UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MarkOne)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to ______________________________
Commission file number 1-13175
=============
VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 74-1828067
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Valero Place
San Antonio, Texas
(Address of principal executive offices)
78212
(Zip Code)
(210) 370-2000
(Registrant's telephone number, including area code)
==============
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
==============
Indicated below is the number of shares outstanding of the registrant's
only class of common stock, as of July 31, 2002.
Number of
Shares
Title of Class Outstanding
-------------- -----------
Common Stock, $0.01 Par Value 105,810,881
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001......... 3
Consolidated Statements of Income for the Three and Six Months
Ended June 30, 2002 and 2001................................................ 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2002 and 2001................................................ 5
Consolidated Statements of Comprehensive Income for the Three and Six Months
Ended June 30, 2002 and 2001................................................ 6
Notes to Consolidated Financial Statements.................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................................... 23
Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 41
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................... 46
Item 4. Submission of Matters to a Vote of Security Holders.................... 49
Item 6. Exhibits and Reports on Form 8-K....................................... 50
SIGNATURE.......................................................................... 51
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Millions of Dollars, Except Par Value)
June 30, December 31,
2002 2001
---- ----
(Unaudited) (Note 1)
ASSETS
Current assets:
Cash and temporary cash investments................................ $ 360.9 $ 269.4
Restricted cash.................................................... 30.3 76.6
Receivables, net................................................... 939.9 750.4
Inventories........................................................ 1,451.1 1,453.1
Income taxes receivable............................................ 30.1 176.7
Current deferred income tax assets................................. 135.4 -
Prepaid expenses and other current assets.......................... 139.3 85.6
Assets held for sale............................................... - 1,303.6
-------- --------
Total current assets............................................. 3,087.0 4,115.4
-------- --------
Property, plant and equipment, at cost............................... 8,545.1 8,154.6
Less accumulated depreciation........................................ (1,095.3) (937.3)
-------- --------
Property, plant and equipment, net................................. 7,449.8 7,217.3
-------- --------
Goodwill............................................................. 2,458.9 2,210.5
Intangible assets, net............................................... 366.9 366.7
Deferred charges and other assets, net............................... 629.3 469.5
-------- --------
Total assets..................................................... $13,991.9 $14,379.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt.............. $ 799.5 $ 505.7
Payable to UDS shareholders........................................ - 2,055.2
Accounts payable................................................... 1,408.0 1,369.8
Accrued expenses................................................... 309.0 420.9
Taxes other than income taxes...................................... 339.1 320.2
Current deferred income tax liabilities........................... - 60.7
-------- --------
Total current liabilities........................................ 2,855.6 4,732.5
-------- --------
Long-term debt, less current portion................................. 3,857.2 2,517.4
-------- --------
Capital lease obligations............................................ 289.9 287.9
-------- --------
Deferred income tax liabilities...................................... 1,525.7 1,388.1
-------- --------
Other long-term liabilities.......................................... 728.6 762.8
-------- --------
Company-obligated preferred securities of subsidiary trusts.......... 372.5 372.5
-------- --------
Minority interest in consolidated partnership........................ 116.0 115.6
-------- --------
Stockholders' equity:
Common stock, $0.01 par value; 300,000,000 shares authorized;
108,198,992 shares issued........................................ 1.1 1.1
Additional paid-in capital......................................... 3,442.3 3,468.6
Treasury stock, at cost; 2,496,375 and 4,001,683 shares as of
June 30, 2002 and December 31, 2001, respectively................ (100.6) (149.6)
Retained earnings.................................................. 816.1 864.4
Accumulated other comprehensive income............................. 87.5 18.1
-------- --------
Total stockholders' equity....................................... 4,246.4 4,202.6
-------- --------
Total liabilities and stockholders' equity....................... $13,991.9 $14,379.4
======== ========
See Notes to Consolidated Financial Statements.
3
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Millions of Dollars, Except per Share Amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Operating revenues........................................ $6,552.4 $4,499.1 $11,674.8 $8,268.4
------- ------- -------- -------
Costs and expenses:
Cost of sales............................................ 5,777.1 3,707.0 10,261.0 6,954.5
Refining operating expenses.............................. 331.3 218.2 638.5 415.1
Retail selling expenses.................................. 166.1 1.5 324.6 2.9
Administrative expenses.................................. 65.1 50.9 123.4 84.4
Depreciation and amortization expense.................... 112.7 57.3 227.0 110.2
------- ------- -------- -------
Total costs and expenses................................ 6,452.3 4,034.9 11,574.5 7,567.1
------- ------- -------- -------
Operating income.......................................... 100.1 464.2 100.3 701.3
Other income (expense), net............................... 2.1 (0.8) 4.9 (1.1)
Interest and debt expense:
Incurred................................................. (76.3) (22.6) (136.2) (43.8)
Capitalized.............................................. 4.0 2.1 9.3 4.6
Minority interest in net income of consolidated
partnership.............................................. (4.0) - (6.6) -
Distributions on preferred securities
of subsidiary trusts..................................... (7.5) (3.3) (15.0) (6.7)
------- ------- -------- -------
Income (loss) before income tax expense (benefit)......... 18.4 439.6 (43.3) 654.3
Income tax expense (benefit).............................. 7.1 164.8 (16.0) 243.4
------- ------- -------- -------
Net income (loss)......................................... $ 11.3 $ 274.8 $ (27.3) $ 410.9
======= ======= ======== =======
Earnings (loss) per common share.......................... $ 0.11 $ 4.50 $ (0.26) $ 6.73
Weighted average common shares outstanding
(in millions)........................................... 105.8 61.1 105.4 61.1
Earnings (loss) per common share
- assuming dilution...................................... $ 0.10 $ 4.23 $ (0.26) $ 6.35
Weighted average common equivalent shares
outstanding (in millions)............................... 110.6 64.9 105.4 64.7
Dividends per share of common stock....................... $ 0.10 $ 0.08 $ 0.20 $ 0.16
See Notes to Consolidated Financial Statements.
4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income (loss)...................................................... $ (27.3) $ 410.9
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization expense............................... 227.0 110.2
Noncash interest expense and other income, net...................... 2.0 5.8
Changes in current assets and current liabilities................... (79.4) (99.0)
Minority interest in net income of consolidated partnership......... 6.6 -
Deferred income tax expense (benefit)............................... (45.1) 108.2
Changes in deferred charges and credits and other, net.............. (61.1) (22.6)
------- ------
Net cash provided by operating activities.......................... 22.7 513.5
------- ------
Cash flows from investing activities:
Capital expenditures.................................................. (365.4) (137.7)
Deferred turnaround and catalyst costs................................ (127.5) (79.0)
Proceeds from liquidation of investment in Diamond-Koch............... 300.9 -
Proceeds from disposition of Golden Eagle Business.................... 925.0 -
Capital expenditures, deferred turnaround costs and other cash
flows related to assets held for sale................................ (183.5) -
Purchase of inventories in connection with El Paso acquisition........ - (108.9)
Huntway acquisition, net of cash acquired............................. - (75.3)
Earn-out payments in connection with acquisitions..................... (23.9) (35.0)
Investment in joint ventures.......................................... (10.3) -
Proceeds from disposition of property, plant and equipment
and other, net....................................................... 6.6 -
------- ------
Net cash provided by (used in) investing activities................ 521.9 (435.9)
------- ------
Cash flows from financing activities:
Cash payment to UDS shareholders in connection with
UDS Acquisition...................................................... (2,055.3) -
Increase (decrease) in short-term debt, net........................... 314.7 (27.0)
Long-term debt borrowings, net of issuance costs...................... 1,851.5 18.1
Long-term debt repayments............................................. (547.1) (18.5)
Issuance of common stock in connection
with employee benefit plans......................................... 50.0 23.1
Common stock dividends................................................ (21.1) (9.8)
Purchase of treasury stock............................................ (44.0) (35.6)
Payment of cash distributions to minority interest in
consolidated partnership............................................ (6.5) -
------- ------
Net cash used in financing activities............................. (457.8) (49.7)
------- ------
Effect of foreign exchange rate changes on cash........................ 4.7 -
------- ------
Net increase in cash and temporary cash investments.................... 91.5 27.9
Cash and temporary cash investments at beginning of period............. 269.4 14.6
------- ------
Cash and temporary cash investments at end of period................... $ 360.9 $ 42.5
======= ======
See Notes to Consolidated Financial Statements.
5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Millions of Dollars)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss)....................................... $11.3 $274.8 $(27.3) $410.9
---- ----- ---- -----
Other comprehensive income:
Foreign currency translation adjustment................ 39.3 - 38.6 -
---- ----- ---- -----
Net gain (loss) on derivative instruments
designated and qualifying as cash flow hedges:
Statement No. 133 transition adjustment,
net of income tax expense of $15.2................ - - - 28.3
Net gain (loss) arising during the period,
net of income tax (expense) benefit of
$(0.6), $8.3, $(30.2) and $3.2.................... 1.5 (15.4) 56.0 (5.9)
Net (gain) loss reclassified into income,
net of income tax expense (benefit) of
$11.7, $(1.3), $13.6 and $(3.9)................... (21.7) 2.5 (25.2) 7.3
---- ----- ---- -----
Net gain (loss) on cash flow hedges.................. (20.2) (12.9) 30.8 29.7
---- ----- ---- -----
Comprehensive income.................................... $30.4 $261.9 $ 42.1 $440.6
==== ===== ==== =====
See Notes to Consolidated Financial Statements.
6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
As used in this report, the term Valero may refer to Valero Energy Corporation,
one or more of its consolidated subsidiaries, or all of them taken as a whole.
Valero, an independent refining and marketing company, owns and operates 12
refineries in the United States and Canada with a combined throughput capacity
of approximately 1.9 million barrels per day. Valero markets refined products
through a network of approximately 4,600 retail outlets in the United States and
eastern Canada under various brand names including Diamond Shamrock(R),
Ultramar(R), Valero(R), Beacon(R), Total(R) and Exxon(R).
The accompanying unaudited consolidated financial statements include the
accounts of Valero and subsidiaries in which Valero has a controlling interest.
Valero owns approximately 73% of Valero L.P., a consolidated partnership that
owns and operates most of the crude oil and refined product pipeline,
terminalling and storage assets that support three of Valero's refineries.
Investments in 50% or less owned entities are accounted for using the equity
method of accounting. Intercompany balances and transactions have been
eliminated in consolidation.
These consolidated financial statements have been prepared in accordance with
United States generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all
of the information and notes required by United States generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Certain previously
reported amounts have been reclassified to conform to the 2002 presentation.
Operating results for the six months ended June 30, 2002 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2002.
The balance sheet as of December 31, 2001 has been derived from the audited
financial statements as of that date but does not include all of the information
and notes required by United States generally accepted accounting principles for
complete financial statements. For further information, refer to the
consolidated financial statements and notes thereto included in Valero's Annual
Report on Form 10-K for the year ended December 31, 2001.
2. ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 142
Effective January 1, 2002, Valero adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets," issued by the
Financial Accounting Standards Board (FASB). This statement, which supercedes
APB Opinion No. 17, "Intangible Assets," provides that goodwill and other
intangible assets that have indefinite useful lives will not be amortized but
instead will be tested at least annually for impairment. Intangible assets that
have finite useful lives will continue to be amortized over their useful lives,
but such lives will not be limited to 40 years. Statement No. 142 provides
specific guidance for testing goodwill and other nonamortized intangible assets
for impairment. Additionally, the statement requires certain disclosures about
goodwill and other intangible assets subsequent to their acquisition, including
changes in the carrying amount of goodwill from period to period, the carrying
amount of intangible assets by major intangible asset class for those assets
subject to amortization and for those not subject to amortization, and the
estimated intangible asset amortization expense for the next five years.
7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Goodwill and other intangible assets acquired in connection with the acquisition
of Ultramar Diamond Shamrock Corporation (UDS) (see Note 3) are accounted for in
accordance with the provisions of Statement No. 142.
Valero did not have goodwill prior to July 1, 2001 (the date that amortization
of goodwill ceased under Statement No. 142) but did have finite-lived intangible
assets that were amortized over their useful lives. The useful lives of those
previously recognized intangible assets were reassessed using the guidance in
Statement No. 142; however, no adjustment to the remaining amortization periods
was necessary. Therefore, there was no impact to Valero's financial position or
results of operations as a result of the adoption of this statement.
FASB Statement No. 144
Effective January 1, 2002, Valero adopted Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement No. 144, which
supercedes Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and
reporting provisions of APB Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,"
establishes accounting standards for the impairment and disposal of long-lived
assets and criteria for determining when a long-lived asset is held for sale.
Statement No. 144 removes the requirement to allocate goodwill to long-lived
assets to be tested for impairment, requires that the depreciable life of a
long-lived asset to be abandoned be revised in accordance with APB Opinion No.
20, "Accounting Changes," provides that one accounting model be used for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and broadens the presentation of discontinued operations to
include more disposal transactions. There was no impact to Valero's financial
position or results of operations as a result of the adoption of this statement.
As of December 31, 2001, Valero classified certain long-lived assets held for
disposal as assets held for sale (see Note 6). Since these assets were committed
to be disposed of under a plan established prior to the adoption of Statement
No. 144, they were accounted for in accordance with Statement No. 121, APB
Opinion No. 30 and other relevant pronouncements rather than Statement No. 144.
FASB Statement No. 145
In April 2002, the FASB issued Statement No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement:
o rescinds Statement No. 4, "Reporting Gains and Losses from Extinguishment
of Debt,"
o rescinds Statement No. 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements,"
o rescinds Statement No. 44, "Accounting for Intangible Assets of Motor
Carriers," and
o amends Statement No. 13, "Accounting for Leases," to eliminate an
inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications
that have economic effects that are similar to sale-leaseback transactions.
8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
This statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their applicability
under changed conditions. There was no impact to Valero's financial position or
results of operations as a result of adopting this statement.
FASB Statement No. 146
In June 2002, the FASB issued Statement of Financial Accounting Standard No.
146, "Accounting for Costs Associated with Exit or Disposal Activities," which
addresses accounting for restructuring and similar costs. Such costs include
lease termination costs and certain employee severance costs that are associated
with a restructuring, discontinued operations, plant closings or other exit or
disposal activities. Statement No. 146 supercedes previous accounting guidance,
principally Emerging Issues Task Force (EITF) Issue No. 94-3. Valero will adopt
the provisions of Statement No. 146 for restructuring activities initiated after
December 31, 2002. Statement No. 146 requires that the liability for costs
associated with an exit or disposal activity be recognized, at fair value, when
the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of the entity's commitment to an exit or disposal plan.
3. ACQUISITIONS
Ultramar Diamond Shamrock Corporation
On December 31, 2001, Valero completed its acquisition of UDS (UDS Acquisition).
