this Section, repay, or to the extent permitted by Section 2.11, prepay Loans, and re-borrow at any time during the Revolving Credit Period under this Section. Section 2.02. Notice of Committed Borrowing. The Borrower shall give the Administrative Agent a Notice of Borrowing not later than 12:30 P.M. (New York City time) on (x) the date of each Base Rate Borrowing and (y) the third Euro-Dollar Business Day before each Euro-Dollar Borrowing, specifying: (a) the date of such Borrowing, which shall be a Domestic Business Day in the case of a Base Rate Borrowing or a Euro-Dollar Business Day in the case of a Euro-Dollar Borrowing; (b) the aggregate amount of such Borrowing; (c) whether the Loans comprising such Borrowing are to be Base Rate Loans or Euro-Dollar Loans; and (d) in the case of a Fixed Rate Borrowing, the duration of the Interest Period applicable thereto, subject to the provisions of the definition of Interest Period. Section 2.03. Money Market Borrowings. (a) The Money Market Option. In addition to Committed Borrowings pursuant to Section 2.01, the Borrower may, as set forth in this Section, request the Banks during the Revolving Credit Period to make offers to make Money Market Loans to the Borrower. The Banks may, but shall have no obligation to, make such offers and the Borrower may, but shall have no obligation to, accept any such offers in the manner set forth in this Section. (b) Money Market Quote Request. When the Borrower wishes to request offers to make Money Market Loans under this Section, it shall transmit to the Administrative Agent by telex or facsimile transmission a Money Market Quote Request substantially in the form of Exhibit B hereto so as to be received no later than 12:30 P.M. (New York City time) on (x) the fifth Euro-Dollar Business Day prior to the date of Money Market Borrowing proposed therein, in the case of a LIBOR Auction or (y) the Domestic Business Day next preceding the date of Borrowing proposed therein, in the case of an Absolute Rate Auction (or, in either case, such other time or date as the Borrower and the Administrative Agent shall have mutually agreed and shall have notified to the Banks not later than the date of the Money Market Quote Request for the first LIBOR Auction or Absolute Rate Auction for which such change is to be effective) specifying: (i) the proposed date of Borrowing, which shall be a Euro-Dollar Business Day in the case of a LIBOR Auction or a Domestic Business Day in the case of an Absolute Rate Auction, (ii) the aggregate amount of such Borrowing, which shall be $1,000,000 or a larger multiple of $1,000,000, (iii) the duration of the Interest Period applicable thereto, subject to the provisions of the definition of Interest Period, and (iv) whether the Money Market Quotes requested are to set forth a Money Market Margin or a Money Market Absolute Rate. The Borrower may request offers to make Money Market Loans for more than one Interest Period in a single Money Market Quote Request. (c) Invitation for Money Market Quotes. Promptly upon receipt of a Money Market Quote Request, the Administrative Agent shall send to the Banks by telex or facsimile transmission an Invitation for Money Market Quotes substantially in the form of Exhibit C hereto, which shall constitute an invitation by the Borrower to each Bank to submit Money Market Quotes offering to make the Money Market Loans to which such Money Market Quote Request relates in accordance with this Section. (d) Submission and Contents of Money Market Quotes. (i) Each Bank may submit a Money Market Quote containing an offer or offers to make Money Market Loans in response to any Invitation for Money Market Quotes. Each Money Market Quote must comply with the requirements of this subsection (d) and must be submitted to the Administrative Agent by telex or facsimile transmission at its offices specified in or pursuant to Section 9.01 not later than (x) 2:00 P.M. (New York City time) on the fourth Euro-Dollar Business Day prior to the proposed date of Borrowing, in the case of a LIBOR Auction or (y) 11:30 A.M. (New York City time) on the proposed date of Borrowing, in the case of an Absolute Rate Auction (or, in either case, such other time or date as the Borrower and the Administrative Agent shall have mutually agreed and shall have notified to the Banks not later than the date of the Money Market Quote Request for the first LIBOR Auction or Absolute Rate Auction for which such change is to be effective); provided that Money Market Quotes submitted by the Administrative Agent (or any affiliate of the Administrative Agent) in the capacity of a Bank may be submitted, and may only be submitted, if the Administrative Agent or such affiliate notifies the Borrower of the terms of the offer or offers contained therein not later than (x) one hour prior to the deadline for the other Banks, in the case of a LIBOR Auction or (y) 15 minutes prior to the deadline for the other Banks, in the case of an Absolute Rate Auction. Subject to Articles 4 and 7, any Money Market Quote so made shall be irrevocable except with the written consent of the Administrative Agent given on the instructions of the Borrower. (ii) Each Money Market Quote shall be in substantially the form of Exhibit D hereto and shall in any case specify: (A) the proposed date of Borrowing; (B) the principal amount of the Money Market Loan for which each such offer is being made, which principal amount (w) may be greater than or less than the Commitment of the quoting Bank, (x) must be $1,000,000 or a larger multiple of $1,000,000, (y) may not exceed the principal amount of Money Market Loans for which offers were requested and (z) may be subject to an aggregate limitation as to the principal amount of Money Market Loans for which offers being made by such quoting Bank may be accepted; (C) in the case of a LIBOR Auction, the margin above or below the applicable London Interbank Offered Rate (the "Money Market Margin") offered for each such Money Market Loan, expressed as a percentage (specified to the nearest 1/10,000th of 1%) to be added to or subtracted from such base rate; (D) in the case of an Absolute Rate Auction, the rate of interest per annum (specified to the nearest 1/10,000th of 1%) (the "Money Market Absolute Rate") offered for each such Money Market Loan; and (E) the identity of the quoting Bank. A Money Market Quote may set forth up to five separate offers by the quoting Bank with respect to each Interest Period specified in the related Invitation for Money Market Quotes. (iii) Any Money Market Quote shall be disregarded if it: (A) is not substantially in conformity with Exhibit D hereto or does not specify all of the information required by subsection (d)(ii); (B) contains qualifying, conditional or similar language; (C) proposes terms other than or in addition to those set forth in the applicable Invitation for Money Market Quotes; or D) arrives after the time set forth in subsection (d)(i). (e) Notice to Borrower. (i) The Administrative Agent shall promptly notify the Borrower of (A) the terms of any Money Market Quote submitted by a Bank that is in accordance with subsection (d) and (B) of any Money Market Quote that amends, modifies or is otherwise inconsistent with a previous Money Market Quote submitted by such Bank with respect to the same Money Market Quote Request. Any such subsequent Money Market Quote shall be disregarded by the Administrative Agent unless such subsequent Money Market Quote is submitted solely to correct a manifest error in such former Money Market Quote. (ii) The Administrative Agent's notice to the Borrower shall specify (A) the aggregate principal amount of Money Market Loans for which offers have been received for each Interest Period specified in the related Money Market Quote Request, (B) the respective principal amounts and Money Market Margins or Money Market Absolute Rates, as the case may be, so offered and (C) if applicable, limitations on the aggregate principal amount of Money Market Loans for which offers in any single Money Market Quote may be accepted. (f) Acceptance and Notice by Borrower. Not later than 12:30 P.M. (New York City time) on (x) the third Euro-Dollar Business Day prior to the proposed date of Borrowing, in the case of a LIBOR Auction or (y) the proposed date of Borrowing, in the case of an Absolute Rate Auction (or, in either case, such other time or date as the Borrower and the Administrative Agent shall have mutually agreed and shall have notified to the Banks not later than the date of the Money Market Quote Request for the first LIBOR Auction or Absolute Rate Auction for which such change is to be effective), the Borrower shall notify the Administrative Agent of its acceptance or non-acceptance of the offers so notified to it pursuant to subsection (e). In the case of acceptance, such notice shall be a Notice of Borrowing which shall specify the aggregate principal amount of offers for each Interest Period that are accepted. The Borrower may accept any Money Market Quote in whole or in part; provided that: (i) the aggregate principal amount of each Money Market Borrowing may not exceed the applicable amount set forth in the related Money Market Quote Request; (ii) the principal amount of each Money Market Borrowing must be $1,000,000 or a larger multiple of $1,000,000; (iii) acceptance of offers may only be made on the basis of ascending Money Market Margins or Money Market Absolute Rates, as the case may be; and (iv) the Borrower may not accept any offer that is described in subsection (d)(iii) or that otherwise fails to comply with the requirements of this Agreement. (g) Allocation by Administrative Agent. If offers are made by two or more Banks with the same Money Market Margins or Money Market Absolute Rates, as the case may be, for a greater aggregate principal amount than the amount in respect of which such offers are accepted for the related Interest Period, the principal amount of Money Market Loans in respect of which such offers are accepted shall be allocated by the Administrative Agent among such Banks as nearly as possible (in multiples of $1,000,000, as the Administrative Agent may deem appropriate) in proportion to the aggregate principal amounts of such offers. Determinations by the Administrative Agent of the amounts of Money Market Loans shall be conclusive in the absence of manifest error. Section 2.04. Notice to Banks; Funding of Loans. (a) Upon receipt of a Notice of Borrowing, the Administrative Agent shall promptly notify each Bank of the contents thereof and of such Bank's share (if any) of such Borrowing and such Notice of Borrowing shall not thereafter be revocable by the Borrower. (b) Not later than 2:00 P.M. (New York City time) on the date of each Borrowing, each Bank participating therein shall (except as provided in subsection (c) of this Section) make available its share of such Borrowing, in Federal or other funds immediately available in New York City, to the Administrative Agent at its address referred to in Section 10.01. Unless the Administrative Agent determines that any applicable condition specified in Article 4 has not been satisfied, the Administrative Agent will make the funds so received from the Banks available tothe Borrower at the Administrative Agent's aforesaid address. (c) If any Bank makes a new Loan hereunder on a day on which the Borrower is to repay all or any part of an outstanding Loan from such Bank, such Bank shall apply the proceeds of its new Loan to make such repayment and only an amount equal to the difference (if any) between the amount being borrowed and the amount being repaid shall be made available by such Bank to the Administrative Agent as provided in subsection (b), or remitted by the Borrower to the Administrative Agent as provided in Section 2.12, as the case may be. (d) Unless the Administrative Agent shall have received notice from a Bank prior to the date of any Borrowing that such Bank will not make available to the Administrative Agent such Bank's share of such Borrowing, the Administrative Agent may assume that such Bank has made such share available to the Administrative Agent on the date of such Borrowing in accordance with subsections (b) and (c) of this Section and the Administrative Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Bank shall not have so made such share available to the Administrative Agent, such Bank and the Borrower severally agree to repay to the Administrative Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Administrative Agent, at the Federal Funds Rate. If such Bank shall repay to the Administrative Agent such corresponding amount, such amount so repaid shall constitute such Bank's Loan included in such Borrowing for purposes of this Agreement. (e) Nothing in subsection (d) shall be deemed to relieve any Bank from its obligation to make Loans or to prejudice any right which the Borrower may have against any Bank if such Bank defaults in the performance of its obligations under this Agreement. Section 2.05. Notes. (a) The Loans of each Bank shall be evidenced by a single Note payable to the order of such Bank for the account of its Applicable Lending Office in an amount equal to the aggregate unpaid principal amount of such Bank's Loans. (b) Each Bank may, by notice to the Borrower and the Administrative Agent, request that its Loans of a particular type be evidenced by a separate Note in an amount equal to the aggregate unpaid principal amount of such Loans. Each such Note shall be in substantially the form of Exhibit A hereto with appropriate modifications to reflect the fact that it evidences solely Loans of the relevant type. Each reference in this Agreement to the "Note" of such Bank shall be deemed to refer to and include any or all of such Notes, as the context may require. (c) Upon receipt of each Bank's Note pursuant to Section 4.01(b), the Administrative Agent shall forward such Note to such Bank. Each Bank shall record the date, amount, type and maturity of each Loan made by it and the date and amount of each payment of principal made by the Borrower with respect thereto, and may, if such Bank so elects in connection with any transfer or enforcement of its Note, endorse on the schedule forming a part thereof appropriate notations to evidence the foregoing information with respect to each such Loan then outstanding; provided that the failure of any Bank to make any such recordation or endorsement shall not affect the obligations of the Borrower hereunder or under the Notes. Each Bank is hereby irrevocably authorized by the Borrower so to endorse its Note and to attach to and make a part of its Note a continuation of any such schedule as and when required. Section 2.06. Maturity of Loans. Each Loan included in any Borrowing shall mature, and the principal amount thereof shall be due and payable, on the last day of the Interest Period applicable to such Borrowing. Section 2.07. Interest Rates. (a) Each Base Rate Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Loan is made until it becomes due, at a rate per annum equal to the Base Rate for such day. Such interest shall be payable in arrears on the third Domestic Business Day following the end of each calendar quarter and on the third Domestic Business Day following the Termination Date (or earlier date of termination of the Commitments in their entirety) for the period to and including the last day of such calendar quarter or the Termination Date (or such earlier date of termination of the Commitments in their entirety). Any overdue principal of or interest on any Base Rate Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate otherwise applicable to Base Rate Loans for such day. (b) Each Euro-Dollar Loan shall bear interest on the outstanding principal amount thereof, for each day during the Interest Period applicable thereto, at a rate per annum equal to the sum of the Euro-Dollar Margin for such day plus the Adjusted London Interbank Offered Rate applicable to such Interest Period. Such interest shall be payable for each Interest Period on the last day thereof and, if such Interest Period is longer than three months, at intervals of three months after the first day thereof. "Euro-Dollar Margin" means a rate per annum determined in accordance with the Pricing Schedule. The "Adjusted London Interbank Offered Rate" applicable to any Interest Period means a rate per annum equal to the quotient obtained (rounded upward, if necessary, to the next higher 1/100 of 1%) by dividing (i) the applicable London Interbank Offered Rate by (ii) 1.00 minus the Euro-Dollar Reserve Percentage. The "London Interbank Offered Rate" applicable to any Interest Period means the average (rounded upward, if necessary, to the next higher 1/16 of 1%) of the respective rates per annum at which deposits in dollars are offered to each of the Reference Banks in the London interbank market at approximately 11:00 A.M. (London time) two Euro-Dollar Business Days before the first day of such Interest Period in an amount approximately equal to the principal amount of the Euro-Dollar Loan of such Reference Bank to which such Interest Period is to apply and for a period of time comparable to such Interest Period. "Euro-Dollar Reserve Percentage" means for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement for a member bank of the Federal Reserve System in New York City with deposits exceeding five billion dollars in respect of "Eurocurrency liabilities" (or in respect of any other category of liabilities which includes deposits by reference to which the interest rate on Euro-Dollar Loans is determined or any category of extensions of credit or other assets which includes loans by a non-United States office of any Bank to United States residents). The Adjusted London Interbank Offered Rate shall be adjusted automatically on and as of the effective date of any change in the Euro-Dollar Reserve Percentage. (c) Any overdue principal of or interest on any Euro-Dollar Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the higher of (i) the sum of 2% plus the Euro-Dollar Margin for such day plus the Adjusted London Interbank Offered Rate applicable to the Interest Period for such Loan and (ii) the sum of 2% plus the Euro-Dollar Margin for such day plus the quotient obtained (rounded upward, if necessary, to the next higher 1/100 of 1%) by dividing (x) the average (rounded upward, if necessary, to the next higher 1/16 of 1%) of the respective rates per annum at which one day (or, if such amount due remains unpaid more than three Euro-Dollar Business Days, then for such other period of time not longer than six months as the Administrative Agent may select) deposits in dollars in an amount approximately equal to such overdue payment due to each of the Reference Banks are offered to such Reference Bank in the London interbank market for the applicable period determined as provided above by (y) 1.00 minus the Euro-Dollar Reserve Percentage (or, if the circumstances described in clause (a) or (b) of Section 9.01 shall exist, at a rate per annum equal to the sum of 2% plus the rate applicable to Base Rate Loans for such day). (d) Subject to Section 9.01(a), each Money Market LIBOR Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the sum of the London Interbank Offered Rate for such Interest Period (determined in accordance with Section 2.07(c) as if the related Money Market LIBOR Borrowing were a Committed Euro-Dollar Borrowing) plus (or minus) the Money Market Margin quoted by the Bank making such Loan in accordance with Section 2.03. Each Money Market Absolute Rate Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the Money Market Absolute Rate quoted by the Bank making such Loan in accordance with Section 2.03. Such interest shall be payable for each Interest Period on the last day thereof and, if such Interest Period is longer than three months, at intervals of three months after the first day thereof. Any overdue principal of or interest on any Money Market Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the Base Rate for such day. (e) The Administrative Agent shall determine each interest rate applicable to the Loans hereunder. The Administrative Agent shall give prompt notice to the Borrower and the participating Banks of each rate of interest so determined, and its determination thereof shall be conclusive in the absence of manifest error. (f) Each Reference Bank agrees to use its best efforts to furnish quotations to the Administrative Agent as contemplated by this Section. If any Reference Bank does not furnish a timely quotation, the Administrative Agent shall determine the relevant interest rate on the basis of the quotation or quotations furnished by the remaining Reference Bank or Banks or, if none of such quotations is available on a timely basis, the provisions of Section 9.01 shall apply. Section 2.08. Facility Fee. The Borrower shall pay to the Administrative Agent for the account of the Banks ratably a facility fee at the Facility Fee Rate (determined daily in accordance with the Pricing Schedule). Such facility fee shall accrue (i) from and including the Effective Date to but excluding the Termination Date (or such earlier date of termination of the Commitments in their entirety), on the daily aggregate amount of the Commitments (whether used or unused) and (ii) from and including the Termination Date or such earlier date of termination to but excluding the date the Loans shall be repaid in their entirety, on the daily sum of the aggregate outstanding principal amount of the Loans and the Letter of Credit Outstandings. Any facility fee payable under this Section shall be payable in arrears on the third Domestic Business Day following the end of each calendar quarter and on the third Domestic Business Day following the Termination Date (or earlier date of termination of the Commitments in their entirety) for the period to and including the last day of such calendar quarter or the Termination Date (or such earlier date of termination of the Commitments in their entirety). Section 2.09. Optional Termination or Reduction of Commitments. During the Revolving Credit Period, the Borrower may, upon at least three Domestic Business Days' notice to the Administrative Agent, (i) terminate the Commitments at any time, if no Loans are outstanding at such time and there are no Letter of Credit Outstandings at such time or (ii) ratably reduce from time to time by an aggregate amount of $5,000,000 or any larger multiple thereof, the aggregate amount of the Commitments in excess of the sum of the aggregate outstanding principal amount of the Loans and the Letter of Credit Outstandings. Section 2.10. Scheduled Termination of Commitments. The Commitments shall terminate on the Termination Date, and any Loans then outstanding (together with accrued interest thereon) shall be due and payable on such date. Section 2.11. Optional Prepayments. (a) Subject in the case of any Euro-Dollar Borrowing to Section 2.13, the Borrower may, upon notifying the Administrative Agent no later than 12:30 p.m. (New York City time) on any Domestic Business Day, prepay any Base Rate Borrowing (or any Money Market Borrowing bearing interest at the Base Rate pursuant to Section 9.01(a)) or upon at least three Euro-Dollar Business Days' notice to the Administrative Agent, prepay any Euro-Dollar Borrowing, in each case in whole at any time, or from time to time in part in amounts aggregating $1,000,000 or any larger multiple of $1,000,000, (i) with respect to any Base Rate Borrowing, by paying the principal amount to be prepaid and (ii) with respect to any Euro-Dollar Borrowing or Money Market Borrowing bearing interest at the Base Rate, by paying the principal amount to be prepaid together with accrued interest thereon to the date of prepayment. Each such optional prepayment shall be applied to prepay ratably the Loans of the several Banks included in such Borrowing. (b) Except as provided in Section 2.11(a), the Borrower may not prepay all or any portion of the principal amount of any Money Market Loan prior to the maturity thereof. (c) Upon receipt of a notice of prepayment pursuant to this Section, the Administrative Agent shall promptly notify each Bank of the contents thereof and of such Bank's ratable share (if any) of such prepayment and such notice shall not thereafter be revocable by the Borrower. Section 2.12. General Provisions as to Payments. (a) The Borrower shall make each payment of principal of, and interest on, the Loans and fees hereunder, not later than 2:00 P.M. (New York City time) on the date when due, in Federal or other funds immediately available in New York City, to the Administrative Agent at its address referred to in Section 10.01. The Administrative Agent will promptly distribute to each Bank its ratable share of each such payment received by the Administrative Agent for the account of the Banks. Whenever any payment of principal of, or interest on, the Base Rate Loans or of fees shall be due on a day which is not a Domestic Business Day, the date for payment thereof shall be extended to the next succeeding Domestic Business Day. Whenever any payment of principal of, or interest on, the Euro-Dollar Loans shall be due on a day which is not a Euro-Dollar Business Day, the date for payment thereof shall be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case the date for payment thereof shall be the next preceding Euro-Dollar Business Day. Whenever any payment of principal of, or interest on, the Money Market Loans shall be due on a day which is not a Euro-Dollar Business Day, the date