UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 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 78212
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (210) 370-2000
Securities registered pursuant to Section 12(b) of the Act: Common stock, $0.01
par value, and Preferred Share Purchase Rights, listed on the New York Stock
Exchange.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule12b-2 of the Act). Yes X No_
The aggregate market value of the voting and non-voting common stock held by
non-affiliates was approximately $4.0 billion based on the last sales price
quoted as of June 28, 2002, the last business day of the registrant's most
recently completed second fiscal quarter.
As of February 28, 2003, 107,634,756 shares of the registrant's common stock
were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Valero intends to file with the Securities and Exchange Commission in March 2003
a definitive Proxy Statement for Valero's Annual Meeting of Stockholders
scheduled for April 24, 2003, at which directors of Valero will be elected.
Portions of the 2003 Proxy Statement are incorporated by reference in Part III
of this Form 10-K and are deemed to be a part of this report.
CROSS-REFERENCE SHEET
The following table indicates the headings in the 2003 Proxy Statement where the
information required in Part III of Form 10-K may be found.
Form 10-K Item No. and Caption Heading in 2003 Proxy Statement
- ------------------------------ -------------------------------
10. Directors and Executive Officers of the
Registrant.................................... Proposal No. 1 - Election of Directors, Information
Concerning Nominees and Other Directors and Section 16(a)
Beneficial Ownership Reporting Compliance
11. Executive Compensation........................... Executive Compensation, Report of the Compensation
Committee of the Board of Directors on Executive
Compensation and Performance Graph
12. Security Ownership of Certain Beneficial
Owners and Management and Related
Stockholder Matters........................... Beneficial Ownership of Valero Securities
13. Certain Relationships and Related
Transactions.................................. Certain Relationships and Related Transactions
Copies of all documents incorporated by reference, other than exhibits to such
documents, will be provided without charge to each person who receives a copy of
this Form 10-K upon written request to Jay D. Browning, Vice President and
Corporate Secretary, Valero Energy Corporation, P.O. Box 500, San Antonio, Texas
78292-0500.
2
CONTENTS
PAGE
PART I
Items 1. & 2. Business & Properties........................................................ 4
Recent Developments........................................................ 5
Segments................................................................... 6
Valero's Operations........................................................ 7
Competition................................................................ 15
Environmental Matters...................................................... 15
Employees.................................................................. 17
Properties................................................................. 17
Executive Officers of the Registrant....................................... 18
Item 3. Legal Proceedings............................................................ 19
Item 4. Submission of Matters to a Vote of Security Holders.......................... 22
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........ 23
Item 6. Selected Financial Data...................................................... 24
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................... 50
Item 8. Financial Statements and Supplementary Data.................................. 55
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................................... 112
PART III
Item 10. Directors and Executive Officers of the Registrant........................... 112
Item 11. Executive Compensation....................................................... 112
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters............................................ 112
Item 13. Certain Relationships and Related Transactions............................... 112
Item 14. Controls and Procedures...................................................... 112
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............. 113
Signatures ............................................................................. 118
Certifications ............................................................................. 120
3
CAUTIONARY STATEMENTS RELEVANT TO FORWARD-LOOKING INFORMATION FOR THE PURPOSE OF
SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
This Form 10-K 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 generally can be
identified by the words "anticipate," "believe," "expect," "plan," "intend,"
"estimate," "project," "budget," "forecast," "will," "could," "should," "may"
and similar expressions.
Some important factors (but not necessarily all factors) that could affect
Valero's sales, growth, profitability and operating results, or that otherwise
could cause actual results to differ materially from those forecasted by Valero
are discussed in (a) Part I of this report under the headings "Competition" and
"Environmental Matters," (b) Management's Discussion and Analysis of Financial
Condition and Results of Operations under the heading "Forward-Looking
Statements," and (c) Valero's other filings with the Securities and Exchange
Commission. Valero does not intend to update these statements unless the
securities laws require Valero to do so, and Valero does not undertake to
release publicly the result of any revisions to any forward-looking statements
that may be made to reflect events or circumstances after the date of this Form
10-K or to reflect the occurrence of unanticipated events.
PART I
ITEMS 1. & 2. BUSINESS & PROPERTIES
Valero Energy Corporation(1) is a Fortune 500 company based in San Antonio,
Texas with approximately 20,000 employees and annual revenues of nearly $27
billion. Valero's common stock trades on the New York Stock Exchange under the
symbol "VLO." Valero's principal executive offices are located at One Valero
Place, San Antonio, Texas, 78212, and its telephone number is (210) 370-2000.
When used in this report, the term "Valero" may refer, depending upon the
context, to Valero Energy Corporation, to one or more of its consolidated
subsidiaries or to all of them taken as a whole.
Valero's annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant
to the Securities Exchange Act of 1934 are available free of charge on Valero's
internet website at http://www.valero.com as soon as reasonably practicable
after Valero electronically files such material with, or furnishes it to, the
Securities and Exchange Commission.
Valero is one of the top three U.S. refining companies in terms of refining
capacity, and is the largest independent refining and marketing company in the
United States. Valero owns and operates 12 refineries in the United States and
Canada with a combined throughput capacity of approximately 1.9 million barrels
per day (BPD) and total crude oil capacity of approximately 1.5 million BPD.
Valero's refining network extends from eastern Canada to the U.S. Gulf Coast and
West Coast. Valero produces premium, environmentally clean products such as
reformulated
- -------------------
(1) Valero was incorporated in Delaware in 1981 under the name Valero Refining
and Marketing Company. On August 1, 1997, Valero's name was changed from Valero
Refining and Marketing Company to Valero Energy Corporation.
4
gasoline (RFG), gasoline meeting the specifications of the California Air
Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and
oxygenates.(2) Valero also produces a substantial slate of conventional
gasolines, distillates, jet fuel, asphalt and petrochemicals.
Valero is also a leading marketer of refined products. Valero markets branded
and unbranded refined products on a wholesale basis in the United States and
Canada through an extensive bulk and rack marketing network. Valero also markets
refined products and convenience store merchandise through a network of
approximately 4,100 retail outlets in the United States and Canada under various
brand names including Diamond Shamrock(R), Shamrock(R), Ultramar(R), Valero(R),
Beacon(R), Total(R) and Exxon(R). Valero's business tends to be seasonal to the
extent of increased demand for gasoline during the summer driving season and, in
the northeast regions, increased demand for home heating oil during the winter
months.
Through agreements with Valero L.P., Valero also has access to a logistics
system that complements Valero's refining and marketing assets in the U.S. Gulf
Coast and Mid-Continent regions. Valero owns approximately 49 percent (including
the general partner interest) of Valero L.P., a master limited partnership that
owns and operates crude oil pipelines, crude oil and intermediate feedstock
storage facilities, and refined product pipelines and terminals primarily in
Texas, Oklahoma, New Mexico and Colorado. Units of Valero L.P. are listed on the
New York Stock Exchange under the symbol "VLI."
RECENT DEVELOPMENTS
Valero L.P. Common Units and Debt Offering. Effective March 18, 2003, Valero
L.P. issued 5,750,000 common units to the public for aggregate proceeds of
approximately $211 million and completed a private placement of $250 million of
debt. The net proceeds from those offerings, combined with borrowings under
Valero L.P.'s credit facility, were used to fund a redemption of common units
from Valero and the acquisition of certain storage tanks and a pipeline system
from Valero discussed below.
Redemption of Common Units and Amendment to Partnership Agreement. Following the
equity and debt offerings discussed above, Valero L.P. redeemed approximately
3.8 million of its common units from subsidiaries of Valero, effectively
reducing Valero's ownership of Valero L.P. from approximately 73 percent to
approximately 49 percent. At the same time, Valero L.P. also amended its
partnership agreement to state that the general partner of Valero L.P. may be
removed by the vote of the holders of at least 58 percent of Valero L.P.'s
common and subordinated units, excluding the units held by affiliates of its
general partner. As a result of the partnership agreement changes and the
issuance and redemption of Valero L.P. common units, Valero will cease
consolidation of Valero L.P.
Contribution of Storage Tanks and Pipeline System. Following the equity and debt
offerings and the common unit redemption discussed above, Valero contributed to
Valero L.P. 58 crude oil and intermediate feedstock storage tanks located at
Valero's Corpus Christi, Texas City and Benicia refineries for approximately
$200 million in cash. The storage tanks have a capacity of approximately 11
million barrels. Valero also contributed to Valero L.P. a refined products
pipeline system for approximately $150 million in cash. The three-pipeline
system connects Valero's Corpus Christi and Three Rivers refineries to markets
in Houston, San Antonio and the Texas Rio Grande Valley. In connection with the
contribution of these assets, Valero entered into certain throughput, handling,
terminalling and service agreements with Valero L.P.
- ---------------
(2) "Oxygenates" are liquid hydrocarbon compounds containing oxygen. Gasoline
that contains oxygenates ususally has lower carbon monoxide emissions than
conventional gasoline. MTBE (methyl tertiary butyl either) is an oxygenate-rich,
high-octane gasoline blendstock produced by reacting methanol and isobutylene,
and is used to manufacture oxygenated and reformulated gasolines.