UDS owned and operated seven refineries (two in Texas, two in California and one
in each of Oklahoma, Colorado and Quebec, Canada) with a combined throughput
capacity of approximately 850,000 barrels per day. UDS also marketed refined
products and a broad range of convenience store merchandise through a network of
approximately 4,500 convenience stores under the Diamond Shamrock(R),
Ultramar(R), Beacon(R) and Total(R) brand names. As a condition for the
regulatory approval of the acquisition, the Federal Trade Commission's (FTC)
consent decree required Valero to divest the 168,000 barrel-per-day Golden Eagle
Refinery located in the San Francisco Bay area, the associated wholesale
marketing business, and 70 associated Beacon- and Ultramar-branded convenience
stores located throughout Northern California (see Note 6). As consideration for
the UDS Acquisition, Valero paid approximately $2.1 billion of cash and issued
approximately 45.9 million shares of Valero common stock to UDS shareholders.
Huntway Refining Company
Effective June 1, 2001, Valero completed the acquisition of Huntway Refining
Company, a leading supplier of asphalt in California (Huntway Acquisition).
Huntway owned and operated two California refineries, at Benicia and Wilmington,
respectively, which primarily process California crude oil to produce liquid
asphalt for use in road construction and repair. The purchase price, net of
Huntway's cash balance on the date of acquisition, was approximately $76 million
and included payment to Huntway's common stockholders of $1.90 per share, as
well as amounts required to retire Huntway's outstanding debt and satisfy
payment obligations under outstanding stock options.
El Paso Refinery and Related Product Logistics Business
Effective June 1, 2001, Valero completed the acquisition of El Paso
Corporation's Corpus Christi, Texas refinery and related product logistics
business (El Paso Acquisition) through capital lease agreements entered into
with certain wholly owned subsidiaries of El Paso Corporation. The lease
agreements are for a term of 20 years and provide for Valero to make annual
lease payments of $18.5 million for the first two years and increased amounts
thereafter. Valero has an option to purchase the facilities for approximately
$294 million at the end of the second year of the lease, and for increasing
amounts in each succeeding year through the end of the lease term. As part of
the acquisition, Valero also purchased inventories for approximately $109
million and assumed certain environmental liabilities.
9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Purchase Price Allocations for Acquisitions in 2001
The UDS, Huntway and El Paso Acquisitions were accounted for using the purchase
method. The purchase price for each acquisition was initially allocated based on
the estimated fair values of the individual assets and liabilities at the date
of acquisition based on each asset's anticipated contribution to the enterprise,
pending the completion of independent appraisals and other evaluations performed
on the same basis. During the second quarter of 2002, independent appraisals for
the Huntway and El Paso Acquisitions, and a final allocation of the purchase
price for those acquisitions, were completed. The excess of purchase price over
the fair values of the net assets acquired is recorded as goodwill.
During the first six months of 2002, the adjustments to the preliminary purchase
price allocations for each of these acquisitions were as follows (in millions):
UDS Huntway El Paso
--- ------- -------
Current assets, excluding assets held for sale...... $ (0.7) $ - $ -
Assets held for sale................................ (204.6) - -
Property, plant and equipment....................... - 0.2 (0.2)
Goodwill............................................ 218.5 - -
Current liabilities, less current portion
of long-term debt and advance from Valero.......... (13.2) (0.2) (0.3)
Other long-term liabilities......................... - - 0.5
The change in assets held for sale was due primarily to a reallocation of
Valero's purchase price of UDS resulting from the difference between the net
cash received by Valero for assets held for sale and the amount recorded as
assets held for sale as of December 31, 2001 (see Note 6).
The operating results of the Huntway and El Paso Acquisitions were included in
the Consolidated Statement of Income beginning June 1, 2001. The operating
results of the UDS Acquisition are included in the Consolidated Statement of
Income beginning January 1, 2002.
Pro Forma Financial Information
The following unaudited pro forma financial information for the six months ended
June 30, 2001 assumes that the UDS, Huntway and El Paso Acquisitions occurred at
the beginning of 2001. The effect of the UDS Acquisition included in this pro
forma financial information assumes:
o the Golden Eagle Business, as described and defined in Note 6, was sold as
of the beginning of 2001;
o approximately $795 million of the cash proceeds from the sale of the Golden
Eagle Business were used to pay down debt; and
o approximately $130 million of the cash proceeds were used to repurchase 2.9
million shares of common stock at $44.99 per share.
10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
This pro forma information is not necessarily indicative of the results of
future operations (in millions, except per share amounts).
Six Months Ended
June 30, 2001
-------------
Operating revenues..................................... $ 15,460.8
Operating income....................................... 1,323.2
Net income............................................. 727.8
Earnings per common share.............................. 6.99
Earnings per common share - assuming dilution.......... 6.67
4. RESTRICTED CASH
Restricted cash as of June 30, 2002 and December 31, 2001 included cash held in
trust related to change-in-control payments to be made to UDS officers and key
employees in connection with the UDS Acquisition, and cash restricted for use
for environmental remediation costs related to the Alma Refinery that was shut
down by UDS in 1999. During the first six months of 2002, $46.4 million was paid
to UDS officers and key employees in connection with the UDS Acquisition.
5. INVENTORIES
Inventories were as follows (in millions):
June 30, December 31,
2002 2001
---- ----
Refinery feedstocks..................... $ 527.2 $ 513.4
Refined products and blendstocks........ 703.7 727.8
Convenience store merchandise........... 82.2 87.9
Materials and supplies.................. 138.0 124.0
------- -------
Inventories........................ $1,451.1 $1,453.1
======= =======
As of June 30, 2002, the replacement cost of Valero's LIFO inventories exceeded
their LIFO carrying values by approximately $390 million. As of December 31,
2001, the replacement cost of LIFO inventories approximated their carrying
value.
6. ASSETS HELD FOR SALE
Golden Eagle Business
In conjunction with the UDS Acquisition, the FTC approved a consent decree
requiring divestiture of certain UDS assets. Similar decrees were finalized with
the states of Oregon and California. Pursuant to the consent decrees, the assets
to be divested were required to be held separate from other Valero operations,
with the operations of the assets overseen by an independent trustee approved by
the FTC. These assets and their related operations were referred to as the
Golden Eagle Business and included:
11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
o the 168,000 barrel-per-day Golden Eagle Refinery located in the San
Francisco Bay area and all tangible assets used in the operation of the
refinery including docks, tanks and pipelines;
o the wholesale marketing business generally associated with the Golden Eagle
Refinery production, which included primarily sales to unbranded customers
located in the northern half of California and Reno, Nevada; and
o 70 Beacon- and Ultramar-branded convenience stores located in Northern
California, including land, buildings, pump equipment, underground storage
tanks and various store equipment.
Assets held for sale as of December 31, 2001 included the amount expected to be
realized from the disposition of the Golden Eagle Business. The amount recorded
was based on an agreement for the sale of the Golden Eagle Business to Tesoro
Refining and Marketing Company (Tesoro) discussed below and expected cash flows
from operations of the Golden Eagle Business from January 1, 2002 through the
anticipated date of sale. Pursuant to an agreement dated February 4, 2002 and
subsequently amended on February 20 and May 3, 2002, Valero reached a definitive
agreement with Tesoro to sell the Golden Eagle Business for $1.075 billion,
which included an estimated $130 million for refinery feedstock and refined
product inventories.
On May 17, 2002, the sale of the Golden Eagle Business was completed. Valero
received cash proceeds of $925.0 million and two ten-year junior subordinated
notes with face amounts totaling $150.0 million as follows:
o a $100.0 million note, due July 17, 2012, which is non-interest bearing for
the first five years and carries a 7.5% interest rate for the remaining
five-year period, and
o a $50.0 million note, due July 17, 2012, which bears no interest during the
first year and bears interest at approximately 7.5% for years two through
ten.
The two notes were recorded with an initial fair value of $58.9 million using a
discount rate of 16%, which represents Valero's best estimate of the fair value
of the notes at the closing date of the sale. The discount is being amortized as
interest income over the life of the notes. The notes receivable are included in
Valero's Consolidated Balance Sheet in deferred charges and other assets, net.
The sales price included the assumption by Tesoro of various employee benefit
and lease obligations, but excluded certain assets and liabilities of the Golden
Eagle Business that were retained by Valero, including accounts receivable,
accounts payable, certain accrued liabilities and income tax obligations.
Results of operations for the Golden Eagle Business are excluded from Valero's
results of operations. The difference between the net cash received by Valero
related to the Golden Eagle Business and the amount recorded as assets held for
sale as of December 31, 2001 was accounted for by reallocating Valero's purchase
price for UDS. No gain or loss was recorded by Valero on this transaction.
Diamond-Koch
During 2001, Koch Industries, Inc. and UDS, both 50% partners in the
Diamond-Koch, L.P. joint venture, decided to sell the operating assets of
Diamond-Koch and began soliciting bids from interested parties. Assets held for
sale as of December 31, 2001 included the amount expected to be realized from
the disposition of the operating assets of Diamond-Koch, L.P. During the quarter
ended March 31, 2002, Diamond-Koch completed the sales of its operating assets
for total proceeds of approximately $576 million. All cash in the joint venture
in excess of amounts necessary to wind up its business was distributed,
resulting in proceeds received by Valero from the liquidation of its investment
of $300.9 million. Proceeds received by Valero in excess of the amount recorded
as of December 31, 2001 were accounted for by reallocating Valero's purchase
price for UDS. No gain or loss was recorded by Valero on this transaction.
12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. INTANGIBLE ASSETS
Intangible assets were as follows (in millions):
June 30, 2002 December 31, 2001
------------------------------ ---------------------------
Gross Accumulated Gross Accumulated
Cost Amortization Cost Amortization
Intangible assets subject to amortization:
Customer lists................................... $ 93.6 $ (3.1) $ 90.0 $ -
U.S. retail intangible assets.................... 77.2 (10.8) 77.2 (6.5)
Air emission credits............................. 50.0 (1.9) 50.0 -
Pension benefits................................. 32.8 (1.3) 32.8 -
Royalties and licenses........................... 35.4 (7.8) 32.3 (7.0)
----- ----- ----- -----
Intangible assets subject to amortization....... 289.0 $(24.9) 282.3 $(13.5)
===== ====
Intangible assets not subject to amortization:
Trade name - Canadian retail operations.......... 102.8 97.9
----- -----
Total...................................... $391.8 $380.2
===== =====
Amortization expense for intangible assets subject to amortization was $11.4
million and $2.6 million for the six months ended June 30, 2002 and 2001,
respectively. The estimated aggregate amortization expense for the years ending
December 31, 2002 through 2006 is approximately $23 million per year.
8. GOODWILL
The changes in the carrying amount of goodwill for the six months ended June 30,
2002 were as follows (in millions):
Balance as of December 31, 2001.......................... $2,210.5
Adjustments to purchase price allocation
related to the UDS Acquisition (see Note 3).......... 218.5
Earn-out payments in connection with
other acquisitions................................... 29.9
-------
Balance as of June 30, 2002.............................. $2,458.9
=======
As of December 31, 2001, goodwill by reportable segments was not available
because the UDS Acquisition was not completed until December 31, 2001. As of
June 30, 2002, a preliminary allocation of goodwill among reportable segments
was completed using a preliminary purchase price allocation for the UDS
Acquisition, and all of the goodwill was allocated to the refining segment.
13
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. LONG-TERM DEBT
On January 7, 2002, Valero financed the $2.1 billion cash portion of the UDS
Acquisition, which was recorded as payable to UDS shareholders as of December
31, 2001, with proceeds from a $1.5 billion bridge loan facility and borrowings
under two new $750 million revolving bank credit facilities.
The bridge loan facility was a single-draw facility with a one-year maturity.
Borrowings under this facility were repaid in April 2002 with proceeds from a
$1.8 billion debt offering discussed below. The two revolving bank credit
facilities provide for commitments of $750 million for a five-year term and $750
million for a 364-day term and, subject to the commitment amounts and terms,
provide for borrowings to be made at various amounts, maturities and interest
rates, at the option of Valero.
On April 15, 2002, Valero sold $1.8 billion of notes as follows:
o $300 million of 6.125% Senior Notes due April 15, 2007, priced to yield
6.17%;
o $750 million of 6.875% Senior Notes due April 15, 2012, priced to yield
6.91%; and
o $750 million of 7.5% Senior Notes due April 15, 2032, priced to yield
7.573%.
As discussed above, proceeds from this offering were used to repay all
borrowings under Valero's $1.5 billion bridge loan facility associated with the
UDS Acquisition, with the remaining proceeds used to reduce borrowings under
Valero's revolving bank credit facilities.
10. STOCKHOLDERS' EQUITY
Common Stock Repurchase Programs
Under common stock repurchase programs approved by Valero's Board of Directors,
Valero repurchases shares of its common stock from time to time for use in
connection with its employee benefit plans and other general corporate purposes.
During the six months ended June 30, 2002 and 2001, Valero repurchased shares of
its common stock under these programs at a cost of $44.0 million and $35.6
million, respectively.
14
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. EARNINGS (LOSS) PER COMMON SHARE
Earnings (loss) per common share amounts were computed as follows (dollars and
shares in millions, except per share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Earnings (Loss) per Common Share:
Net income (loss) applicable to common shares.......... $ 11.3 $ 274.8 $(27.3) $ 410.9
===== ===== ===== =====
Weighted-average common shares outstanding............. 105.8 61.1 105.4 61.1
===== ===== ===== =====
Earnings (loss) per common share....................... $ 0.11 $ 4.50 $ (0.26) $ 6.73
===== ===== ===== =====
Earnings (Loss) per Common Share - Assuming Dilution:
Net income (loss) available to
common equivalent shares.............................. $ 11.3 $ 274.8 $ (27.3) $ 410.9
===== ===== ===== =====
Weighted-average common shares outstanding............. 105.8 61.1 105.4 61.1
Effect of dilutive securities:
Stock options......................................... 3.3 2.1 - 1.9
Performance awards and other benefit plans............ 1.1 0.9 - 0.9
PEPS Units............................................ 0.4 0.8 - 0.8
----- ----- ----- -----
Weighted-average common equivalent
shares outstanding.................................... 110.6 64.9 105.4 64.7
===== ===== ===== =====
Earnings (loss) per common share
- assuming dilution................................... $ 0.10 $ 4.23 $ (0.26) $ 6.35
===== ===== ===== =====
<
15
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net income
(loss) is adjusted by, among other things, changes in current assets and current
liabilities as follows (in millions):
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Decrease (increase) in current assets:
Restricted cash.................................... $ 46.3 $ -
Receivables, net................................... (184.7) (75.0)
Inventories........................................ 12.3 (106.3)
Income taxes receivable............................ 147.6 -
Prepaid expenses and other current assets.......... (8.8) (16.9)
Increase (decrease) in current liabilities:
Accounts payable................................... 21.9 (33.1)
Accrued expenses................................... (126.8) 29.3
Taxes other than income taxes...................... 12.8 16.1
Income taxes payable............................... - 86.9
------ -----
Changes in current assets and current liabilities... $(79.4) $(99.0)
====== =====
The amounts shown above exclude changes in cash and temporary cash investments,
assets held for sale, current deferred income tax assets and liabilities, and
short-term debt and current portion of long-term debt. Also excluded from the
table above are the current assets and current liabilities acquired in
connection with the Huntway and El Paso Acquisitions in 2001, which are
reflected separately in the Consolidated Statements of Cash Flows.