for payment thereof shall be extended to the next succeeding Euro-Dollar Business Day. If the date for any payment of principal is extended by operation of law or otherwise, interest thereon shall be payable for such extended time. (b) Unless the Administrative Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Banks hereunder that the Borrower will not make such payment in full, the Administrative Agent may assume that the Borrower has made such payment in full to the Administrative Agent on such date and the Administrative Agent may, in reliance upon such assumption, cause to be distributed to each Bank on such due date an amount equal to the amount then due such Bank. If and to the extent that the Borrower shall not have so made such payment, each Bank shall repay to the Administrative Agent forthwith on demand such amount distributed to such Bank together with interest thereon, for each day from the date such amount is distributed to such Bank until the date such Bank repays such amount to the Administrative Agent, at the Federal Funds Rate. Section 2.13. Funding Losses. If the Borrower makes any payment of principal with respect to any Fixed Rate Loan (pursuant to Article 2, 7 or 9 or otherwise) on any day other than the last day of the Interest Period applicable thereto, or the last day of an applicable period fixed pursuant to Section 2.07(d), or if the Borrower fails to borrow or prepay any Fixed Rate Loans after notice has been given to any Bank in accordance with Section 2.04(a) or 2.11(c), the Borrower shall reimburse each Bank within 15 days after demand for any resulting loss or expense incurred by it (or by an existing or prospective Participant in the related Loan), including (without limitation) any loss incurred in obtaining, liquidating or employing deposits from third parties, but excluding loss of margin for the period after any such payment or failure to borrow or prepay, provided that such Bank shall have delivered to the Borrower a certificate as to the amount of and basis for determining such loss or expense, which certificate shall be conclusive in the absence of manifest error. Section 2.14. Computation of Interest and Fees. Interest based on the Prime Rate hereunder shall be computed on the basis of a year of 365 days (or 366 days in a leap year) and paid for the actual number of days elapsed (including the first day but excluding the last day). All other interest and all fees shall be computed on the basis of a year of 360 days and paid for the actual number of days elapsed (including the first day but excluding the last day). ARTICLE 3 Letters of Credit Section 3.01. Letter of Credit Commitment. (a) Subject to and upon the terms and conditions herein set forth, the Borrower may request the Issuing Bank to issue, and the Issuing Bank agrees to issue, at any time and from time to time on or after the Effective Date and prior to the Letter of Credit Termination Date, one or more irrevocable letters of credit ("Letters of Credit") for the account of the Borrower, and for the benefit of any obligee of payment obligations of the Borrower or any of its Subsidiaries, in amounts such that the sum of the aggregate outstanding principal amount of the Loans and the Letter of Credit Outstandings shall at no time exceed the aggregate amount of the Commitments. (b) Each Letter of Credit shall be in a form customarily used by the Issuing Bank on the Effective Date or otherwise in such form as may be approved by the Issuing Bank. Each Letter of Credit shall be subject to the Uniform Customs and Practice for Documentary Credits (1994 Revision), International Chamber of Commerce Publication No. 500, (and any subsequent revisions thereof approved by a Congress of the International Chamber of Commerce and adhered to by the Issuing Bank), and shall also be subject to Section 5-114 of the New York Uniform Commercial Code. (c) Each Letter of Credit issued hereunder shall (i) be denominated in United States dollars and provide for the payment of sight drafts and/or documents when presented for honor thereunder in accordance with the terms thereof and accompanied by the documents described therein, and (ii) have an expiry date occurring not later than (1) the earliest of one year after the date of issuance or (2) the Letter of Credit Termination Date. Notwithstanding anything to the contrary contained in clause (ii) of the preceding sentence, if requested prior to the Letter of Credit Termination Date, but not earlier than 45 days prior to the expiry date of any Letter of Credit, the expiry date of such Letter of Credit may be extended for a period of up to one year from the expiry date in effect before giving effect to such extension (but in no event later than the Letter of Credit Termination Date) so long as such Letter of Credit could otherwise be issued at such time pursuant to this Agreement. (d) Upon the issuance of any Letter of Credit (or upon the Effective Date with respect to any Existing Letter of Credit), the Issuing Bank shall be deemed to have sold and each Bank shall be deemed to have acquired, an undivided participation in each Letter of Credit issued by the Issuing Bank in accordance with the terms hereof and in each drawing made thereunder in a percentage equal to the Percentage Participation of such Bank. Section 3.02. Letter of Credit Requests. Whenever the Borrower desires that a Letter of Credit be issued for its account, the Borrower shall give the Issuing Bank and the Administrative Agent notice no later than 12:30 p.m. (Chicago time) on any Domestic Business Day, including instructions in such notice, and such letter of credit applications or other documents that the Issuing Bank customarily requires in connection therewith. In the event any provision of any letter of credit application is inconsistent with, or in conflict with, any provision of this Agreement, the provisions of this Agreement shall control. Section 3.03. Letter of Credit Fees. (a) The Borrower agrees to pay to the Administrative Agent for the account of the Banks, a letter of credit fee at a rate per annum equal to the applicable Letter of Credit Rate (determined daily in accordance with the Pricing Schedule) for such day on the aggregate daily amount available for drawing under all Letters of Credit issued hereunder, such fee to be payable for the account of the Banks ratably in proportion to their participation therein. (b) The Borrower agrees to pay the Issuing Bank, for its own account, a fronting fee in respect of each Letter of Credit issued hereunder in accordance with BMO's Fee Letter. (c) Fees payable pursuant to subsections (a) and (b) shall be calculated to the end of each calendar quarter and to the Letter of Credit Termination Date, and shall be due and payable on the third Domestic Business Day following the end of each calendar quarter during the term hereof and on the third Domestic Business Day following the Letter of Credit Termination Date. Section 3.04. Agreement to Repay Letter of Credit Drawings. (a) The Borrower hereby agrees to reimburse the Issuing Bank for any payment or disbursement made by the Issuing Bank under any Letter of Credit (each such amount so paid or disbursed until reimbursed, an "Unpaid Drawing") within one Business Day after the date of such payment or disbursement, with interest on the amount so paid or disbursed by the Issuing Bank, if and to the extent not reimbursed prior to 2:00 P.M., Chicago time, on the date of such payment or disbursement, from and including the date paid or disbursed to but excluding the date the Issuing Bank was reimbursed therefor at a rate per annum which shall be the rate of interest that would be applicable to Base Rate Loans during such period. (b) The Borrower's obligations under this Section 3.04 to reimburse the Issuing Bank with respect to Unpaid Drawings in respect of Letters of Credit (including, in each case, interest thereon) shall be absolute and unconditional under any and all circumstances and irrespective of any set off, counterclaim or defense to payment which the Borrower may have or have had against any Bank (including the Issuing Bank in its capacity as issuer of the Letter of Credit or as a Bank), including, without limitation, any defense based upon the failure of any drawing under a Letter of Credit (each a "Drawing") to conform to the terms of the Letter of Credit or any non-application or misapplication by the beneficiary of the proceeds of such Drawing. The Borrower assumes all risks as a result of the acts or omissions of the user of any Letter of Credit and all risks of the misuse of any Letter of Credit. The Issuing Bank in its capacity as issuer of any Letter of Credit shall not be liable: (i) for the form, validity, sufficiency, accuracy, genuineness or legal effect of any document reasonably believed to be genuine by the Person examining such document in connection with any Letter of Credit, even if it should prove to be in any respect invalid, insufficient, inaccurate, fraudulent or forged, (ii) for the validity or insufficiency of any instrument transferring or assigning or purporting to assign any Letter of Credit or the rights and benefits thereunder or the proceeds thereof, (iii) for clerical, administrative or other ministerial errors, such as failure of any draft to bear any reference or adequate reference to any applicable Letter of Credit, or failure of any Person to note the amount of any draft on any applicable Letter of Credit or to surrender or take up any applicable Letter of Credit or to send forward any such document apart from drafts as required by the terms of any Letter of Credit, each of which provisions, if contained in any Letter of Credit, may be waived by the Issuing Bank, (iv) for errors, omissions, interruptions or delays in transmissions or delivery of any message, by mail, telegraph, telex or otherwise, (v) for any error, neglect, default, suspension or insolvency of any correspondent, (vi) for errors in translation or for errors in interpretation of technical terms, (vii) for any loss or delay in the transmission or otherwise of any Letter of Credit or any document or draft in connection therewith or the proceeds thereof, (viii) for any consequence arising from causes beyond the control of the Issuing Bank, or (ix) for any other act or omission to act or delay of any kind by any Bank (including the Issuing Bank), the Administrative Agent or any other Person which might, but for the provisions of this subsection (vii), constitute a legal or equitable discharge of or defense to the Borrower's obligations hereunder. Nothing in this subsection (b) is intended to limit the right of the Borrower to make a claim against the Issuing Bank for damages as contemplated by the proviso to the first sentence of Section 3.05. (c) Promptly upon the occurrence of any Unpaid Drawing, the Issuing Bank shall notify the Borrower and the Banks thereof. Failure to give such notice, however, shall not affect the obligations of the Borrower or the Banks in respect of such Unpaid Drawing. (d) Promptly after receiving notice of any Unpaid Drawing, each Bank shall pay to the Issuing Bank the amount of such Bank's Percentage Participation in such Unpaid Drawing by transferring the same to the Issuing Bank in immediately available funds at the office specified by it in such notice. To the extent any Bank does not effect such payment on the date of any Unpaid Drawing, such Bank agrees to pay interest to the Issuing Bank on such amount until such payment is made at the overnight Federal Funds Rate. If a Bank shall have made all payments to the Issuing Bank required by this Section, the Issuing Bank shall pay such Bank its proportionate share of all payments received by the Issuing Bank from the Borrower in respect of Unpaid Drawings, all as, and, to the extent possible, when received by the Issuing Bank. Section 3.05. Indemnity. The Borrower hereby indemnifies and holds harmless the Administrative Agent and each Bank from and against any and all claims, damages, losses, liabilities, costs or expenses which it may incur, and none of the Banks (including any Issuing Bank) nor the Administrative Agent nor any of their officers, directors, employees or agents shall be liable or responsible, by reason of or in connection with the execution and delivery or transfer of or payment or failure to pay under any Letter of Credit, including without limitation (i) any error, omission, interruption or delay in transmission or delivery of any messages, by mail, cable, telegraph, telex or otherwise, (ii) any error in interpretation of technical terms, (iii) any loss or delay in the transmission of any document required in order to make a drawing under a Letter of Credit, (iv) any consequences arising from causes beyond the control of the Issuing Bank, including without limitation any government acts, or any other circumstances whatsoever (including without limitation the circumstances enumerated in Section 3.04(b) above) in making or failing to make payment under such Letter of Credit; provided that the Borrower shall have a claim against the Issuing Bank for direct (but not consequential) damage suffered by it, to the extent caused by (x) the willful misconduct or gross negligence of the Issuing Bank in determining whether a request presented under any Letter of Credit complied with the terms of such Letter of Credit or (y) the Issuing Bank's failure to pay under any Letter of Credit after the presentation to it of a request that strictly complies with the terms and conditions of such Letter of Credit. Nothing in this Section is intended to limit the obligations of the Borrower under any other provision of this Agreement. ARTICLE 4 Conditions Section 4.01. Effectiveness. This Amended Agreement shall become effective on the date (the "Effective Date") that each of the following conditions shall have been satisfied (or waived in accordance with Section 10.05): (a) receipt by the Administrative Agent of counterparts hereof signed by each of the parties hereto (or, in the case of any party as to which an executed counterpart shall not have been received, receipt by the Administrative Agent in form satisfactory to it of telegraphic, telex or other written confirmation from such party of execution of a counterpart hereof by such party); (b) receipt by the Administrative Agent of a duly executed Note for the account of each Bank dated on or before the Effective Date complying with the provisions of Section 2.05; (c) receipt by the Administrative Agent of an opinion of the General Counsel of the Borrower, substantially in the form of Exhibit E hereto and covering such additional matters relating to the transactions contemplated hereby as the Required Banks may reasonably request; (d) receipt by the Administrative Agent of an opinion of Davis Polk & Wardwell, special counsel for the Administrative Agent, substantially in the form of Exhibit F hereto and covering such additional matters relating to the transactions contemplated hereby as the Required Banks may reasonably request; (e) receipt by the Administrative Agent of evidence satisfactory to it of the payment of all principal of and interest on any loans outstanding under, and of all other amounts payable under, the Existing Credit Agreement up to but excluding the Effective Date; and] (f) receipt by the Administrative Agent of all documents it may reasonably request relating to the existence of the Borrower, the corporate authority for and the validity of this Amended Agreement and the Notes, and any other matters relevant hereto, all in form and substance satisfactory to the Administrative Agent. On the Effective Date the Existing Credit Agreement will be automatically amended and restated in its entirety to read as set forth herein. On and after the Effective Date the rights and obligations of the parties hereto shall be governed by this Amended Agreement; provided the rights and obligations of the parties hereto that are parties to the Existing Credit Agreement shall continue to be governed by the provisions of the Existing Credit Agreement with respect to the period prior to the Effective Date. On the Effective Date, any Bank whose Commitment is changed to zero shall cease to be a Bank party to this Agreement and all accrued fees and other amounts payable under this Agreement for the account of such Bank shall be due and payable on such date; provided that the provisions of Sections 9.03, 9.04 and 10.03 of this Agreement shall continue to inure to the benefit of each such Bank. The Notes delivered to each Bank under the Existing Credit Agreement shall be canceled and Notes under this Amended Agreement shall be given in substitution therefor. Each Bank shall promptly after the Effective Date deliver to the Borrower for cancellation the Note delivered to such Bank under the Existing Credit Agreement. The parties hereto acknowledge that on and as of the Effective Date, the Subsidiary Guaranty Agreement delivered to the Administrative Agent pursuant to Section 4.03(c) of the Existing Credit Agreement shall be automatically terminated without further action of the parties thereto or hereto and the obligations of the guarantors thereunder shall be released. The Administrative Agent shall promptly notify the Borrower and each Bank of the effectiveness of this Amended Agreement, and such notice shall be conclusive and binding on all parties hereto. Section 4.02. Borrowings. The obligation of any Bank to make a Loan on the occasion of any Borrowing or of the Issuing Bank to issue or extend any Letter of Credit is subject to the satisfaction of the following conditions: (a) receipt by the Administrative Agent of a Notice of Borrowing as required by Section 2.02 or 2.03, or by the Issuing Bank and the Administrative Agent of a notice as required by Section 3.02, as may be applicable; (b) the fact that, immediately after such Borrowing or the issuance of such Letter of Credit, as the case may be, (i) the sum of the aggregate outstanding principal amount of the Loans and the Letter of Credit Outstandings will not exceed the aggregate amount of the Commitments and (ii) the aggregate amount of the Letter of Credit Outstandings in respect of Financial Letters of Credit shall not exceed $400,000,000; (c) the fact that, immediately before and after such Borrowing, no Default shall have occurred and be continuing; and (d) the fact that the representations and warranties of the Borrower contained in this Agreement (except, in the case of a Refunding Borrowing, the representations and warranties set forth in Sections 5.04(c) and 5.05 as to any matter which has theretofore been disclosed in writing by the Borrower to the Banks) shall be true on and as of the date of such Borrowing. Each Borrowing hereunder shall be deemed to be a representation and warranty by the Borrower on the date of such Borrowing as to the facts specified in clauses (b), (c) and (d) of this Section. ARTICLE 5 Representations and Warranties The Borrower represents and warrants that: Section 5.01. Corporate Existence and Power. The Borrower and each Guarantor is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, and has all corporate powers and all material governmental licenses, authorizations, consents and approvals required to carry on its business as now conducted. Section 5.02. Corporate and Governmental Authorization; No Contravention. The execution, delivery and performance by the Borrower and each Guarantor of each Financing Document to which it is a party are within its corporate powers, have been duly authorized by all necessary corporate action, require no action by or in respect of, or filing with, any governmental body, agency or official (except for any reports required to be filed by the Borrower with or to the Securities and Exchange Commission (or any successor thereto) pursuant to the Exchange Act) and do not contravene, or constitute a default under, any provision of applicable law or regulation or of its certificate of incorporation or by-laws or of any agreement, judgment, injunction, order, decree or other instrument binding upon the Borrower or any of its Subsidiaries or result in the creation or imposition of any Lien on any asset of the Borrower or any of its Subsidiaries. Section 5.03. Binding Effect. This Agreement constitutes a valid and binding agreement of the Borrower, and each other Financing Document, when executed and delivered in accordance with this Agreement, will constitute a valid and binding obligation of the Borrower and each Guarantor party thereto, in each case enforceable in accordance with its terms. Section 5.04. Financial Information. (a) The unaudited pro forma consolidated balance sheet of the Borrower as of December 31, 1996 and the related unaudited pro forma consolidated statement of income for the year ended December 31, 1996 set forth in the Valero S-1, are complete and correct in all material respects and have been prepared on the basis described therein and otherwise in conformity with generally accepted accounting principles applied on a basis consistent with the financial statements referred to in subsection (b) of this Section and show the consolidated financial position and results of operations of the Borrower as if the Transactions (as defined in the Existing Credit Agreement) had occurred, in the case of the consolidated balance sheet, on December 31, 1996 and in the case of the consolidated statement of earnings, as of January 1, 1996. (b) The consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of September 30, 1997 and the related consolidated statements of income and cash flows for the fiscal period then ended, set forth in the Valero Form 10-Q, a copy of which has been delivered to each of the Banks, fairly present, in conformity with generally accepted accounting principles, the consolidated financial position of the Borrower and its Consolidated Subsidiaries as of such date and their consolidated results of operations and cash flows for such fiscal period. (c) Since September 30, 1997, there has been no material adverse change in the business, financial position, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole. Section 5.05. Litigation. Except as disclosed in the Valero Form 10-Q or otherwise disclosed in writing to the Banks prior to the execution and delivery of this Amended Agreement, there is no action, suit or proceeding pending against, or to the knowledge of the Borrower threatened against or affecting, the Borrower or any of its Subsidiaries before any court or arbitrator or any governmental body, agency or official in which there is a reasonable possibility of an adverse decision which could reasonably be expected to materially adversely affect the business, consolidated financial position or consolidated results of operations of the Borrower and its Consolidated Subsidiaries, considered as a whole, or which in any manner draws into question the validity of any Financing Document. Section 5.06. Compliance with ERISA. Each member of the ERISA Group has fulfilled its obligations under the minimum funding standards of ERISA and the Internal Revenue Code with respect to each Plan and is in compliance in all material respects with the presently applicable provisions of ERISA and the Internal Revenue Code with respect to each Plan. No member of the ERISA Group has (i) sought a waiver of the minimum funding standard under Section 412 of the Internal Revenue Code in respect of any Plan, (ii) failed to make any contribution or payment to any Plan or Multi-employer Plan or in respect of any Benefit Arrangement, or made any amendment to any Plan or Benefit Arrangement, which has resulted or could reasonably be expected to result in the imposition of a Lien or the posting of a bond or other security under ERISA or the Internal Revenue Code or (iii) incurred any liability under Title IV of ERISA other than a liability to the PBGC for premiums under Section 4007 of ERISA. Section 5.07. Environmental Matters. In the ordinary course of its business, the Borrower conducts or causes to be conducted an ongoing review of the effect of Environmental Laws on the business, operations and properties of the Borrower and its Subsidiaries, in the course of which it identifies and evaluates associated liabilities and costs (including, without limitation, any capital or operating expenditures required for clean-up or closure of properties presently or previously owned, any capital or operating expenditures required to achieve or maintain compliance with environmental protection standards imposed by law or as a condition of any license, permit or contract, any related constraints on operating activities, including any periodic or permanent shutdown of any facility or reduction in the level of or change in the nature of operations conducted thereat, any costs or liabilities in connection with off-site disposal of wastes or Hazardous Substances, and any actual or potential liabilities to third parties, including employees, and any related costs and expenses). On the basis of this review, the Borrower has reasonably concluded that such associated liabilities and costs, including the costs of compliance with Environmental Laws, are unlikely to have a material adverse effect on the business, financial condition, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole. Section 5.08. Taxes. The Borrower and its Subsidiaries have filed all United States Federal income tax returns and all other material tax returns which are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any assessment received by the Borrower or any Subsidiary. The