5
Acquisition of Ultramar Diamond Shamrock Corporation. Effective December 31,
2001, Valero completed the merger of Ultramar Diamond Shamrock Corporation (UDS)
into Valero Energy Corporation, with Valero being the surviving corporation. The
transaction is referred to in this report as the UDS Acquisition. In the merger,
each outstanding share of UDS common stock, other than treasury shares (which
were cancelled) and shares in employee benefit plans (which were converted
directly into Valero common stock), was converted into the right to receive, at
the shareholder's election but subject to proration, either (i) cash, (ii) a
number of shares of Valero common stock, or (iii) a combination of cash and
Valero common stock, in each case having a value equal to the sum of $27.50 and
..614 shares of Valero common stock (valued at the average closing Valero common
stock price over a ten trading-day period ending three days prior to the
merger). Merger consideration paid by Valero to UDS shareholders included
approximately $2.1 billion in cash and 45.9 million shares of Valero common
stock (based on an average Valero common stock price of $35.78 during the
measurement period).
UDS was an independent refiner and retailer of refined products and convenience
store merchandise in the central, southwest and northeast regions of the United
States and eastern Canada. UDS owned and operated seven refineries, including
two in Texas, two in California and one each in Oklahoma, Colorado and Quebec
with a combined throughput capacity of approximately 850,000 BPD. UDS marketed
refined products and a broad range of convenience store merchandise through a
wide network of convenience stores in the United States and eastern Canada.
UDS's Northeast operations also included a retail home heating oil business.
As a condition to approval of the UDS Acquisition, the Federal Trade Commission
required Valero to sell UDS's 168,000 BPD Golden Eagle Refinery located in the
San Francisco Bay Area, its related wholesale marketing business, and 70
associated Beacon- and Ultramar-branded retail sites in Northern California.
Valero sold these assets on May 17, 2002 to Tesoro Refining and Marketing
Company for $1.075 billion. See Note 6 of Notes to Consolidated Financial
Statements.
SEGMENTS
Valero's primary reportable business segments are refining and retail. Valero's
refining segment includes refining operations, wholesale marketing, product
supply and distribution, and transportation operations. The refining segment is
segregated geographically into the Gulf Coast, Mid-Continent, West Coast and
Northeast regions. Valero's retail segment includes company-operated convenience
stores, Canadian dealers/jobbers, truckstop facilities, cardlocks and home
heating oil operations. The retail segment is also segregated geographically.
Valero's retail operations in the northeastern United States and eastern Canada
are referred to as the Northeast System, and Valero's remaining retail
operations in the United States are referred to as the U.S. System. See Note 20
of Notes to Consolidated Financial Statements for financial information about
Valero's segments.
6
VALERO'S OPERATIONS
REFINING
Valero's refining operations include 12 refineries with a combined total
throughput capacity of approximately 1.9 million BPD. The following table lists
the location of each of Valero's refineries and its respective feedstock
throughput capacity.
Refinery Location Throughput Capacity (a)
(barrels per day)
----------------
Gulf Coast:
Corpus Christi Texas 340,000
Texas City Texas 243,000
Houston Texas 135,000
Three Rivers Texas 98,000
Krotz Springs Louisiana 85,000
-------
901,000
-------
West Coast:
Benicia California 180,000
Wilmington California 140,000
-------
320,000
-------
Mid-Continent:
McKee Texas 170,000
Ardmore Oklahoma 85,000
Denver Colorado 27,000
-------
282,000
-------
Northeast:
Jean Gaulin Quebec, Canada 215,000
Paulsboro New Jersey 195,000
-------
410,000
-------
Total 1,913,000
=========
--------
(a) Throughput capacity includes crude oil, intermediates and other
feedstocks. Total crude oil capacity is approximately 1,500,000 BPD.
Valero's refineries produce gasolines, distillates, asphalt and other refined
products. Gasolines and blendstocks represent about 55 percent of Valero's
refined product slate. Distillates - such as home heating oil, diesel fuel and
jet fuel - represent about 30 percent, while asphalt, lubricants, petrochemicals
and other heavy products comprise the remaining 15 percent. Of the gasoline that
Valero produces, about 40 percent is reformulated gasoline and CARB gasoline,
which sell at a premium over conventional grades of gasoline. About 75 percent
of Valero's distillate slate is low-sulfur diesel, CARB diesel and jet fuel,
which sell at a premium over high-sulfur heating oil.
7
GULF COAST
Valero's Gulf Coast refining region includes the Corpus Christi Refinery, the
Texas City Refinery, the Houston Refinery, the Three Rivers Refinery and the
Krotz Springs Refinery. The following table presents the percentages of
principal feedstock charges and product yields (on a combined basis) for the
five refineries in this region for the year ended December 31, 2002.
Combined Gulf Coast Region Feedstocks and Products
2002 Actual
-----------
Percentage
----------
Feedstocks:
sour crude oil 48%
sweet crude oil 21%
residual fuel oil 11%
other feedstocks and blendstocks 20%
Products:
gasolines and blendstocks 55%
distillates 25%
petrochemicals 5%
lubes and asphalts 3%
other products 12%
Corpus Christi Refinery. The Corpus Christi Refinery is located along the Corpus
Christi Ship Channel on the Texas Gulf Coast. The refinery is composed of two
plants, Valero's flagship West Plant and the recently acquired East Plant. The
West Plant is a highly complex refinery that specializes in processing primarily
lower-cost sour crude oil and residual fuel oil (resid) into premium products
such as RFG and CARB gasoline. Valero has substantially integrated the
operations of the West Plant and the East Plant, allowing for the transfer of
various feedstocks and blending components between the plants and the sharing of
resources. The refinery typically receives and delivers its feedstocks and
products by tanker and barge via deep-water docking facilities along the Corpus
Christi Ship Channel. In addition, the refinery has an eight-bay truck rack for
servicing local markets and ultimately uses the Colonial, Explorer, Valley and
other major pipelines - including Valero L.P.'s pipelines - for distribution of
its products.
Texas City Refinery. The Texas City Refinery is located approximately 40 miles
southeast of Houston on the Texas City Ship Channel. The Texas City Refinery
processes primarily lower-cost sour crude oils into a wide slate of products. A
45,000 BPD coking unit and related facilities are being constructed at the
refinery and are expected to be operational in late 2003. The refinery typically
receives and delivers its feedstocks and products by tanker and barge via
deep-water docking facilities along the Texas City Ship Channel and also has
access to the Colonial, Explorer and TEPPCO pipelines for distribution of its
products.
Houston Refinery. The Houston Refinery is located on the Houston Ship Channel.
The refinery typically receives its feedstocks via tanker at deep-water docking
facilities along the Houston Ship Channel. The refinery primarily delivers its
products through major product pipelines, including the Colonial, Explorer and
TEPPCO pipelines.
Three Rivers Refinery. The Three Rivers Refinery is located in South Texas
between Corpus Christi and San Antonio. The Three Rivers Refinery has access to
crude oil from foreign sources delivered to the Texas Gulf Coast at Corpus
Christi as well as crude oil from domestic sources through third-party
pipelines. A 70-mile pipeline that can deliver 120,000 BPD of crude oil connects
the Three Rivers Refinery to Corpus Christi. Valero distributes refined products
produced at this refinery primarily through pipelines owned by Valero L.P.
8
Krotz Springs Refinery. The Krotz Springs Refinery is located between Baton
Rouge and Lafayette, Louisiana on the Atchafalaya River. The refinery's location
provides access to upriver markets on the Mississippi River, and its docking
facilities along the Atchafalaya River are sufficiently deep to allow barge
access. The facility also uses the Colonial pipeline to transport products to
markets in the Southeast and Northeast.
WEST COAST
Valero's West Coast refining region includes the Benicia Refinery and the
Wilmington Refinery. The following table presents the percentages of principal
feedstock charges and product yields (on a combined basis) for the two
refineries in this region for the year ended December 31, 2002.
Combined West Coast Region Feedstocks and Products
2002 Actual
-----------
Percentage
----------
Feedstocks:
sour crude oil 66%
sweet crude oil 3%
residual fuel oil 0%
other feedstocks and blendstocks 31%
Products:
gasolines and blendstocks 65%
distillates 19%
petrochemicals 0%
lubes and asphalts 3%
other products 13%
Benicia Refinery. The Benicia Refinery is located northeast of San Francisco on
the Carquinez Straits of San Francisco Bay. It is a highly complex refinery that
processes sour crude oils into a high percentage of premium products, primarily
CARB gasoline. The refinery can receive crude oil supplies via a deep-water dock
that can berth large crude oil carriers and a 20-inch crude oil pipeline
connected to a southern California crude oil delivery system. Most of the
refinery's products are distributed via the Kinder Morgan pipeline in
California.
Wilmington Refinery. The Wilmington Refinery is located near Los Angeles,
California. The refinery processes a blend of lower-cost heavy and high-sulfur
crude oils. The refinery can produce all of its gasoline as CARB gasoline. The
refinery is connected by pipeline to marine terminals and associated dock
facilities that can move and store crude oil and other feedstocks. Refined
products are distributed via a third-party pipeline and terminals in southern
California, Nevada and Arizona.
9
MID-CONTINENT
Valero's Mid-Continent refining region includes the McKee Refinery, the Ardmore
Refinery and the Denver Refinery. The following table presents the percentages
of principal feedstock charges and product yields (on a combined basis) for the
three refineries in this region for the year ended December 31, 2002.
Combined Mid-Continent Region Feedstocks and Products
2002 Actual
-----------
Percentage
----------
Feedstocks:
sour crude oil 20%
sweet crude oil 74%
residual fuel oil 0%
other feedstocks and blendstocks 6%
Products:
gasolines and blendstocks 59%
distillates 27%
petrochemicals 3%
lubes and asphalts 8%
other products 3%
McKee Refinery. The McKee Refinery is located in the Texas Panhandle. The McKee
Refinery has access to crude oil from Texas, Oklahoma, Kansas and Colorado
through Valero L.P.'s pipelines and third-party pipelines. The refinery also has
access at Wichita Falls, Texas to third-party pipelines that transport crude oil
from the Texas Gulf Coast and West Texas to the Mid-Continent region. The
refinery distributes its products primarily via Valero L.P.'s pipelines to
markets in North Texas, New Mexico, Arizona, Colorado and Oklahoma.