Cash flows related to interest and income taxes were as follows (in millions):
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
Interest paid (net of amount capitalized)... $107.3 $36.1
Income taxes paid........................... 14.8 50.2
Income tax refunds received................. 132.8 1.9
Noncash investing activities for the six months ended June 30, 2002 included:
o the adjustment to goodwill and assets held for sale to reflect the
difference between estimated and actual proceeds received on the
liquidation of the investment in Diamond-Koch and the disposition of the
Golden Eagle Business;
o the receipt of $150.0 million of notes from Tesoro with an estimated fair
value of $58.9 million in connection with the disposition of the Golden
Eagle Business; and
o various adjustments to property, plant and equipment, goodwill and certain
current and noncurrent assets and liabilities resulting from adjustments to
the purchase price allocations related to the Huntway, El Paso and UDS
Acquisitions.
16
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Noncash investing and financing activities for the six months ended June 30,
2001 included increases to property, plant and equipment, other long-term
liabilities, and capital lease obligations resulting from the El Paso
Acquisition.
13. PRICE RISK MANAGEMENT ACTIVITIES
Commodity Price Risk
Valero is exposed to market risks related to the volatility of crude oil and
refined product prices, as well as volatility in the price of natural gas used
in its refining operations. To reduce the impact of this price volatility,
Valero uses derivative commodity instruments (swaps, futures and options) to
manage its exposure to:
o changes in the fair value of a portion of its refinery feedstock and
refined product inventories and a portion of its unrecognized firm
commitments to purchase these inventories (fair value hedges);
o changes in cash flows of certain forecasted transactions such as forecasted
feedstock purchases, natural gas purchases and product sales (cash flow
hedges); and,
o price volatility on a portion of its refined product inventories and on
certain forecasted feedstock and refined product purchases that are not
designated as either fair value or cash flow hedges (economic hedges).
In addition, Valero uses derivative commodity instruments for trading purposes
based on its fundamental and technical analysis of market conditions.
Interest Rate Risk
Valero is exposed to market risk for changes in interest rates related to
certain of its long-term debt obligations. Interest rate swap agreements, which
have been designated and qualify as fair value hedging instruments, are used to
manage a portion of the exposure to changing interest rates by converting
certain fixed-rate debt to floating rate.
Foreign Currency Risk
Valero is exposed to exchange rate fluctuations on transactions related to its
Canadian operations. To manage its exposure to these exchange rate fluctuations,
Valero uses foreign currency exchange and purchase contracts. These contracts
are not designated as hedging instruments.
During May 2002, Valero entered into foreign currency exchange contracts to
hedge its exposure to exchange rate fluctuations on an investment in its
Canadian operations. Under these contracts, Valero sold $400.0 million of
Canadian dollars and bought $253.4 million of U.S. dollars. These contracts
mature annually at various amounts from 2003 through 2007. As of June 30, 2002,
these contracts had a negative fair value of $6.1 million. This loss, which was
recognized in income for the three months and six months ended June 30, 2002,
was more than offset by a gain recognized from the effect of the exchange rate
fluctuation on the hedged investment.
17
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Certain Financial Statement Disclosures
The net gain (loss) recognized in income representing the amount of hedge
ineffectiveness was as follows (in millions):
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ------------------------
2002 2001 2002 2001
---- ---- ---- ----
Fair value hedges...... $ 1.5 $ (3.0) $ 3.0 $ (6.4)
Cash flow hedges....... (2.5) (7.6) 12.4 (15.9)
The above amounts were included in cost of sales in the Consolidated Statements
of Income. No component of the derivative instruments' gain or loss was excluded
from the assessment of hedge effectiveness. No amounts were recognized in income
for hedged firm commitments that no longer qualify as fair value hedges.
For cash flow hedges, gains and losses currently reported in accumulated other
comprehensive income in the Consolidated Balance Sheet will be reclassified into
income when the forecasted feedstock purchase, natural gas purchase, or product
sale affects income. The estimated amount of existing net gain included in
accumulated other comprehensive income as of June 30, 2002 that is expected to
be reclassified into income within the next 12 months is $49.8 million. As of
June 30, 2002, the maximum length of time over which Valero was hedging its
exposure to the variability in future cash flows for forecasted transactions was
18 months.
Market and Credit Risk
Valero's price risk management activities involve the receipt or payment of
fixed price commitments into the future. These transactions give rise to market
risk, the risk that future changes in market conditions may make an instrument
less valuable. Valero closely monitors and manages its exposure to market risk
on a daily basis in accordance with policies approved by its Board of Directors.
Market risks are monitored by a risk control group to ensure compliance with
Valero's stated risk management policy. Concentrations of customers in the
refining industry may impact Valero's overall exposure to credit risk, in that
these customers may be similarly affected by changes in economic or other
conditions. Valero believes that its counterparties will be able to satisfy
their obligations under their price risk management contracts with Valero.
14. SEGMENT INFORMATION
Prior to the UDS Acquisition, Valero had one reportable segment, the refining
and marketing of refined products. Beginning January 1, 2002, Valero has two
reportable segments, refining and retail, because of Valero's acquisition of UDS
on December 31, 2001, and its significant retail operations. Valero's refining
segment includes refinery, wholesale marketing, product supply and distribution,
and transportation operations. The retail segment includes company-operated
convenience stores, Canadian dealers/jobbers and truckstop facilities, cardlock
facilities and home heating oil operations. Operations that are not included in
either of the two reportable segments are included in the corporate category.
The reportable segments are strategic business units that offer different
products and services. They are managed separately as each business requires
unique technology and marketing strategies. Performance is evaluated based on
operating income. Intersegment sales are generally derived from transactions
made at prevailing market rates.
18
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Refining Retail Corporate Total
-------- ------ --------- -----
(in millions)
Three months ended June 30, 2002:
Operating revenues from external customers......... $5,223.1 $1,329.3 $ - $ 6,552.4
Intersegment revenues.............................. 654.0 - - 654.0
Operating income (loss)............................ 124.8 47.4 (72.1) 100.1
Three months ended June 30, 2001:
Operating revenues from external customers......... 4,486.3 12.8 - 4,499.1
Intersegment revenues.............................. 8.5 - - 8.5
Operating income (loss)............................ 516.9 0.2 (52.9) 464.2
Six months ended June 30, 2002:
Operating revenues from external customers......... 9,175.3 2,499.5 - 11,674.8
Intersegment revenues.............................. 1,198.0 - - 1,198.0
Operating income (loss)............................ 186.9 50.8 (137.4) 100.3
Six months ended June 30, 2001:
Operating revenues from external customers......... 8,245.9 22.5 - 8,268.4
Intersegment revenues.............................. 14.7 - - 14.7
Operating income (loss)............................ 789.9 - (88.6) 701.3
Total assets by reportable segment have not changed significantly since December
31, 2001, except for the preliminary allocation of goodwill to the refining
segment as discussed in Note 3.
15. ENVIRONMENTAL MATTERS
Liabilities for future remediation costs are recorded when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Other than for assessments, the timing and magnitude of these
accruals are generally based on the completion of investigations or other
studies or a commitment to a formal plan of action. Environmental liabilities
are based on best estimates of probable undiscounted future costs using
currently available technology and applying current regulations, as well as
Valero's own internal environmental policies.
The balance of and changes in the accruals for environmental matters, which are
principally included in other long-term liabilities, were as follows (in
millions):
Balance as of December 31, 2001..................... $173.8
Additions to accrual............................. 1.2
Payments, net of third-party recoveries.......... (13.4)
-----
Balance as of June 30, 2002......................... $161.6
=====
19
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Valero believes that it has adequately provided for its environmental
liabilities with the accruals referred to above. These liabilities have not been
reduced by potential future recoveries from third parties. Environmental
liabilities are difficult to assess and estimate due to unknown factors such as
the magnitude of possible contamination, the timing and extent of remediation,
the determination of Valero's liability in proportion to other parties,
improvements in cleanup technologies, and the extent to which environmental laws
and regulations may change in the future. Although environmental costs may have
a significant impact on results of operations for a single period, Valero
believes that these costs will not have a material adverse effect on its
financial position.
16. LITIGATION AND CONTINGENCIES
Unocal
On January 22, 2002, Union Oil Company of California (Unocal) filed a patent
infringement lawsuit against Valero in California federal court. The complaint
seeks a 5.75 cent per gallon royalty on all reformulated gasoline infringing on
Unocal's '393 and '126 patents. These patents cover certain compositions of
cleaner-burning gasoline. The complaint seeks treble damages for Valero's
alleged willful infringement of Unocal's patents and Valero's alleged conduct to
induce others to infringe the patents. In a previous lawsuit involving its '393
patent, Unocal prevailed against five other major refiners. In August 2001, the
FTC announced that it would begin an antitrust investigation concerning Unocal's
conduct with a joint industry research group during the time that Unocal was
prosecuting its patents at the U.S. Patent and Trademark Office (PTO). The FTC
could potentially issue an injunction against Unocal's enforcement of its
patents as a result of the FTC investigation. In 2001, the PTO began a
reexamination of Unocal's '393 patent, and in January 2002, issued a notice of
rejection of all claims of the '393 patent. In January 2002, the PTO began a
reexamination of Unocal's '126 patent, and on June 26, 2002 issued a notice of
rejection of all claims of the '126 patent. On July 3, 2002, the PTO began a
second reexamination of the '393 patent. The PTO has not issued a final decision
with respect to either patent. The three pending reexaminations could affect the
scope and validity of the patents. By agreement, the court stayed the patent
lawsuit until September 30, 2002, and Valero will seek a further stay pending
the outcome of the PTO reexamination proceedings. Notwithstanding the judgment
against the other refiners in the previous litigation, Valero believes that it
has several strong defenses to Unocal's lawsuit, including those arising from
Unocal's misconduct, and Valero believes it will prevail in the lawsuit.
However, due to the inherent uncertainty of litigation, there can be no
assurance that Valero will prevail, and an adverse result could have a material
adverse effect on Valero's results of operations and financial position.
MTBE Litigation
Valero has been named as defendant in several cases alleging MTBE contamination
in groundwater in New York, Texas and California. Complaints in four New York
cases - including those in In re: MTBE Products Liability Litigation (formerly
styled Berisha and O'Brien v. Amerada Hess Corporation, et al.), Case No. MDL
1358, Master File C.A. No. 1:00-1898 [SAS], United States District Court for the
Southern District of New York - allege that the gasoline suppliers produced
and/or distributed gasoline that is alleged to be defective because it contained
MTBE. In In re: MTBE Products Liability Litigation, the plaintiffs sought to
certify a class composed of private well owners with detectable levels of MTBE.
On July 16, 2002, however, the court denied the plaintiffs' motion for class
certification, thereby reducing the case to the claims of the few individual
plaintiffs involved in the various consolidated actions. In two other New York
cases, on July 31, 2002 and August 1, 2002, the trial judge granted Valero's
motion to dismiss the lawsuits, upholding the defendants' argument that the
plaintiffs' claims were preempted by the Congressional objectives of the Clean
Air Act and the EPA's approval of the use of MTBE as an oxygenate. Valero also
has been named, but not served, in an MTBE lawsuit filed by the Suffolk County
Water Authority and the County of Suffolk, New York against Valero and several
other defendants.
20
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The four Texas cases are based on the alleged discharge of gasoline into East
Caddo Creek in Hunt County, Texas on March 9, 2000 when a pipeline belonging to
Explorer Pipeline Company ruptured. Valero was named in City of Dallas v.
Explorer Pipeline Company, Inc., Valero Energy Corporation, et al. (removed to
the United States District Court for the Northern District of Texas from the
160th State District Court, Dallas County, Texas) and three related private
landowner cases. In August 2002, Valero and representatives of the City of
Dallas negotiated a settlement of the Explorer lawsuit on terms immaterial to
Valero's results of operations and financial position. The settlement is subject
to formal approval by the City, which is expected in the third quarter of 2002.
The three California cases are primarily based on a product liability/product
defect theory, and are filed by local water providers, including the City of
Santa Monica, the City of Dinuba and Fruitridge Vista Water Company. In the New
York, Texas and California cases, the plaintiffs generally seek individual,
unquantified compensatory and punitive damages and attorneys' fees. Valero
believes it is unlikely that the final outcome of any one of these claims or
proceedings would have a material adverse effect on its results of operations or
financial position, but that an adverse result in a majority of these cases
could have a material adverse effect on Valero's results of operations and
financial position.
Valero is also a party to additional claims and legal proceedings arising in the
ordinary course of business. Valero believes it is unlikely that the final
outcome of any of the claims or proceedings to which it is a party would have a
material adverse effect on its financial position, results of operations or
liquidity; however, due to the inherent uncertainty of litigation, the range of
possible loss, if any, cannot be estimated with a reasonable degree of precision
and there can be no assurance that the resolution of any particular claim or
proceeding would not have an adverse effect on Valero's results of operations,
financial position or liquidity.
17. SUBSEQUENT EVENTS
On July 1, 2002, $275.0 million of 8.625% Guaranteed Notes and interest rate
swaps with a notional amount of $200.0 million matured. Valero refinanced the
debt in July 2002 with borrowings under its bank credit facilities.
On July 15, 2002, Valero Logistics Operations, L.P., a subsidiary of Valero
L.P., completed the sale of $100.0 million aggregate principal amount of 6.875%
senior notes, which mature on July 15, 2012. Valero L.P. fully and
unconditionally guarantees the senior notes. Proceeds from the offering were
used to reduce borrowings under Valero Logistics Operations, L.P.'s revolving
credit facility and for general corporate purposes.
On July 18, 2002, Valero's Board of Directors declared a regular quarterly cash
dividend of $0.10 per common share payable September 11, 2002 to holders of
record as of the close of business on August 14, 2002.
21
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On July 19, 2002, Valero L.P. declared a quarterly partnership distribution of
$0.70 per unit payable on August 14, 2002 to unitholders of record on August 1,
2002. The total distribution is expected to be approximately $14 million of
which approximately $4 million is payable to minority unitholders.
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FORWARD-LOOKING STATEMENTS
This Form 10-Q, including without limitation the discussion below under the
heading "Results of Operations - Outlook," contains certain estimates,
predictions, projections, assumptions and other "forward-looking statements" (as
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) that involve various risks and uncertainties.