charges, accruals and reserves on the books of the Borrower and its Subsidiaries in respect of taxes or other governmental charges are, in the opinion of the Borrower, adequate. Section 5.09. SubsidiariesEach of the Borrower's Subsidiaries is a corporation, partnership or other legal entity duly organized, validly existing and is in good standing in each jurisdiction in which the ownership of its properties or the conduct of its business requires such qualification and where the failure to so qualify could reasonably be expected to have a material adverse effect on the business, financial position or results of operations of the Borrower and its Subsidiaries, taken as a whole. Each of the Borrower's Subsidiaries has all legal power and all governmental licenses, authorizations, consents and approvals required to own its assets and to carry on its business as now conducted and where the failure to have any such corporate or partnership power, licenses, authorizations, consents or approvals could reasonably be expected to have a material adverse effect on the business, financial position, results of operation of the Borrower and its Subsidiaries, taken as a whole. Section 5.10. Not an Investment Company. The Borrower is not an "investment company" within the meaning of the Investment Company Act of 1940, as amended. Section 5.11. Full Disclosure. All information heretofore furnished by the Borrower to the Administrative Agent or any Bank for purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all such information hereafter furnished by the Borrower to the Administrative Agent or any Bank will be, true and accurate in all material respects on the date as of which such information is stated or certified. The Borrower has disclosed to the Banks in writing any and all facts which materially and adversely affect or could reasonably be expected to materially and adversely affect (to the extent the Borrower can now reasonably foresee), the business, operations or financial condition of the Borrower and its Consolidated Subsidiaries, taken as a whole, or the ability of the Borrower to perform its obligations under the Financing Documents. Section 5.12. Representations in Subsidiary Guarantee Agreement. Each representation and warranty of each Guarantor set forth in its Subsidiary Guarantee Agreement (if any) is true and correct. ARTICLE 6 Covenants The Borrower agrees that, so long as any Bank has any Commitment hereunder or any Letter of Credit Outstanding hereunder or any amount payable under any Note remains unpaid: Section 6.01. Information. The Borrower will deliver to each of the Banks: (a) as soon as available and in any event within 105 days after the end of each fiscal year of the Borrower, a Form 10-K of the Borrower and its Consolidated Subsidiaries for such fiscal year as filed with the Securities and Exchange Commission; (b) as soon as available and in any event within 60 days after the end of each of the first three quarters of each fiscal year of the Borrower, a Form 10-Q of the Borrower and its Consolidated Subsidiaries for such quarter as filed with the Securities and Exchange Commission; (c) simultaneously with the delivery of each set of financial statements referred to in clauses (a) and (b) above, a certificate of a Financial Officer of the Borrower (i) setting forth whether the Borrower was in compliance with the requirements of Sections 6.07 to 6.13, inclusive, on the date of such financial statements, (ii) with respect to Sections 6.07 to 6.09, inclusive, and Sections 6.11 and 6.13, setting forth the calculations in reasonable detail required to establish whether the Borrower was in compliance with the requirements of such Sections and (iii) stating whether any Default exists on the date of such certificate and, if any Default then exists, setting forth the details thereof and the action which the Borrower is taking or proposes to take with respect thereto; (d) simultaneously with the delivery of each set of financial statements referred to in clause (a) above, a statement of the firm of independent public accountants which reported on such statements whether anything has come to their attention to cause them to believe that any Default existed on the date of such statements. (e) within five days after any Financial Officer of the Borrower obtains knowledge of any Default, if such Default is then continuing, a certificate of a Financial Officer of the Borrower setting forth the details thereof and the action which the Borrower is taking or proposes to take with respect thereto; (f) promptly upon the mailing thereof to the shareholders of the Borrower generally, copies of all financial statements, reports and proxy statements so mailed; (g) promptly upon the filing thereof, copies of all registration statements (other than the exhibits thereto and any registration statements on Form S-8 or its equivalent) and reports on Forms 10-K, 10-Q and 8-K (or their equivalents) which the Borrower shall have filed with the Securities and Exchange Commission; (h) if and when any member of the ERISA Group (i) gives or is required to give notice to the PBGC of any "reportable event" (as defined in Section 4043 of ERISA) with respect to any Plan which could reasonably be expected to constitute grounds for a termination of such Plan under Title IV of ERISA, or knows that the plan administrator of any Plan has given or is required to give notice of any such reportable event, a copy of the notice of such reportable event given or required to be given to the PBGC; (ii) receives notice of complete or partial withdrawal liability under Title IV of ERISA or notice that any Multi-employer Plan is in reorganization, is insolvent or has been terminated, a copy of such notice; (iii) receives notice from the PBGC under Title IV of ERISA of an intent to terminate, impose liability (other than for premiums under Section 4007 of ERISA) in respect of, or appoint a trustee to administer any Plan, a copy of such notice; (iv) applies for a waiver of the minimum funding standard under Section 412 of the Internal Revenue Code, a copy of such application; (v) gives notice of intent to terminate any Plan under Section 4041(c) of ERISA, a copy of such notice and other information filed with the PBGC; (vi) gives notice of withdrawal from any Plan pursuant to Section 4063 of ERISA, a copy of such notice; or (vii) fails to make any payment or contribution to any Plan or Multi-employer Plan or in respect of any Benefit Arrangement or makes any amendment to any Plan or Benefit Arrangement which has resulted or could reasonably be expected to result in the imposition of a Lien or the posting of a bond or other security, a certificate of a Financial Officer of the Borrower setting forth details as to such occurrence and action, if any, which the Borrower or applicable member of the ERISA Group is required or proposes to take; and (i) from time to time such additional information regarding the financial position or business of the Borrower and its Subsidiaries as the Administrative Agent, at the request of any Bank, may reasonably request. Section 6.02. Payment of Obligations. The Borrower will pay and discharge, and will cause each of its Subsidiaries to pay and discharge, at or before maturity, all their respective material obligations and liabilities, including, without limitation, tax liabilities, except where the same may be contested in good faith by appropriate proceedings, and will maintain, and will cause each of its Subsidiaries to maintain, in accordance with generally accepted accounting principles, appropriate reserves for the accrual of any of the same. Section 6.03. Maintenance of Property; Insurance. (a) The Borrower will keep, and will cause each of its Subsidiaries to keep, all of its property useful and necessary in its business in good working order and condition, ordinary wear and tear excepted, as would a prudent owner and operator of similar properties. (b) The Borrower shall, and shall cause each of its Subsidiaries to, maintain or cause to be maintained, with financially sound and reputable insurers, insurance with respect to its properties and business and the properties and business of its Subsidiaries against loss or damage of the kinds customarily insured against by corporations of established reputation engaged in the same or similar businesses and similarly situated, of such type and in such amounts and with such levels of deductibles, as are customarily carried under similar circumstances by such other corporations. Sectin 6.04. Conduct of Business and Maintenance of Existence. The Borrower will continue, and will cause each of its Subsidiaries to continue, to engage in business of the same general type as now conducted by the Borrower and its Subsidiaries, and will preserve, renew and keep in full force and effect, and will cause each of its Subsidiaries to preserve, renew and keep in full force and effect their respective legal existence and their respective rights, privileges and franchises necessary or desirable in the normal conduct of business; provided that nothing in this Section shall prohibit (i) the merger of a Subsidiary into the Borrower or the merger or consolidation of a Subsidiary with or into another Person if the entity surviving such consolidation or merger is a Subsidiary and if, in each case, after giving effect thereto, no Default shall have occurred and be continuing or (ii) the termination of the business or legal existence of any Subsidiary if the Borrower in good faith determines that such termination is in the best interest of the Borrower and is not materially disadvantageous to the Banks. Section 6.05. Compliance with Laws. The Borrower will comply, and cause each of its Subsidiaries to comply, in all material respects with all applicable laws, ordinances, rules, regulations, and requirements of governmental authorities (including, without limitation, Environmental Laws and ERISA and the rules and regulations thereunder) except where the necessity of compliance therewith is contested in good faith by appropriate proceedings. Section 6.06. Inspection of Property, Books and Records. The Borrower will keep, and will cause each of its Subsidiaries to keep, proper books of record and account in which complete and accurate entries shall be made of all financial and business transactions of the Borrower and its Subsidiaries; and will permit, and will cause each of its Subsidiaries to permit, representatives of any Bank at such Bank's expense to visit and inspect any of their respective properties, to examine and make abstracts from any of their respective books and records and to discuss their respective affairs, finances and accounts with their respective officers, employees and independent public accountants, all at such reasonable times and as often as may reasonably be desired. Section 6.07. Fixed Charge Coverage. After the Effective Date, the Borrower will not permit the ratio of: (a) the sum (without duplication) of (i) Consolidated Net Income (excluding extraordinary items) of the Borrower for the applicable period, plus (ii) interest expense for the Borrower and its Subsidiaries on a consolidated basis for such period, plus (iii) deferred federal and state income taxes deducted in determining such Consolidated Net Income for such period, plus (iv) depreciation and amortization expense deducted in determining such Consolidated Net Income for such period, plus (v) other noncash charges deducted in determining such Consolidated Net Income for such period, minus (vi) other noncash credits added in determining such Consolidated Net Income for such period, plus (vii) Deferred Turnaround and Catalyst Cost for such period, to (b) the sum (without duplication) of (i) interest incurred by the Borrower and its Subsidiaries on a consolidated basis for such period (whether expensed or capitalized), plus (ii) cash dividends paid by the Borrower on its preferred stock during such period (other than dividends paid on preferred stock held by the Borrower or a Subsidiary of the Borrower), plus (iii) cash dividends paid by the Borrower on its common stock during such period (other than dividends reinvested in newly issued or treasury shares of common stock of the Borrower pursuant to any dividend reinvestment plan maintained by the Borrower for holders of its common stock), plus (iv) the amount of mandatory redemptions of preferred stock made by the Borrower during such period (excluding redemptions of shares of such preferred stock held by the Borrower or Subsidiaries of the Borrower), plus (v) Deferred Turnaround and Catalyst Cost for such period, to be less than 1.8 to 1.0 (i) until such time as four full fiscal quarters shall have commenced and ended subsequent to July 31, 1997, for the period consisting of such number of consecutive full fiscal quarters as at the time shall have commenced and ended subsequent to July 31, 1997 and (ii) thereafter, for any period of four consecutive fiscal quarters (taken as one accounting period). Section 6.08. Debt. Consolidated Debt of the Borrower will at no time exceed 45% of the sum of Consolidated Debt of the Borrower plus the Consolidated Net Worth of the Borrower plus the involuntary liquidation value of outstanding shares of redeemable preferred stock of the Borrower. Section 6.09. Minimum Consolidated Net Worth. Consolidated Net Worth of the Borrower will at no time at or after the Effective Date be less than the sum of (i) $850,000,000 plus (ii) an amount equal to 50% of Consolidated Net Income Applicable to Common Stock for each fiscal quarter of the Borrower ending after September 30, 1997 but prior to the date of determination for which fiscal quarter Consolidated Net Income Applicable to Common Stock is positive (but with no deduction on account of negative Consolidated Net Income Applicable to Common Stock for any fiscal period of the Borrower) plus (iii) 75% of the aggregate increase in Consolidated Net Worth attributable to the issuance and sale after September 30, 1997 of any capital stock of the Borrower (other than the proceeds of any issuance and sale of any capital stock (x) to a Subsidiary of the Borrower or (y) which is required to be redeemed, or is redeemable at the option of the holder, if certain events or conditions occur or exist or otherwise) or in connection with the conversion or exchange of any Debt of the Borrower into capital stock after September 30, 1997. Section 6.10. Negative Pledge-Liens. Neither the Borrower nor any Subsidiary will create, assume or suffer to exist any Lien on any asset now owned or hereafter acquired by it, except for: (a) Liens existing on the date of the Existing Credit Agreement securing Debt outstanding on the date of the Existing Credit Agreement in an aggregate principal or face amount not exceeding $5,000,000; (b) any Lien existing on any asset of any Person at the time such Person becomes a Subsidiary; (c) any Lien on any asset securing Debt incurred or assumed for the purpose of financing all or any part of the cost of acquiring such asset, provided that such Lien attaches to such asset concurrently with or within 90 days after the acquisition thereof; (d) any Lien on any asset of any Person existing at the time such Person is merged or consolidated with or into the Borrower or a Subsidiary; (e) any Lien existing on any asset prior to the acquisition thereof by the Borrower or a Subsidiary; (f) any Lien arising out of refinancing, extending, renewing or refunding (or successively refinancing, extending, renewing or refunding) any Debt secured by any Lien permitted by any of the foregoing clauses of this Section, provided that the principal amount of such Debt is not increased and such Debt is not secured by any additional assets; (g) any Lien on property constituting substitutions or replacements for, or additions or accessions to, property of the Borrower or a Subsidiary and created pursuant to after-acquired property provisions of any Lien otherwise permitted by any of the foregoing clauses; (h) Liens for or in connection with taxes or assessments, governmental charges and similar charges not delinquent or being contested in good faith by appropriate proceedings, including deposits as security in connection therewith; (i) Liens reserved in or arising under leases constituting "Debt" as described in clause (ii) of the definition thereof, or reserved in or arising under licenses, permits or operating leases for rent or other charges or to secure the performance of obligations thereunder; (j) Liens granted or arising in favor of an operator on assets subject to joint operations to secure payments or other obligations due such operator in connection with the operation of such assets; (k) Liens granted or arising on joint venture and partnership interests in favor of such joint ventures or partnerships or the other partners or owners thereof on the Borrower's or its Subsidiaries' interests therein, or on the assets of such partnerships or joint ventures, to secure payments or other obligations due to such partnerships or joint ventures or the other partners or owners thereof with respect to the business of such partnerships or joint ventures; (l) Mechanics' and materialmens' liens or any lien or charge in connection with workmens' compensation, unemployment insurance or other social security or old age pension obligations or deposits in connection therewith, including obligations under ERISA; good faith deposits in connection with tenders or leases of real estate, bids or contracts; deposits to secure public or statutory obligations or to secure or in lieu of surety bonds; (m) Liens securing judgments or orders for the payment of money, or surety or appeal bonds with respect to any such judgments or order, in an aggregate amount not exceeding $25,000,000, so long as no Event of Default exists with respect thereto under Section 7.01(j); (n) Liens on property of a Subsidiary to secure obligations of such Subsidiary to the Borrower or to another Subsidiary; provided however, that the obligations so secured may not be assigned, sold or otherwise transferred to a Person other than the Borrower or another Subsidiary unless such Liens are otherwise permitted hereunder; (o) Rights reserved to or vested in, or obligations or duties owed to, any governmental or public authority or railroad or utility by the terms of any right, power, franchise, grant, license, permit or provision of law; and any easement, right-of-way, mineral lease or other agreement relating to the exploration, development, production or other exploitation of mining, oil, gas, timber or other natural resources, exception or reservation in any property of the Borrower or any Subsidiary granted or reserved in any property of the Borrower or any Subsidiary which do not materially impair the use of the property of the Borrower and its Subsidiaries, taken as a whole, for the purposes for which it is held in the operation of the business of the Borrower and its Subsidiaries; (p) Liens and encumbrances (other than those securing Debt or Derivative Obligations) existing upon property or rights in or relating thereto, including rights of tenants in common or other common owners; zoning, planning, environmental laws and ordinances and governmental regulations; and minor defects or irregularities in or encumbrances on the titles to properties which in the aggregate do not materially impair the use of the property of the Borrower and its Subsidiaries, taken as a whole, for the purposes for which it is held in the operation of the business of the Borrower and its Subsidiaries; (q) Liens on cash, cash equivalents, options or futures positions and other account holdings securing Derivatives Obligations or otherwise incurred in connection with margin accounts with brokerage or commodities firms; provided that the aggregate amount of assets subject to such Liens shall at no time exceed $60,000,000; (r) Liens arising in connection with statutory or contractual set-off provisions granted or arising in the ordinary course of business in favor of banks, brokers or other creditors; (s) Liens arising in the ordinary course of its business which (i) do not secure Debt or Derivatives Obligations, (ii) do not secure any obligation in an amount exceeding $25,000,000 and (iii) do not in the aggregate materially detract from the value of its assets or materially impair the use thereof in the operation of its business; and (t) Liens not otherwise permitted by the foregoing clauses of this Section securing Debt in an aggregate principal or face amount at any date not to exceed 5% of Consolidated Net Worth. Section 6.11. Subsidiary Debt. The total Debt of all Consolidated Subsidiaries (excluding (i) Debt secured by a Lien permitted by clauses (a) through (r) of Section 6.10, (ii) Debt of a Person existing at the time such Person becomes a Subsidiary and not created in contemplation of such event, (iii) the Additional IDB, (iv) Debt of the Borrower owing to any Subsidiary or Debt of a Subsidiary owing to the Borrower or to any other Subsidiary and (v) refinancings, extensions, renewals or refundings of any Debt permitted by the foregoing clauses of this Section, provided that the principal amount of such Debt referred to in clauses (i), (ii) and (iii) is not increased) will at no time exceed $5,000,000 in aggregate outstanding principal amount. Sectin 6.12. Guarantors. At such time (if any) hereafter as the Borrower ceases to have an Investment Grade Rating, the Borrower agrees (i) to cause each Material Subsidiary to become a Guarantor hereunder within 10 days of such event and (ii) thereafter within 10 days after any Person becomes a Material Subsidiary, to cause such Person to become a Guarantor hereunder. Section 6.13. Consolidations, Mergers and Transfers of Assets. (a) The Borrower will not consolidate or merge with or into any other Person; provided that the Borrower may merge with another Person if: (i) the Borrower or a Wholly-Owned Consolidated Subsidiary is the corporation surviving such merger; (ii) the Person (if other than the Borrower) formed by such consolidation or into which the Borrower is merged (any such Person, the "Successor"), shall be organized and existing under the laws of the United States, any state thereof or the District of Columbia and shall expressly assume, in a writing executed and delivered to the Administrative Agent for delivery to each of the Banks, in form reasonably satisfactory to the Administrative Agent, the due and punctual payment of the principal of and interest on the Notes and the performance of the other obligations under this Agreement and the Notes on the part of the Borrower to be performed or observed, as fully as if such Successor were originally named as the Borrower in this Agreement; (iii) after giving effect to such merger, no Default shall have occurred and be continuing; and (iv) the Borrower has delivered to the Administrative Agent a certificate on behalf of the Borrower signed by a Financial Officer and an opinion of counsel (which counsel may be an employee of the Borrower), each stating that all conditions provided in this Section 6.13 relating to such transaction have been satisfied. (b) The Borrower and its Subsidiaries will not, sell, lease, transfer or otherwise dispose of (each, a "Transfer") all or part of the assets of the Borrower and its Subsidiaries taken as a whole (other than (w) Transfers of inventory or of abandoned, obsolete or worn-out machinery, fixtures, equipment and materials in the ordinary course of business; (x) Transfers of inventory pursuant to inventory monetization arrangements which provide for financing not in excess of $150,000,000, (y) Transfers of cash or short-term investments and (z) (i) if the Borrower has an Investment Grade Rating, Transfers of assets by the Borrower to any Subsidiary or by any Subsidiary to the Borrower or any other Subsidiary and (ii) otherwise, Transfers of assets by the Borrower to any Guarantor or by any Guarantor to the Borrower or any other Guarantor), to any Person, which assets have a fair market value (as determined in good faith by the Borrower's Board of Directors) which, when aggregated with the proceeds of the other assets of the Borrower and its Subsidiaries taken as a whole Transferred subsequent to the date hereof (exclusive of Transfers permitted by the foregoing clauses (w), (x), (y) and (z)) are in an amount in excess of 25% of Consolidated Total Assets as of the end of the immediately preceding fiscal year. Section 6.14. Use of Proceeds. The proceeds of the Loans made under this Amended Agreement will be used by the Borrower to fund working capital, letters of credit and for general corporate purposes. None of such proceeds will be used, directly or indirectly, for the purpose, whether immediate, incidental or ultimate, of buying or carrying any "margin stock" within the meaning of Regulation U and Regulation G. Section 6.15. Restriction on Other Agreements. The Borrower will not, and will not permit any of its Subsidiaries to, enter into any agreement prohibiting or having the effect of restricting the ability of any Subsidiary of the Borrower to pay dividends or make any distribution, loans or advances to the Borrower or any Subsidiary of the Borrower owning any capital stock of or other equity interest in such Subsidiary (other than this Agreement). ARTICLE 7 Defaults Section 7.01. Events of Default. If one or more of the following events ("Events of Default") shall have occurred and be continuing: (a) the Borrower shall fail to pay when due any principal of any Loan or any Unpaid Drawing, or