Ardmore Refinery. The Ardmore Refinery is located in Ardmore, Oklahoma,
approximately 90 miles from Oklahoma City. Crude oil is delivered to the
refinery through Valero L.P.'s crude oil gathering and trunkline systems,
third-party pipelines and trucking operations. Refined products are transported
via pipelines, rail cars and trucks.
Denver Refinery. The Denver Refinery is located outside Denver, Colorado. Crude
oil for the refinery is supplied by a third-party pipeline and by truck. The
refinery benefits from a refined product pipeline that runs from the McKee
Refinery, which enhances flexibility of operations at both refineries.
10
NORTHEAST
Valero's Northeast refining region includes the Jean Gaulin Refinery in Quebec,
Canada and the Paulsboro Refinery in New Jersey. The following table presents
the percentages of principal feedstock charges and product yields (on a combined
basis) for the two refineries in this region for the year ended December 31,
2002.
Combined Northeast Region Feedstocks and Products
2002 Actual
-----------
Percentage
----------
Feedstocks:
sour crude oil 38%
sweet crude oil 57%
residual fuel oil 0%
other feedstocks and blendstocks 5%
Products:
gasolines and blendstocks 42%
distillates 38%
petrochemicals 1%
lubes and asphalts 6%
other products 13%
Jean Gaulin Refinery. Valero's Jean Gaulin Refinery is located in Levis, Canada
(near Quebec City). The refinery receives crude oil by ship at its deep-water
dock on the St. Lawrence River. Valero charters large ice-strengthened,
double-hulled crude oil tankers that can navigate the St. Lawrence River
year-round. The refinery's production is transported primarily by unit trains to
markets in Quebec and New Brunswick, and by tankers and trucks to markets in
Canada's Atlantic Provinces.
Paulsboro Refinery. The Paulsboro Refinery is located in Paulsboro, New Jersey
approximately 15 miles south of Philadelphia on the Delaware River. The refinery
processes primarily sour crude oils into a wide slate of products including
gasoline, distillates, a variety of lube oil basestocks, asphalt and fuel oil.
Feedstocks and refined products are typically transported by tanker and barge
via refinery-owned dock facilities along the Delaware River, Exxon Mobil
Corporation's product distribution system, an onsite truck rack and the Colonial
pipeline, which allows products to be sold into the New York Harbor market.
WHOLESALE MARKETING
Valero is a leading wholesale marketer of unbranded and branded refined
products. Valero markets on a wholesale basis in about 40 U.S. states and Canada
primarily through an extensive bulk and rack marketing network. Approximately
90% of Valero's gasoline and distillate production is distributed through bulk
(60%) and rack (30%) channels. Approximately 75% of Valero's wholesale volumes
are sold through unbranded channels; the remainder is sold through approximately
1,800 branded sites in the United States under several brand names including
Diamond Shamrock(R), Shamrock(R), Ultramar(R), Valero(R), Beacon(R), Total(R)
and Exxon(R). Valero expects to consolidate the number of brands used in its
various markets. For the wholesale branded sites, Valero intends to move to the
Valero(R) and Beacon(R) brands in California, and to the Valero(R) and
Shamrock(R) brands in the Northeast United States. In the Mid-Continent and
Southwest regions, Valero will use the Diamond Shamrock(R) and Shamrock(R)
brands. Valero's Canadian wholesale operations will continue to use the
Ultramar(R) brand.
11
Valero's bulk gasoline and distillate sales are made to various oil companies
and gasoline distributors and are transported by pipeline, barges and tankers.
The principal purchasers of Valero's transportation fuels from terminal truck
racks are wholesalers, distributors, retailers and end users (such as railroads,
airlines and utilities) throughout the United States. Most of Valero's
refineries have access to deep-water transportation facilities, and all
interconnect with common-carrier pipeline systems, allowing Valero to sell
products in most major geographic regions of the United States and eastern
Canada.
Valero also enters into refined product exchange and purchase agreements. These
agreements enable Valero to minimize transportation costs, optimize refinery
utilization, balance refined product availability, broaden geographic
distribution and sell to markets not connected to Valero's refined product
pipeline system. Exchange agreements provide for the delivery of refined
products to unaffiliated companies at Valero's and third parties' terminals in
exchange for delivery of a similar amount of refined products to Valero by these
unaffiliated companies at specified locations. Purchase agreements involve
Valero's purchase of refined products from third parties with delivery occurring
at specified locations. Most of these agreements are long-standing arrangements.
However, they generally can be terminated with 30 to 90 days notice. Valero does
not anticipate an interruption in its ability to exchange or purchase refined
products in the near future.
Valero also sells a variety of other products produced at its refineries
including asphalt, lube base oils and commodity petrochemicals. These products
are transported via pipelines, barges, trucks and railcars. Valero produces and
markets approximately 60,000 BPD of asphalt to customers in the paving and
roofing industries. Valero is the second largest producer of asphalt in the
United States. Valero produces asphalt at nine refineries and markets asphalt
from coast to coast in 20 states through 13 terminal facilities.
Lube base oils are produced at Valero's Paulsboro Refinery and are sold to a
variety of customers, including ExxonMobil under a long-term agreement.
ExxonMobil purchases about 50% of the refinery's lube oil production with the
balance sold to independent motor oil and industrial lubricant customers.
Valero produces and markets a variety of commodity petrochemicals including
aromatic solvents (benzene, toluene, and xylene), refinery- and chemical-grade
propylene and anhydrous ammonia. Aromatic solvents and propylene are sold to
customers in the chemical industry for further processing into such products as
paints, plastics and adhesives. Ammonia, produced at Valero's McKee Refinery, is
sold to customers in the agriculture industry to be used as fertilizer.
No customer accounted for more than 10 percent of Valero's total operating
revenues in 2002.
FEEDSTOCK SUPPLY
Valero processes a wide slate of feedstocks including sour crude oils,
intermediates and resid, which can typically be purchased at a discount to West
Texas Intermediate, a benchmark crude oil. Sour crude oils and resid represent
approximately 60 percent of Valero's present feedstock slate, sweet crude oils
represent approximately 30 percent, and the remaining 10 percent is composed of
blendstocks and other feedstocks.
About two-thirds of Valero's crude oil feedstock requirements are purchased
through term contracts. The remainder of Valero's feedstock requirements are
generally purchased on the spot market. Valero's term supply agreements include
arrangements to purchase feedstocks directly or indirectly from various foreign
national oil companies (including feedstocks originating in Saudi Arabia,
Mexico, Iraq, Kuwait, Venezuela and Africa) and domestic integrated oil
companies at market-related prices. Valero uses the futures market to manage the
price risk inherent in purchasing crude oil in advance of its delivery date and
in maintaining Valero's inventories.
12
Valero's U.S. network of crude oil pipelines and terminals (including those
facilities owned by Valero L.P.) allows Valero to acquire crude oil from
producing leases, domestic crude oil trading centers and ships delivering
cargoes of foreign and domestic crude oil. The network also allows Valero to
transport crude oil supplies to many of its U.S. refineries at a competitive
cost (compared to facilities that lack proprietary supply networks). Valero's
Jean Gaulin Refinery relies on foreign crude oil that is delivered to its St.
Lawrence River dock facility by ship.
Valero's cost to acquire feedstocks, and the price for which Valero ultimately
can sell refined products, depend on a number of factors beyond Valero's
control, including regional and global supply of and demand for crude oil,
gasoline, diesel and other feedstocks and refined products. These in turn are
dependent upon, among other things, the availability of imports, the production
levels of domestic and foreign suppliers, competitive fuels, U.S. relationships
with foreign governments, political affairs and the extent of governmental
regulation.
VALERO L.P.
Through agreements with Valero L.P., Valero has access to a logistics system
that complements its refining and marketing business in the U.S. Gulf Coast and
Mid-Continent regions. Valero L.P. is a master limited partnership that owns
almost 800 miles of crude oil pipelines, 8 crude oil and intermediate feedstock
storage facilities, approximately 3,300 miles of refined product pipelines and
18 refined product terminals. Valero assumed its ownership interest in Valero
L.P. (formerly known as "Shamrock Logistics, L.P.") upon completion of the UDS
Acquisition. At December 31, 2002, Valero owned approximately 73 percent of
Valero L.P. As discussed above under the caption "Recent Developments," on March
18, 2003, Valero reduced its ownership of Valero L.P. to approximately 49
percent. Valero's present ownership includes 100 percent of the general partner
interest in Valero L.P. Valero L.P. is generally referred to in this report as
the Partnership.
The Partnership's revenues for the year ended December 31, 2002, were $118.5
million. The Partnership generates revenues from its pipeline operations by
charging tariffs for transporting crude oil and refined products through its
pipelines. The Partnership also generates revenues from its terminalling
operations by charging a terminalling fee to its customers. Terminalling fees
are earned when refined products enter the Partnership's terminals; the fees
include the cost of transferring the refined products from the terminal to
trucks. An additional fee is charged at the terminals for blending additives
into various refined products. The Partnership's primary customer for its
pipeline and terminalling operations is Valero. Valero accounted for
approximately 99% of the Partnership's revenues in 2002.