While these forward-looking statements, and any assumptions upon which they are
based, are made in good faith and reflect Valero's current judgment regarding
the direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, assumptions, or other
future performance suggested in this report. These forward-looking statements
can generally be identified by the words "anticipate," "believe," "expect,"
"plan," "intend," "estimate," "project," "budget," "forecast," "will," "could,"
"should," "may" and similar expressions. These forward-looking statements
include, among other things, statements regarding:
o the effect of Valero's recently completed acquisition of UDS on Valero's
business, results of operations and financial position;
o future refining margins, including gasoline and heating oil margins;
o future retail margins, including gasoline, diesel fuel, home heating oil
and convenience store merchandise margins;
o expectations regarding feedstock costs, including crude oil discounts, and
operating expenses;
o anticipated levels of crude oil and refined product inventories;
o Valero's anticipated level of capital investments, including deferred
refinery turnaround and catalyst costs and capital expenditures for
environmental and other purposes, and the effect of these capital
investments on Valero's results of operations;
o anticipated trends in the supply and demand for crude oil feedstocks and
refined products in the United States, Canada and elsewhere;
o expectations regarding environmental and other regulatory initiatives; and
o the effect of general economic and other conditions on refining and retail
industry fundamentals.
Valero's forward-looking statements are based on its beliefs and assumptions
derived from information available at the time the statements are made.
Differences between actual results and any future performance suggested in these
forward-looking statements could result from a variety of factors, including the
following:
o acts of terrorism aimed at either Valero's facilities or other facilities
that could impair Valero's ability to produce and/or transport refined
products or receive foreign feedstocks;
o political conditions in crude oil producing regions, including the Middle
East;
o the domestic and foreign supplies of refined products such as gasoline,
diesel, jet fuel, home heating oil and petrochemicals;
o the domestic and foreign supplies of crude oil and other feedstocks;
o the ability of the members of the Organization of Petroleum Exporting
Countries (OPEC) to agree on and to maintain crude oil price and production
controls;
o the level of consumer demand, including seasonal fluctuations;
o refinery overcapacity or undercapacity;
o the actions taken by competitors, including both pricing and the expansion
and retirement of refining capacity in response to market conditions;
o environmental and other regulations at both the state and federal levels
and in foreign countries;
o the level of foreign imports of refined products;
23
o accidents or other unscheduled shutdowns affecting Valero's refineries,
machinery, pipelines or equipment, or those of Valero's suppliers or
customers;
o changes in the cost or availability of transportation for feedstocks and
refined products;
o the price, availability and acceptance of alternative fuels and
alternative-fuel vehicles;
o cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such projects or
cost overruns in constructing such planned capital projects;
o earthquakes, tornadoes and irregular weather, which can unforeseeably
affect the price or availability of feedstocks and refined products;
o rulings, judgments, or settlements in litigation or other legal or
regulatory matters, including unexpected environmental remediation costs in
excess of any reserves or insurance coverage;
o the introduction or enactment of federal or state legislation which may
adversely affect Valero's business or operations;
o changes in the credit ratings assigned to Valero's debt securities and
trade credit;
o changes in the value of the Canadian dollar relative to the U.S. dollar;
o overall economic conditions; and
o other economic, business, competitive and/or regulatory factors that may
affect Valero's business generally as described in Valero's filings with
the SEC.
Any one of these factors, or a combination of these factors, could materially
affect Valero's future results of operations and whether any forward-looking
statements ultimately prove to be accurate. Valero's forward-looking statements
are not guarantees of future performance, and actual results and future
performance may differ materially from those suggested in any forward-looking
statement. Valero does not intend to update these statements unless it is
required by the securities laws to do so.
All subsequent written and oral forward-looking statements attributable to
Valero or persons acting on its behalf are expressly qualified in their entirety
by the foregoing. Valero undertakes no obligation to publicly release the result
of any revisions to any such forward-looking statements that may be made to
reflect events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events.
24
RESULTS OF OPERATIONS
Second Quarter 2002 Compared to Second Quarter 2001
Financial Highlights (millions of dollars, except per share amounts)
Three Months Ended June 30,
---------------------------
2002(a) 2001(a) Change
------ ------ ------
Operating revenues............................................. $ 6,552.4 $ 4,499.1 $2,053.3
Cost of sales.................................................. (5,777.1) (3,707.0) (2,070.1)
Refining operating expenses:
Cash (fixed and variable)..................................... (331.3) (218.2) (113.1)
Depreciation and amortization................................. (94.8) (54.8) (40.0)
Retail selling expenses:
Cash.......................................................... (166.1) (1.5) (164.6)
Depreciation and amortization................................. (10.9) (0.5) (10.4)
Administrative expenses:
Cash.......................................................... (65.1) (50.9) (14.2)
Depreciation and amortization................................. (7.0) (2.0) (5.0)
------- ------- --------
Operating income............................................... 100.1 464.2 (364.1)
Other income (expense), net.................................... 2.1 (0.8) 2.9
Interest and debt expense, net................................. (72.3) (20.5) (51.8)
Minority interest in net income of consolidated
partnership................................................... (4.0) - (4.0)
Distributions on preferred securities of subsidiary trusts..... (7.5) (3.3) (4.2)
Income tax expense............................................. (7.1) (164.8) 157.7
------- ------- --------
Net income.. ............................................... $ 11.3 $ 274.8 $ (263.5)
======== ======= ========
Earnings per common share - assuming dilution.................. $ 0.10 $ 4.23 $ (4.13)
Earnings before interest, taxes, depreciation and
amortization (EBITDA)......................................... $ 202.4 $ 517.4 $ (315.0)
Ratio of EBITDA to interest incurred........................... 2.7x 22.9x (20.2x)
- ----------------------------------------------------------------------------------------------------------------
The following notes relate to references on pages 25 through 28.
(a) The second quarter of 2002 includes the operations of UDS, Huntway and the
El Paso Corpus Christi Refinery and related product logistics business. The
second quarter of 2001 excludes the operations of UDS but includes the
operations of Huntway and the El Paso Corpus Christi Refinery and related
product logistics business beginning June 1, 2001.
(b) The Gulf Coast refining region includes the Corpus Christi, Texas City,
Houston, Three Rivers and Krotz Springs Refineries; the Mid-Continent
refining region includes the McKee, Ardmore and Denver Refineries; the
Northeast refining region includes the Quebec and Paulsboro Refineries; and
the West Coast refining region includes the Benicia and Wilmington
Refineries.
(c) The market reference differential for sour crude oil is based on 50% Arab
Medium and 50% Arab Light posted prices.
25
Operating Highlights
Three Months Ended June 30,
---------------------------
2002(a) 2001(a) Change
------ ------ ------
Refining:
Throughput volumes (thousand barrels per day)... 1,549 1,045 504
Average throughput margin per barrel............ $ 3.91 $ 8.31 $ (4.40)
Operating costs per barrel:
Cash (fixed and variable).................... $ 2.35 $ 2.30 $ 0.05
Depreciation and amortization................ 0.67 0.57 0.10
---- ---- ----
Total operating costs per barrel........... $ 3.02 $ 2.87 $ 0.15
==== ==== ====
Charges:
Crude oils:
Sour....................................... 43% 62% (19)
Sweet...................................... 34 11 23
-- -- ---
Total crude oils......................... 77 73 4
Residual fuel oil............................ 4 9 (5)
Other feedstocks and blendstocks............. 19 18 1
--- --- ---
Total charges.............................. 100% 100% -
=== === ===
Yields:
Gasolines and blendstocks.................... 56% 54% 2
Distillates.................................. 26 27 (1)
Petrochemicals............................... 3 3 -
Lubes and asphalts........................... 5 3 2
Other products............................... 10 13 (3)
--- --- ---
Total yields............................... 100% 100% -
=== === ===
Retail - U.S.:
Company-operated fuel sites (average)........... 1,399 11 1,388
Fuel volumes (gallons per day per site)......... 4,371 6,449 (2,078)
Fuel margin (per gallon)........................ $0.137 $0.294 $(0.157)
Merchandise sales (in millions)................. $275.8 $ 0.9 $ 274.9
Merchandise margin (percentage of sales)........ 27.8% 27.0% 0.8%
Margin on miscellaneous sales (in millions)..... $ 11.7 $ - $ 11.7
Selling expenses (per gallon)................... $0.226 $0.224 $ 0.002
Retail - Northeast:
Fuel volumes (thousand gallons per day)......... 3,127 N/A
Fuel margin (per gallon)........................ $0.177 N/A
Merchandise sales (in millions)................. $ 24.7 N/A
Merchandise margin (percentage of sales)........ 22.6% N/A
Margin on miscellaneous sales (in millions)..... $ 4.0 N/A
Selling expenses (per gallon)................... $0.141 N/A
26
Refining Operating Highlights by Region (b)
Three Months Ended June 30,
--------------------------
2002(a) 2001(a) Change
------ ------ ------
Gulf Coast:
Throughput volumes (thousand barrels per day)....... 643 681 (38)
Average throughput margin per barrel................ $ 3.94 $ 8.01 $(4.07)
Operating costs per barrel:
Cash (fixed and variable).......................... $ 2.60 $ 2.06 $ 0.54
Depreciation and amortization...................... 0.78 0.59 0.19
---- ---- ----
Total operating costs per barrel.................. $ 3.38 $ 2.65 $ 0.73
==== ==== ====
Mid-Continent:
Throughput volumes (thousand barrels per day)....... 269 N/A
Average throughput margin per barrel................ $ 4.89 N/A
Operating costs per barrel:
Cash (fixed and variable).......................... $ 2.08 N/A
Depreciation and amortization...................... 0.54 N/A
----
Total operating costs per barrel.................. $ 2.62 N/A
====
Northeast:
Throughput volumes (thousand barrels per day)....... 336 186 150
Average throughput margin per barrel................ $ 2.39 $ 7.18 $(4.79)
Operating costs per barrel:
Cash (fixed and variable).......................... $ 1.60 $ 2.56 $(0.96)
Depreciation and amortization...................... 0.51 0.47 0.04
---- ---- ----
Total operating costs per barrel.................. $ 2.11 $ 3.03 $(0.92)
==== ==== ====
West Coast:
Throughput volumes (thousand barrels per day)....... 301 178 123
Average throughput margin per barrel................ $ 4.68 $10.59 $(5.91)
Operating costs per barrel:
Cash (fixed and variable)......................... $ 2.91 $ 2.91 $ -
Depreciation and amortization..................... 0.76 0.60 0.16
---- ---- ----
Total operating costs per barrel................. $ 3.67 $ 3.51 $ 0.16
==== ==== ====
27
Average Market Reference Prices and Differentials (dollars per barrel)
Three Months Ended June 30,
---------------------------
2002(a) 2001(a) Change
------ ------ ------
Feedstocks:
West Texas Intermediate (WTI) crude oil........ $26.27 $27.91 $ (1.64)
WTI less sour crude oil at U.S. Gulf Coast (c). $ 2.06 $ 6.10 $ (4.04)
WTI less Alaska North Slope (ANS).............. $ 1.27 $ 1.83 $ (0.56)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI............ $ 5.31 $ 8.86 $ (3.55)
No. 2 fuel oil less WTI...................... $ 0.34 $ 3.22 $ (2.88)
Propylene less WTI........................... $ 4.95 $(6.79) $ 11.74
U.S. Mid-Continent:
Conventional 87 gasoline less WTI........... $ 6.42 $14.34 $ (7.92)
Low-sulfur diesel less WTI.................. $ 2.23 $ 9.34 $ (7.11)
U.S. East Coast:
Conventional 87 gasoline less WTI............ $ 3.87 $ 8.18 $ (4.31)
No. 2 fuel oil less WTI...................... $ 1.38 $ 4.20 $ (2.82)
Lube oils less WTI........................... $13.42 $26.56 $(13.14)
U.S. West Coast:
CARB 87 gasoline less ANS.................... $11.53 $20.57 $ (9.04)
Low-sulfur diesel less ANS................... $ 3.67 $ 9.97 $ (6.30)
General
Valero reported net income for the second quarter of 2002 of $11.3 million, or
$0.10 per share, compared to net income of $274.8 million, or $4.23 per share,
in the second quarter of 2001.
Operating revenues increased 46% in the second quarter of 2002 compared to the
second quarter of 2001 primarily as a result of the additional throughput
volumes from the refinery operations acquired in the UDS, El Paso and Huntway
Acquisitions, somewhat offset by a significant decline in refined product
prices. However, operating income for the second quarter of 2002 decreased
significantly to $100.1 million compared to operating income of $464.2 million
for the same period in 2001. The decrease in operating income from 2001 to 2002
was due mainly to a 53% decline in refining throughput margin per barrel,
attributable primarily to exceptionally weak discounts for sour crude oil,
Valero's primary feedstock, and significantly lower refined product margins in
virtually all of Valero's markets. In addition to the overall poor refining
margin environment, operating income was also lower due to a significant level
of scheduled and unscheduled downtimes at several of Valero's refineries.
Refining
Operating income for Valero's refining segment was $124.8 million for the
quarter ended June 30, 2002, compared to operating income of $516.9 million for
the quarter ended June 30, 2001. In the second quarter of 2001, gasoline margins
were high as a result of strong demand and the carryover effects of high
refinery turnaround activity during the first quarter of 2001. In addition,
distillate margins were strong as a result of fuel switching due to high natural
gas prices and sour crude oil discounts to WTI were at near-record levels due to
increased supplies of heavier crude oil. However, in the second quarter of 2002,
refining operating results were impacted by the following factors:
28
o distillate margins declined over 60% in every region from the second
quarter of 2001 due to high inventory levels as a result of weak economic
conditions, the unusually warm winter in the northeastern part of the
United States and in Europe, and lower jet fuel demand following the
September 11, 2001 terrorist attacks;
o discounts on Valero's sour crude oil feedstocks during the second quarter
of 2002 declined over 66% from second quarter 2001 levels primarily due to
crude oil production cuts by OPEC and limited availability of Iraqi sour
crude oil on the world market;
o although gasoline demand was strong, gasoline margins declined in all
regions of the United States from the extremely high margins experienced in
the second quarter of 2001 due to higher levels of gasoline inventories,
resulting mainly from higher imports in the second quarter of 2002 which
has moderated price spikes relative to the previous two years, and
increased production of CARB gasoline in California; and,
o refinery utilization rates were lower than normal operating rates during
the second quarter of 2002. The refinery utilization rates were impacted by
the following factors:
o Valero's Texas City Refinery was affected by unscheduled downtime and
turnaround activity, which started in mid-March 2002 and was completed
in late May 2002, and high vibrations in a main airblower of the FCCU
that caused a shutdown in early June 2002 for over one week.
o The hydrogen unit at the Benicia Refinery was shut down for almost one
month after power failures interrupted operations in early June 2002.
The shutdown reduced production of CARB gasoline by approximately
30,000 barrels per day during this period.
o Production at ten of Valero's refineries was cut during June 2002 by
as much as 23% from normal levels due to uneconomic operating
conditions.
Partially offsetting the above decreases in operating income was an approximate
net $14 million benefit to operating income resulting from the settlement in
June 2002 of a petroleum products purchase agreement and related hedge assumed
as part of the UDS Acquisition.
Refining cash operating expenses were 52% higher during the second quarter of
2002 as compared to the second quarter of 2001 due to the additional refinery
operations from the UDS, El Paso and Huntway Acquisitions. However, cash
operating costs per barrel increased only 2% between the quarters.