shall fail to pay within five days of the due date any interest, any fees or any other amount payable hereunder; (b) the Borrower shall fail to observe or perform any covenant contained in Sections 6.07 to 6.15, inclusive; (c) the Borrower or any Guarantor shall fail to observe or perform any covenant or agreement contained in the Financing Documents (other than those covered by clause (a) or (b) above) for 30 days after notice thereof has been given to the Borrower by the Administrative Agent at the request of any Bank; (d) any representation, warranty, certification or statement made by the Borrower or any Guarantor in the Financing Documents or in any certificate, financial statement or other document delivered pursuant to the Financing Documents shall prove to have been incorrect in any material respect when made (or deemed made); (e) the Borrower or any Subsidiary of the Borrower shall fail to make any payment in respect of any Material Financial Obligations when due or within any applicable grace period; (f) any event or condition shall occur which results in the acceleration of the maturity of any Material Debt or enables (or, with the giving of notice or lapse of time or both, would enable) the holder of such Debt or any Person acting on such holder's behalf to accelerate the maturity thereof; (g) the Borrower or any Material Subsidiary of the Borrower shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing; (h) an involuntary case or other proceeding shall be commenced against the Borrower or any Material Subsidiary of the Borrower seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against the Borrower or any Material Subsidiary of the Borrower under the federal bankruptcy laws as now or hereafter in effect; (i) any member of the ERISA Group shall fail to pay when due an amount or amounts aggregating in excess of $25,000,000 which it shall have become liable to pay under Title IV of ERISA; or notice of intent to terminate a Material Plan shall be filed under Title IV of ERISA by any member of the ERISA Group, any plan administrator or any combination of the foregoing; or the PBGC shall institute proceedings under Title IV of ERISA to terminate, to impose liability (other than for premiums under Section 4007 of ERISA) in respect of, or to cause a trustee to be appointed to administer any Material Plan; or a condition shall exist by reason of which the PBGC would be entitled to obtain a decree adjudicating that any Material Plan must be terminated; or there shall occur a complete or partial withdrawal from, or a default, within the meaning of Section 4219(c)(5) of ERISA, with respect to, one or more Multi-employer Plans which could cause one or more members of the ERISA Group to incur a current payment obligation in excess of $25,000,000; (j) judgments or orders for the payment of money in excess of $25,000,000 in the aggregate shall be rendered against the Borrower or any Subsidiary of the Borrower and such judgments or orders shall continue unsatisfied and unstayed for a period of 60 days; (k) any person or group of persons (within the meaning of Section 13 or 14 of the Securities Exchange Act of 1934, as amended) shall have acquired beneficial ownership (within the meaning of Rule 13d-3 promulgated by the Securities and Exchange Commission under said Act) of 20% or more of the outstanding shares of common stock of the Borrower (excluding, however, any such Person or group entitled to report such ownership on Schedule 13G in accordance with Rule 13d-1(b)(1) or (2)); or, during any period of 24 consecutive calendar months, individuals who were directors of the Borrower on the first day of such period shall cease to constitute a majority of the board of directors of the Borrower (unless the election, or the nomination for election, by the shareholders of the Borrower, or the appointment by the Board of Directors, of each new director during such 24-month period was approved by the vote at a meeting or the written consent of at least two-thirds of the directors then still in office who were directors at the beginning of such period); then, and in every such event, the Administrative Agent shall (i) if requested by Banks having more than 66 2/3% in aggregate amount of the Commitments, by notice to the Borrower terminate the Commitments and they shall thereupon terminate, and (ii) if requested by Banks holding Notes evidencing more than 66 2/3% in aggregate principal amount of the Loans, by notice to the Borrower declare the Notes (together with accrued interest thereon) to be, and the Notes shall thereupon become, immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Borrower; provided that in the case of any of the Events of Default specified in clause (g) or (h) above with respect to the Borrower, without any notice to the Borrower or any other act by the Administrative Agent or the Banks, the Commitments shall thereupon terminate and the Notes (together with accrued interest thereon) shall become immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Borrower. Section 7.02. Cash Cover. The Borrower agrees, in addition to the provisions of Section 7.01 hereof, that upon the occurrence and during the continuance of any Event of Default, it shall, if requested by the Administrative Agent upon the instruction of the Required Banks, pay to the Administrative Agent an amount in immediately available funds (which funds shall be held as collateral for the Letter of Credit Outstandings) equal to the aggregate amount available for drawing under all Letters of Credit then outstanding at such time, provided that, upon the occurrence of any Event of Default specified in Section 7.01(g) or 7.01(h) with respect to the Borrower, the Borrower shall pay such amount forthwith without any notice or demand or any other act by the Administrative Agent or the Banks. Section 7.03. Notice of Default. The Administrative Agent shall give notice to the Borrower under Section 7.01(c) promptly upon being requested to do so by any Bank and shall thereupon notify all the Banks thereof. ARTICLE 8 The Administrative Agent Section 8.01. Appointment and Authorization. Each Bank irrevocably appoints and authorizes the Administrative Agent to take such action as Administrative Agent on its behalf and to exercise such powers under the Financing Documents and the Notes as are delegated to the Administrative Agent by the terms thereof, together with all such powers as are reasonably incidental thereto. Section 8.02. Administrative Agent and Agent. Morgan Guaranty shall have the same rights and powers under the Financing Documents as any other Bank and may exercise or refrain from exercising the same as though it were not the Administrative Agent, and Morgan Guaranty and its affiliates may accept deposits from, lend money to, and generally engage in any kind of business with the Borrower or any Subsidiary or affiliate of the Borrower as if it were not an Administrative Agent hereunder. Section 8.03. Action by Administrative Agent. The obligations of the Administrative Agent under the Financing Documents are only those expressly set forth therein. Without limiting the generality of the foregoing, the Administrative Agent shall not be required to take any action with respect to any Default, except as expressly provided in Article 7. Section 8.04. Consultation with Experts. Each of the Administrative Agent and the Issuing Bank may consult with legal counsel (who may be counsel for the Borrower), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken by it in good faith in accordance with the advice of such counsel, accountants or experts. Section 8.05. Liability of Administrative Agent. Neither the Administrative Agent nor the Issuing Bank nor any of their affiliates nor any of their respective directors, officers, agents or employees shall be liable for any action taken or not taken by it in connection with the Financing Documents (i) with the consent or at the request of the Required Banks or (ii) in the absence of its own gross negligence or willful misconduct. Neither the Administrative Agent nor the Issuing Bank nor any of their affiliates nor any of their respective directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into or verify (i) any statement, warranty or representation made in connection with the Financing Documents or any borrowing hereunder; (ii) the performance or observance of any of the covenants or agreements of the Borrower; (iii) the satisfaction of any condition specified in Article 4, except receipt of items required to be delivered to the Administrative Agent or the Issuing Bank; or (iv) the validity, effectiveness or genuineness of the Financing Documents or any other instrument or writing furnished in connection therewith. Neither the Administrative Agent nor the Issuing Bank shall incur any liability by acting in reliance upon any notice, consent, certificate, statement, or other writing (which may be a bank wire, telex, facsimile transmission or similar writing) believed by it to be genuine or to be signed by the proper party or parties. Section 8.06. Indemnification. Each Bank shall, ratably in accordance with its Commitment, indemnify the Administrative Agent and the Issuing Bank, its affiliates and their respective directors, officers, agents and employees (to the extent not reimbursed by the Borrower) against any cost, expense (including counsel fees and disbursements), claim, demand, action, loss or liability (except such as result from such indemnitees' gross negligence or willful misconduct) that such indemnitees may suffer or incur in connection with the Financing Documents or any action taken or omitted by such indemnitees thereunder. Section 8.07. Credit Decision. Each Bank acknowledges that it has, independently and without reliance upon the Administrative Agent, the Syndication Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Bank also acknowledges that it will, independently and without reliance upon the Administrative Agent, the Syndication Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking any action under this Agreement. Section 8.08. Successor Administrative Agent. The Administrative Agent may resign at any time by giving notice thereof to the Banks and the Borrower. Upon any such resignation, the Required Banks shall have the right to appoint a successor Administrative Agent. If no successor Administrative Agent shall have been so appointed by the Required Banks, and shall have accepted such appointment, within 30 days after the retiring Administrative Agent gives notice of resignation, then the retiring Administrative Agent may, on behalf of the Banks, appoint a successor Administrative Agent, which shall be a commercial bank organized or licensed under the laws of the United States of America or of any State thereof and having a combined capital and surplus of at least $50,000,000. Upon the acceptance of its appointment as Administrative Agent hereunder by a successor Administrative Agent, such successor Administrative Agent shall thereupon succeed to and become vested with all the rights and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from its duties and obligations under the Financing Documents. After any retiring Administrative Agent's resignation hereunder as Administrative Agent, the provisions of this Article shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Administrative Agent. Section 8.09. Administrative Agent's Fee. The Borrower shall pay to each of the Administrative Agent, the Syndication Agent and the Issuing Bank, for its own account fees in the amounts and at the times specified in the Fee Letters. Section 8.10. Syndication Agent. Nothing in this Agreement shall impose upon the Syndication Agent, in such capacity, any obligation or liability whatsoever. ARTICLE 9 Change in Circumstances Section 9.01. Basis for Determining Interest Rate Inadequate or Unfair. If on or prior to the first day of any Interest Period for any Fixed Rate Borrowing: (a) the Administrative Agent is advised by the Reference Banks that deposits in dollars (in the applicable amounts) are not being offered to the Reference Banks in the London interbank market for such Interest Period, or (b) in the case of a Committed Borrowing, Banks having 50% or more of the aggregate amount of the Commitments advise the Administrative Agent that the Adjusted London Interbank Offered Rate, as the case may be, as determined by the Administrative Agent will not adequately and fairly reflect the cost to such Banks of funding their Euro-Dollar Loans for such Interest Period, the Administrative Agent shall forthwith give notice thereof to the Borrower and the Banks, whereupon until the Administrative Agent notifies the Borrower that the circumstances giving rise to such suspension no longer exist, the obligations of the Banks to make Euro-Dollar Loans shall be suspended. Unless the Borrower notifies the Administrative Agent at least two Domestic Business Days before the date of any Fixed Rate Borrowing for which a Notice of Borrowing has previously been given that it elects not to borrow on such date, (i) if such Fixed Rate Borrowing is a Committed Borrowing, such Borrowing shall instead be made as a Base Rate Borrowing and (ii) if such Fixed Rate Borrowing is a Money Market LIBOR Borrowing, the Money Market LIBOR Loans comprising such Borrowing shall bear interest for each day from and including the first day to but excluding the last day of the Interest Period applicable thereto at the Base Rate for such day. Section 9.02. Illegality. If, on or after the date of this Amended Agreement, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Euro-Dollar Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall make it unlawful or impossible for any Bank (or its Euro-Dollar Lending Office) to make, maintain or fund its Euro-Dollar Loans and such Bank shall so notify the Administrative Agent, the Administrative Agent shall forthwith give notice thereof to the other Banks and the Borrower, whereupon until such Bank notifies the Borrower and the Administrative Agent that the circumstances giving rise to such suspension no longer exist, the obligation of such Bank to make Euro-Dollar Loans shall be suspended. Before giving any notice to the Administrative Agent pursuant to this Section, such Bank shall designate a different Euro-Dollar Lending Office if such designation will avoid the need for giving such notice and will not, in the judgment of such Bank, be otherwise disadvantageous to such Bank. If such Bank shall determine that it may not lawfully continue to maintain and fund any of its outstanding Euro-Dollar Loans to maturity and shall so specify in such notice, the Borrower shall immediately prepay in full the then outstanding principal amount of each such Euro-Dollar Loan, together with accrued interest thereon. Concurrently with prepaying each such Euro-Dollar Loan, the Borrower shall borrow a Base Rate Loan in an equal principal amount from such Bank (on which interest and principal shall be payable contemporaneously with the related Euro-Dollar Loans of the other Banks), and such Bank shall make such a Base Rate Loan. Section 9.03. Increased Cost and Reduced Return. (a) If on or after (x) the date of this Amended Agreement, in the case of any Committed Loan or any obligation to make Committed Loans or (y) the date of the related Money Market Quote, in the case of any Money Market Loan, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Applicable Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall impose, modify or deem applicable any reserve (including, without limitation, any such requirement imposed by the Board of Governors of the Federal Reserve System, but excluding with respect to any Euro-Dollar Loan any such requirement included in an applicable Euro-Dollar Reserve Percentage), special deposit, insurance assessment or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Bank (or its Applicable Lending Office) or shall impose on any Bank (or its Applicable Lending Office) or on the United States market for certificates of deposit or the London interbank market any other condition affecting its Fixed Rate Loans, its Note or its obligation to make Fixed Rate Loans or its obligations hereunder in respect of Letters of Credit and the result of any of the foregoing is to increase the cost to such Bank (or its Applicable Lending Office) of making or maintaining any Fixed Rate Loan or of issuing or participating in any Letter of Credit, or to reduce the amount of any sum received or receivable by such Bank (or its Applicable Lending Office) under this Agreement or under its Note with respect thereto, by an amount deemed by such Bank to be material, then, within 15 days after demand by such Bank (with a copy to the Administrative Agent), the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank for such increased cost or reduction. (b) If any Bank shall have determined that, after the date of this Amended Agreement, the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change in any such law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on capital of such Bank (or its Parent) as a consequence of such Bank's obligations hereunder to a level below that which such Bank (or its Parent) could have achieved but for such adoption, change, request or directive (taking into consideration its policies with respect to capital adequacy) by an amount deemed by such Bank to be material, then from time to time, within 15 days after demand by such Bank (with a copy to the Administrative Agent), the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank (or its Parent) for such reduction. (c) Each Bank will promptly notify the Borrower and the Administrative Agent of any event of which it has knowledge, occurring after the date hereof, which will entitle such Bank to compensation pursuant to this Section and will designate a different Applicable Lending Office if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the judgment of such Bank, be otherwise disadvantageous to such Bank. A certificate of any Bank claiming compensation under this Section and setting forth the additional amount or amounts to be paid to it hereunder, together with the basis for determining such additional amounts, shall be conclusive in the absence of manifest error. In determining such amount, such Bank agrees to act in good faith and to use reasonable averaging and attribution methods. (d) In the event any Bank shall seek compensation pursuant to this Section, the Borrower may give notice to such Bank (with copy to the Administrative Agent) that it wishes to seek one or more financial institutions (which may be one or more of the Banks) to assume the Commitment of such Bank and to purchase its outstanding Loans and Note and its interest in any outstanding Letters of Credit. Each Bank requesting compensation pursuant to this Section agrees to sell its Commitment, Loans, Note and interest in this Agreement and any other credit documents to any such financial institution pursuant to, and subject to the conditions contained in Section 9.06. Section 9.04. Taxes. (a) For purposes of this Section, the following terms have the following meanings: "Taxes" means any and all present or future taxes, duties, levies, imposts, deductions, charges or withholdings with respect to any payment by the Borrower pursuant to this Agreement or under any Note, and all liabilities with respect thereto, excluding (i) in the case of each Bank and the Administrative Agent, taxes imposed on or measured by its income and/or net worth, and franchise or similar taxes imposed on it by a jurisdiction under the laws of which such Bank or the Administrative Agent (as the case may be) is organized or in which its principal executive office is located or, in the case of each Bank, in which its Applicable Lending Office or other permanent establishment for the conduct of business is located, and (ii) in the case of each Bank, any United States withholding tax imposed on such payments but only to the extent that such Bank is subject to United States withholding tax at the time such Bank first becomes a party to this Agreement. "Other Taxes" means any present or future stamp or documentary taxes and any other excise or property taxes, or similar charges or levies, which arise from any payment made pursuant to this Agreement or under any Letter of Credit or any Note or from the execution or delivery of, or otherwise with respect to, this Agreement or any Letter of Credit or any Note. (b) Any and all payments by the Borrower to or for the account of any Bank or the Administrative Agent hereunder or under any Note shall be made without deduction for any Taxes or Other Taxes; provided that, if the Borrower shall be required by law to deduct any Taxes or Other Taxes from any such payments, (i) the sum payable shall be increased as necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section such Bank or the Administrative Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions, (iii) the Borrower shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law and (iv) the Borrower shall furnish to the Administrative Agent, at its address referred to in Section 10.01, the original or a certified copy of a receipt evidencing payment thereof. (c) The Borrower agrees to indemnify each Bank and the Administrative Agent for the full amount of Taxes or Other Taxes (including, without limitation, any Taxes or Other Taxes imposed or asserted by any jurisdiction on amounts payable under this Section paid by such Bank or the Administrative Agent (as the case may be) and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto. This indemnification shall be paid within 15 days after such Bank or the Administrative Agent (as the case may be) makes demand therefor. (d) Each Bank organized under the laws of a jurisdiction outside the United States, on or prior to the date of its execution and delivery of this Agreement in the case of each Bank listed on the signature pages hereof and on or prior to the date on which it becomes a Bank in the case of each other Bank, and from time to time thereafter if requested in writing by the Borrower (but only so long as such Bank remains lawfully able to do so), shall provide the Borrower with Internal Revenue Service form 1001 or 4224, as appropriate, or any successor form prescribed by the Internal Revenue Service, certifying that such Bank is entitled to benefits under an income tax treaty to which the United States is a party which exempts the Bank from United States withholding tax or reduces the rate of withholding tax on payments of interest for the account of such Bank or certifying that the income receivable pursuant to this Agreement is effectively connected with the conduct of a trade or business in the United States. (e) For any period with respect to which a Bank has failed to provide the Borrower with the appropriate form pursuant to Section 9.04(d) (unless such failure is due to a change in treaty, law or regulation occurring subsequent to the date on which such form originally was required to be provided), such Bank shall not be entitled to indemnification under Section 9.04(b) or (c) with respect to Taxes imposed by the United States; provided that if a Bank, which is otherwise exempt from or subject to a reduced rate of withholding tax, becomes subject to Taxes because of its failure to deliver a form required hereunder, the Borrower shall take such steps as such Bank shall reasonably request to assist such Bank to recover such Taxes. (f) Each Bank will promptly notify the Borrower and the Administrative Agent of any event of which it has knowledge, occurring after the date hereof, which would require the Borrower to pay additional amounts to or for the account of such Bank pursuant to this Section 9.04, and such Bank will change the jurisdiction of its Applicable Lending Office if, in the judgment of such Bank, such change (i) will eliminate or reduce any such additional payment which may thereafter accrue and (ii) is not otherwise disadvantageous to such Bank. A certificate of any Bank claiming compensation under this Section, and setting forth the additional amount or amounts to be paid to it hereunder, together with the basis for determining such additional amounts, shall be conclusive in the absence of manifest error. In determining such amount, such Bank agrees to act in good faith and to use reasonable averaging and attribution methods. Section 9.05. Base Rate Loans Substituted for Affected Fixed Rate Loans. If (i) the obligation of any Bank to make Euro-Dollar Loans has been suspended pursuant to Section 9.02 or (ii) any Bank has demanded compensation under Section 9.03 or 9.04 with respect to its Euro-Dollar Loans and the Borrower shall, by at least five Euro-Dollar Business Days' prior notice to such Bank through the Administrative Agent, have elected that the provisions of this Section shall apply to such Bank, then, unless and until such Bank notifies the Borrower that the circumstances giving rise to such suspension or demand for compensation no longer exist: (a) all Loans which would otherwise be made by such Bank as Euro-Dollar Loans shall be made instead as Base Rate Loans (on which interest and principal shall be payable contemporaneously with the related Euro-Dollar Loans of the other Banks); and (b) after each of its Euro-Dollar Loans has been repaid, all payments of principal which would otherwise be applied to repay such Euro-Dollar Loans shall be applied to repay its Base Rate Loans instead. Section 9.06. Borrower's Right to Replace Banks. If at any time any Bank