The Partnership's refined product pipelines transport the majority of all
refined products from Valero's McKee, Three Rivers and Ardmore refineries,
directly or indirectly, to markets in Texas, Oklahoma, Colorado, New Mexico,
Arizona and other Mid-Continent states. In addition, the Partnership's crude oil
pipelines deliver to these three refineries crude oil and other feedstocks, such
as gas oil and normal butane, from various points in Texas, Oklahoma, Kansas and
Colorado, and provide access to Texas, Gulf Coast and foreign crude oil sources.
The Partnership's crude oil and intermediate feedstock storage facilities have
an aggregate capacity of almost 14.5 million barrels. They are located in Texas,
Oklahoma and California and serve Valero's Corpus Christi, Texas City, McKee,
Three Rivers, Ardmore and Benicia refineries. The Partnership's refined product
terminals are located in Texas, Colorado, New Mexico and California, and have an
aggregate capacity of almost 4 million barrels.
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Retail
Valero is one of the largest independent retailers of refined products in the
central and southwest United States, with strong brand identification in a
12-state retail area, including Texas, California, Colorado and Oklahoma, and in
eastern Canada. Approximately 10% of Valero's gasoline and distillate production
is distributed through retail channels. Valero's retail operations are
segregated geographically into two groups: the U.S. System and the Northeast
System.
For the year ended December 31, 2002, total sales of refined products through
the U.S. System's retail sites averaged approximately 142,000 BPD. Valero has
about 1,265 company-operated sites in its U.S. System; of these sites, about
one-half are owned and one-half are leased. Company-operated stores are operated
under a variety of brand names including Corner Store(R), Ultramart(R) and Stop
N Go(R). Stores in Valero's U.S. System sell gasoline and diesel fuel under
several brand names including Diamond Shamrock(R), Valero(R), Beacon(R),
Ultramar(R) and Total(R). In California, Valero intends to convert its retail
facilities from the Beacon(R) and Ultramar(R) brands to the Valero(R) brand. In
the Mid-Continent and Southwest regions, Valero intends to convert its
Total(R)-branded sites to the Diamond Shamrock(R) brand.
The company-operated convenience stores sell, in addition to gasoline and diesel
fuels, a wide variety of immediately consumable products such as snacks, candy,
beer, fast foods, cigarettes and fountain drinks. Valero has an ongoing program
to modernize and upgrade the convenience stores it operates. These efforts are
focused primarily on improving the uniformity and appearance of existing stores.
Improvements generally include new exterior signage, lighting and canopies, and
pump and interior store upgrades. Under a plan adopted by Valero in connection
with the UDS Acquisition, Valero conducted a detailed review of its retail
network to identify appropriate markets for further investment and to identify
under-performing stores where future investment was deemed to be non-strategic.
Stores identified in the under-performing group were to be closed or divested,
while the remaining stores were further evaluated on a store-by-store basis to
determine the level of investment upgrade each would receive. Through this
process, 76 stores were re-imaged and upgraded in 2002, approximately 160 stores
were closed or divested during the year and approximately 150 additional stores
were identified for closure or divestiture.
Valero's Northeast System includes retail operations in the northeastern United
States and eastern Canada. In eastern Canada, Valero is a major supplier of
refined products serving Quebec, Ontario and the Atlantic Provinces of
Newfoundland, Nova Scotia, New Brunswick and Prince Edward Island. For the year
ended December 31, 2002, total retail sales of refined products through the
Northeast System averaged approximately 77,000 BPD. Gasoline and diesel fuel are
sold under the Ultramar(R) brand through a network of approximately 1,100
outlets throughout eastern Canada. Valero plans to continue to use the
Ultramar(R) brand in its Canadian markets. As of December 31, 2002, Valero owned
(or controlled under long-term leases) nearly 500 stores and distributed
gasoline to approximately 600 dealers and independent jobbers. In addition, the
Northeast System operates 85 cardlocks, which are card- or key-activated,
self-service, unattended stations that allow commercial, trucking and
governmental fleets to buy gasoline and diesel fuel 24 hours a day.
The Northeast System operations also include one of the largest home heating oil
businesses in North America. In 2002, Valero sold home heating oil under the
Ultramar(R) brand to approximately 250,000 households in eastern Canada and the
northeastern United States.
Valero's competitive retail position is supported by its proprietary credit card
program, which had about 900,000 active accounts as of December 31, 2002. Valero
uses electronic point-of-sale (POS) credit card processing at substantially all
of its company- and dealer-operated stores. POS processing reduces transaction
time at the sales counter and lowers Valero's credit card program costs.
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COMPETITION
The refining and marketing industry continues to be highly competitive. Valero's
competitors include fully integrated major oil companies (e.g., ExxonMobil and
ConocoPhillips) and other independent refining and marketing entities (e.g.,
Sunoco and Premcor) that operate in all of Valero's market areas. Many of
Valero's competitors are engaged on a national or international basis in many
segments of the petroleum business, including exploration, production,
transportation, refining and marketing, on scales much larger than Valero's.
Such competitors may have greater flexibility in responding to or absorbing
market changes occurring in one or more of such segments. All of Valero's crude
oil and feedstock supplies are purchased from third-party sources, while some
competitors have proprietary sources of crude oil available for their own
refineries.
Financial returns in the refining and marketing industry depend largely on
refining margins and retail fuel margins, both of which fluctuate significantly.
Refining margins are frequently impacted by sharp changes in crude oil costs
which are not immediately - or necessarily - reflected in refined product
prices. Historically, refining margins have been volatile, and they are likely
to continue to be volatile in the future. Valero's ability to process
significant amounts of sour crude oils enhances Valero's competitive position in
the industry as sour crude oils typically can be purchased at a discount to
sweet crude oils.
Valero's retail business faces fierce competition from fully integrated major
oil companies that have increased their efforts to capture retail market share
in recent years. Valero also competes with large grocery stores and other
merchandisers (the so-called "hypermarts") that often sell gasoline at
aggressively competitive prices in order to attract customers to their sites. In
Quebec, Canada and in the adjacent Atlantic Provinces, Valero is the largest
independent retailer of gasoline.
ENVIRONMENTAL MATTERS
The principal environmental risks associated with Valero's operations are
emissions into the air and releases into the soil, surface water or groundwater.
Valero's operations are subject to environmental regulation by the U.S.
Environmental Protection Agency (EPA) and numerous federal, state and local
authorities under extensive federal, state and local environmental laws and
regulations, including those relating to the discharge of materials into the
environment, waste management, pollution prevention and characteristics and
compositions of fuels. The significant federal laws applicable to Valero's
operations include the Clean Air Act, the Clean Water Act, the Comprehensive
Environmental Response, Compensation and Liability Act (CERCLA), and the Solid
Waste Disposal Act, as amended by the Resource Conservation and Recovery Act
(RCRA). A discussion of significant environmental regulations affecting Valero's
operations follows.
EPA's "Tier II" Gasoline and Diesel Standards. The EPA's "Tier II" gasoline
standard, adopted under the Clean Air Act, requires the sulfur content in
gasoline to be reduced in phases from approximately 300 parts per million
(beginning in 2004) to 30 parts per million by 2006. In addition, the EPA's Tier
II diesel standard requires the sulfur content of diesel fuel sold to highway
consumers to be reduced from 500 parts per million to 15 parts per million
beginning in 2006. Modifications will be required at most of Valero's refineries
as a result of the Tier II gasoline and diesel standards. Valero believes that
capital expenditures of about $1 billion will be required between now and 2006
for Valero to meet the new Tier II specifications. This includes approximately
$300 million for related projects at two Valero refineries to improve refinery
yield and octane balance and to provide hydrogen as part of the process of
removing sulfur during the production of gasoline and diesel. Valero expects
that such estimates will change as additional engineering analyses are completed
and progress is made toward construction of these various projects. Factors that
will affect the impact of these regulations on Valero include Valero's ultimate
selection of specific technologies to meet the Tier II standards and
uncertainties related to timing, permitting and construction of specific units.
Valero expects to meet all Tier II gasoline and diesel standards by their
respective effective dates, both in the U.S. and Canada.
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EPA's Section 114 Initiative. 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 has completed its response to the request. Several
other refiners have reached settlements with the EPA regarding this enforcement
initiative. Though Valero has not been named in any proceeding, it also has been
discussing the possibility of settlement with the EPA regarding this initiative.
Based in part upon announced settlements and evaluation of its relative
position, Valero expects to incur penalties and related expenses in connection
with a potential settlement of this enforcement initiative. Valero believes that
any potential settlement penalties will be immaterial to its financial position.
However, Valero believes that any potential settlement with the EPA in this
matter will require various capital improvements or changes in operating
parameters, or both, at some or all of its refineries which could be material in
the aggregate.
Houston/Galveston SIP. Valero's Houston and Texas City Refineries are located in
the Houston/Galveston area which is classified as "severe nonattainment" for
compliance with EPA air-quality standards for ozone. In October 2001, the EPA
approved a State Implementation Plan (SIP) to bring the Houston/Galveston area
into compliance with the EPA's ozone standards by 2007. The EPA-approved plan
was based on a requirement for industry sources to reduce emissions of nitrogen
oxides (NOx) by 90 percent. Certain industry and business groups challenged the
plan based on technical feasibility of the 90 percent NOx control and its
effectiveness in meeting the ozone standard. In December 2002, the Texas
Commission on Environmental Quality (TCEQ) adopted a revised approach for the
Houston/Galveston SIP. This alternative requires an 80 percent reduction in NOx
emissions and a 64 percent reduction in so-called highly reactive volatile
organic compounds (HRVOC). This alternative plan is subject to EPA scrutiny and
approval. Valero's Texas City and Houston Refineries will be required to install
NOx and HRVOC control and monitoring equipment and practices by 2007, at a cost
estimated by Valero to be approximately $60 million based on the proposed TCEQ
approach.