Retail
Retail operating income was $47.4 million for the quarter ended June 30, 2002,
compared to operating income of $0.2 million for the quarter ended June 30,
2001, which included only the 11 northern California retail stores operated by
Valero at that time. U.S. retail operations generated operating income of $31.8
million for the second quarter of 2002 as fuel margins improved to $0.137 per
gallon in the second quarter from the low margins of $0.05 per gallon realized
in the first quarter of 2002. Valero's Northeast retail operations, which
include retail outlets in Canada and the home heating oil business in Canada and
the northeastern U.S., generated an operating profit of $15.6 million resulting
from a fuel margin of $0.177 per gallon.
Retail cash selling expenses for the second quarter of 2002 increased $164.6
million from the second quarter of 2001 due to the additional retail stores
acquired in the UDS Acquisition.
Corporate Expenses and Other
Administrative expenses, excluding depreciation and amortization, increased
$14.2 million in the second quarter of 2002 compared to the second quarter of
2001 due primarily to the UDS Acquisition, partially offset by reduced variable
compensation as a result of significantly lower income generated in 2002.
29
Net interest expense increased $51.8 million to $72.3 million in the second
quarter of 2002 compared to the second quarter of 2001 due primarily to the
incremental debt incurred to finance the UDS Acquisition, the additional debt
assumed in the UDS Acquisition, and increased interest incurred in 2002 in
connection with the capital leases associated with the El Paso Acquisition which
was effective June 1, 2001. Interest expense on the debt incurred to finance the
UDS Acquisition increased in the second quarter of 2002 compared to the first
quarter of 2002 as fixed rates related to the issuance of $1.8 billion of
long-term senior notes issued in mid-April 2002 were higher than the floating
rates under the bridge loan that was repaid with the senior note proceeds.
The minority interest in net income of consolidated partnership of $4.0 million
represents the minority unitholders' share of the net income of Valero L.P.
Valero L.P. owns and operates most of the crude oil and refined product
pipeline, terminalling and storage assets located in Texas, Oklahoma, New Mexico
and Colorado that support Valero's McKee, Three Rivers and Ardmore Refineries.
Distributions on preferred securities of subsidiary trusts increased $4.2
million from $3.3 million in the second quarter of 2001 to $7.5 million in the
second quarter of 2002. This increase is due to the distributions incurred on
the $200 million of 8.32% Trust Originated Preferred Securities assumed in the
UDS Acquisition.
Income tax expense decreased $157.7 million from $164.8 million in the second
quarter of 2001 to $7.1 million in the second quarter of 2002, due mainly to a
$421.2 million decrease in pre-tax income resulting mainly from the lower
operating income and higher interest expense.
The decrease in the ratio of EBITDA to interest incurred for the quarter ended
June 30, 2002 from the quarter ended June 30, 2001 was due mainly to the
combination of lower operating income and higher interest expense in 2002.
30
Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001
Financial Highlights (millions of dollars, except per share amounts)
Six Months Ended June 30,
-------------------------
2002(a) 2001(a) Change
------ ------ ------
Operating revenues.......................................... $11,674.8 $8,268.4 $3,406.4
Cost of sales............................................... (10,261.0) (6,954.5) (3,306.5)
Refining operating expenses:
Cash (fixed and variable).................................. (638.5) (415.1) (223.4)
Depreciation and amortization.............................. (192.2) (105.3) (86.9)
Retail selling expenses:
Cash....................................................... (324.6) (2.9) (321.7)
Depreciation and amortization.............................. (20.8) (0.7) (20.1)
Administrative expenses:
Cash....................................................... (123.4) (84.4) (39.0)
Depreciation and amortization.............................. (14.0) (4.2) (9.8)
-------- ------- -------
Operating income............................................ 100.3 701.3 (601.0)
Other income (expense), net................................. 4.9 (1.1) 6.0
Interest and debt expense, net.............................. (126.9) (39.2) (87.7)
Minority interest in net income of consolidated
partnership................................................ (6.6) - (6.6)
Distributions on preferred securities of subsidiary trusts.. (15.0) (6.7) (8.3)
Income tax benefit (expense)................................ 16.0 (243.4) 259.4
-------- ------- -------
Net income (loss)........................................ $ (27.3) $ 410.9 $ (438.2)
======== ======= =======
Earnings (loss) per common share - assuming dilution........ $ (0.26) $ 6.35 $ (6.61)
EBITDA...................................................... $ 309.6 $ 803.7 $ (494.1)
Ratio of EBITDA to interest incurred........................ 2.3x 18.3x (16.0x)
- --------------------------------------------------------------------------------------------------------
The following notes relate to references on pages 31 through 34.
(a) The six months ended June 30, 2002 includes the operations of UDS, Huntway
and the El Paso Corpus Christi Refinery and related product logistics
business. The six months ended June 30, 2001 excludes the operations of UDS
but includes the operations of Huntway and the El Paso Corpus Christi
Refinery and related product logistics business beginning June 1, 2001.
(b) The Gulf Coast refining region includes the Corpus Christi, Texas City,
Houston, Three Rivers and Krotz Springs Refineries; the Mid-Continent
refining region includes the McKee, Ardmore and Denver Refineries; the
Northeast refining region includes the Quebec and Paulsboro Refineries; and
the West Coast refining region includes the Benicia and Wilmington
Refineries.
(c) The market reference differential for sour crude oil is based on 50% Arab
Medium and 50% Arab Light posted prices.
31
Operating Highlights
Six Months Ended June 30,
-------------------------
2002(a) 2001(a) Change
------ ------ ------
Refining:
Throughput volumes (thousand barrels per day)............. 1,536 961 575
Average throughput margin per barrel...................... $ 3.66 $ 7.53 $(3.87)
Operating costs per barrel:
Cash (fixed and variable)................................ $ 2.30 $ 2.39 $(0.09)
Depreciation and amortization............................ 0.69 0.60 0.09
---- ---- ----
Total operating costs per barrel........................ $ 2.99 $ 2.99 $ -
==== ==== ====
Charges:
Crude oils:
Sour.................................................... 45% 61% (16)
Sweet................................................... 34 12 22
--- -- ---
Total crude oils....................................... 79 73 6
Residual fuel oil........................................ 4 8 (4)
Other feedstocks and blendstocks......................... 17 19 (2)
--- --- --
Total charges.......................................... 100% 100% -
=== === ===
Yields:
Gasolines and blendstocks................................ 54% 54% -
Distillates.............................................. 27 27 -
Petrochemicals........................................... 3 3 -
Lubes and asphalts....................................... 4 3 1
Other products........................................... 12 13 (1)
--- --- ---
Total yields............................................ 100% 100% -
=== === ===
Retail - U.S.:
Company-operated fuel sites (average)..................... 1,409 11 1,398
Fuel volumes (gallons per day per site)................... 4,436 5,908 (1,472)
Fuel margin (per gallon).................................. $ 0.094 $ 0.257 $(0.163)
Merchandise sales (in millions)........................... $ 524.0 $ 1.8 $ 522.2
Merchandise margin (percentage of sales).................. 27.1% 30.8% (3.7)%
Margin on miscellaneous sales (in millions)............... $ 22.5 $ - $ 22.5
Selling expenses (per gallon)............................. $ 0.217 $ 0.246 $(0.029)
Retail - Northeast:
Fuel volumes (thousand gallons per day)................... 3,227 N/A
Fuel margin (per gallon).................................. $ 0.183 N/A
Merchandise sales (in millions)........................... $ 45.3 N/A
Merchandise margin (percentage of sales).................. 22.5% N/A
Margin on miscellaneous sales (in millions)............... $ 8.1 N/A
Selling expenses (per gallon)............................. $ 0.135 N/A
32
Refining Operating Highlights by Region (b)
Six Months Ended June 30,
-------------------------
2002(a) 2001(a) Change
------ ------ ------
Gulf Coast:
Throughput volumes (thousand barrels per day).. 636 609 27
Average throughput margin per barrel.......... $ 3.54 $ 7.30 $(3.76)
Operating costs per barrel:
Cash (fixed and variable).................... $ 2.46 $ 2.19 $ 0.27
Depreciation and amortization................ 0.81 0.64 0.17
---- ---- ----
Total operating costs per barrel............ $ 3.27 $ 2.83 $ 0.44
==== ==== ====
Mid-Continent:
Throughput volumes (thousand barrels per day). 257 N/A
Average throughput margin per barrel.......... $ 4.19 N/A
Operating costs per barrel:
Cash (fixed and variable).................... $ 2.21 N/A
Depreciation and amortization................ 0.55 N/A
---- N/A
Total operating costs per barrel............ $ 2.76 N/A
====
Northeast:
Throughput volumes (thousand barrels per day). 346 186 160
Average throughput margin per barrel.......... $ 2.23 $ 5.96 $(3.73)
Operating costs per barrel:
Cash (fixed and variable).................... $ 1.55 $ 2.30 $(0.75)
Depreciation and amortization................ 0.50 0.48 0.02
---- ---- ----
Total operating costs per barrel............ $ 2.05 $ 2.78 $(0.73)
==== ==== ====
West Coast:
Throughput volumes (thousand barrels per day). 297 166 131
Average throughput margin per barrel.......... $ 5.11 $10.12 $(5.01)
Operating costs per barrel:
Cash (fixed and variable).................... $ 2.90 $ 3.22 $(0.32)
Depreciation and amortization................ 0.76 0.59 0.17
---- ---- ----
Total operating costs per barrel............ $ 3.66 $ 3.81 $(0.15)
==== ==== ====
33
Average Market Reference Prices and Differentials (dollars per barrel)
Six Months Ended June 30,
-------------------------
2002(a) 2001(a) Change
------ ------ ------
Feedstocks:
WTI crude oil..................................... $ 23.94 $ 28.35 $ (4.41)
WTI less sour crude oil at U.S. Gulf Coast (c).... $ 2.33 $ 5.72 $ (3.39)
WTI less ANS...................................... $ 1.51 $ 2.79 $ (1.28)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI............... $ 4.42 $ 7.31 $ (2.89)
No. 2 fuel oil less WTI......................... $ 0.83 $ 3.35 $ (2.52)
Propylene less WTI.............................. $ 2.87 $ (2.06) $ 4.93
U.S. Mid-Continent:
Conventional 87 gasoline less WTI.............. $ 5.48 $ 10.52 $ (5.04)
Low-sulfur diesel less WTI..................... $ 2.41 $ 7.56 $ (5.15)
U.S. East Coast:
Conventional 87 gasoline less WTI............... $ 3.68 $ 6.73 $ (3.05)
No. 2 fuel oil less WTI......................... $ 1.88 $ 4.26 $ (2.38)
Lube oils less WTI.............................. $ 15.37 $ 26.40 $(11.03)
U.S. West Coast:
CARB 87 gasoline less ANS....................... $ 11.37 $ 20.02 $ (8.65)
Low-sulfur diesel less ANS...................... $ 4.46 $ 9.68 $ (5.22)
General
Valero reported a net loss for the six months ended June 30, 2002 of $27.3
million, or $0.26 per share, compared to net income of $410.9 million, or $6.35
per share, for the six months ended June 30, 2001.
Operating revenues increased 41% in the first six months of 2002 to $11.7
billion compared to $8.3 billion in the first six months of 2001 primarily as a
result of the additional throughput volumes from the refinery operations
acquired in the UDS, El Paso and Huntway Acquisitions, partially offset by a
significant decline in refined product prices. However, operating income for the
first six months of 2002 decreased significantly to $100.3 million compared to
operating income of $701.3 million for the same period in 2001. The decrease in
operating income from 2001 to 2002 was due mainly to a 51% decline in refining
throughput margin per barrel, attributable primarily to depressed sour crude oil
discounts and significantly lower refined product margins in virtually all of
Valero's markets. In addition to the overall poor refining margin environment,
operating income was also lower due to a significant level of scheduled and
unscheduled downtimes at several of Valero's refineries.
Refining
Operating income for Valero's refining segment was $186.9 million for the six
months ended June 30, 2002, compared to operating income of $789.9 million for
the six months ended June 30, 2001. In the first six months of 2001, gasoline
and distillate margins were exceptionally high as a result of strong demand, a
cold winter and high natural gas prices, and sour crude oil discounts to WTI
were at near-record levels. However, in the first six months of 2002, refining
operating results were impacted by the following factors:
o gasoline and distillate margins declined significantly due to high
inventory levels for these products as a result of weak economic
conditions, an unusually warm winter in the northeastern part of the United
States and in Europe, and lower jet fuel demand following the September 11,
2001 terrorist attacks.
34
In addition, higher imports of gasoline have kept inventories at normal
levels and have moderated price spikes relative to the previous two years;
o discounts on Valero's sour crude oil feedstocks during the first six months
of 2002 declined almost 60% from the first six months of 2001 levels
primarily due to OPEC's crude oil production cuts, which were predominantly
sour crude oils; and
o refinery utilization rates were significantly below normal operating rates
during the six months ended June 30, 2002, as seven of Valero's twelve
refineries were affected by turnaround activities. In addition to the
scheduled downtime, Valero also experienced some unplanned maintenance
during the first six months of 2002, and production at several refineries
was cut by as much as 25% due to uneconomic operating conditions.
Partially offsetting the above decreases in operating income was an approximate
net $14 million benefit to operating income resulting from the settlement in
June 2002 of a petroleum products purchase agreement and related hedge assumed
as part of the UDS Acquisition.
Refining cash operating expenses were 54% higher for the six months ended June
30, 2002 as compared to the six months ended June 30, 2001 due to the additional
refinery operations from the UDS, El Paso and Huntway Acquisitions. However,
cash operating costs per barrel decreased 4% between the periods.
Retail
Retail operating income was $50.8 million for the six months ended June 30,
2002, compared to breakeven operations for the six months ended June 30, 2001,
which included only the 11 northern California retail stores operated by Valero
at that time. U.S. retail operations realized fuel margins of $0.094 per gallon
for the six months ended June 30, 2002, recovering in the second quarter of 2002
from the very low margin environment that prevailed in the first quarter of
2002. Valero's Northeast retail operations generated operating income of $38.3
million resulting from a fuel margin of $0.183 per gallon.
Retail selling expenses for the first six months of 2002 were significantly
higher than the first six months of 2001 due to the additional retail stores
acquired in the UDS Acquisition.
Corporate Expenses and Other
Administrative expenses, excluding depreciation and amortization, increased from
$84.4 million for the six months ended June 30, 2001 to $123.4 million for the
same period in 2002. This increase was due primarily to the UDS Acquisition,
partially offset by reduced variable compensation as a result of the loss
incurred in the first half of 2002.
Net interest expense increased $87.7 million to $126.9 million in the first six
months of 2002 compared to the first six months of 2001 due primarily to the
incremental debt incurred to finance the UDS Acquisition, the additional debt
assumed in the UDS Acquisition, and interest incurred in 2002 in connection with
the capital leases associated with the El Paso Acquisition which was effective
June 1, 2001.