shall be in receivership or shall seek compensation or recompense pursuant to any provision of this Article 9, the Borrower shall have the right to replace such Bank with another financial institution; provided, that such new financial institution shall be acceptable to the Issuing Bank and the Administrative Agent (unless the Bank to be replaced is the Administrative Agent, in which case such new financial institution shall be acceptable to the Issuing Bank). Each Bank agrees to its replacement at the option of the Borrower pursuant to this Section, provided, that the successor financial institution shall purchase without recourse the Commitment of such Bank and all obligations of the Borrower to such Bank hereunder and under the Notes for cash in an aggregate amount equal to the aggregate unpaid principal thereof, all unpaid interest accrued thereon, all unpaid fees and letter of credit fees accrued for the account of such Bank, and all other amounts (if any) then owing to such Bank hereunder and otherwise in accordance with this Agreement (including such amounts, if any, as would be payable by the Borrower pursuant to Section 2.13 if the Loans of such Bank were prepaid in full on such date). Nothing contained in this Section shall alter or modify the Borrower's obligation to pay any amount payable to or for the account of the replaced Bank pursuant to any other Section of this Article 9 accruing prior to the replacement of such Bank. Notwithstanding anything to the contrary contained in this Section 9.06, the Issuing Bank may not be replaced hereunder at any time while it has Letters of Credit outstanding hereunder unless arrangements satisfactory to the such bank (including, the furnishing of a standby letter of credit in form and substance, and issued by an issuer, satisfactory to such bank or the furnishing of cash collateral in amounts and pursuant to arrangements satisfactory to such bank) have been made with respect to such outstanding Letters of Credit. ARTICLE 10 Miscellaneous Section 10.01. Notices. All notices, requests and other communications to any party hereunder shall be in writing (including bank wire, telex, facsimile transmission or similar writing) and shall be given to such party: (w) in the case of the Borrower or the Administrative Agent, at its address, facsimile number or telex number set forth on the signature pages hereof, (x) in the case of any Guarantor, to it care of the Borrower, (y) in the case of any Bank, at its address, facsimile number or telex number set forth in its Questionnaire or (z) in the case of any party, such other address, facsimile number or telex number as such party may hereafter specify for the purpose by notice to the Administrative Agent and the Borrower. Each such notice, request or other communication shall be effective (i) if given by telex, when such telex is transmitted to the telex number specified in this Section and the appropriate answerback is received, (ii) if given by facsimile transmission, when transmitted to the facsimile number specified in this Section and confirmation of receipt is received, (iii) if given by mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid or (iv) if given by any other means, when delivered at the address specified in this Section; provided that notices to the Administrative Agent under Article 2 or Article 10 shall not be effective until received. Section 10.02. No Waivers. No failure or delay by the Administrative Agent or any Bank in exercising any right, power or privilege or under any Financing Document shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies provided in the Financing Documents shall be cumulative and not exclusive of any rights or remedies provided by law. Section 10.03. Expenses; Indemnification. (a) The Borrower shall pay (i) all reasonable out-of-pocket expenses of the Administrative Agent and the Issuing Bank, including fees and disbursements of special counsel for the Administrative Agent, in connection with the preparation of the Financing Documents, any waiver or consent thereunder or any amendment thereof or any Default or alleged Default hereunder and (ii) if an Event of Default occurs, all out-of-pocket expenses incurred by the Administrative Agent, the Issuing Bank and each Bank, including (without duplication) the reasonable fees and disbursements of outside counsel and the allocated cost of inside counsel, in connection with such Event of Default and collection, bankruptcy, insolvency and other enforcement proceedings resulting therefrom. (b) The Borrower agrees to indemnify the Administrative Agent, the Issuing Bank and each Bank, their respective affiliates and the respective directors, officers, agents and employees of the foregoing (each an "Indemnitee") and hold each Indemnitee harmless from and against any and all liabilities, losses, damages, costs and expenses of any kind, including, without limitation, the reasonable fees and disbursements of counsel, which may be incurred by such Indemnitee in connection with any investigative, administrative or judicial proceeding (whether or not such Indemnitee shall be designated a party thereto) brought or threatened relating to or arising out of the Financing Documents or any actual or proposed use of proceeds of Loans hereunder; provided that no Indemnitee shall have the right to be indemnified hereunder for such Indemnitee's own gross negligence or willful misconduct as determined by a court of competent jurisdiction. Section 10.04. Sharing of Set-Offs. Each Bank agrees that if it shall, by exercising any right of set-off or counterclaim or otherwise, receive payment of a proportion of the aggregate amount of principal and interest due with respect to any Note held by it which is greater than the proportion received by any other Bank in respect of the aggregate amount of principal and interest due with respect to any Note held by such other Bank, the Bank receiving such proportionately greater payment shall purchase such participations in the Notes held by the other Banks, and such other adjustments shall be made, as may be required so that all such payments of principal and interest with respect to the Notes held by the Banks shall be shared by the Banks pro rata; provided that nothing in this Section shall impair the right of any Bank to exercise any right of set-off or counterclaim it may have and to apply the amount subject to such exercise to the payment of indebtedness of the Borrower other than its indebtedness hereunder. Each of the Borrower and the Guarantors agrees, to the fullest extent it may effectively do so under applicable law, that any holder of a participation in a Note, whether or not acquired pursuant to the foregoing arrangements, may exercise rights of set-off or counterclaim and other rights with respect to such participation as fully as if such holder of a participation were a direct creditor of the Borrower or such Guarantor, as the case may be, in the amount of such participation. Section 10.05. Amendments and Waivers. Any provision of this Agreement or the Notes may be amended or waived if, but only if, such amendment or waiver is in writing and is signed by the Borrower and the Required Banks (and, if the rights or duties of the Administrative Agent, the Syndication Agent or the Issuing Bank are affected thereby, by it); provided that no such amendment or waiver shall, unless signed by all the Banks, (i) increase or decrease the Commitment of any Bank (except for a ratable decrease in the Commitments of all Banks) or subject any Bank to any additional obligation, (ii) reduce the principal of or rate of interest on any Loan or any Unpaid Drawing or any fees hereunder, (iii) postpone the date fixed for any payment of principal of or interest on any Loan or any Unpaid Drawing or any fees hereunder or for termination of any Commitment, (iv) extend the Letter of Credit Termination Date or (except as expressly contemplated by Section 3.02) the expiry date of any Letter of Credit or (v) change this Section 10.05 or the percentage of the Commitments or of the aggregate unpaid principal amount of the Notes, or the number of Banks, which shall be required for the Banks or any of them to take any action under this Section or any other provision of this Agreement. Section 10.06. Successors and Assigns. (a) The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, provided that, the Borrower may not assign or otherwise transfer any of its rights under this Agreement without the prior written consent of all Banks. (b) Any Bank may at any time grant to one or more banks or other institutions (each a "Participant") participating interests in its Commitment or any or all of its Loans. In the event of any such grant by a Bank of a participating interest to a Participant, whether or not upon notice to the Borrower and the Administrative Agent, such Bank shall remain responsible for the performance of its obligations hereunder, and the Borrower and the Administrative Agent shall continue to deal solely and directly with such Bank in connection with such Bank's rights and obligations under this Agreement. Any agreement pursuant to which any Bank may grant such a participating interest shall provide that such Bank shall retain the sole right and responsibility to enforce the obligations of the Borrower hereunder including, without limitation, the right to approve any amendment, modification or waiver of any provision of this Agreement; provided that such participation agreement may provide that such Bank will not agree to any modification, amendment or waiver of this Agreement described in clause (i), (ii), (iii) or (iv) of Section 10.05 without the consent of the Participant. The Borrower agrees that each Participant shall, to the extent provided in its participation agreement, be entitled to the benefits of Article 9 with respect to its participating interest. An assignment or other transfer which is not permitted by subsection (c) or (d) below shall be given effect for purposes of this Agreement only to the extent of a participating interest granted in accordance with this subsection (b). (c) Any Bank may at any time assign to one or more banks or other institutions (each an "Assignee") all, or a proportionate part (equivalent to an initial Commitment of not less than $5,000,000 or such lesser amount as may be acceptable to the Borrower and the Administrative Agent), of all, of its rights and obligations under this Agreement and the Notes, and such Assignee shall assume such rights and obligations, pursuant to an Assignment and Assumption Agreement in substantially the form of Exhibit G hereto executed by such Assignee and such transferor Bank, with (and subject to) the subscribed consent of the Borrower, which shall not be unreasonably withheld, the Issuing Bank and the Administrative Agent; provided that if an Assignee is an affiliate of such transferor Bank, no such consent shall be required; and provided further that such assignment may, but need not, include rights of the transferor Bank in respect of outstanding Money Market Loans. Upon execution and delivery of such instrument and payment by such Assignee to such transferor Bank of an amount equal to the purchase price agreed between such transferor Bank and such Assignee, such Assignee shall be a Bank party to this Agreement and shall have all the rights and obligations of a Bank with a Commitment as set forth in such instrument of assumption, and the transferor Bank shall be released from its obligations hereunder to a corresponding extent, and no further consent or action by any party shall be required. Upon the consummation of any assignment pursuant to this subsection (c), the transferor Bank, the Administrative Agent and the Borrower shall make appropriate arrangements so that, if required, a new Note is issued to the Assignee. In connection with any such assignment, the transferor Bank shall pay to the Administrative Agent an administrative fee for processing such assignment in the amount of $2,500. If the Assignee is not incorporated under the laws of the United States of America or a state thereof, it shall deliver to the Borrower and the Administrative Agent certification as to exemption from deduction or withholding of any United States federal income taxes in accordance with Section 9.04. (d) Any Bank may at any time assign all or any portion of its rights under this Agreement and its Note to a Federal Reserve Bank. No such assignment shall release the transferor Bank from its obligations hereunder. (e) No Assignee, Participant or other transferee of any Bank's rights shall be entitled to receive any greater payment under Section 9.03 or 9.04 than such Bank would have been entitled to receive with respect to the rights transferred, unless such transfer is made with the Borrower's prior written consent or by reason of the provisions of Section 9.02, 9.03 or 9.04 requiring such Bank to designate a different Applicable Lending Office under certain circumstances or at a time when the circumstances giving rise to such greater payment did not exist. Section 10.07. Collateral. Each of the Banks represents to the Administrative Agent, the Syndication Agent and each of the other Banks that it in good faith is not relying upon any "margin stock" (as defined in Regulation U and Regulation G) as collateral in the extension or maintenance of the credit provided for in this Agreement. Section 10.08. Governing Law; Submission to Jurisdiction. This Agreement and each Note shall be governed by and construed in accordance with the laws of the State of New York. The parties hereto hereby (i) submit to the nonexclusive jurisdiction of the United States District Court for the Southern District of New York and of any New York State court sitting in New York City for purposes of all legal proceedings arising out of or relating to this Agreement or the transactions contemplated hereby and (ii) irrevocably waive, to the fullest extent permitted by law, any objection which they may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum; provided, however, that nothing in this Section is intended to waive the right of any party to remove any such action or proceeding commenced in any such New York State court to an appropriate New York Federal court to the extent the basis for such removal exists under applicable law. Section 10.09. Counterparts; Integration. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement constitutes the entire agreement and understanding among the parties hereto and supersedes any and all prior agreements and understandings, oral or written, relating to the subject matter hereof. Section 10.10. WAIVER OF JURY TRIAL. EACH OF THE BORROWER, THE ADMINISTRATIVE AGENT AND THE BANKS HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. VALERO ENERGY CORPORATION By /s/ John D. Gibbons Title: Vice President, Finance & Treasurer Facsimile number: 210-370-2988 MORGAN GUARANTY TRUST COMPANY OF NEW YORK By /s/ James S. Finch Title: Vice President BANK OF MONTREAL By /s/ Donald G. Skipper Title: Director BANK OF TOKYO-MITSUBISHI, LTD. By /s/ T. Yokokawa Title: Deputy General Manager BANKBOSTON, N.A. By /s/ Terrence Ronan Title: Vice President BANQUE NATIONALE DE PARIS, HOUSTON AGENCY By /s/ Henry F. Setina Title: Vice President BHF-BANK AKTIENGESELLSCHAFT By /s/ Paul Travers Title:Vice President By /s/ John Sykes Title: Assistant Vice President CIBC INC. By /s/ Aleksandra K. Dymanus Title: Director CREDIT LYONNAIS NEW YORK BRANCH By /s/ Pascal Poupelle Title: Executive Vice President THE FIRST NATIONAL BANK OF CHICAGO By /s/ Dixon P. Schultz Title: Vice President THE FUJI BANK, LIMITED By /s/ Jacques M. Azagury Title: Vice President & Manager ROYAL BANK OF CANADA By /s/ Gil J. Benard Title: Senior Manager SOCIETE GENERALE By /s/ Richard A. Gould Title: Vice President TORONTO DOMINION (TEXAS), INC. By /s/ Frederic Hawley Title: Vice President BARCLAYS BANK PLC By /s/ Nicholas A. Bell Title: Director, Portfolio Management CHRISTIANIA BANK, NEW YORK BRANCH By /s/ William S. Phillips Title: Vice President By /s/ Peter M. Dodge Title: First Vice President DEN NORSKE BANK ASA By /s/ Byron L. Cooley Title: Senior Vice President By /s/ J. Morten Kreutz Title: Vice President GUARANTY FEDERAL BANK, F.S.B. By /s/ Jim R. Hamilton Title: Vice President THE INDUSTRIAL BANK OF JAPAN, LIMITED, NEW YORK BRANCH By /s/ Kazutoshi Kuwahara Title: Executive Vice President, Houston Office THE SUMITOMO BANK, LIMITED By /s/ Reiji Sato Title: Joint General Manager THE BANK OF NOVA SCOTIA By /s/ F.C.H. Ashby Title: Senior Manger, Loan Operations CREDIT AGRICOLE INDOSUEZ By /s/ Katharine L. Abbott Title: First Vice President By /s/ Dean Balice Title: Senior Vice President Branch Manager THE DAI-ICHI KANGYO BANK, LTD. By /s/ Seiji Imai Title: Vice President THE FROST NATIONAL BANK By /s/ Jim Crosby Title: Senior Vice President MELLON BANK, N.A. By /s/ Roger E. Howard Title: Vice President THE MITSUI TRUST AND BANKING COMPANY, LIMITED By /s/ Margaret Holloway Title: Vice President & Manager THE SANWA BANK, LIMITED, DALLAS AGENCY By /s/ Matthew G. Patrick Title: Vice President UNION BANK OF SWITZERLAND, HOUSTON AGENCY By /s/ Dan O. Boyle Title: Managing Director By /s/ W. Benson Vance Title: Assistant Vice President MORGAN GUARANTY TRUST COMPANY OF NEW YORK,as Administrative Agent By /s/ James S. Finch Title: Vice President 60 Wall Street New York, New York 10260-0060 Fax: 212-648-5023 BANK OF MONTREAL, as Syndication Agent and Issuing Bank By /s/ Donald G. Skipper Title: Director 700 Louisiana Avenue, Suite 4400 Houston, Texas 77002 Fax: 713-223-4007 Pricing Schedule The "Euro-Dollar Margin", "Facility Fee Rate" and "Letter of Credit Rate" for any day are the respective percentages set forth below in the applicable row under the column corresponding to the Status that exists on such day: Status Level I Level II Level III Level IV Level V Euro-Dollar Margin 0.2100% 0.2150% 0.3000% 0.500% 0.875% Facility Fee Rate 0.0900% 0.110% 0.150% 0.250% 0.375% Letter of Credit Rate Performance 0.1050% 0.1075% 0.1500% 0.2500% 0.4375% Financial 0.2100% 0.2150% 0.3000% 0.5000% 0.8750% For purposes of this Schedule, the following terms have the following meanings (subject to the last paragraph of this Schedule): "Level I Status" exists at any date if, at such date, the Borrower's long-term debt is rated at least BBB+ by S&P or at least Baa1 by Moody's. "Level II Status" exists at any date if, at such date, (i) the Borrower's long-term debt is rated at least BBB by S&P or at least Baa2 by Moody's and (ii) Level I Status does not exist. "Level III Status" exists at any date if, at such date, (i) the Borrower's long-term debt is rated at least BBB- by S&P or at least Baa3 by Moody's and (ii) neither Level I Status nor Level II Status exists. "Level IV Status" exists at any date if, at such date, (i) the Borrower's long-term debt is rated at least BB+ by S&P and least Ba1 by Moody's and (ii) none of Level I Status, Level II Status and Level III Status exists. "Level V Status" exists at any date if, at such date, no other Status exists. "Status" refers to the determination of which of Level I Status, Level II Status, Level III Status, Level IV Status or Level V Status exists at any date. The credit ratings to be utilized for purposes of this Schedule are those assigned to the senior unsecured long-term debt securities of the Borrower without third-party credit enhancement, and any rating assigned to any other debt security of the Borrower shall be disregarded. The rating in effect at any date is that in effect at the close of business on such date. So long as the Borrower is rated at least BB- by S&P and at least Ba3 by Moody's, if Borrower is split-rated and the ratings differential is one level, the higher of the two ratings will apply (e.g., BBB/Baa3 results in Level II Status). If the Borrower is split-rated and the ratings differential is more than one level, the average of the two ratings (or the higher of two intermediate ratings) shall be used (e.g., BBB-/Ba1 results in Level III Status, as does BBB/Ba2). Commitment Schedule Bank Commitment Morgan Guaranty Trust Company of New York $ 47,750,000 Bank of Montreal 47,750,000 Bank of Tokyo-Mitsubishi, Ltd. 39,500,000 BankBoston, N.A. 39,500,000 Banque Nationale De Paris, Houston Agency 39,500,000 Barclays Bank PLC 39,500,000 CIBC Inc. 39,500,000 Credit Lyonnais New York Branch 39,500,000 The First National Bank of Chicago 39,500,000 The Fuji Bank, Limited 39,500,000 Royal Bank of Canada 39,500,000 Societe Generale 39,500,000 Toronto Dominion (Texas), Inc. 39,500,000 Union Bank of Switzerland, Houston Agency 39,500,000 Den Norske Bank ASA 35,000,000 Christiania Bank, New York Branch 30,000,000 The Industrial Bank of Japan, Limited, New York Branch 30,000,000 Guaranty Federal Bank, F.S.B. 28,000,000 The Bank of Nova Scotia 22,500,000 Mellon Bank, N.A. 22,500,000 The Sanwa Bank, Limited, Dallas Agency 22,500,000 Credit Agricole Indosuez 20,000,000 The Dai-Ichi Kangyo Bank, Ltd. 20,000,000 The Frost National Bank 20,000,000 BHF-Bank Aktiengesellschaft 15,000,000 The Sumitomo Bank, Limited 0 The Mitsui Trust and Banking Company, Limited 0 Total $835,000,000 EX-10.12 3 EMPLOYMENT AGREEMENT - WEG Exhibit 10.12 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is between Valero Refining and Marketing Company, a Delaware corporation ("Valero"), and William E. Greehey, a resident of San Antonio, Texas, ("Greehey"). This Agreement is effective on the day that all of the capital stock of Valero is distributed by Valero Energy Corporation ("VEC") to its stockholders ("Effective Date"). Valero and Greehey are sometimes referred to herein individually as a "Party", and collectively as the "Parties". The Parties hereby agree as follows: 1. Employment. Valero hereby employs Greehey, and Greehey hereby accepts employment with Valero, subject to the terms and conditions set forth in this Agreement. 2. Term. Subject to the provisions for termination of employment as provided in Section 9(a), this Agreement shall be in effect for a period of two years beginning on the Effective Date and ending on the second anniversary of the Effective Date ("Initial Period"). If Greehey notifies Valero at least ninety (90) days prior to the end of the Initial Period of his intention to extend this Agreement, then this Agreement shall be extended on a month-to-month basis ("Extension Period"). Greehey may terminate this Agreement within the Extension Period by giving Valero ninety (90) calendar days written notice of termination. 3. Compensation. Greehey's compensation during his employment under the terms of this Agreement and prior to his retirement shall be as follows: (a) Base Salary. Valero shall pay to Greehey a base salary (the "Base Salary") of Nine Hundred Thousand Dollars ($900,000) per year. In addition, the Board of Directors of Valero shall in good faith consider granting annual increases to the Base Salary based upon such factors as Greehey's performance and the growth and profitability of Valero, but it shall have no obligation to grant any such increases in compensation. Any such increase to the Base Salary shall be deemed thereafter to be the Base Salary; provided, however, based upon the same such factors, the Board of Directors of Valero may thereafter reduce the Base Salary to an amount that is not below the amount first set forth above in this Paragraph 3(a). The Base Salary shall be payable in equal, semi-monthly installments on the 15th day and last day of each month or at such other times and in such installments as may be agreed between Valero and Greehey. All payments shall be subject to the deduction of payroll taxes, income tax withholdings, and similar deductions and withholdings as required by law. (b) Bonus. In addition to the Base Salary, Greehey shall be eligible to receive bonus compensation in such amounts and at such times as the Board of Directors of Valero shall from time to time determine. In the year of his retirement, Greehey shall receive a pro-rata share of bonus compensation in such amount as the Board of Directors of Valero shall determine at the customary time annual bonuses are determined and paid to executive officers of Valero. (c) Stock Option Grant. Greehey shall receive a nonqualified stock option grant to purchase 290,000 shares of Valero Energy Corporation common stock, granted on the fifth (5th) business day following approval of said grant by the Board of Directors of Valero Energy Corporation ("Grant Date") with an exercise price per share equal to the fair market value of Valero Energy Corporation common stock on the Grant Date. These options shall vest at the rate of 50% on the first anniversary of the Grant Date and the remaining 50% on the second anniversary of the Grant Date, and shall have a total term of ten years from the Grant Date. These vesting periods shall not be modified by the accelerated vesting provisions set forth in Paragraph 7(f). 