MTBE Restrictions. The presence of MTBE in some water supplies in California and
other states, resulting from gasoline leaks primarily from underground and
aboveground storage tanks, has led to public concern that MTBE poses a possible
health risk. As a result of heightened public concern, California passed
initiatives to ban the use of MTBE as a gasoline component in California by the
end of 2003. The California Air Resources Board's specifications for CARB Phase
III gasoline will become effective at the beginning of 2004. Valero estimates
that the cost to permit and modify its California refineries to comply with CARB
Phase III gasoline specifications and eliminate MTBE as a gasoline component is
approximately $60 million. In addition, other states and the EPA have either
passed or proposed or are considering proposals to restrict or ban the use of
MTBE. If MTBE were to be restricted or banned throughout the United States,
Valero believes that its major non-California MTBE-producing facilities could be
modified to produce other octane enhancing products for a capital investment of
approximately $35 million.
Capital Expenditures Attributable to Compliance with Environmental Regulations.
In 2002, Valero's capital expenditures attributable to compliance with
environmental regulations were approximately $130 million, and are currently
estimated to be approximately $500 million for 2003 and approximately $570
million for 2004. These estimates for 2003 and 2004 do not include amounts
related to constructed facilities for which the portion of expenditures relating
to compliance with environmental regulations is not determinable.
Governmental regulations are complex, are subject to different interpretations
and are becoming increasingly more stringent. Therefore, future legislative
action and regulatory initiatives could result in changes to operating permits,
additional remedial actions or increased capital expenditures and operating
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costs that cannot be assessed with certainty at this time. In addition, because
certain air emissions at Valero's refineries have been grandfathered under
particular environmental laws, any major upgrades at any of its refineries could
require potentially material additional expenditures to comply with
environmental laws and regulations.
EMPLOYEES
As of February 28, 2003, Valero had 19,947 employees, including salaried and
hourly employees, of which 16,451 were employed in the United States and 3,496
were employed in Canada.
PROPERTIES
Valero's principal properties are described above under the caption "Valero's
Operations." In addition, Valero owns feedstock and refined product storage
facilities in various locations. Valero believes that its properties and
facilities are generally adequate for its operations and that its facilities are
maintained in a good state of repair. Valero is the lessee under a number of
cancelable and non-cancelable leases for certain properties, including the
Benicia Refinery dock facility, office facilities, retail facilities,
transportation equipment and various assets used to store, transport and produce
refinery feedstocks and/or refined products. See Note 22 of Notes to
Consolidated Financial Statements.
Valero's patents relating to its refining operations are not material to Valero
as a whole. The trademarks and tradenames under which Valero conducts its retail
and branded wholesale business - specifically Diamond Shamrock(R), Shamrock(R),
Ultramar(R), Valero(R), Beacon(R), Total(R), Corner Store(R), Ultramart(R), Stop
N Go(R) and ValPar(TM) - and other trademarks employed in the marketing of
petroleum products are important to Valero's wholesale and retail marketing
operations.
Valero currently has approximately 150 company-operated convenience stores and
supplies approximately 450 distributor-owned sites under a brand license
agreement with TotalFinaElf for use of the Total(R) brand. The Total-branded
sites are located primarily in Arkansas, Iowa, Kansas, Missouri, Nebraska and
Oklahoma. Under Valero's license agreement with TotalFinaElf, Valero's rights to
use the Total(R) brand will expire in various states from year to year through
2007. Valero believes that it can successfully convert, when necessary, from the
Total(R) brand to the Diamond Shamrock(R) or Shamrock(R) brand without adversely
impacting Valero's operations.
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EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Positions Held with Valero Officer Since
---- --- -------------------------- -------------
William E. Greehey 66 Chairman of the Board and Chief Executive Officer 1979
Gregory C. King 42 President 1997
Keith D. Booke 44 Executive Vice President and Chief Administrative Officer 1997
John D. Gibbons 49 Executive Vice President and Chief Financial Officer 1997
William R. Klesse 56 Executive Vice President and Chief Operating Officer 2001
Mr. Greehey has served as Chairman of the Board and Chief Executive Officer, and
at various times, President of Valero and its former parent company since 1979.
Most recently, he was President of Valero from the end of 1998 to January 2003.
Mr. Greehey is also Chairman of the Board of the managing general partner of
Valero L.P.
Mr. King was elected President in January 2003. He previously served as
Executive Vice President and General Counsel since September 2001, and prior to
that time he served as Executive Vice President and Chief Operating Officer
since January 2001. Mr. King was Senior Vice President and Chief Operating
Officer from 1999 to January 2001. He was elected Vice President and General
Counsel of Valero in 1997. He joined Valero's former parent in 1993 as Associate
General Counsel and prior to that was a partner in the Houston law firm of
Bracewell and Patterson.
Mr. Booke was elected Executive Vice President and Chief Administrative Officer
in January 2001. He was first elected as Chief Administrative Officer in 1999.
Prior to that, he had served as Vice President-Administration and Human
Resources of Valero since 1998, Vice President-Administration of Valero since
1997 and Vice President-Investor Relations of Valero's former parent since 1994.
He joined Valero's former parent in 1983.
Mr. Gibbons was elected Executive Vice President and Chief Financial Officer in
January 2001. He was first elected as Chief Financial Officer in 1998.
Previously, he was elected Vice President - Finance and Treasurer of Valero in
1997 and was elected Treasurer of Valero's former parent in 1992. He joined
Valero's former parent in 1981.
Mr. Klesse was elected Executive Vice President and Chief Operating Officer in
January 2003. He previously served as Executive Vice President - Refining and
Commercial Operations of Valero since the closing of the UDS Acquisition on
December 31, 2001. He had served as Executive Vice President, Operations of UDS
from January 1999 through December 2001. Prior to that he served as an Executive
Vice President for UDS since February 1995, overseeing operations, refining,
product supply and logistics.
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ITEM 3. LEGAL PROCEEDINGS
Unocal
Union Oil Company of California v. Valero Energy Corporation, United States
District Court, Central District of California (filed January 22, 2002). In
2002, Union Oil Company of California (Unocal) sued Valero alleging patent
infringement. 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 2001, the FTC began 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). On March 4, 2003, the FTC announced that it was filing a complaint
against Unocal for antitrust violations. The FTC's complaint seeks an injunction
against any future patent enforcement activity by Unocal. Each of the '393 and
'126 patents is being reexamined by the PTO. The PTO has issued notices of
rejection of all claims of each of these patents. These rejections are subject
to additional proceedings, including administrative appeal by Unocal, followed
by an appeal in federal district court or the court of appeals. Ultimate
invalidation would preclude Unocal from pursuing claims based on the '393 or
'126 patents. Unocal's patent lawsuit against Valero is indefinitely stayed as a
result of the PTO reexamination proceedings. Notwithstanding the judgment
against the other refiners in the previous litigation, Valero believes that it
has several strong defenses to Unocal's lawsuit, including those arising from
Unocal's misconduct, and Valero believes it will prevail in the lawsuit.
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 is a defendant in various cases alleging MTBE contamination in
groundwater in New York and California. The plaintiffs generally allege that
refiners and manufacturers of gasoline containing MTBE are liable for
manufacturing a defective product. In California, the lawsuits have been filed
by local water providers, including the City of Santa Monica, the City of Dinuba
and Fruitridge Vista Water Company. In New York, a lawsuit has been filed by the
Suffolk County Water Authority. These cases are primarily based on a product
liability/product defect theory and seek individual, unquantified compensatory
and punitive damages and attorneys' fees. Valero believes it is unlikely that
the final outcome of any one of these suits filed by local water providers 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 Proceedings
United States Environmental Protection Agency Region II, In the Matter of: Mobil
Oil Corporation, Notice of Violation CAA-02-2001-1305 (May 15, 2001) (Paulsboro
Refinery). The EPA issued notices of violation (NOVs) relating to Mobil Oil
Corporation's operation of the Paulsboro Refinery prior to Valero's ownership of
the refinery. Valero purchased the refinery from Mobil in 1998. The NOVs allege
that Mobil performed certain actions on the refinery's fluid catalytic cracking
unit (FCCU) without satisfying certain permitting and other requirements under
the New Source Review (NSR) provisions of the Clean Air Act. Mobil tendered the
NOVs to Valero for indemnification under the refinery purchase agreement between
Mobil and Valero. In 2002, an arbitration panel determined that Valero must bear
responsibility for the NOVs. EPA has not asserted a specific demand for
administrative or civil penalties or equitable relief under the NOVs, but
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potential penalties under the NOVs could exceed $100,000. Valero is in the
process of assuming the defense of these NOVs. Valero believes that it has
various legal and equitable defenses in support of its position that no material
liability should be borne by Valero with respect to these NOVs.
United States Environmental Protection Agency Region V v. Total Petroleum, Inc.