The minority interest in net income of consolidated partnership of $6.6 million
represents the minority unitholders' share of the net income of Valero L.P.
Distributions on preferred securities of subsidiary trusts increased $8.3
million from $6.7 million for the six months ended June 30, 2001 to $15.0
million for the six months ended June 30, 2002. This increase is due to the
distributions incurred on the $200 million of 8.32% Trust Originated Preferred
Securities assumed in the UDS Acquisition.
35
Income taxes decreased $259.4 million from tax expense of $243.4 million in the
first six months of 2001 to a tax benefit of $16.0 million in the first six
months of 2002, due mainly to the significant decrease in operating income and
increased interest expense.
The decrease in the ratio of EBITDA to interest incurred for the six months
ended June 30, 2002 from the six months ended June 30, 2001 was due mainly to
the combination of lower operating income and higher interest expense in 2002.
OUTLOOK
Industry fundamentals have created a challenging environment for refining
companies during the first half of 2002. Although Valero is encouraged by the
recent positive trends in certain key components of the refining and marketing
business, certain other unfavorable trends continue that mitigate Valero's
optimism about the outlook for the remainder of 2002.
Gasoline demand increased about 2.5% for the first seven months of 2002 compared
to the same period in 2001, due primarily to lower gasoline prices at the retail
level, an increasing number of sport utility vehicles, and more travelers opting
to drive rather than fly. Gasoline margins in July 2002 were higher than average
levels for that time of year but were still below the near-record margins in
2001, due in part to higher imports and increased inventories in 2002. In July
2002, gasoline margins averaged $4.79 per barrel in the Gulf Coast region, $7.65
per barrel in the Mid-continent region, and $5.02 per barrel in the Northeast
region. West Coast CARB gasoline margins averaged about $10.18 per barrel, which
were slightly below normal, due primarily to increased gasoline production.
Gasoline demand is expected to remain strong on a seasonal basis, which should
help to sustain gasoline margins at reasonable levels through at least August
2002. If gasoline production and imports continue at recently high levels,
margins could be pressured as demand declines beyond the summer driving season.
Distillate margins continue to be negatively impacted by high distillate
inventories caused by reduced jet fuel demand following the September 11, 2001
terrorist attacks and record warm winter temperatures in the Northeast in early
2002. Although demand for distillates has improved recently to more normal
levels for this time of year, distillate margins are expected to remain weak
until distillate inventories are reduced.
Although the sour crude oil discount to WTI has recently improved, it remains
lower than the five-year average discount of $3.25 per barrel and is
substantially less than the $4.37 per barrel discount in the third quarter of
2001. The crude oil production cuts by OPEC dramatically reduced the supply of
heavy, sour crude oil and negatively impacted those discounts and, accordingly,
Valero's net income. As economic conditions begin to improve and demand for
crude oil increases, Valero expects that additional sour crude oil will be
produced, which should increase sour crude oil discounts and positively affect
Valero's net income.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows for the Six Months Ended June 30, 2002 and 2001
During the first six months of 2002, net cash provided by operating activities
was $22.7 million as compared to net cash provided by operating activities of
$513.5 million during the first six months of 2001. The decrease in cash
provided by operating activities was due primarily to the unfavorable change in
income as described above under "Results of Operations."
36
During the six months ended June 30, 2002, cash and temporary cash investments
increased $91.5 million as Valero received $300.9 million from the liquidation
of its investment in the Diamond-Koch joint venture, $925.0 million from the
sale of the Golden Eagle Business, and $1.8 billion from the sale of senior
notes. Valero used these proceeds, together with $314.7 million of short-term
borrowings and $50.0 million from the issuance of common stock in connection
with employee benefit plans, to:
o fund the $2.1 billion cash payment to UDS shareholders in connection with
the UDS Acquisition,
o fund capital expenditures, deferred turnaround and catalyst costs and
earn-out payments of $516.8 million,
o fund $183.5 million of cash flows related to the Golden Eagle Business,
primarily capital expenditures and deferred turnaround costs,
o repay long-term debt of $547.1 million,
o repurchase $44.0 million of its common stock, and
o pay $21.1 million of common stock dividends.
Net cash provided by operating activities during the first six months of 2001
was $513.5 million, primarily due to profitable operations as discussed above
under "Results of Operations," offset by cash used for working capital
requirements as detailed in Note 12 of Notes to Consolidated Financial
Statements. During the first six months of 2001, working capital requirements
increased by $99.0 million, primarily resulting from an increase in operating
inventory levels and an increase in receivables resulting from both increased
sales volumes and amounts that were billed and collected in July rather than
June due to certain delays resulting from the implementation of a new accounting
system. Partially offsetting these increased working capital requirements was an
increase in federal income taxes payable due to the significant increase in net
income. During the first six months of 2001, cash and temporary cash investments
increased $27.9 million as cash provided by operating activities and issuances
of common stock related to Valero's benefit plans exceeded amounts required to:
o fund capital expenditures, deferred turnaround and catalyst costs, and the
earn-out contingency payment to Salomon Inc discussed below,
o fund the acquisition of Huntway and inventories related to the acquisition
of El Paso's Corpus Christi refinery and related product logistics
business,
o reduce short-term bank borrowings,
o repurchase shares of Valero common stock, and
o pay common stock dividends.
Contractual Obligations and Commercial Bank Commitments
As of June 30, 2002, Valero had two $750 million revolving bank credit
facilities, which provide for commitments of $750 million for a five-year term
and $750 million for a 364-day term. These facilities contain certain
restrictive covenants including an interest coverage ratio and a
debt-to-capitalization ratio.
Valero's committed credit facilities as of June 30, 2002 were as follows (in
millions):
Borrowing Borrowings
Capacity Outstanding
--------- -----------
5-year revolving credit facility........................... $ 750.0 $ -
364-day revolving credit facility.......................... 750.0 305.0
Committed revolving credit facility for Valero L.P......... 120.0 91.0
Canadian committed revolving credit facility............... Cdn $ 200.0 -
37
As of June 30, 2002, Valero had $209.7 million outstanding under various
uncommitted short-term bank credit facilities. In addition, Valero had $195.0
million of letters of credit outstanding under the uncommitted short-term
facilities and $65.7 million of letters of credit under its committed
facilities.
As of June 30, 2002, Valero had $150 million principal amount of 6.75% notes
outstanding, under which a third party has an option to purchase the notes under
certain circumstances at par on December 15, 2002. If the third party does not
exercise its purchase option, Valero will be required to repurchase the notes at
par on December 15, 2002. Based on current interest rates, Valero expects that
the third party would exercise its purchase option, in which case the term of
the notes would be extended to December 15, 2032.
As of June 30, 2002, Valero had $275.0 million of 8.625% Guaranteed Notes
outstanding, which matured on July 1, 2002. Valero refinanced this debt in July
2002 with borrowings under its bank credit facilities.
Under Valero's revolving bank credit facilities, Valero's debt-to-capitalization
ratio (net of cash) was 50.7% as of June 30, 2002. For purposes of this
computation, 50% of the $200 million of 8.32% Trust Originated Preferred
Securities assumed in the UDS Acquisition and 20% of the aggregate liquidation
amount of trust preferred securities issued as part of the PEPS Units were
included as debt.
On June 6, 2002, Valero L.P. and Valero Logistics Operations filed a $500.0
million universal shelf registration statement with the Securities and Exchange
Commission, under which debt and equity offerings can be made. On July 15, 2002,
Valero Logistics Operations completed the sale of $100.0 million of 6.875%
senior notes, issued under its shelf registration, for total proceeds of $99.7
million. The net proceeds of $98.5 million, after deducting underwriters'
commissions and offering expenses of $1.2 million, were used to pay off the
$91.0 million outstanding under the Valero Logistics Operations revolving credit
facility.
On March 22, 2002, Valero filed a $3.5 billion universal shelf registration
statement with the Securities and Exchange Commission. On April 15, 2002, Valero
sold to the public $1.8 billion of notes under its universal shelf registration
as follows:
o $300 million of 6.125% Senior Notes due April 15, 2007, priced to yield
6.17%;
o $750 million of 6.875% Senior Notes due April 15, 2012, priced to yield
6.91%; and
o $750 million of 7.5% Senior Notes due April 15, 2032, priced to yield
7.573%.
Proceeds from this offering were used to pay off the $1.5 billion bridge loan
facility and reduce borrowings under the bank credit facilities associated with
the UDS Acquisition. The net proceeds received by Valero from this offering were
approximately $1.8 billion, net of aggregate discount and commissions of
approximately $22 million.
In February 2002, Valero entered into a $170 million structured lease
arrangement with a non-consolidated third-party entity to combine a portion of
an existing structured lease assumed in the UDS Acquisition related to the UDS
headquarters facility with the funding of planned construction to expand this
facility for future use as Valero's new corporate headquarters. The portion of
the new arrangement related to the existing UDS facility is being accounted for
as an operating lease, while the portion related to planned construction will be
accounted for as an operating lease upon completion of the construction. This
structured lease has a lease term that expires in February 2007 and provides for
up to two one-year renewal periods exercisable at Valero's option. If Valero
elects to renew the lease, Valero is required to provide cash collateral in an
amount equal to the residual value guarantee, which is currently estimated to be
$147.7 million.
Valero has various long-term operating lease commitments that have been funded
through structured lease arrangements with non-consolidated third-party
entities. Certain of these leases, which were assumed in the UDS Acquisition,
were utilized to accommodate the construction of convenience stores. After the
initial lease term, the leases may be extended by agreement of the parties or
Valero may purchase the leased assets or arrange for the sale of the properties
to a third party at the lease expiration date. In August 2002, one of these
structured lease arrangements expires. Valero intends to purchase the
convenience stores associated with this lease. The expected purchase price of
the leased assets is approximately $19 million.
38
In September 1997, Valero sold approximately 7.5 million barrels of feedstock
and refined product inventories for $150.0 million and entered into a petroleum
products purchase agreement that matures in August 2002. Under this agreement,
Valero plans to exercise its option on August 30, 2002 to purchase feedstock and
refined product volumes equivalent to those sold at current market prices. As of
June 30, 2002, the fair value of the feedstock and refined product volumes under
this purchase option was approximately $200 million. Valero also currently holds
commodity price swap contracts to hedge this anticipated purchase of the
feedstock and refined product inventories. The commodity price swap contracts,
which also mature on August 30, 2002, are expected to reduce the cost of the
purchased inventories to approximately $150 million.
In connection with the UDS Acquisition, Valero assumed a similar arrangement,
which matured in June 2002, under which UDS originally sold approximately 6.4
million barrels of feedstock and refined product inventories for $140.0 million.
On June 20, 2002, Valero exercised its option to purchase the barrels under this
agreement for $140.9 million, net of the effect of a related commodity price
swap contract that also matured on June 20, 2002, resulting in a net pre-tax
benefit of $14 million.
Valero, through a wholly owned subsidiary, has an agreement, which matures in
September 2002, with a third-party financial institution to sell on a revolving
basis up to $150.0 million of eligible trade accounts receivable. In connection
with the UDS Acquisition, Valero assumed a $360.0 million revolving accounts
receivable sales facility, which matures in June 2003, under which Valero can
sell eligible credit card and trade accounts receivable on an ongoing basis
through a wholly owned subsidiary to a third party financial institution. Under
these agreements, the subsidiaries sell an undivided percentage ownership
interest in the eligible receivables, without recourse, to the third party
financial institutions which maintain a 3% equity interest at all times in their
undivided interest in the receivables. Valero remains responsible for servicing
the transferred receivables and pays certain fees related to its sale of
receivables under these programs. As of June 30, 2002, the amount of eligible
receivables sold to the third-party financial institutions under these programs
was $335.0 million.
Valero believes it has sufficient funds from operations, and to the extent
necessary, from the public and private capital markets and bank markets, to fund
its ongoing operating requirements. Valero expects that, to the extent
necessary, it can raise additional funds from time to time through equity or
debt financings. However, there can be no assurances regarding the availability
of any future financings or whether such financings can be made available on
terms acceptable to Valero.
Common Stock Repurchase Programs
Under common stock repurchase programs approved by Valero's Board of Directors,
Valero repurchases shares of its common stock from time to time for use in
connection with its employee benefit plans and other general corporate purposes.
During the seven months ended July 31, 2002, Valero repurchased shares of its
common stock at a cost of approximately $44 million.
Assets Held For Sale
Pursuant to a sale and purchase agreement dated February 4, 2002, and
subsequently amended on February 20 and May 3, 2002, Valero sold the Golden
Eagle Business to Tesoro on May 17, 2002 for $1.075 billion, which included an
estimated $130 million for refinery feedstock and refined product inventories.
Valero received cash proceeds of $925.0 million and two notes totaling $150.0
million. The two notes were recorded with an initial fair value of $58.9 million
using a discount rate of 16%, which represents Valero's best estimate of the
fair value of the notes at the closing date of the sale. The discount is being
amortized as interest income over the life of the notes. The proceeds received
from the sale of the Golden Eagle Business were used to reduce bank borrowings
and for other general corporate purposes.
39
Capital Investments
In connection with Valero's acquisitions of the Paulsboro Refinery and Basis
Petroleum, Inc., the sellers are entitled to receive payments in any of the five
years and ten years, respectively, following these acquisitions if certain
average refining margins during any of those years exceed a specified level. Any
payments due under these earn-out arrangements are limited based on annual and
aggregate limits. In May 2002, Valero made an earn-out contingency payment to
Salomon Inc in connection with Valero's acquisition of Basis Petroleum, Inc. of
$23.9 million.
For the year ending December 31, 2002, Valero expects to incur approximately
$800 million for capital investments, which includes deferred turnaround and
catalyst costs and approximately $150 million for environmental -related
projects. During the six months ended June 30, 2002, Valero expended $492.9
million for capital investments of which $365.4 million related to capital
expenditures and $127.5 million related to deferred turnaround costs. Capital
expenditures for the six months ended June 30, 2002 included:
o $100.6 million for the expansion of the fluid catalytic cracking unit
(FCCU) and the expansion of the alkylation unit at the Texas City Refinery.
Aggregate costs incurred for these projects through June 30, 2002 totaled
$163.3 million.
o $32.5 million to reconfigure the Three Rivers Refinery to produce clean
fuels in response to new low-sulfur regulations and to process a more sour
crude oil slate. Aggregate costs incurred for this project through June 30,
2002 totaled $58.6 million.
o $16.6 million to construct a cogeneration facility at the Benicia Refinery
to produce electric power and steam. Aggregate costs incurred for this
project through June 30, 2002 totaled $56.4 million. The cogeneration
facility is expected to begin operations in September 2002.
o $6.5 million to complete an FCCU expansion at the Krotz Springs Refinery.