4. Expenses and Benefits. During his employment, Greehey is authorized to incur reasonable expenses in connection with the business of Valero, including expenses for entertainment, travel and similar matters. Valero will reimburse Greehey for such expenses upon presentation by Greehey of such accounts and records as Valero may from time to time reasonably require. Valero also agrees to provide Greehey with the following benefits during employment: (a) Insurance. Permanent life insurance in addition to any life insurance under Valero's normal benefit plans in accordance with Paragraph 7(g). (b) Employee Benefit Plans. Participation in any employee benefit plans now existing or hereafter adopted by Valero for its executives or other officers and employees. (c) Club Memberships. Valero shall reimburse Greehey for all monthly dues and fees for Greehey's present country club memberships and for any expenses incurred by Greehey in connection with such club memberships in representing Valero's interests. (d) Vacations. Greehey shall be entitled (in addition to the usual Valero holidays) to a paid vacation for a period in each calendar year not exceeding five weeks. (e) Working Facilities. Greehey shall be furnished by Valero with an office, secretarial help and other facilities and services, including but not limited to full use of Valero's mail and communication facilities and services reasonably suitable to his position and reasonably necessary for the performance of his duties under this Agreement. (f) Tax Planning. Greehey will be furnished tax planning services by an independent certified public accounting firm of the type furnished to executive officers of Valero. (g) Other. Such other items as Valero shall from time to time consider necessary or appropriate to assist Greehey in or to provide incentives or compensation for the performance of his duties under this Agreement. 5. Positions and Duties. Greehey is employed as Chief Executive Officer of Valero and for no additional compensation shall, subject to his being elected or re-elected as a director by Valero's stockholders, serve at the discretion of the Board as its Chairman of the Board. In addition, if requested to do so, Greehey shall serve as the chief executive officer or as a member of the Board of Directors, or both, of any subsidiary or affiliate of Valero. Such duties shall be performed at Valero's principal place of business in San Antonio, Texas. 6. Extent of Service. Greehey shall, during his employment under the terms of this Agreement, devote substantially all of his working time, attention, energies and business efforts to his duties as an employee of Valero and to the business of Valero generally, and shall not, during the term of this Agreement, engage in any other business activity whatsoever, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; however, this Paragraph 6 shall not be construed to prevent Greehey from serving as a member of the board of directors of other companies, or from investing his personal, private assets as a passive investor in such form or manner as will not require any active services on the part of Greehey in the management or operation of the affairs of the companies, partnerships, or other business entities in which any such passive investments are made. 7. Retirement. Notwithstanding the term and notice provisions of Paragraph 2, Greehey may retire at any time as Chief Executive Officer of Valero under the terms of this Agreement by giving Valero written notice of his intention to retire 90 days in advance of the designated retirement date. Upon retirement, and provided that Valero has not terminated Greehey for cause pursuant to Paragraph 9(a), Greehey shall no longer be employed by Valero, but he shall have the following rights and obligations: (a) Continuation as Chairman. Greehey agrees to continue serving at the discretion of the Board as Chairman of the Board of Valero for two years following his effective date of retirement; (b) Duties. As Chairman of the Board of Valero, Greehey shall perform such duties as are reasonably required by a person holding such position. However, it is agreed and understood that Greehey shall not be obligated to devote any particular amount of time to the affairs of Valero over and above that which he determines is necessary to perform his duties as a director, and will be free to pursue other business interests provided the pursuit thereof does not violate any fiduciary duty owed to Valero in Greehey's capacity as Chairman of the Board or violate the provisions of Paragraphs 11 or 12; (c) Compensation. Greehey shall be paid compensation for serving as Chairman of the Board equal to one half of the Base Salary being paid to Greehey at the time of his retirement. This payment shall continue for the two year period Greehey serves as Chairman of the Board (other than as a result of Greehey's refusal to serve as Chairman of the Board) and shall be payable in semi-monthly installments; (d) Working Facilities. Valero shall provide Greehey with off-site office facilities and secretarial and other office services reasonably commensurate with Greehey's position as retired Chief Executive Officer of Valero. The office facilities and secretarial and other services to be provided to Greehey following his retirement shall continue until December 31, 2005. (e) Annual Physical Examination. Valero shall pay for an annual physical examination for Greehey for the remainder of his life. (f) Vesting and Option Exercise Periods. Upon retirement, Greehey's stock options, stock appreciation rights, restricted stock grants, performance share awards, and any other similar stock or long-term incentive rights or benefits previously granted to Greehey, which have not fully vested, shall immediately fully vest, except for any unvested stock options granted to Greehey pursuant to Paragraph 3(c). Greehey shall have the right to exercise any vested stock options, stock appreciation rights, restricted stock grants, performance share awards, and other similar stock or long-term incentive rights or benefits for the full remaining term thereof. Any outstanding performance share award shall be deemed to have been earned at the target level for the full term. (g) Retirement Benefits and Supplemental Retirement Benefits. Greehey shall be entitled to all retirement benefits provided under the Valero Energy Corporation Pension Plan ("Pension Plan") and Supplemental Executive Retirement Plan (SERP), with the following supplemental benefits: (i) retiree medical coverage consistent with coverage amount and/or deductibles and costs as provided to Valero retirees; (ii) paid up permanent life insurance, in addition to life insurance included in Valero's normal retirement benefit plans, with cash value of at least $300,000; (iii) a total of eight "points" under the SERP to be added to his years of credited service, or his age, or divided between both in such proportion that total eight, as he elects at time of retirement. The amount per month equal to the difference between Greehey's normal monthly retirement benefit under the Pension Plan and the SERP with the eight added points shall constitute a supplemental monthly retirement payment, payable at the time each payment is made under the Pension Plan. For purposes of calculating Greehey's monthly retirement benefits, service shall be deemed continuous from August 19, 1963 through the date of retirement pursuant to this Agreement. Greehey shall not be entitled to participate in nor receive the benefits of any special "window" retirement or early retirement program, if any, that may be offered to other employees of Valero or subsidiaries at or about the time of Greehey's giving notice of retirement or actual retirement; and (iv) payments under any other employee benefit plan(s), which are due as a result of separation of service. 8. Death and Disability. (a) Death. If during the term of Greehey's employment under this Agreement and prior to the date of retirement Greehey dies, then in addition to all other employee benefits to which Greehey's estate, spouse or other beneficiaries may be entitled, Valero shall pay in equal semi-monthly installments to the beneficiary designated by Greehey, or his estate if no such beneficiary has been designated in writing to Valero, the Base Salary which Greehey would have received if he had remained employed to the end of the Initial Period or if his employment has been extended pursuant to Paragraph 2, to the end of the Extension Period. (b) Disability. (i) If during the term of Greehey's employment under this Agreement Greehey becomes unable to perform his duties as Chief Executive Officer as a result of illness or physical injury as defined in Valero's Long Term Disability Plan, Greehey shall be deemed to have retired and be entitled to the benefits described in Paragraph 7(d), (e), (f) and (g). (ii) If following his retirement as Chief Executive Officer, Greehey becomes unable to perform his duties as Chairman of the Board, as determined by a majority of the other Directors, Greehey's benefits under Paragraph 7(a) and (b) shall cease; however, Greehey shall be entitled to the balance of the remaining two years' compensation for serving as Chairman of the Board, as defined in Paragraph 7 (c), payable in semi-monthly installments. 9. Termination by Valero. Valero shall have the right to terminate Greehey's employment as hereinafter provided. (a) Termination for Cause. Valero shall have the right to terminate Greehey's employment under this Agreement for cause. As used herein, "cause" shall mean and be strictly limited to: (i) Greehey's conviction of a crime constituting a felony under federal or state law or involving moral turpitude; (ii) an illegal act or acts that were intended to and did defraud Valero; or (iii) the willful refusal by Greehey to fulfill responsibilities under this Agreement after written notice of such willful refusal from the Board and the failure to correct such refusal within 30 days from the date such notice is given. If Valero terminates this Agreement pursuant to the provisions of this Paragraph 9(a): (i) all compensation or other benefits due Greehey pursuant to Paragraphs 3 and 4 hereto shall be paid by Valero to Greehey to the date of such termination; and (ii) all supplemental and additional benefits and rights granted to Greehey at retirement by Paragraph 7 are revoked and become null and void; and, upon such payment by Valero, all obligations of Valero to Greehey hereunder shall be totally and completely satisfied, and Valero shall have no further obligations of any type to Greehey pursuant to this Agreement. (b) Termination other than for Cause. Valero shall have the right to terminate Greehey's employment as Chief Executive Officer under this Agreement without cause, and Greehey's employment under this Agreement shall be deemed terminated upon the giving of 90 days written notice to such effect by Valero to Greehey. A termination of employment other than as a result of death, retirement, disability, or in accordance with Paragraph 9(a) shall be deemed a termination without cause. In the event of termination without cause: (i) Valero shall pay Greehey in cash a lump sum amount equal to the product of Greehey's semi-monthly Base Salary being paid to Greehey at the date of such termination multiplied by the number of semi-monthly pay periods remaining to the end of the Initial Period (or successive period if employment has been extended pursuant to Paragraph 2), plus an amount equal to the highest annual bonus paid to Greehey during the five years preceding the time of such termination. Such amount shall be paid within five days of termination; (ii) Greehey shall receive all the payments and benefits to which he is entitled pursuant to Paragraph 7(f) and (g); but shall not be entitled to receive any further payments or benefits under Paragraph 7 after the date of such termination, including any payment under 7 (c). (c) Termination as Chairman of the Board. If for any reason Greehey is removed by a majority of the other Directors as Chairman of the Board after his retirement as Chief Executive Officer, other than as a result of death or disability, he shall receive the balance of the remaining two years' compensation for serving as Chairman of the Board as defined in Paragraph 7(c), payable in semi-monthly installments. 10. Executive Severance Agreement. In the event Greehey receives any cash payments under that certain Executive Severance Agreement dated December 15, 1982 between Valero and Greehey, Valero shall be entitled to credit any cash payments that are made to Greehey pursuant to his Executive Severance Agreement against any cash payments that it is obligated to make under this Agreement. Valero agrees that if remuneration or benefits of any form paid to Greehey by Valero during or after his employment with Valero are excess parachute payments as defined in Section 280G of the Internal Revenue Code of 1986, as amended ("Code"), and are subject to the 20% excise tax imposed by Section 4999 of the Code, Valero shall pay Greehey a bonus no later than seven days prior to the earliest of the due date for the excise tax return or initial estimated payment, in an amount equal to the excise tax payable as a result of the excess parachute payment and any additional federal income taxes (including any additional excise taxes) payable by him as a result of the bonus, assuming that he will be subject to federal income taxes at the highest individual marginal rate. It is the intention of the Parties that the bonus be "grossed up" so that the bonus contains sufficient funds to pay the excise and all additional federal income taxes due as a result of the bonus payment so that Greehey will suffer no detriment from the excise tax payable as a result of the excess golden parachute payments. 11. Disclosure of Confidential Information. Except to the extent absolutely required in the performance of his duties and obligations to Valero as expressly authorized herein, or by prior written consent of a duly authorized officer or director of Valero, Greehey will not, directly or indirectly, at any time during his employment with Valero, or at any time subsequent to the termination thereof, for any reason whatsoever, with or without cause, breach the confidence reposed in him by Valero by using, disseminating, disclosing, divulging or in any manner whatsoever disclosing or permitting to be divulged or disclosed in any manner to any person, firm, corporation, association or other business entity, trade secrets, secret methods or "Confidential Information" of Valero, nor will Greehey lecture on or publish articles concerning any trade secrets, secret methods or "Confidential Information" of Valero. As used herein, the term "Confidential Information" means any and all information concerning Valero's products, processes, sources of supply, and services, including information relating to research, development, inventions, manufacture, purchasing, accounting, engineering, marketing, merchandising, or the selling of any product or products to any customers of Valero, disclosed to Greehey or known by Greehey as a consequence of or through his employment by Valero (or any parent, subsidiary or affiliated corporations of Valero) including, but not necessarily limited to, any person, firm, corporation, association or other business entity with which Valero has any type of agency agreement, or any shareholders, directors, or officers of any such person, firm, corporation, association or other business entity, if such information is not generally known in any industry in which Valero is or may become engaged during the term of this Agreement. On termination of employment with Valero, all documents, records, notebooks, or similar repositories of or containing Confidential Information, including all copies of any documents, records, notebooks, or similar repositories of or containing Confidential Information, then in Greehey's possession or in the possession of any third party under the control of Greehey or pursuant to any agreement with Greehey, whether prepared by Greehey or any other person, firm, corporation, association or other business entity, will be delivered to Valero by Greehey. 12. Noncompetition. Greehey recognizes and understands that in performing the responsibilities of his employment, he will occupy a position of fiduciary trust and confidence, pursuant to which he will develop and acquire experience and knowledge with respect to Valero's business. It is the expressed intent and agreement of Greehey and Valero that such knowledge and experience shall be used exclusively in the furtherance of the interests of Valero and not in any manner which would be detrimental to Valero's interests. Greehey further understands and agrees that Valero conducts its business within a specialized market segment throughout the United States, and that it would be detrimental to the interests of Valero if Greehey used the knowledge and experience which he currently possesses or which he acquires pursuant to his employment hereunder for the purpose of directly or indirectly competing with Valero or for the purpose of aiding other persons or entities in so competing with Valero. In consideration for the benefits herein, Greehey therefore agrees that so long as he is employed by Valero and for a period of the greater of (i) two years after termination of Greehey's employment, or (ii) as long as he is receiving any payments under paragraph 7(c), unless he first secures the written consent of Valero, Greehey will not directly or indirectly invest, engage or participate in any entity in direct or indirect competition with Valero's business or contract to do so, other than investments in amounts aggregating less than 1% in any securities of any company that is obligated under the 1934 Act to file periodic reports pursuant to Section 13 thereunder. In the event that the provisions of this Paragraph 12 should ever be deemed to exceed the time or geographic limitations permitted by applicable laws, then such provisions shall be reformed to the maximum time or geographic limitations permitted by applicable law. 13. Insurance. Valero may, in its sole and absolute discretion, at any time after the Effective Date, apply for and procure, as owner and for its own benefit, insurance on the life of Greehey, in such amounts and in such forms as Valero may choose. Unless otherwise agreed by Valero, Greehey shall have no interest whatsoever in any such policy or policies, but Greehey shall, at Valero's request, submit to such medical examinations, supply such information, and execute and deliver such documents as may be required by the insurance company or companies to which Valero has applied for such insurance. 14. Acknowledgment of Greehey. Greehey hereby acknowledges that his execution of this Agreement is given in consideration of the following, any of which Greehey acknowledges is adequate consideration: (i) Valero's employment of Greehey under the terms and conditions contained herein; and (ii) The termination by Valero of any previous employment agreement between Valero and Greehey. 15. Notice. Any notice, request, reply, instruction, or other communication provided or permitted in this Agreement must be given in writing and may be served by depositing same in the United States mail in certified or registered form, postage prepaid, addressed to the Party to be notified with return receipt requested, or by delivering the notice in person to such Party. Unless actual receipt is required by any provision of this Agreement, notice deposited in the United States mail in the manner herein prescribed shall be effective on dispatch. For purposes of notice, the address of Greehey, his spouse, any purported donee or transferee or any administrator, executor or legal representative of Greehey or his estate, as the case may be, shall be as follows: Mr. William E. Greehey 307 Grandview San Antonio, Texas 78209 The address of Valero shall be: Valero Refining and Marketing Company Post Office Box 500 San Antonio, Texas 78292 Attention: General Counsel Valero and Greehey shall have the right from time to time and at any time to change their respective addresses and shall have the right to specify as their respective addresses any other address by giving at least ten days written notice to the other Party as provided hereby. 16. Termination of other Employment Agreements. On the Effective Date, all other prior employment agreements between the Parties in effect on the Effective Date shall terminate and forever be from the date null, void and of no further force or effect whatsoever, and any and all such agreements shall be superseded in their entirety by this Agreement. 17. Litigation. In the event litigation shall be brought by either Party to enforce or interpret any provision contained in this Agreement the following provisions shall apply: (a) if Greehey brings such an action, and it is not established by clear and convincing evidence that Greehey has no meritorious bases for such action, Valero shall pay all of Greehey's and Valero's legal fees incurred in connection with such litigation; (b) in the event Valero brings such an action, and it is not established by clear and convincing evidence that Greehey has no meritorious defenses to such action, Valero shall pay all of Greehey's and Valero's legal fees incurred in connection with such litigation; and (c) any claim by Valero of a right to terminate this Agreement pursuant to Paragraph 9(a) which is subjected to litigation must be established by Valero by clear and convincing evidence. 18. Controlling Law. The execution, validity, interpretation, and performance of this Agreement shall be determined and governed by the laws of the State of Texas. 19. Additional Instruments. Valero and Greehey shall execute and deliver any and all additional instruments and agreements which may be necessary or proper to carry out this Agreement. 20. Entire Agreement. This Agreement contains the entire agreement of the Parties. This Agreement may not be changed orally but only by an agreement in writing signed by the Party against whom enforcement of any waiver, change, modification, extension or discharge is sought. 21. Separability. If any provision of the Agreement is rendered or declared illegal or unenforceable by reason of any existing or subsequently enacted legislation or by decree of a court of last resort, Valero and Greehey shall promptly meet and negotiate substitute provisions for those rendered and declared illegal or unenforceable, and all the remaining provisions of this Agreement shall remain in full force and effect. 22. Effect of Agreement. This Agreement shall be binding upon Greehey and his heirs, executors, legal representatives, successors and assigns, and Valero and its legal representatives, successors and assigns. 23. Execution. This Agreement may be executed in multiple counterparts each of which shall be deemed an original and all of which shall constitute one instrument. 24. Waiver of Breach. The waiver by Valero of a breach of any provision of the Agreement by Greehey shall not operate or be construed as a waiver by Valero of any subsequent breach by Greehey. The waiver by Greehey of a breach of any provision of the Agreement by Valero shall not operate or be construed as a waiver by Greehey of any subsequent breach by Valero. IN WITNESS WHEREOF, the Parties have executed this Agreement as of the date below written. ____________________________________ William E. Greehey Valero Refining and Marketing Company By:___________________________________ Edward C. Benninger President Date: June 18, 1997 EX-10.13 4 EMPLOYMENT AGREEMENT - ECB Exhibit 10.13 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement") is between Valero Refining and Marketing Company, a Delaware corporation ("Valero"), and Edward C. Benninger, a resident of San Antonio, Texas, ("Benninger"). This Agreement is effective on the day that all of the capital stock of Valero is distributed by Valero Energy Corporation ("VEC") to its stockholders ("Effective Date"). Valero and Benninger are sometimes referred to herein individually as a "Party", and collectively as the "Parties". The Parties hereby agree as follows: 1. Employment. Valero hereby employs Benninger as President and Benninger hereby accepts employment with Valero, subject to the terms and conditions set forth in this Agreement. 2. Term. Subject to the provisions for termination of employment as provided in Section 9(a), this Agreement shall be in effect for a period of two years beginning on the Effective Date and ending on the second anniversary of the Effective Date ("Initial Period"). If Benninger notifies Valero at least ninety (90) days prior to the end of the Initial Period of his intention to extend this Agreement, then this Agreement shall be extended on a month-to-month basis ("Extension Period"). Benninger may terminate this Agreement within the Extension Period by giving Valero ninety (90) calendar days written notice of termination. 