(Alma Refinery). This enforcement action began in September 1997. The
allegations pertain to a refinery at Alma, Michigan, owned by Total Petroleum,
Inc. (TPI) and include alleged Clean Air Act violations relating to emissions
monitoring, reporting and inspection. Other allegations included alleged RCRA
violations relating to maintenance of wastewater ponds, storage of hazardous
waste, and disposal of wastes. UDS acquired TPI in 1997, and in 1999, UDS closed
the Alma Refinery. In April 2000, TPI settled the EPA enforcement action, which
required the funding of $9.9 million of specific environmental and economic
development projects and the payment of $4.0 million in penalties. A Consent
Decree reflecting the settlement was entered by the district court on March 27,
2001. These settlement amounts were fully accrued as of March 31, 2001. In
January 2003, Valero finalized the terms of a RCRA corrective-action agreement
with the Michigan Department of Environmental Quality as required by the Consent
Decree. No additional accruals were recorded by Valero in connection with
finalization of the corrective-action agreement.
Bay Area Air Quality Management District (Benicia Refinery). Valero received 14
violation notices (VNs), from April 11, 2002 through July 25, 2002, from the
BAAQMD pertaining to Valero's Benicia Refinery. Six 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 with
respect to this set of VNs. Valero received an additional 17 VNs between August
15, 2002 and February 20, 2003. These VNs also primarily allege excess emissions
from, or equipment failure at, various refinery units. No penalties have been
assessed with respect to this second set of VNs. Valero is negotiating with the
BAAQMD to resolve all of these matters.
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, to 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. In
January 2003, CRC received a remedial order from CDPHE requiring the
installation of interim control measures to contain groundwater at CRC's
property boundary and to prevent migration of hydrocarbons offsite. Valero
estimates the capital cost of the interim boundary control system (extraction,
treatment and reinjection) to be approximately $4.4 million (engineering and
construction from 2003 to 2005), with additional operational and maintenance
costs of approximately $2.5 million from 2004 to 2012. A final control measure
ultimately will be required after the CDPHE completes a study of the interim
measure's effectiveness. Valero expects the final measure to be substantially
the same as the interim measure, but the final plan will be subject to the
results of CDPHE's study and assessment of any continued contamination. Valero
does not expect the CDPHE to issue any final order for closure of this matter
until after 2012.
Communities for a Better Environment, a California non-profit organization, and
Nicole McAdam, on behalf of the general public v. Tosco Corporation, Ultramar
Inc., et al., Superior Court of the State of California for the County of San
Francisco, Case No. 300595 (filed January 19, 1999). Communities for a Better
Environment (CBE) is a non-profit organization that brought this lawsuit under
California's Safe Drinking Water and Toxic Enforcement Act of 1986, also known
as California Proposition 65. Any individual acting in the public interest may
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enforce Proposition 65 by filing a lawsuit against a business alleged to be in
violation of this law. CBE originally filed this suit against 13 energy
companies, including Ultramar Inc., a wholly owned subsidiary of Valero. CBE has
recently served additional defendants, including two other Valero subsidiaries.
CBE alleges violations of the Safe Drinking Water and Toxic Enforcement Act of
1986 at several gasoline stations in California, including alleged releases of
benzene and toluene into groundwater. Approximately 30 Valero sites are named in
this proceeding. (Valero was also included on the basis of its ownership of the
Golden Eagle Refinery following the UDS Acquisition and prior to the sale of
that refinery to Tesoro). Plaintiffs seek, among other things, unquantified
property damages, remediation, installation of monitoring equipment and
attorneys' fees. The judge in this matter ordered a bifurcated proceeding to
litigate the claims of CBE; Valero does not expect to litigate the claims
pertaining to the Valero sites until 2004. Valero believes that it has valid
defenses with respect to several CBE claims but is unable to predict the outcome
of this litigation.
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 the
liability associated with this matter will be covered by Imlay's indemnity under
the agreement between TPI and Imlay for the sale of the station. In a separate
ruling, Valero prevailed against Imlay and its owner for indemnification under
the sales agreement.
New Jersey Department of Environmental Protection (NJDEP) (Paulsboro Refinery).
Valero received several related and unrelated NJDEP Administrative Orders and
Notices of Civil Administrative Penalty Assessments (Orders) from February 2002
to December 2002 for alleged noncompliance with certain NJDEP emission limits
and NJDEP stack testing, inspection, nuisance and record-keeping requirements.
None of the Orders contains proposed penalties in excess of $100,000, but in the
aggregate, the Orders' potential penalties could exceed $100,000. Valero has
asserted certain defenses to the Orders. Valero is negotiating with the NJDEP to
resolve these issues and believes that a majority of these Orders can be
settled.
NJDEP (Paulsboro Refinery). In 2002, Valero received four Administrative Orders
and Notices of Civil Administrative Penalty Assessments in the aggregate amount
of $318,300 from the NJDEP. The penalties are for alleged failures to repair
certain leak detection points in the refinery within the 15-day regulatory
deadline for repairs, and are based on multiple inspections of the refinery by
NJDEP during the fourth quarter of 1999 and from the first through the third
quarter of 2002. Valero has asserted certain defenses to the Orders and has
taken certain corrective actions with respect to these incidents.
Other Litigation
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
any possible loss cannot be estimated with a reasonable degree of precision and
Valero cannot provide assurance that the resolution of any particular claim or
proceeding would not have an adverse effect on its results of operations,
financial position or liquidity.
21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2002.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Valero's common stock is traded on the New York Stock Exchange under the symbol
"VLO." In connection with the UDS Acquisition on December 31, 2001,
approximately 45.9 million shares of Valero common stock were issued to UDS
shareholders in exchange for shares of UDS common stock under the terms of the
merger agreement (see Note 2 of Notes to Consolidated Financial Statements).
As of February 28, 2003, there were 7,174 holders of record and an estimated
52,000 additional beneficial owners of Valero's common stock.
The following table shows the high and low sales prices of and dividends
declared on Valero's common stock for each quarter of 2002 and 2001.
Sales Prices of the
Common Stock Dividends
------------ Per
High Low Common Share
---- --- ------------
Quarter Ended
-------------
2002:
December 31............. $ 38.55 $ 23.15 $ 0.10
September 30............ 38.18 26.10 0.10
June 30................. 49.47 35.90 0.10
March 31................ 49.97 36.99 0.10
2001:
December 31............. $ 40.44 $ 34.10 $ 0.10
September 30............ 44.06 32.12 0.08
June 30................. 52.60 34.99 0.08
March 31................ 39.97 31.50 0.08
On January 23, 2003, Valero's Board of Directors declared a regular quarterly
cash dividend of $0.10 per common share payable March 12, 2003 to holders of
record at the close of business on February 12, 2003. Dividends are considered
quarterly by the Board of Directors and may be paid only when approved by the
Board.
23
ITEM 6. SELECTED FINANCIAL DATA
The consolidated selected financial data for the five-year period ended December
31, 2002 was derived from Valero's audited consolidated financial statements.
Certain previously reported amounts have been reclassified to conform to the
2002 presentation. The following table should be read together with the
historical consolidated financial statements and accompanying notes included in
Item 8. Financial Statements and Supplementary Data and with Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
The following summaries are in millions of dollars except for per share amounts:
Year Ended December 31,
----------------------------------------------------------------------------
2002(a) 2001(b) 2000(c) 1999 1998(d)(e)
------- ------- ------- ---- ----------
Operating revenues......................... $ 26,976.2 $ 14,988.3 $ 14,671.1 $ 7,961.2 $ 5,539.3
Operating income (loss).................... $ 470.9 $ 1,001.4 $ 611.0 $ 72.0 $ (48.3)
Net income (loss).......................... $ 91.5 $ 563.6 $ 339.1 $ 14.3 $ (47.3)
Earnings (loss) per common share
- assuming dilution....................... $ 0.83 $ 8.83 $ 5.60 $ 0.25 $ (0.84)
Dividends per common share................. $ 0.40 $ 0.34 $ 0.32 $ 0.32 $ 0.32
Property, plant and equipment, net......... $ 7,412.0 $ 7,217.3 $ 2,676.7 $ 1,914.1 $ 1,886.0
Goodwill................................... $ 2,580.0 $ 2,210.5 $ - $ - $ -
Total assets............................... $ 14,465.2 $ 14,399.8 $ 4,307.7 $ 2,979.3 $ 2,725.7
Long-term debt (less current portion)
and capital lease obligations............. $ 4,494.1 $ 2,805.3 $ 1,042.4 $ 785.5 $ 822.3
Company-obligated preferred securities
of subsidiary trusts...................... $ 372.5 $ 372.5 $ 172.5 $ - $ -
Stockholders' equity....................... $ 4,308.3 $ 4,202.6 $ 1,527.1 $ 1,084.8 $ 1,085.3
(a) Includes the operations of UDS beginning January 1, 2002.
(b) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and related refined product logistics business
beginning June 1, 2001. Property, plant and equipment, net, goodwill, total
assets, long-term debt (less current portion) and capital lease
obligations, company-obligated preferred securities of subsidiary trusts
and stockholders' equity include amounts related to UDS, which was acquired
by Valero on December 31, 2001.
(c) Includes the operations related to the Benicia Refinery and the related
distribution assets (Distribution Assets) beginning May 16, 2000 and the
operations related to service stations included as part of the acquisition
from ExxonMobil (Service Stations) beginning June 16, 2000 (combined, the
Benicia Acquisition).
(d) Includes the operations of the Paulsboro Refinery beginning
September 17, 1998.
(e) The 1998 operating loss includes a $170.9 million write-down of inventories
to market value, which resulted in a $111.1 million reduction in net
income, or $1.98 per share.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following review of the results of operations and financial condition of
Valero should be read in conjunction with Items 1. & 2. Business & Properties
and Item 8. Financial Statements and Supplementary Data included in this report.
In the discussions that follow, all per share amounts assume dilution.