Environmental Matters
Valero is subject to extensive federal, state and local environmental laws and
regulations, including those relating to the discharge of materials into the
environment, waste management, pollution prevention measures and characteristics
and composition of gasoline and distillates. Because environmental laws and
regulations are becoming more complex and stringent and new environmental laws
and regulations are continuously being enacted or proposed, the level of future
expenditures required for environmental matters will increase in the future. In
addition, any major upgrades in any of Valero's refineries could require
material additional expenditures to comply with environmental laws and
regulations. Although environmental costs may have a significant impact on
results of operations for a single period, Valero believes that these costs will
not have a material adverse effect on its financial position or liquidity.
In February 2000, the Environmental Protection Agency's (EPA) Tier II gasoline
standard was published in final form under the Clean Air Act. The standard will
ultimately require the sulfur content in gasoline to be reduced from
approximately 300 parts per million to 30 parts per million, on average at the
refinery gate. The regulation will be phased in beginning in 2004. In addition,
the EPA finalized its Tier II diesel standard to reduce the sulfur content of
on-road diesel fuel sold to highway consumers by 97%, from 500 parts per million
to 15 parts per million maximum at the retail pump, beginning June 1, 2006.
Valero has determined that modifications will be required at most of its
refineries as a result of the Tier II gasoline and diesel standards. Based on
current estimates, Valero believes capital expenditures of $1 billion will be
required, between now and 2006, for Valero to meet the new Tier II
specifications. This includes approximately $275 million for related projects at
two Valero refineries that will improve refinery yield and octane balance in
addition to providing hydrogen necessary for the removal of sulfur in connection
with the production of gasoline and diesel. Valero expects that such estimates
will change as additional engineering analyses are completed and progress is
made toward
40
construction of these various projects. The ultimate impact of these regulations
on Valero is subject to technology selection and timing uncertainties created by
permitting and construction. Valero expects to meet all Tier II gasoline and
distillate standards by the respective effective date, both in the U.S. and
Canada.
In 2000, the EPA issued to a majority of refiners operating in the United States
a series of information requests pursuant to Section 114 of the Clean Air Act as
part of an enforcement initiative. Valero received a Section 114 information
request pertaining to all of its refineries owned at that time. Valero completed
its response to the request and has provided additional clarification requested
by the EPA. After Valero received its Section 114 information request, Valero
acquired the Benicia Refinery and completed the El Paso Acquisition and the UDS
Acquisition. Valero has not been named in any proceeding. However, based in part
upon announced settlements and evaluation of its relative position, Valero
expects to incur penalties and related expenses in connection with its potential
settlement of this enforcement initiative. Valero believes that any potential
settlement penalties and expenses will be immaterial to its financial position.
However, Valero believes that any potential settlement with the EPA in this
matter will require various capital improvements or changes in operating
parameters, or both, at some or all of its refineries which could be material in
the aggregate.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
COMMODITY PRICE RISK
Valero is exposed to market risks related to the volatility of crude oil and
refined product prices, as well as volatility in the price of natural gas used
in its refining operations. In order to reduce the risks of these price
fluctuations, Valero uses derivative commodity instruments to hedge a portion of
its refinery feedstock and refined product inventories and a portion of its
unrecognized firm commitments to purchase these inventories (fair value hedges).
Valero also uses derivative commodity instruments to hedge the price risk of
forecasted transactions such as forecasted feedstock and natural gas purchases
and product sales (cash flow hedges). In addition, Valero uses derivative
commodity instruments to manage its exposure to price volatility on a portion of
its refined product inventories and on certain forecasted feedstock and refined
product purchases that do not receive hedge accounting treatment. These
derivative instruments are considered economic hedges for which changes in their
fair value are reported currently in operating income. Finally, Valero uses
derivative commodity instruments for trading purposes based on its fundamental
and technical analysis of market conditions.
The types of instruments used in Valero's hedging and trading activities
described above include swaps, futures and options. Valero's positions in
derivative commodity instruments are monitored and managed on a daily basis by a
risk control group to ensure compliance with Valero's stated risk management
policy which has been approved by Valero's Board of Directors.
The following tables provide information about Valero's derivative commodity
instruments as of June 30, 2002 and December 31, 2001 (dollars in millions,
except for the weighted-average pay and receive prices as described below),
including:
o fair value hedges - held to hedge refining inventories and unrecognized
firm commitments,
o cash flow hedges - held to hedge forecasted feedstock purchases and product
sales,
o economic hedges - (i) held to manage price volatility in refined product
inventories, and (ii) held to manage price volatility in forecasted
feedstock, natural gas and refined product purchases, and
o trading activity - held or issued for trading purposes.
41
Contract volumes are presented in thousands of barrels (for crude oil and
refined products) or in billions of British thermal units (for natural gas). The
weighted-average pay and receive prices represent amounts per barrel (for crude
oil and refined products) or amounts per million British thermal units (for
natural gas). Volumes shown for swaps represent notional volumes, which are used
to calculate amounts due under the agreements. The gain (loss) on swaps is equal
to the fair value amount and represents the excess of the receive price over the
pay price times the notional contract volumes. For futures and options, the gain
(loss) represents (i) the excess of the fair value amount over the contract
amount for long positions, and (ii) the excess of the contract amount over the
fair value amount for short positions. Additionally, for futures and options,
the weighted-average pay price represents the contract price for long positions
and the weighted-average receive price represents the contract price for short
positions. The weighted-average pay price and weighted-average receive price for
options represents their strike price. All derivative commodity instruments
assumed in connection with the UDS Acquisition were recorded at fair value on
December 31, 2001; therefore no gain (loss) is shown as of that date in the
tables below. Accordingly, swaps assumed in the UDS Acquisition have zero fair
value as of December 31, 2001 as the weighted-average pay price is equal to the
weighted-average receive price. Additionally, for futures and options assumed in
the UDS Acquisition, the contract amount is equal to the fair value of the
assumed contracts as of December 31, 2001.
42
June 30, 2002
------------------------------------------------------------------------
Wtd Avg Wtd Avg
Contract Pay Receive Contract Fair Gain
Volumes Price Price Value Value (Loss)
------- ----- ----- ---- ----- -----
Fair Value Hedges:
Swaps - long:
2002 (crude oil and refined products) 600 $(2.42) $(1.30) N/A $ 0.7 $ 0.7
Futures - long:
2002 (crude oil and refined products) 16,449 28.24 N/A 464.5 473.6 9.1
Futures - short:
2002 (crude oil and refined products) 20,390 N/A 26.95 549.5 563.9 (14.4)
Cash Flow Hedges:
Futures - long:
2002 (crude oil and refined products) 13,508 27.12 N/A 366.3 374.8 8.5
2003 (crude oil and refined products) 38 26.00 N/A 1.0 1.1 0.1
Futures - short:
2002 (crude oil and refined products) 10,324 N/A 27.10 279.8 285.2 (5.4)
Economic Hedges:
Swaps - long:
2002 (crude oil and refined products) 1,507 1.06 0.47 N/A (0.9) (0.9)
Swaps - short:
2002 (crude oil and refined products) 4,699 1.37 2.33 N/A 4.5 4.5
2003 (crude oil and refined products) 16,200 3.84 4.02 N/A 2.9 2.9
Futures - long:
2002 (crude oil and refined products) 8,472 28.23 N/A 239.2 245.2 6.0
2003 (crude oil and refined products) 142 27.32 N/A 3.9 4.1 0.2
Futures - short:
2002 (crude oil and refined products) 9,130 N/A 29.04 265.1 270.6 (5.5)
Options - long:
2002 (crude oil and refined products) 6,827 1.85 N/A 0.1 1.5 1.4
Options - short:
2002 (crude oil and refined products) 1,100 N/A 12.67 (0.2) (0.1) (0.1)
Trading Activities:
Swaps - long:
2002 (crude oil and refined products) 4,850 4.32 3.53 N/A (3.9) (3.9)
2003 (crude oil and refined products) 915 3.45 3.35 N/A (0.1) (0.1)
Swaps - short:
2002 (crude oil and refined products) 7,635 3.78 4.50 N/A 5.5 5.5
2003 (crude oil and refined products) 3,615 3.59 3.74 N/A 0.5 0.5
Futures - long:
2002 (crude oil and refined products) 17,424 26.10 N/A 454.7 473.7 19.0
2003 (crude oil and refined products) 700 26.14 N/A 18.3 18.8 0.5
2002 (natural gas) 900 3.12 N/A 3.0 3.1 0.1
Futures - short:
2002 (crude oil and refined products) 13,366 N/A 26.53 354.6 368.6 (14.0)
2003 (crude oil and refined products) 880 N/A 26.97 23.7 24.4 (0.7)
2002 (natural gas) 700 N/A 3.09 (2.2) (2.3) 0.1
Options - long:
2002 (crude oil and refined products) 13,855 19.48 N/A (1.7) 1.5 3.2
2003 (crude oil and refined products) 3,335 8.05 N/A 0.1 0.2 0.1
Options - short:
2002 (crude oil and refined products) 10,680 N/A 15.01 (5.2) ( 7.1) 1.9
2003 (crude oil and refined products) 168 N/A 0.68 - - -
43
December 31, 2001
----------------------------------------------------------------------
Wtd Avg Wtd Avg
Contract Pay Receive Contract Fair Gain
Volumes Price Price Value Value (Loss)
------- ----- ----- ----- ----- ------
Fair Value Hedges:
Swaps - long:
2002 (crude oil and refined products) 75 $ 1.20 $ 1.37 N/A $ - $ -
Futures - long:
2002 (crude oil and refined products) 1,428 24.73 N/A $35.3 33.6 (1.7)
Futures - short:
2002 (crude oil and refined products) 7,177 N/A 24.31 174.5 170.8 3.7
Cash Flow Hedges:
Swaps - short:
2002 (crude oil and refined products) 5,040 3.07 3.93 N/A 4.3 4.3
Futures - long:
2002 (crude oil and refined products) 13,845 21.35 N/A 295.5 291.8 (3.7)
Futures - short:
2002 (crude oil and refined products) 10,706 N/A 21.04 225.3 222.9 2.4
Options - short:
2002 (crude oil and refined products) 2,100 N/A 3.29 1.4 2.7 (1.3)
Economic Hedges:
Swaps - long:
2002 (crude oil and refined products) 724 7.36 7.36 N/A - -
2002 (natural gas) 13,663 2.84 2.84 N/A - -
Swaps - short:
2002 (natural gas) 11,403 3.90 3.90 N/A - -
Futures - long:
2002 (crude oil and refined products) 2,469 21.02 N/A 51.9 51.3 (0.6)
2003 (crude oil and refined products) 13 24.62 N/A 0.3 0.3 -
Futures - short:
2002 (crude oil and refined products) 11,523 N/A 21.30 245.5 244.2 1.3
2002 (natural gas) 300 N/A 2.98 0.9 0.8 0.1
Options - long:
2002 (crude oil and refined products) 250 0.29 N/A 0.1 0.1 -
Trading Activities:
Swaps - long:
2002 (crude oil and refined products) 4,575 5.37 5.24 N/A (0.6) (0.6)
Swaps - short:
2002 (crude oil and refined products) 5,150 3.86 4.15 N/A 1.5 1.5
Futures - long:
2002 (crude oil and refined products) 2,597 23.41 N/A 60.8 56.4 (4.4)
2002 (natural gas) 250 2.97 N/A 0.7 0.6 (0.1)
Futures - short:
2002 (crude oil and refined products) 2,597 N/A 23.66 61.4 57.3 4.1
2002 (natural gas) 900 N/A 2.88 2.6 2.3 0.3
Options - short:
2002 (crude oil and refined products) 600 N/A 4.47 0.5 0.9 (0.4)
2002 (natural gas) 600 N/A 3.29 0.2 0.1 0.1
In addition to the above, as of June 30, 2002 and December 31, 2001, Valero was
the fixed price payor under certain swap contracts held to hedge anticipated
purchases of refinery feedstocks and refined products that mature in August
2002, have notional volumes totaling approximately 7.5 million barrels, and have
a weighted-average pay price of $20.11 per barrel. As of June 30, 2002 and
December 31, 2001, these swaps had a weighted-average receive price of $26.74
and $20.53 per barrel, respectively, and a net after-tax gain recorded in other
comprehensive income of approximately $47 million and $17 million, respectively.
44
INTEREST RATE RISK
Valero's primary market risk exposure for changes in interest rates relates to
its long-term debt obligations. Valero manages its exposure to changing interest
rates principally through the use of a combination of fixed and floating rate
debt. In connection with the UDS Acquisition, Valero assumed certain interest
rate swap agreements entered into in order to manage exposure to changing
interest rates on certain fixed-rate debt obligations.
The following table provides information about the assumed long-term debt and
interest rate swaps, both of which are sensitive to changes in interest rates.
For long-term debt, principal cash flows and related weighted-average interest
rates by expected maturity dates are presented. For interest rate swaps, the
table presents notional amounts and weighted-average interest rates by expected
(contractual) maturity dates. Notional amounts are used to calculate the
contractual payments to be exchanged under the contract. Weighted-average
floating rates are based on implied forward rates in the yield curve at the
reporting date.
June 30, 2002
------------------------------------------------------------------------------------
Expected Maturity Dates
----------------------------------------------------------
There- Fair
2002 2003 2004 2005 2006 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
(in millions, except interest rates)
Long-term Debt:
Fixed rate................... $ 276.0 $ 28.8 $ 0.6 $396.6 $300.6 $3,056.1 $4,058.7 $ 4,219.6
Average interest rate...... 8.6% 8.2% 7.7% 8.1% 7.4% 7.1% 7.4%
Floating rate................ $ 514.6 - - - $ 91.0 - $ 605.6 $ 605.6
Average interest rate...... 3.1% - - - 2.5% - 3.0%
Interest Rate Swaps
Fixed to Floating:
Notional amount.............. $ 200.0 - - $150.0 - $ 100.0 $ 450.0 $ 19.3
Average pay rate........... 1.9% 2.8% 4.2% 4.8% 5.5% 6.5% 5.1%
Average receive rate....... 6.4% 6.6% 6.6% 6.6% 6.9% 6.9% 6.8%
On July 1, 2002, $275.0 million of long-term fixed rate debt and interest rate
swaps with a notional amount of $200.0 million matured. Valero refinanced the
debt with borrowings under its bank credit facilities.