3. Compensation. Benninger's compensation during his employment under the terms of this Agreement and prior to his retirement shall be as follows: (a) Base Salary. Valero shall pay to Benninger a base salary (the "Base Salary") of Four Hundred Thousand Dollars ($400,000) per year. In addition, the Board of Directors of Valero shall in good faith consider granting annual increases to the Base Salary based upon such factors as Benninger's performance and the growth and profitability of Valero, but it shall have no obligation to grant any such increases in compensation. Any such increase to the Base Salary shall be deemed thereafter to be the Base Salary; provided, however, based upon the same such factors, the Board of Directors of Valero may thereafter reduce the Base Salary to an amount that is not below the amount first set forth above in this Paragraph 3(a). The Base Salary shall be payable in equal, semi-monthly installments on the 15th day and last day of each month or at such other times and in such installments as may be agreed between Valero and Benninger. All payments shall be subject to the deduction of payroll taxes, income tax withholdings, and similar deductions and withholdings as required by law. (b) Bonus. In addition to the Base Salary, Benninger shall be eligible to receive bonus compensation in such amounts and at such times as the Board of Directors of Valero shall from time to time determine. In the year of his retirement, Benninger shall receive a pro-rata share of bonus compensation in such amount as the Board of Directors of Valero shall determine at the customary time annual bonuses are determined and paid to executive officers of Valero. (c) Stock Option Grant. Benninger shall receive a nonqualified stock option grant to purchase 110,000 shares of Valero Energy Corporation common stock, granted on the fifth (5th) business day following approval of said grant by the Board of Directors of Valero Energy Corporation ("Grant Date") with an exercise price per share equal to the fair market value of Valero Energy Corporation common stock on the Grant Date. These options shall vest at the rate of 50% on the first anniversary of the Grant Date and the remaining 50% on the second anniversary of the Grant Date, and shall have a total term of ten years from the Grant Date. These vesting periods shall not be modified by the accelerated vesting provisions set forth in Paragraph 7(c). 4. Expenses and Benefits. During his employment, Benninger is authorized to incur reasonable expenses in connection with the business of Valero, including expenses for entertainment, travel and similar matters. Valero will reimburse Benninger for such expenses upon presentation by Benninger of such accounts and records as Valero may from time to time reasonably require. Valero also agrees to provide Benninger with the following benefits during employment: (a) Employee Benefit Plans. Participation in any employee benefit plans now existing or hereafter adopted by Valero for its executives or other officers and employees. (b) Club Memberships. Valero shall reimburse Benninger for all monthly dues and fees for Benninger's present country club memberships and for any expenses incurred by Benninger in connection with such club memberships in representing Valero's interests. (c) Vacations. Benninger shall be entitled (in addition to the usual Valero holidays) to a paid vacation for a period in each calendar year not exceeding five weeks. (d) Working Facilities. Benninger shall be furnished by Valero with an office, secretarial help and other facilities and services, including but not limited to full use of Valero's mail and communication facilities and services reasonably suitable to his position and reasonably necessary for the performance of his duties under this Agreement. (e) Tax Planning. Benninger will be furnished tax planning services by an independent certified public accounting firm of the type furnished to executive officers of Valero. (f) Other. Such other items as Valero shall from time to time consider necessary or appropriate to assist Benninger in or to provide incentives or compensation for the performance of his duties under this Agreement. 5. Positions and Duties. Benninger is employed as President of Valero. In addition, if requested to do so, Benninger shall serve as President of any subsidiary or affiliate of Valero. Such duties shall be performed at Valero's principal place of business in San Antonio, Texas. 6. Extent of Service. Benninger shall, during his employment under the terms of this Agreement, devote substantially all of his working time, attention, energies and business efforts to his duties as an employee of Valero and to the business of Valero generally, and shall not, during the term of this Agreement, engage in any other business activity whatsoever, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; however, this Paragraph 6 shall not be construed to prevent Benninger from serving as a member of the board of directors of other companies, or from investing his personal, private assets as a passive investor in such form or manner as will not require any active services on the part of Benninger in the management or operation of the affairs of the companies, partnerships, or other business entities in which any such passive investments are made. 7. Retirement. Notwithstanding the term and notice provisions of Paragraph 2, Benninger may retire at any time as President of Valero under the terms of this Agreement by giving Valero written notice of his intention to retire 90 days in advance of the designated retirement date. Upon retirement, and provided that Valero has not terminated Benninger for cause pursuant to Paragraph 9(a), Benninger shall no longer be employed by Valero, but he shall have the following rights and obligations: (a) Working Facilities. Valero shall provide Benninger with off-site office facilities and secretarial and other office services reasonably commensurate with Benninger's position as retired President of Valero. The office facilities and secretarial and other services to be provided to Benninger following his retirement shall continue for two years from his retirement date. (b) Dominion Country Club Membership. Valero will transfer to Benninger the corporate Dominion Country Club membership currently assigned to him, with Valero paying or reimbursing any membership transfer fee, and with Benninger being responsible for all membership dues and fees. (c) Vesting and Option Exercise Periods. Upon retirement, Benninger's stock options, stock appreciation rights, restricted stock grants, performance share awards, and any other similar stock or long-term incentive rights or benefits previously granted to Benninger, which have not fully vested, shall immediately fully vest, except for any unvested stock options granted to Benninger pursuant to Paragraph 3(c). Benninger shall have the right to exercise any vested stock options, stock appreciation rights, restricted stock grants, performance share awards, and other similar stock or long-term incentive rights or benefits for the full remaining term thereof. Any outstanding performance share award shall be deemed to have been earned at the target level for the full term. (d) Retirement Benefits and Supplemental Retirement Benefits. Benninger shall be entitled to all retirement benefits provided under the Valero Energy Corporation Pension Plan ("Pension Plan") and Supplemental Executive Retirement Plan (SERP), with the following supplemental benefits: (i) retiree medical coverage consistent with coverage amount and/or deductibles and costs as provided to Valero retirees; (ii) a total of eight "points" under the SERP to be added to his years of credited service, or his age, or divided between both in such proportion that total eight, as he elects at time of retirement. The amount per month equal to the difference between Benninger's normal monthly retirement benefit under the Pension Plan and the SERP with the eight added points shall constitute a supplemental monthly retirement payment, payable at the time each payment is made under the Pension Plan. The eight "points" will also be applied to other age or service related benefits. Benninger shall not be entitled to participate in nor receive the benefits of any special "window" retirement or early retirement program, if any, that may be offered to other employees of Valero or subsidiaries at or about the time of Benninger's giving notice of retirement or actual retirement; and (iii) payments under any other employee benefit plan(s), which are due as a result of separation of service. 8. Death and Disability. (a) Death. If during the term of Benninger's employment under this Agreement and prior to the date of retirement Benninger dies, then in addition to all other employee benefits to which Benninger's estate, spouse or other beneficiaries may be entitled, Valero shall pay in equal semi-monthly installments to the beneficiary designated by Benninger, or his estate if no such beneficiary has been designated in writing to Valero, the Base Salary which Benninger would have received if he had remained employed to the end of the Initial Period or if his employment has been extended pursuant to Paragraph 2, to the end of the Extension Period. (b) Disability. If during the term of Benninger's employment under this Agreement Benninger becomes unable to perform his duties as President as a result of illness or physical injury as defined in Valero's Long Term Disability Plan, Benninger shall be deemed to have retired and be entitled to the benefits described in Paragraph 7(b), (c), and (d). 9. Termination by Valero. Valero shall have the right to terminate Benninger's employment as hereinafter provided. (a) Termination for Cause. Valero shall have the right to terminate Benninger's employment under this Agreement for cause. As used herein, "cause" shall mean and be strictly limited to: (i) Benninger's conviction of a crime constituting a felony under federal or state law or involving moral turpitude; (ii) an illegal act or acts that were intended to and did defraud Valero; or (iii) the willful refusal by Benninger to fulfill responsibilities under this Agreement after written notice of such willful refusal from the Board and the failure to correct such refusal within 30 days from the date such notice is given. If Valero terminates this Agreement pursuant to the provisions of this Paragraph 9(a): (i) all compensation or other benefits due Benninger pursuant to Paragraphs 3 and 4 hereto shall be paid by Valero to Benninger to the date of such termination; and (ii) all supplemental and additional benefits and rights granted to Benninger at retirement by Paragraph 7 are revoked and become null and void; and, upon such payment by Valero, all obligations of Valero to Benninger hereunder shall be totally and completely satisfied, and Valero shall have no further obligations of any type to Benninger pursuant to this Agreement. (b) Termination other than for Cause. Valero shall have the right to terminate Benninger's employment as President under this Agreement without cause, and Benninger's employment under this Agreement shall be deemed terminated upon the giving of 90 days written notice to such effect by Valero to Benninger. A termination of employment other than as a result of death, retirement, disability, or in accordance with Paragraph 9(a) shall be deemed a termination without cause. In the event of termination without cause: (i) Valero shall pay Benninger in cash a lump sum amount equal to the product of Benninger's semi-monthly Base Salary being paid to Benninger at the date of such termination multiplied by the number of semi-monthly pay periods remaining to the end of the Initial Period (or successive period if employment has been extended pursuant to Paragraph 2), plus an amount equal to the highest annual bonus paid to Benninger during the five years preceding the time of such termination. Such amount shall be paid within five days of termination; (ii) Benninger shall receive all the payments and benefits to which he is entitled pursuant to Paragraph 7(b), (c), and (d). 10. Executive Severance Agreement. In the event Benninger receives any cash payments under that certain Executive Severance Agreement dated December 15, 1982 between Valero and Benninger, Valero shall be entitled to credit any cash payments that are made to Benninger pursuant to his Executive Severance Agreement against any cash payments that it is obligated to make under this Agreement. Valero agrees that if remuneration or benefits of any form paid to Benninger by Valero during or after his employment with Valero are excess parachute payments as defined in Section 280G of the Internal Revenue Code of 1986, as amended ("Code"), and are subject to the 20% excise tax imposed by Section 4999 of the Code, Valero shall pay Benninger a bonus no later than seven days prior to the earliest of the due date for the excise tax return or initial estimated payment, in an amount equal to the excise tax payable as a result of the excess parachute payment and any additional federal income taxes (including any additional excise taxes) payable by him as a result of the bonus, assuming that he will be subject to federal income taxes at the highest individual marginal rate. It is the intention of the Parties that the bonus be "grossed up" so that the bonus contains sufficient funds to pay the excise and all additional federal income taxes due as a result of the bonus payment so that Benninger will suffer no detriment from the excise tax payable as a result of the excess golden parachute payments. 11. Disclosure of Confidential Information. Except to the extent absolutely required in the performance of his duties and obligations to Valero as expressly authorized herein, or by prior written consent of a duly authorized officer or director of Valero, Benninger will not, directly or indirectly, at any time during his employment with Valero, or at any time subsequent to the termination thereof, for any reason whatsoever, with or without cause, breach the confidence reposed in him by Valero by using, disseminating, disclosing, divulging or in any manner whatsoever disclosing or permitting to be divulged or disclosed in any manner to any person, firm, corporation, association or other business entity, trade secrets, secret methods or "Confidential Information" of Valero, nor will Benninger lecture on or publish articles concerning any trade secrets, secret methods or "Confidential Information" of Valero. As used herein, the term "Confidential Information" means any and all information concerning Valero's products, processes, sources of supply, and services, including information relating to research, development, inventions, manufacture, purchasing, accounting, engineering, marketing, merchandising, or the selling of any product or products to any customers of Valero, disclosed to Benninger or known by Benninger as a consequence of or through his employment by Valero (or any parent, subsidiary or affiliated corporations of Valero) including, but not necessarily limited to, any person, firm, corporation, association or other business entity with which Valero has any type of agency agreement, or any shareholders, directors, or officers of any such person, firm, corporation, association or other business entity, if such information is not generally known in any industry in which Valero is or may become engaged during the term of this Agreement. On termination of employment with Valero, all documents, records, notebooks, or similar repositories of or containing Confidential Information, including all copies of any documents, records, notebooks, or similar repositories of or containing Confidential Information, then in Benninger's possession or in the possession of any third party under the control of Benninger or pursuant to any agreement with Benninger, whether prepared by Benninger or any other person, firm, corporation, association or other business entity, will be delivered to Valero by Benninger. 12. Noncompetition. Benninger recognizes and understands that in performing the responsibilities of his employment, he will occupy a position of fiduciary trust and confidence, pursuant to which he will develop and acquire experience and knowledge with respect to Valero's business. It is the expressed intent and agreement of Benninger and Valero that such knowledge and experience shall be used exclusively in the furtherance of the interests of Valero and not in any manner which would be detrimental to Valero's interests. Benninger further understands and agrees that Valero conducts its business within a specialized market segment throughout the United States, and that it would be detrimental to the interests of Valero if Benninger used the knowledge and experience which he currently possesses or which he acquires pursuant to his employment hereunder for the purpose of directly or indirectly competing with Valero or for the purpose of aiding other persons or entities in so competing with Valero. In consideration for the benefits herein, Benninger therefore agrees that so long as he is employed by Valero and for a period of two years after termination of Benninger's employment, unless he first secures the written consent of Valero, Benninger will not directly or indirectly invest, engage or participate in any entity in direct or indirect competition with Valero's business or contract to do so, other than investments in amounts aggregating less than 1% in any securities of any company that is obligated under the 1934 Act to file periodic reports pursuant to Section 13 thereunder. In the event that the provisions of this Paragraph 12 should ever be deemed to exceed the time or geographic limitations permitted by applicable laws, then such provisions shall be reformed to the maximum time or geographic limitations permitted by applicable law. 13. Insurance. Valero may, in its sole and absolute discretion, at any time after the Effective Date, apply for and procure, as owner and for its own benefit, insurance on the life of Benninger, in such amounts and in such forms as Valero may choose. Unless otherwise agreed by Valero, Benninger shall have no interest whatsoever in any such policy or policies, but Benninger shall, at Valero's request, submit to such medical examinations, supply such information, and execute and deliver such documents as may be required by the insurance company or companies to which Valero has applied for such insurance. 14. Acknowledgment of Benninger. Benninger hereby acknowledges that his execution of this Agreement is given in consideration of the following, any of which Benninger acknowledges is adequate consideration: (i) Valero's employment of Benninger under the terms and conditions contained herein; and (ii) The termination by Valero of any previous employment agreement between Valero and Benninger. 15. Notice. Any notice, request, reply, instruction, or other communication provided or permitted in this Agreement must be given in writing and may be served by depositing same in the United States mail in certified or registered form, postage prepaid, addressed to the Party to be notified with return receipt requested, or by delivering the notice in person to such Party. Unless actual receipt is required by any provision of this Agreement, notice deposited in the United States mail in the manner herein prescribed shall be effective on dispatch. For purposes of notice, the address of Benninger, his spouse, any purported donee or transferee or any administrator, executor or legal representative of Benninger or his estate, as the case may be, shall be as follows: Mr. Edward C. Benninger 21 Devon Wood San Antonio, Texas 78257 The address of Valero shall be: Valero Refining and Marketing Company Post Office Box 500 San Antonio, Texas 78292 Attention: General Counsel Valero and Benninger shall have the right from time to time and at any time to change their respective addresses and shall have the right to specify as their respective addresses any other address by giving at least ten days written notice to the other Party as provided hereby. 16. Termination of other Employment Agreements. On the Effective Date, all other prior employment agreements between the Parties in effect on the Effective Date shall terminate and forever be from the date null, void and of no further force or effect whatsoever, and any and all such agreements shall be superseded in their entirety by this Agreement. 17. Litigation. In the event litigation shall be brought by either Party to enforce or interpret any provision contained in this Agreement the following provisions shall apply: (a) if Benninger brings such an action, and it is not established by clear and convincing evidence that Benninger has no meritorious bases for such action, Valero shall pay all of Benninger's and Valero's legal fees incurred in connection with such litigation; (b) in the event Valero brings such an action, and it is not established by clear and convincing evidence that Benninger has no meritorious defenses to such action, Valero shall pay all of Benninger's and Valero's legal fees incurred in connection with such litigation; and (c) any claim by Valero of a right to terminate this Agreement pursuant to Paragraph 9(a) which is subjected to litigation must be established by Valero by clear and convincing evidence. 18. Controlling Law. The execution, validity, interpretation, and performance of this Agreement shall be determined and governed by the laws of the State of Texas. 19. Additional Instruments. Valero and Benninger shall execute and deliver any and all additional instruments and agreements which may be necessary or proper to carry out this Agreement. 20. Entire Agreement. This Agreement contains the entire agreement of the Parties. This Agreement may not be changed orally but only by an agreement in writing signed by the Party against whom enforcement of any waiver, change, modification, extension or discharge is sought. 21. Separability. If any provision of the Agreement is rendered or declared illegal or unenforceable by reason of any existing or subsequently enacted legislation or by decree of a court of last resort, Valero and Benninger shall promptly meet and negotiate substitute provisions for those rendered and declared illegal or unenforceable, and all the remaining provisions of this Agreement shall remain in full force and effect. 22. Effect of Agreement. This Agreement shall be binding upon Benninger and his heirs, executors, legal representatives, successors and assigns, and Valero and its legal representatives, successors and assigns. 23. Execution. This Agreement may be executed in multiple counterparts each of which shall be deemed an original and all of which shall constitute one instrument. 24. Waiver of Breach. The waiver by Valero of a breach of any provision of the Agreement by Benninger shall not operate or be construed as a waiver by Valero of any subsequent breach by Benninger. The waiver by Benninger of a breach of any provision of the Agreement by Valero shall not operate or be construed as a waiver by Benninger of any subsequent breach by Valero. IN WITNESS WHEREOF, the Parties have executed this Agreement as of the date below written. ____________________________________ Edward C. Benninger Valero Refining and Marketing Company By:___________________________________ William E. Greehey Chief Executive Officer Date: June 18, 1997 EX-10.14 5 MANAGEMENT STABILITY - GCK MANAGEMENT STABILITY AGREEMENT AGREEMENT dated effective August 1, 1997 ("Agreement") between Valero Energy Corporation (formerly Valero Refining and Marketing Company), a Delaware corporation (the "Corporation"), and Gregory C. King (the "Executive"), WITNESSETH: WHEREAS, Executive and Valero Energy Corporation ("VEC"), (now, by change of name, PG&E Gas Transmission Texas Co.) entered into that certain Management Stability Agreement dated November 1, 1996 (the "Prior Agreement"); and WHEREAS, the Prior Agreement specifies that, in the event of a Divestiture (as defined in the Prior Agreement), the Corporation shall execute and deliver this Agreement to Executive; and WHEREAS, at a meeting of the Board of Directors of the Corporation held on April 23, 1997, the Board of Directors approved the execution, delivery and performance by the Corporation of management retention agreements, substantially in the form of this Agreement, between the Corporation and certain officers and other key executives of the Corporation and its subsidiaries, including the Executive; WHEREAS, should the Corporation become involved in any Change of Control situation, in addition to Executive's regular duties, Executive may be called upon to assist in the assessment of any third-party or internal proposals, advise management and the Board as to whether such proposals would be in the best interests of the Corporation and its shareholders, participate in successfully completing such transactions and to take such other actions as the Board might determine appropriate; NOW, THEREFORE, to assure that the Corporation will have the continued dedication of the Executive, and the availability of Executive's advice and counsel as to the best interests of the Corporation and its stockholders, notwithstanding the possibility, threat, or occurrence of a Change of Control, and to induce the Executive to remain in the employ of the Corporation and/or its designated subsidiaries, and for other good and valuable consideration, Corporation and Executive agree as follows: 1. Certain Definitions. The following terms, as used herein, have the following meanings: "Applicable Period" shall mean the two-year period following the Termination Date. "Annual Rate of Compensation" shall mean the aggregate regular base salary paid or payable to Executive by the Corporation and/or VEC with respect to any period of 12 consecutive months. "Cause" shall mean (i) Executive's conviction of a crime under federal or state law (excluding a misdemeanor offense not involving moral turpitude), or (ii) Executive's gross and deliberate disregard of Executive's duties and responsibilities, as reasonably determined by the Board of Directors of the Corporation after written notice of such failure and the failure or refusal by Executive to correct such failure within 10 days from the date notice is given, or (iii) the continued material impairment of Executive's ability to fulfill his responsibilities as a result of alcoholism or drug dependency after written notice of such material impairment and the failure to correct such impairment within 45 days from the date notice is given or such longer period as may be required under applicable law. "Change of Control" shall mean: (i) The acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended) of 15% or more of either (a) the then outstanding shares of common stock of the Corporation (the "Outstanding Corporation Common Stock") or (b) the combined voting power of the then outstanding voting securities of the Corporation entitled to vote generally in the election of directors (the "Outstanding Corporation Voting Securities"); provided, however, that for purposes of this subparagraph (i), the following acquisitions shall not constitute a Change of Control: (a) any acquisition directly from the Corporation, (b) any acquisition by the Corporation, (c) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Corporation or any corporation or other entity controlled by the Corporation or (d) any acquisition by any corporation or other entity pursuant to a transaction which complies with clauses (a), (b) and (c) of subparagraph (iii) of this definition; (ii) Individuals who, as of the date hereof, constitute the Board of Directors of the Corporation (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Corporation's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (iii) Consummation of a reorganization, merger or consolidation, or sale, transfer, or other disposition of all or substantially all of the assets of the Corporation (a "Business Combination"), in each case, unless, following such Business Combination, (a) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation or other entity surviving or resulting from such Business Combination (including, without limitation, a corporation or other entity which as a result of such transaction owns the Corporation or all or substantially all of the Corporation's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership immediately prior to such Business Combination of the Outstanding Corporation Common Stock and Outstanding Corporation Voting Securities, as the case may be, (b) no Person (excluding any corporation or other entity surviving or resulting from such Business Combination or any employee benefit plan (or related trust) of the Corporation or such corporation or other entity surviving or resulting from such Business Combination) beneficially owns, directly or indirectly, 15% or more of, respectively, the then outstanding shares of common stock of the corporation or other entity surviving or resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation or other entity except to the extent that such ownership existed prior to the Business Combination and (c) at least a majority of the members of the board of directors or other governing body of the corporation or other entity surviving or resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement or of the action of the Board, providing for such Business Combination; or (iv) Approval by the shareholders of the Corporation of a complete liquidation or dissolution of the Corporation; or (v) any other event determined by the Board of Directors or the Committee to constitute a "Change of Control" hereunder. "Good Reason" shall mean (i) the occurrence of any event or circumstance which, if occurring following a Change in Control, would render Executive's termination of employment "involuntary" (as defined in Paragraph 3.D), or (ii) a breach (other than an insubstantial failure which is remedied by the Corporation promptly after receipt of notice thereof from the Executive) by the Corporation of any provision of this Agreement "Person" shall mean any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended). "Termination Date" shall mean the Executive's last day of employment with the Corporation or any of its subsidiaries. 