FORWARD-LOOKING STATEMENTS
This Form 10-K, including without limitation the discussion below under the
heading "Results of Operations - Outlook," contains certain estimates,
predictions, projections, assumptions and other "forward-looking statements" (as
defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) that involve various risks and uncertainties.
While these forward-looking statements, and any assumptions upon which they are
based, are made in good faith and reflect Valero's current judgment regarding
the direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, assumptions or other
future performance suggested in this report. These forward-looking statements
can generally be identified by the words "anticipate," "believe," "expect,"
"plan," "intend," "estimate," "project," "budget," "forecast," "will," "could,"
"should," "may" and similar expressions. These forward-looking statements
include, among other things, statements regarding:
o the effect of Valero's acquisition of UDS on Valero's business,
results of operations and financial position;
o future refining margins, including gasoline and heating oil margins;
o future retail margins, including gasoline, diesel, home heating oil
and convenience store merchandise margins;
o expectations regarding feedstock costs, including crude oil discounts
and operating expenses;
o anticipated levels of crude oil and refined product inventories;
o Valero's anticipated level of capital investments, including deferred
refinery turnaround and catalyst costs and capital expenditures for
environmental and other purposes, and the effect of those capital
investments on Valero's results of operations;
o anticipated trends in the supply of and demand for crude oil and other
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 fuel, 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;
25
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;
o accidents or other unscheduled shutdowns affecting Valero's
refineries, machinery, pipelines or equipment, or those of Valero's
suppliers or customers;
o changes in the cost or availability of transportation for feedstocks
and refined products;
o the price, availability and acceptance of alternative fuels and
alternative-fuel vehicles;
o cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such
projects or cost overruns in constructing such planned capital
projects;
o earthquakes, hurricanes, tornadoes and irregular weather, which can
unforeseeably affect the price or availability of natural gas, crude
oil and other 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; and
o overall economic conditions.
Any one of these factors, or a combination of these factors, could materially
affect Valero's future results of operations and whether any forward-looking
statements ultimately prove to be accurate. Valero's forward-looking statements
are not guarantees of future performance, and actual results and future
performance may differ materially from those suggested in any forward-looking
statements. 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.
26
RESULTS OF OPERATIONS
2002 Compared to 2001
Financial Highlights (millions of dollars, except per share amounts)
Year Ended December 31,
----------------------------------------------
2002 (a) 2001 (b) Change
------- -------- ------
Operating revenues...................................... $ 26,976.2 $ 14,988.3 $ 11,987.9
Cost of sales........................................... (23,795.0) (12,745.2) (11,049.8)
Refining operating expenses:
Cash (fixed and variable).............................. (1,331.6) (845.5) (486.1)
Depreciation and amortization.......................... (388.3) (228.2) (160.1)
Retail selling expenses:
Cash................................................... (647.3) (5.8) (641.5)
Depreciation and amortization.......................... (43.1) (0.9) (42.2)
Administrative expenses:
Cash................................................... (282.1) (152.7) (129.4)
Depreciation and amortization.......................... (17.9) (8.6) (9.3)
-------- -------- --------
Operating income........................................ 470.9 1,001.4 (530.5)
Other income (expense), net............................. 8.6 (4.6) 13.2
Interest and debt expense, net.......................... (285.7) (88.5) (197.2)
Minority interest in net income of
consolidated partnership............................... (14.1) - (14.1)
Distributions on preferred securities of
subsidiary trusts...................................... (30.0) (13.4) (16.6)
Income tax expense...................................... (58.2) (331.3) 273.1
-------- -------- --------
Net income.............................................. $ 91.5 $ 563.6 $ (472.1)
======== ======== ========
Earnings per common share -
assuming dilution...................................... $ 0.83 $ 8.83 $ (8.00)
Earnings before interest, taxes, depreciation
and amortization (EBITDA) (c).......................... $ 878.8 $ 1,221.1 $ (342.3)
Ratio of EBITDA to interest incurred (d)................ 2.9x 12.3x (9.4)x
- ----------------------------------------------------------------------------------------------------------
The following notes relate to references on pages 27 through 30.
(a) Includes the operations of UDS beginning January 1, 2002.
(b) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and related refined product logistics business
beginning June 1, 2001 and excludes operations of UDS which were acquired
on December 31, 2001.
(c) A reconciliation of the amounts used for the calculation of EBITDA is
included in "Results of Operations - Corporate Expenses and Other."
(d) The ratio of EBITDA to interest incurred is calculated by dividing EBITDA
by interest and debt expense incurred.
(e) 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.
(f) The market reference differential for sour crude oil is based on 50% Arab
Medium and 50% Arab Light posted prices.
27
Operating Highlights
(millions of dollars, except per barrel and per gallon amounts)
Year Ended December 31,
-----------------------------------
2002 (a) 2001 (b) Change
------- ------- ------
Refining:
Operating income........................................ $ 642.4 $ 1,160.8 $ (518.4)
Throughput volumes (thousand barrels per day)........... 1,595 1,001 594
Throughput margin per barrel............................ $ 4.06 $ 6.12 $ (2.06)
Operating costs per barrel:
Cash (fixed and variable).............................. $ 2.29 $ 2.31 $ (0.02)
Depreciation and amortization.......................... 0.66 0.63 0.03
---- ---- ----
Total operating costs per barrel...................... $ 2.95 $ 2.94 $ 0.01
==== ==== ====
Charges:
Crude oils:
Sour................................................. 45% 62% (17)%
Sweet................................................ 34 11 23
---- ---- ----
Total crude oils.................................... 79 73 6
Residual fuel oil...................................... 5 8 (3)
Other feedstocks and blendstocks....................... 16 19 (3)
---- ---- ----
Total charges........................................ 100% 100% -%
==== ==== ====
Yields:
Gasolines and blendstocks.............................. 55% 53% 2%
Distillates............................................ 27 27 -
Petrochemicals......................................... 3 3 -
Lubes and asphalts..................................... 4 4 -
Other products......................................... 11 13 (2)
---- ---- ----
Total yields......................................... 100% 100% -%
==== ==== ====
Retail - U.S.:
Operating income........................................ $ 58.8 $ 1.9 $ 56.9
Company-operated fuel sites (average)................... 1,359 11 1,348
Fuel volumes (gallons per day per site)................. 4,401 6,280 (1,879)
Fuel margin per gallon.................................. $ 0.111 $ 0.302 $ (0.191)
Merchandise sales....................................... $ 1,011.5 $ 3.7 $ 1,007.8
Merchandise margin (percentage of sales)................ 27.8% 29.7% (1.9)%
Margin on miscellaneous sales........................... $ 44.4 $ - $ 44.4
Selling expenses........................................ $ 486.0 $ 5.8 $ 480.2
Retail - Northeast:
Operating income........................................ $ 69.7 N/A
Fuel volumes (thousand gallons per day)................. 3,235 N/A
Fuel margin per gallon.................................. $ 0.179 N/A
Merchandise sales....................................... $ 99.0 N/A
Merchandise margin (percentage of sales)................ 22.5% N/A
Margin on miscellaneous sales........................... $ 16.4 N/A
Selling expenses........................................ $ 161.3 N/A
28
Refining Operating Highlights by Region (e)
Year Ended December 31,
----------------------------------
2002(a) 2001(b) Change
------- ------- ------
Gulf Coast:
Throughput volumes (thousand barrels per day)..... 675 648 27
Throughput margin per barrel...................... $ 4.18 $ 5.70 $ (1.52)
Operating costs per barrel:
Cash (fixed and variable)........................ $ 2.46 $ 2.10 $ 0.36
Depreciation and amortization.................... 0.77 0.66 0.11
---- ---- ----
Total operating costs per barrel................ $ 3.23 $ 2.76 $ 0.47
==== ==== ====
Mid-Continent:
Throughput volumes (thousand barrels per day)..... 265 N/A
Throughput margin per barrel...................... $ 4.35 N/A
Operating costs per barrel:
Cash (fixed and variable)........................ $ 2.12 N/A
Depreciation and amortization.................... 0.55 N/A
----
Total operating costs per barrel................ $ 2.67 N/A
====
Northeast:
Throughput volumes (thousand barrels per day)..... 355 183 172
Throughput margin per barrel...................... $ 2.86 $ 5.11 $ (2.25)
Operating costs per barrel:
Cash (fixed and variable)........................ $ 1.53 $ 2.23 $ (0.70)
Depreciation and amortization.................... 0.49 0.52 (0.03)
----- ---- ----
Total operating costs per barrel................ $ 2.02 $ 2.75 $ (0.73)
==== ==== ====
West Coast:
Throughput volumes (thousand barrels per day)..... 300 170 130
Throughput margin per barrel...................... $ 4.96 $ 8.78 $ (3.82)
Operating costs per barrel:
Cash (fixed and variable)........................ $ 2.93 $ 3.20 $ (0.27)
Depreciation and amortization.................... 0.77 0.62 0.15
---- ---- ----
Total operating costs per barrel................ $ 3.70 $ 3.82 $ (0.12)
==== ==== ====
29
Average Market Reference Prices and Differentials (dollars per barrel)
Year Ended December 31,
------------------------------------
2002 (a) 2001 (b) Change
-------- -------- ------
Feedstocks:
West Texas Intermediate (WTI) crude oil............ $ 26.09 $ 25.93 $ 0.16
WTI less sour crude oil at U.S. Gulf Coast (f)..... $ 2.53 $ 5.01 $(2.48)
WTI less Alaska North Slope (ANS) crude oil........ $ 1.37 $ 2.69 $(1.32)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI................ $ 4.14 $ 5.07 $ (0.93)
No. 2 fuel oil less WTI.......................... $ 1.48 $ 3.01 $ (1.53)
Propylene less WTI............................... $ 1.69 $ (0.83) $ 2.52
U.S. Mid-Continent:
Conventional 87 gasoline less WTI ............... $ 5.59 $ 8.43 $ (2.84)
Low-sulfur diesel less WTI....................... $ 3.67 $ 7.29 $ (3.62)
U.S. Northeast:
Conventional 87 gasoline less WTI................ $ 4.16 $ 5.05 $ (0.89)
No. 2 fuel oil less WTI.......................... $ 2.41 $ 3.83 $ (1.42)
Lube oils less WTI............................... $ 17.57 $ 26.83 $ (9.26)
U.S. West Coast:
CARB 87 gasoline less ANS........................ $ 10.06 $ 16.04 $ (5.98)
Low-sulfur diesel less ANS....................... $ 5.34 $ 9.05 $ (3.71)
General
Valero's net income for the year ended December 31, 2002 was $91.5 million, or
$0.83 per share, compared to net income of $563.6 million, or $8.83 per share,
for the year ended December 31, 2001. For the fourth quarter of 2002, Valero's
net income was $89.0 million, or $0.81 per share, compared to $51.6 million, or
$0.82 per share, for the fourth quarter of 2001. Since the UDS Acquisition was
completed on December 31, 2001, the operations of UDS were not included in the
2001 results. In addition, since the Huntway and El Paso Acquisitions were
completed on June 1, 2001, the operations related to those acquisitions were
included in 2001 results for only the last seven months of 2001.