December 31, 2001
--------------------------------------------------------------------------------------------
Expected Maturity Dates
--------------------------------------------------------------
There- Fair
2002 2003 2004 2005 2006 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
(in millions, except interest rates)
Long-term Debt:
Fixed rate................... $276.5 $28.8 $0.6 $396.6 $300.6 $1,256.2 $2,259.3 $2,310.7
Average interest rate...... 8.6% 8.2% 7.7% 8.1% 7.4% 7.3% 7.6%
Floating rate................ $ 21.5 - - - $541.0 - $ 562.5 $ 562.5
Average interest rate...... 4.0% - - - 2.7% - 2.7%
Interest Rate Swaps
Fixed to Floating:
Notional amount.............. $200.0 $ - $ - $150.0 $ - $ 100.0 $ 450.0 $ 17.8
Average pay rate........... 1.8% 3.9% 5.2% 5.6% 6.1% 6.5% 5.4%
Average receive rate....... 6.4% 6.6% 6.6% 6.6% 6.9% 6.9% 6.7%
45
FOREIGN CURRENCY RISK
Valero may enter into foreign currency exchange and purchase contracts to manage
its exposure to exchange rate fluctuations on transactions related to its
Canadian operations. During May 2002, Valero entered into foreign currency
exchange contracts to hedge its exposure to exchange rate fluctuations on an
investment in its Canadian operations. Under these contracts, Valero sold $400.0
million of Canadian dollars and bought $253.4 million of U.S. dollars. These
contracts mature annually at various amounts from 2003 through 2007. As of June
30, 2002, these contracts had a negative fair value of $6.1 million. This loss,
which was recognized in income for the three months and six months ended June
30, 2002, was more than offset by a gain recognized from the effect of the
exchange rate fluctuation on the hedged investment.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Unocal
Union Oil Company of California v. Valero Energy Corporation, United States
District Court, Central District of California (filed January 22, 2002) (this
matter was last reported in Valero's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002). On January 22, 2002, Union Oil Company of
California (Unocal) filed a patent infringement lawsuit against Valero in
California federal court. The complaint seeks a 5.75-cent per gallon royalty on
all reformulated gasoline infringing on Unocal's '393 and '126 patents. These
patents cover certain compositions of cleaner-burning gasoline. The complaint
seeks treble damages for Valero's alleged willful infringement of Unocal's
patents and Valero's alleged conduct to induce others to infringe the patents.
In a previous lawsuit involving its '393 patent, Unocal prevailed against five
other major refiners.
In August 2001, the FTC announced that it would begin an antitrust investigation
concerning Unocal's conduct with a joint industry research group during the time
that Unocal was prosecuting its patents at the U.S. Patent and Trademark Office
(PTO). The FTC could potentially issue an injunction against Unocal's
enforcement of its patents as a result of the FTC investigation. In 2001, the
PTO began a reexamination of Unocal's '393 patent, and in January 2002, the PTO
issued a notice of rejection of all claims of the '393 patent. In January 2002,
the PTO began a reexamination of Unocal's '126 patent, and on June 26, 2002,
issued a notice of rejection of all claims of the '126 patent. On July 3, 2002,
the PTO began a second reexamination of the '393 patent. The PTO has not issued
a final decision with respect to either patent. The three pending reexaminations
could affect the scope and validity of the patents.
By agreement, the court stayed the patent lawsuit until September 30, 2002, and
Valero will seek a further stay pending the outcome of the PTO reexamination
proceedings. Notwithstanding the judgment against the other refiners in the
previous litigation, Valero believes that it has several strong defenses to
Unocal's lawsuit, including those arising from Unocal's misconduct, and Valero
believes it will prevail in the lawsuit. However, due to the inherent
uncertainty of litigation, there can be no assurance that Valero will prevail,
and an adverse result could have a material adverse effect on Valero's results
of operations and financial position.
MTBE Litigation
Valero has been named as defendant in several cases alleging MTBE contamination
in groundwater in New York, Texas and California. Complaints in four New York
cases - including those in In re: MTBE Products Liability Litigation (formerly
styled Berisha and O'Brien v. Amerada Hess Corporation, et al.), Case No. MDL
1358, Master File C.A. No. 1:00-1898 [SAS], United States District Court for the
Southern District of New York - allege that the gasoline suppliers produced
46
and/or distributed gasoline that is alleged to be defective because it contained
MTBE. In In re: MTBE Products Liability Litigation, the plaintiffs sought to
certify a class composed of private well owners with detectable levels of MTBE.
On July 16, 2002, however, the court denied the plaintiffs' motion for class
certification, thereby reducing the case to the claims of the few individual
plaintiffs involved in the various consolidated actions. In two other New York
cases, on July 31, 2002 and August 1, 2002, the trial judge granted Valero's
motion to dismiss the lawsuits, upholding the defendants' argument that the
plaintiffs' claims were preempted by the Congressional objectives of the Clean
Air Act and the EPA's approval of the use of MTBE as an oxygenate.
County of Suffolk, et al. v. Atlantic Richfield Co. et al., United States
District Court for the Eastern District of New York (filed May 6, 2002). Valero
has been named but not served in a lawsuit filed by the Suffolk County Water
Authority and the County of Suffolk, New York against several defendants
including Valero. The complaint alleges MTBE contamination of the groundwater of
Suffolk County and seeks money damages and cleanup of the groundwater.
The four Texas cases are based on the alleged discharge of gasoline into East
Caddo Creek in Hunt County, Texas on March 9, 2000 when a pipeline belonging to
Explorer Pipeline Company ruptured. Valero was named in City of Dallas v.
Explorer Pipeline Company, Inc., Valero Energy Corporation, et al. (removed to
the United States District Court for the Northern District of Texas from the
160th State District Court, Dallas County, Texas) and three related private
landowner cases. In August 2002, Valero and representatives of the City of
Dallas negotiated a settlement of the Explorer lawsuit on terms immaterial to
Valero's results of operations and financial position. The settlement is subject
to formal approval by the City, which is expected in the third quarter of 2002.
The three California cases are primarily based on a product liability/product
defect theory, and are filed by local water providers, including the City of
Santa Monica, the City of Dinuba and Fruitridge Vista Water Company. In the New
York, Texas and California cases, the plaintiffs generally seek individual,
unquantified compensatory and punitive damages and attorneys' fees.
Valero believes it is unlikely that the final outcome of any one of these claims
or proceedings would have a material adverse effect on its results of operations
or financial position, but that an adverse result in a majority of these cases
could have a material adverse effect on Valero's results of operations and
financial position.
Environmental Matters
EPA Region VI v. Diamond Shamrock Refining and Marketing Company (Albuquerque
products terminal) (this matter was last reported in Valero's Annual Report on
Form 10-K for the year ended December 31, 2001). In 1998, the EPA issued a
notice of violation alleging noncompliance with certain Clean Air Act fuel
loading procedures, inspection and leak detection requirements, record-keeping
provisions, throughput limitations on certain tanks and VOC emissions
limitations. Valero recently settled this matter with the EPA and the Department
of Justice for an immaterial amount.
Bay Area Air Quality Management District (Benicia Refinery). Valero has received
15 violation notices (VNs) from the BAAQMD pertaining to Valero's Benicia
Refinery. The VNs were issued primarily from April 11, 2002 through July 25,
2002. Five of the VNs relate to alleged excess emissions in connection with
certain power failures at the refinery in the second quarter of 2002. The
remaining VNs allege excess emissions from or equipment failures at various
units at the refinery. No enforcement orders have been issued. Initial penalties
of $277,000 have been proposed by the BAAQMD. Valero is negotiating with the
BAAQMD to resolve these matters.
47
Colorado Department of Public Health and Environment (CDPHE) (Denver Refinery).
An initial consent order was issued jointly by the CDPHE and EPA in 1989 to
Colorado Refining Company (CRC), a wholly owned subsidiary of Valero, and Conoco
to address groundwater contamination under the two parties' adjacent refining
facilities in Colorado. In 1992, Conoco and CRC received a joint Notice of
Additional Work requiring the companies to install interim measures to meet
state groundwater standards at Sand Creek (down gradient from both refineries).
In 1998, Conoco and CRC received duplicate orders from CDPHE and EPA to install
new boundary controls at Sand Creek, evaluate the need for additional boundary
controls and to recover free product under the refineries. CRC has conducted
monitoring and other operations to comply with these orders. CRC expects that
the CDPHE will issue a new order to CRC late in 2002 that will specify the
installation requirements for a control system to contain groundwater at CRC's
property boundary. Valero estimates that the boundary control (extraction,
treatment and reinjection) system will cost approximately $3 million.
Michigan Department of Environmental Quality, et al. v. Imlay City Gas & Oil,
Inc. and TPI Petroleum, Inc., 30th State Judicial Circuit Court, Ingham County,
Michigan (filed June 28, 2002). This lawsuit is a civil action brought by the
Attorney General of the State of Michigan and the Michigan Department of
Environmental Quality (MDEQ) to enforce an Administrative Order for Response
Activity issued by the MDEQ. The Administrative Order requires the defendants to
take specific actions to abate and remedy releases of alleged hazardous
substances from a commercial petroleum dispensing station in Tuscola County,
Michigan. The defendants are present and prior owners of the station. TPI
Petroleum, Inc. (TPI) is a wholly owned subsidiary of Valero. TPI sold the
station in 1993 to Imlay City Gas & Oil, Inc. (Imlay). The plaintiffs seek
judicial enforcement of the Administrative Order and civil fines of up to
$25,000 per day of noncompliance for alleged violations of the Order. Plaintiffs
also seek reimbursement for the state's response activity costs and exemplary
damages equal to three times the amount of these costs. Valero believes that
most of the liability associated with this matter will be covered by Imlay's
indemnification obligations under the agreement between TPI and Imlay for the
sale of the station. Valero has filed a complaint against Imlay and its owner
for indemnification.
New Jersey Department of Environmental Protection (NJDEP) (Paulsboro Refinery)
(this matter was last reported in Valero's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2002). Valero received a Demand for Payment of
Stipulated Penalties from NJDEP dated February 1, 2002 for alleged noncompliance
with a prior Administrative Consent Order (the Demand). Valero recently resolved
the Demand upon payment of a penalty to NJDEP of less than $100,000. In early
2002, Valero also received four Administrative Orders and Notices of Civil
Administrative Penalty Assessments (Orders) from the NJDEP dated February 22,
2002, March 21, 2002, April 17, 2002 and April 19, 2002 for alleged
noncompliance with certain NJDEP stack testing, air emission, nuisance, and
record-keeping requirements. In the second quarter 2002, Valero also received an
Order dated June 7, 2002 with similar allegations pertaining to the Paulsboro
refinery's FCC Unit. The aggregate proposed penalties for the violations alleged
in these Orders has been revised to approximately $159,400. Valero is
negotiating with the NJDEP to resolve these issues.
Texas Natural Resource Conservation Commission (TNRCC) (Corpus Christi West
Plant) (this matter was last reported in Valero's Annual Report on Form 10-K for
the year ended December 31, 2001). Valero received notices of enforcement from
the TNRCC on May 1, 2001; June 22, 2001; August 30, 2001; and December 7, 2001,
for alleged noncompliance with certain TNRCC air upset, air emission and
record-keeping requirements. After further investigation, the TNRCC is revising
its proposed penalties for these matters, which Valero believes will be an
amount less than $100,000.
TNRCC (Texas City Refinery) (this matter was last reported in Valero's Annual
Report on Form 10-K for the year ended December 31, 2001). Valero previously
reported receiving a notice of violation from the TNRCC in January 2002
regarding alleged violations of requirements for air quality at the Texas City
refinery. Following a violation review meeting, the TNRCC formally rescinded the
notice of violation from Valero's compliance history on March 15, 2002.
48
TNRCC (Three Rivers Refinery) (this matter was last reported in Valero's Annual
Report on Form 10-K for the year ended December 31, 2001). A notice of
enforcement from the TNRCC was issued on August 31, 2001 for alleged
noncompliance with certain air upset/maintenance regulations and record-keeping
requirements. After further review, the TNRCC determined that the alleged
violations were not sufficiently serious in nature to warrant the immediate
initiation of formal enforcement, and reduced the enforcement notice to a notice
of violation. Valero does not expect the matter to result in potential monetary
sanctions in excess of $100,000.
Item 4. Submission of Matters to a Vote of Security Holders
Valero's annual meeting of stockholders was held May 9, 2002. Matters voted on
at the meeting and the results thereof were as follows:
(i) a proposal to elect two Class I directors to serve until the 2004 annual
meeting, four Class II directors to serve until the 2005 annual meeting,
and one Class III director to serve until the 2003 annual meeting was
approved as follows:
Affirmative Abstentions
----------- -----------
Class I Directors
E. Glenn Biggs..................... 90,101,051 1,058,869
Bob Marbut......................... 90,575,006 584,914
Class II Directors
Ronald K. Calgaard................. 90,594,868 565,052
William E. Greehey................. 90,595,090 564,830
Susan Kaufman Purcell.............. 90,102,325 1,057,595
W.E. Bradford...................... 90,098,434 1,061,486
Class III Director
W.H. Clark......................... 90,598,143 561,777
(ii) a proposal to ratify the appointment of Ernst & Young LLP as independent
public accountants to examine Valero's accounts for the year 2002 was
approved as follows:
Affirmative Negative Abstentions
----------- -------- -----------
88,749,472 2,344,758 65,690
Directors whose terms of office continued after the annual meeting were: Donald
M. Carlton, Jerry D. Choate, Robert G. Dettmer, Ruben M. Escobedo and William B.
Richardson. Effective June 30, 2002, William B. Richardson resigned from the
board to pursue the office of governor of New Mexico.
49
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit 99.1 Certification of William E. Greehey Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
Exhibit 99.2 Certification of John D. Gibbons Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
(i) On April 3, 2002, Valero filed an amendment on Form 8-K/A to its
Current Report on Form 8-K dated March 12, 2002 (filed March 14, 2002) reporting
Item 4 (Changes in Registrant's Certifying Accountant) in connection with
Valero's dismissal on March 12, 2002 of Arthur Andersen LLP and retention of
Ernst & Young LLP as Valero's independent auditors for the fiscal year ending
December 31, 2002. Financial statements were not filed with this report.
(ii) On April 15, 2002, Valero filed a Current Report on Form 8-K dated
April 10, 2002 reporting Item 5 (Other Events) in connection with Valero's
execution of an underwriting agreement for the public offering of $300,000,000
aggregate principal amount of its 6 1/8% Notes due 2007, $750,000,000 aggregate
principal amount of its 6 7/8% Notes due 2012 and $750,000,000 aggregate
principal amount of its 7 1/2% Notes due 2032 (the Notes). The issuance and sale
of the Notes closed on April 15, 2002. Financial statements were not filed with
this report.
(iii) On May 23, 2002, Valero filed pursuant to Regulation FD a Current
Report on Form 8-K dated May 23, 2002 reporting Item 9 (Regulation FD
Disclosure) furnishing a copy of the slide presentation made by Valero's
management to attendees at the May 23, 2002 Refining & Marketing Conference in
Quebec, Canada. Financial statements were not filed with this report.
50
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By: /s/ John D. Gibbons
----------------------------------
John D. Gibbons
Executive Vice President and Chief
Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Date: August 13, 2002
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Valero Energy Corporation (the
"Company") on Form 10-Q for the quarter ending June 30, 2002, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"),
I, William E. Greehey, Chief Executive Officer of the Company, hereby
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ William E. Greehey
------------------------------------
William E. Greehey
Chief Executive Officer
August 13, 2002
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Valero Energy Corporation (the
"Company") on Form 10-Q for the quarter ending June 30, 2002, as filed with
the Securities and Exchange Commission on the date hereof (the "Report"),
I, John D. Gibbons, Chief Financial Officer of the Company, hereby certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ John D. Gibbons
------------------------------------
John D. Gibbons
Chief Financial Officer
August 13, 2002