2. Services During Certain Events. A. In the event any Person (i) begins a tender or exchange offer for equity securities of the Corporation, (ii) or publicly announces an intention to take or consider taking any actions which, if consummated, would constitute a Change of Control, (iii) circulates a stockholder consent or solicits a proxy for the election of directors, (iv) enters into an agreement with the Corporation, the consummation of which would result in a Change of Control, (v) becomes an "Acquiring Person" under the Rights Agreement dated July 17, 1997 between the Corporation and Harris Trust and Savings Bank, as Rights Agent, or (vi) publicly takes other steps which, if consummated, would constitute a Change of Control, Executive agrees not to voluntarily leave the employ of the Corporation or its subsidiaries, and will render the services contemplated in the recitals to this Agreement and in any employment agreement between the Corporation and Executive, until the earlier of (x) such date as such Person has abandoned or terminated efforts to effect a Change of Control, (y) sixty days following the date on which a Change of Control has occurred or (z) thirty days following written notice to the Corporation that Executive intends to terminate employment with the Corporation. B. The provisions of Paragraph 2.A notwithstanding, Executive may terminate employment for any reason prior to the occurrence of an event specified in Paragraph 2.A(i)-(vi), and, following the occurrence of any such event may terminate employment through retirement, total and permanent disability, or for Good Reason. 3. Termination After Change of Control. In the event that, within two years following the occurrence of a Change of Control of the Corporation, Executive's employment is terminated so that Executive is no longer employed with the Corporation or any of its subsidiaries, then, except as is otherwise provided in Paragraph 3.C below, Executive shall be entitled to receive the following payments and other benefits: A. Lump Sum Cash Payment. On or before Executive's Termination Date, the Corporation will pay to Executive (in addition to any base salary, bonuses, incentive compensation, expenses, vacation, benefits, benefit plan distributions and other amounts which would otherwise normally be payable to Executive, to the extent not theretofore paid), as compensation for services rendered to the Corporation, a lump sum cash amount (subject to any applicable payroll or other taxes required to be withheld) equal to two (2) times the Executive's highest Annual Rate of Compensation in effect with the Corporation or VEC at any time during the 36-month period ending on the Termination Date.In the event there are fewer than 24 months remaining from the Termination Date to Executive's normal retirement date at age 65, the amount otherwise payable hereunder shall be reduced as follows: the amount otherwise calculated under this Paragraph 3.A will be multiplied by a fraction, the numerator of which is the number of days remaining to Executive's normal retirement date and the denominator of which is 720, and the resulting product shall be the amount payable to Executive under this Paragraph 3.A. B. Other Benefits. (i) Insurance or Other Special Benefits. For the Applicable Period, or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Corporation shall continue benefits to Executive and/or Executive's family at least equal to those which would have been provided to them under the welfare benefit plans, practices, policies and programs provided by the Corporation (including, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs) immediately prior to such termination if the Executive's employment had not been terminated; provided, however, that in no event shall the continued benefits provided hereunder be less favorable, in the aggregate, than those provided under the most favorable of such plans, practices, policies and programs in effect for Executive at any time during the 120-day period immediately preceding the Termination Date or, if more favorable to Executive, those provided generally at any time after the Termination Date to other peer executives of the Corporation, its affiliated companies or their successors. To the extent that, during the Applicable Period, or any portion thereof, the benefits required to be provided under this Paragraph 3.B are also required to be provided by the Corporation under applicable provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"), the Corporation may discharge such portion of its obligation hereunder by providing such COBRA-mandated benefits, but at the Corporation's sole cost and expense. If Executive is reemployed by another employer and is eligible to receive medical or other welfare benefits under another employer-provided plan, the medical and other welfare benefits described herein shall be secondary to those provided under such other plan during the Applicable Period. (ii) Thrift and Other Plans. The Executive's participation in the Corporation's Thrift Plan, retirement plan for employees generally ("Pension Plan"), Supplemental Executive Retirement Plan ("SERP") or other applicable plans of the Corporation shall not continue after the Termination Date. Any terminating distributions and/or vested rights under such plans shall be governed by the terms of the respective plans. C. The foregoing provisions of this Paragraph 3 notwithstanding, Executive shall not be entitled to receive, and the Corporation shall not be obligated to make, the payments and other benefits specified in Paragraphs 3.A and 3.B above if Executive's termination employment occurs under any one of more of the following circumstances: (i) Executive's termination of employment is "voluntary"; (ii) Executive is terminated by his employer company for Cause; (iii) Executive's termination is a consequence of death or total and permanent disability; or (iv) Executive retires under the Corporation's Pension Plan. D. "Voluntary"/involuntary". In the event that Executive ceases to be an employee of the Corporation or its subsidiaries after (i) Executive's base salary is reduced to an amount below the base salary pertaining immediately prior to the Change of Control, or (ii) Executive's benefits (to include, without limitation, medical, prescription, dental, disability, employee life, group life, accidental death and travel accident insurance plans and programs, vacation benefits, retirement benefits, participation in stock option, restricted stock and other employee stock plans, and participation in executive incentive bonus programs) are reduced so as not to be at least substantially comparable with the benefits to which Executive was entitled prior to the Change of Control, or (iii) Executive is required to relocate to a new principal place of employment under circumstances in which Executive would not be reimbursed for all expenses reasonably incurred in such relocation (including taxes payable on such reimbursement; costs of packing, shipping and unpacking household goods; reasonable expenses of travel, meals and lodging in moving to the new location; reasonable costs of temporary living expenses at the new location; and a home sale allowance or other assistance in selling Executive's home commensurate with the assistance customarily provided by the Corporation to transferred executives prior to the Change of Control, then such termination of employment shall be deemed for all purposes of this Agreement to be "involuntary" and Executive shall be entitled to the benefits specified in Paragraphs 3.A and 3.B. If the Executive's termination of employment is not "involuntary," as defined above, and does not arise from one or more of the circumstances itemized in Paragraph 3.C(ii) through (iv), then such termination of employment is deemed to be "voluntary" for purposes of this Agreement. 4. Acceleration of Options and Rights in Certain Events. Stock options ("options") and stock appreciation or similar rights ("rights"), if any, granted to Executive by the Corporation under the Corporation's Stock Option Plan and Executive Stock Incentive Plan (collectively the "Plans") (or any other stock option or stock appreciation rights plan adopted by the Corporation) and not previously exercised, canceled or otherwise terminated will be exercisable in full for a period of 90 days, or if longer, such period as is specified in such plan, commencing on the earlier of (a) the date of the Change of Control of the Corporation or (b) the date of approval by the Corporation's shareholders of a transaction constituting a Change of Control; provided however, that no such option or right shall be exercisable after the expiration date of such option or right. 5. Removal of Restrictions on Stock Grants. Stock previously granted to Executive by the Corporation as restricted stock or performance shares under the Corporation's Executive Stock Incentive Plan (or any other similar stock plan adopted by the Corporation) will have all restrictions removed on the earlier of (a) the date of the Change of Control of the Corporation, or (b) on the date of approval by the Corporation's shareholders of a transaction constituting a Change of Control; provided, that, in the case of stock previously granted to Executive as performance shares under the Corporation's Executive Stock Incentive Plan (or any other similar stock plan adopted by the Corporation), the performance period shall be deemed to have terminated on the earlier of the dates specified in clauses (a) or (b) above, and the number of shares to which the Executive is then entitled shall be determined in accordance with such plan. 6. Excess Amounts. A. Excise Taxes. Anything in this Agreement to the contrary notwithstanding, in the event any payment or distribution by the Corporation to or for the benefit of Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") (such excise tax, including any interest or penalties incurred with respect thereto, being referred to herein as the "Excise Tax"), then the lump-sum amount payable to the Executive pursuant to Paragraph 3.A hereof shall be reduced to such amount (the "Reduced Payment") but not below zero, such that the receipt of the Executive of the Reduced Payment and all other payments and distributions pursuant to this Agreement would not give rise to any Excise Tax. B. No Duplication. Subject to the terms and conditions hereof, if Executive has received either (i) the lump-sum payment specified in Section 3.A of the Prior Agreement, or (ii) the lump-sum payment and other benefits specified in Paragraph 3 of this Agreement for one Change of Control event under this Agreement, Executive shall not be entitled to receive a lump-sum payment or other such benefits under this Agreement from the Corporation for any Change of Control event occurring subsequent to the event resulting in such payment. In addition, if Executive receives a lump-sum payment under this Agreement, then, except as may be expressly provided in a separate agreement between Executive and the Corporation, Executive shall not be entitled to participate in and receive a severance benefit under any other severance plan maintained by the Corporation for executive officers or employees generally. The foregoing limitations shall not be construed to prevent Executive from receiving a payment from the Corporation under any separate agreement, contract or arrangement. C. Overpayments and Underpayments. All determinations required to be made under Paragraph 6.A shall be made by the Corporation which shall provide detailed supporting calculations to the Executive no later than the Termination Date. As a result of uncertainty in the application of Section 280G of the Code at the time of the initial determination hereunder, it is possible that payments will have been made by the Corporation which should not have been made ("Overpayment") or that additional payments, which will not have been made by the Corporation could have been made ("Underpayment"), in each case, consistent with the calculations required to be made hereunder. In the event that an Overpayment has been made, any such Overpayment shall be treated for all purposes as a loan to the Executive which the Executive shall repay to the Corporation together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code; provided, however, that no amount shall be payable by the Executive to the Corporation (or if paid by the Executive to the Corporation shall be returned to the Executive) if and to the extent such payment would not reduce the amount which is subject to taxation under Section 4999 of the Code. In the event that an Underpayment has occurred, any such Underpayment shall be promptly paid by the Corporation to or for the benefit of the Executive together with interest at the applicable Federal rate provided for in Section 7872(f)(2) of the Code. 7. General. A. Indemnification. If litigation is initiated to enforce or interpret any provision contained herein, the Corporation hereby agrees to indemnify Executive for reasonable attorneys' fees and disbursements incurred by Executive in such litigation (including any appellate proceedings, and regardless of whether or not such litigation is ultimately resolved in favor of Executive), and hereby agrees to pay pre-judgement interest on any money judgement obtained by Executive, calculated at the "prime rate" of interest announced by Morgan Guaranty Trust Company of New York, New York as being in effect from time to time, from the date that payment(s) to Executive should have been made in accordance with the provisions of this Agreement. B. Payment Obligations Absolute. The Corporation's obligation to pay Executive the compensation and other amounts specified herein and to make the arrangements provided herein shall be absolute and unconditional and shall not be affected by any circumstances, including, without limitation, any set-off, counterclaim, recoupment, defense or other right which the Corporation may have against Executive or anyone else, or the completion of any Change of Control . All amounts payable by the Corporation hereunder shall be paid without notice or demand. Each and every payment made hereunder by the Corporation shall be final and the Corporation will not seek to recover all or any part of such payment from Executive or from whoever may be entitled thereto, for any reason whatsoever, excluding manifest error. Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise, nor shall the amount of any payment provided for in this Agreement be reduced by any compensation earned by Executive as a result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owing by Executive to the Corporation, or otherwise. C. Successors. This Agreement shall be binding upon and inure to the benefit of Executive and Executive's estate, and the Corporation and any successor of the Corporation, but neither this Agreement nor any rights arising hereunder may be assigned or pledged by Executive. D. Severability. Any provision in this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective only to the extent of such prohibition or unenforceability without invalidating or affecting the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. E. Controlling Law and Interpretation. This Agreement shall in all respects be governed by, and construed in accordance with, the laws of the State of Texas. In the event that the interpretation or application of any provision of this Agreement is determined in any proceeding to be ambiguous or uncertain, the parties expressly intend and agree that such ambiguity or uncertainty shall be resolved in favor of Executive. F. Assumption of Obligations under Prior Agreement. The parties recognize that, under the Prior Agreement, VEC has agreed to provide a lump sum cash payment and certain other benefits to Executive if Executive's employment with the Corporation is terminated within the period and under the circumstances specified therein, and that the Prior Agreement requires the Corporation to jointly and severally assume such obligation. Accordingly, the Corporation further agrees to, and does hereby, assume, jointly and severally with VEC, all obligations and liabilities of VEC to Executive under the Prior Agreement, and agrees that any claim, demand, or cause of action which Executive may have or claim to have under the Prior Agreement may be brought directly against the Corporation with the same force and effect as if the Corporation were an original party to the Prior Agreement; provided, however, that this assumption of obligations is not intended and shall not be construed to (i) release VEC from any obligation or liability to Executive under the Prior Agreement, or (ii) in any way enlarge or otherwise alter the obligations of VEC under the Prior Agreement, or extend the effectiveness of such Prior Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement effective as of the date set forth above. Gregory C. King VALERO ENERGY CORPORATION (formerly Valero Refining and Marketing Company) By: Edward C. Benninger President EX-10.15 6 SCHEDULE OF MANAGEMENT STABILITY AGREEMENTS Exhibit 10.15 Schedule of Management Stability Agreements Employee Date of Agreement Keith D. Booke August 1, 1997 Jay D. Browning August 1, 1997 Michael S. Ciskowski August 1, 1997 John D. Gibbons August 1, 1997 James A. Greenwood August 1, 1997 Gregory C. King August 1, 1997 John H. Krueger August 1, 1997 William N. Latham August 1, 1997 Robert R. Taylor August 1, 1997 T. Wyatt Stripling August 1, 1997 EX-11.1 7 COMPUTATION OF EARNINGS PER SHARE
EXHIBIT 11.1 VALERO ENERGY CORPORATION AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE (Thousands of Dollars, Except Per Share Amounts) Year Ended December 31, 1997 1996 1995 COMPUTATION OF BASIC EARNINGS PER SHARE: Income from continuing operations . . . . . . . $ 111,768 $ 22,472 $ 58,242 Income (loss) from discontinued operations, net of income taxes. . . . . . . . . . . . . $ (15,672) $ 50,229 $ 1,596 Less: Preferred stock dividend requirements and redemption premium . . . . . . . . . . . (4,592) (11,327) (11,818) Income (loss) from discontinued operations applicable to common stock . . . . . . . . . $ (20,264) $ 38,902 $ (10,222) Weighted average number of shares of common stock outstanding . . . . . . . . . . 51,662,449 43,926,026 43,651,914 Earnings (loss) per share: Continuing operations. . . . . . . . . . . . $ 2.16 $ .51 $ 1.33 Discontinued operations. . . . . . . . . . . (.39) .89 (.23) Total . . . . . . . . . . . . . . . . . . $ 1.77 $ 1.40 $ 1.10 COMPUTATION OF EARNINGS PER SHARE ASSUMING DILUTION: Income from continuing operations assuming dilution . . . . . . $ 111,768 $ 22,472 $ 58,242 Income (loss) from discontinued operations, net of income taxes . . . . . . . . . . . . . . . . $ (15,672) $ 50,229 $ 1,596 Less: Preferred stock dividend requirements and redemption premium . . . . . . . . . . . (4,592) (11,327) (11,818) Add: Reduction of preferred stock dividends applicable to the assumed conversion of Convertible Preferred Stock at the beginning of the period . . . . . . . 4,522 10,781 10,781 Income (loss) from discontinued operations applicable to common stock assuming dilution . . . . . . . . $ (15,742) $ 49,683 $ 559 Weighted average number of shares of common stock outstanding . . . . . . . . . . 51,662,449 43,926,026 43,651,914 Effect of dilutive securities: Stock options. . . . . . . . . . . . . . . . 880,864 424,986 209,045 Performance awards . . . . . . . . . . . . . 91,151 44,050 - Convertible preferred stock. . . . . . . . . 2,494,905 6,381,798 6,381,798 Weighted average number of shares of common stock outstanding assuming dilution. . . . . . 55,129,369 50,776,860 50,242,757 Earnings (loss) per share - assuming dilution: Continuing operations. . . . . . . . . . . . $ 2.03 $ .44 $ 1.16 Discontinued operations. . . . . . . . . . . (.29) .98 .01 Total . . . . . . . . . . . . . $ 1.74 $ 1.42 $ 1.17
EX-21.1 8 VEC SUBSIDIARIES Exhibit 21.1 Valero Energy Corporation Schedule of Subsidiaries Name of Subsidiary State of Organization Valero Energy Corporation Delaware Valero Corporate Services Company Delaware Valero Coal Company Delaware Valero Producing Company Delaware VMGA Company Delaware Valero Refining and Marketing Company Delaware Valero Marketing and Supply Company Delaware Valero Refining Company-Louisiana Delaware Valero Refining Company-Texas Texas Valero Javelina Company Delaware Valero Mediterranean Company Delaware Valero Mexico Company Delaware Valero MTBE Investments Company Delaware Valero MTBE Operating Company Delaware Valero Technical Services Company Delaware EX-23.1 9 CONSENT OF ARTHUR ANDERSEN LLP Exhibit 23.1 Consent of Independent Public Accountants As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K into the Company's previously filed Registration Statements on Form S-8 (File Nos. 333-31709, 333-31721, 333-31723 and 333-31727). ARTHUR ANDERSEN LLP /s/ Arthur Andersen LLP San Antonio, Texas February 26, 1998 EX-27.1 10 FINANCIAL DATA SCHEDULE 1997
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 DEC-31-1997 9,935 0 367,590 1,275 369,355 789,025 2,132,489 539,956 2,493,043 597,284 430,183 0 0 561 1,158,280 2,493,043 5,756,220 5,756,220 5,545,186 5,545,186 0 0 42,455 175,557 63,789 111,768 (15,672) 0 0 96,096 1.77 1.74
EX-27.2 11 RESTATED FINANCIAL DATA SCHEDULE 1996
5 1,000 12-MOS DEC-31-1996 DEC-31-1996 10 0 163,432 975 159,871 351,849 1,712,334 480,124 1,985,631 300,584 353,307 1,150 3,450 44,186 1,028,189 1,985,631 2,757,853 2,757,853 2,668,105 2,668,105 0 0 38,534 39,083 16,611 22,472 50,229 0 0 72,701 1.40 1.42
EX-27.3 12 RESTATED FINANCIAL DATA SCHEDULE 1995
5 1,000 12-MOS DEC-31-1995 DEC-31-1995 13 0 129,479 675 101,782 268,373 1,653,064 423,437 1,904,655 168,522 454,621 6,900 3,450 43,739 977,024 1,904,655 1,772,638 1,772,638 1,648,883 1,648,883 0 0 40,935 88,696 30,454 58,242 1,596 0 0 59,838 1.10 1.17
-----END PRIVACY-ENHANCED MESSAGE-----