Operating revenues increased 80% for 2002 compared to 2001 primarily as a result
of the additional throughput volumes from the refinery operations acquired in
the UDS, El Paso and Huntway Acquisitions and the additional revenues generated
from the retail operations acquired in the UDS Acquisition, partially offset by
a decline in refined product prices. However, operating income for 2002 declined
$530.5 million, or 53%, from the $1.0 billion reported in 2001 due mainly to a
$518.4 million decrease in operating income from the refining segment and a
$138.7 million increase in administrative expenses (including related
depreciation and amortization expense), partially offset by an increase of
$126.6 million in operating income from the retail segment attributable to the
retail operations acquired in the UDS Acquisition.
Operating income for 2002 benefited from synergies that were created as a result
of the merger between Valero and UDS. The combined company benefited in 2002
from gross margin improvements and from reductions in operating and
administrative expenses. The improvement in gross margin resulted primarily from
a reduction in inventory levels, yield optimization and procurement initiatives.
Operating and administrative expense synergies were achieved mainly from
incorporating best practices between the two companies and eliminating salaries
and benefits associated with former UDS executives and other employees.
30
Refining
Operating income for Valero's refining segment declined from $1,160.8 million
for the year ended December 31, 2001 to $642.4 million for the year ended
December 31, 2002. The decrease in refining segment operating income was due
principally to a 34% decline in the throughput margin per barrel attributable to
depressed sour crude oil discounts and lower refined product margins in all of
Valero's markets.
During 2002, refining operating results were negatively impacted by the
following factors:
o discounts on Valero's sour crude oil feedstocks during 2002 declined
approximately 50% from 2001 levels primarily due to OPEC's crude oil
production cuts in 2002, which limited the availability of sour crude
oil on the world market, whereas 2001 benefited from increased
supplies of sour crude oil while demand for sweeter crude oil
increased to meet lower sulfur requirements for certain refined
products;
o gasoline and distillate margins declined significantly in all regions
of the United States from 2001 to 2002 due to high inventory levels
for these products as a result of an increase in gasoline imports,
increased gasoline production (particularly in California), an
unusually warm winter in the northeastern part of the United States
and in Europe, and lower jet fuel demand. Although gasoline demand
increased during the year, high imports of gasoline kept inventories
at above-normal levels; and
o Valero's refinery utilization rates were significantly below its
normal operating rates during 2002 as eight of Valero's twelve
refineries were affected by turnaround activities. In addition to the
scheduled downtime, Valero also experienced significant unplanned
maintenance at its refineries during 2002, and production at most of
its refineries was reduced at various times during the year due to
uneconomic operating conditions.
The above decreases in refining operating income were partially offset by the
increased throughput volumes resulting from the UDS, Huntway and El Paso
Acquisitions, an approximate net $76 million benefit resulting from the
settlement in June and August 2002 of petroleum products purchase agreements and
related hedges, and a $39 million benefit from the liquidation of certain of its
LIFO inventories.
Refining cash operating expenses and refining depreciation and amortization
expense were 57% and 70% higher, respectively, for the year ended December 31,
2002 compared to the year ended December 31, 2001 as a result of the additional
refinery operations from the UDS, El Paso and Huntway Acquisitions. However,
these operating costs on a per barrel basis remained stable from 2001 to 2002.
Retail
Retail operating income was $128.5 million for the year ended December 31, 2002
compared to $1.9 million for the year ended December 31, 2001. The 2002 retail
operating income includes both the U.S. and Northeast retail operations acquired
in the UDS Acquisition. The 2001 retail operations included only 11 northern
California retail stores operated by Valero at that time.
During 2002, pursuant to a plan adopted in conjunction with the UDS Acquisition,
Valero implemented various changes in its retail operations that benefited
results in 2002 and are expected to further benefit future results for the
retail segment. As part of these changes, 76 stores were reimaged and upgraded
in 2002. These changes also included the closure or divestiture of approximately
160 stores and the identification of an additional 150 stores for closure or
divestiture. Gains or losses on closed or divested stores will be recognized to
the extent of the difference between any net proceeds received on disposition
and the net book value of each store. Since the value assigned to these stores
was established as part of the final purchase price allocation for the UDS
Acquisition, and due to the short period of time between the UDS Acquisition and
the actual or planned disposition, any gains or losses have been and are
expected to be insignificant.
31
Retail cash selling expenses and retail depreciation and amortization expense
for the year ended December 31, 2002 were significantly higher than 2001 due to
the additional retail stores acquired in the UDS Acquisition.
Corporate Expenses and Other
Administrative expenses, including depreciation and amortization expense,
increased $138.7 million for the year ended December 31, 2002 compared to the
year ended December 31, 2001. The increase was due primarily to additional
administrative expenses resulting from the UDS Acquisition and increases in
employee salaries and benefits and professional services, partially offset by
reduced variable compensation expense as a result of the lower level of
operating income recognized during 2002 and the nonrecurrence in 2002 of
integration and early retirement costs incurred in 2001 in connection with the
UDS Acquisition. For the year ended December 31, 2001, cash administrative
expenses for the combined operations of UDS and Valero would have been
approximately $323 million compared to approximately $282 million for the year
ended December 31, 2002. The reduction in cash administrative expenses was due
mainly to synergies resulting from the UDS Acquisition, primarily attributable
to the elimination of salaries and benefits associated with former UDS
executives and other employees.
Other income (expense), net increased $13.2 million from expense of $4.6 million
for the year ended December 31, 2001 to income of $8.6 million for the year
ended December 31, 2002 due primarily to a $7.0 million increase in equity
income from Valero's investments in joint ventures and $5.9 million of interest
income related to the amortization of the discount on the notes receivable from
Tesoro in connection with the sale of the Golden Eagle Business.
Net interest and debt expense increased $197.2 million for the year ended
December 31, 2002 compared to the year ended December 31, 2001 due primarily to
interest expense on borrowings incurred to finance the UDS Acquisition coupled
with interest expense incurred on the debt assumed in the UDS Acquisition, as
well as the full-year effect of interest expense on the capital lease
obligations associated with the June 1, 2001 El Paso Acquisition.
The minority interest in net income of consolidated partnership of $14.1 million
represents the minority unitholders' share of the net income of Valero L.P.
Distributions on preferred securities of subsidiary trusts increased to $30.0
million for the year ended December 31, 2002 from $13.4 million for the year
ended December 31, 2001 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 $273.1 million from 2001 to 2002 mainly as a result
of lower operating income and higher interest expense. The effective income tax
rate was 39% for 2002 compared to 37% for 2001 due to the impact of the Canadian
operations acquired in the UDS Acquisition.
32
The following is a reconciliation of net income to EBITDA (in millions):
Year Ended December 31,
-----------------------
2002 2001
---- ----
Net income.............................................. $ 91.5 $ 563.6
Interest and debt expense:
Incurred.............................................. 301.9 99.1
Capitalized........................................... (16.2) (10.6)
Income tax expense...................................... 58.2 331.3
Depreciation and amortization expense................... 449.3 237.7
Noncash interest income from Tesoro notes receivable.... (5.9) -
----- -------
EBITDA................................................ $ 878.8 $ 1,221.1
===== =======
Valero utilizes the financial measure of earnings before interest, income taxes,
depreciation and amortization (EBITDA), which is not defined under United States
generally accepted accounting principles. Management presents EBITDA in its
filings under the Securities Exchange Act of 1934 and its press releases.
Management uses this financial measure because it is a widely accepted financial
indicator used by some investors and analysts to analyze and compare companies
on the basis of operating performance. In addition, EBITDA is used in the
computation of certain debt covenant ratios included in Valero's various debt
agreements. EBITDA is not intended to represent cash flows for the period, nor
is it presented as an alternative to operating income or income before income
taxes. It should not be considered in isolation or as a substitute for a measure
of performance prepared in accordance with United States generally accepted
accounting principles. Valero's method of computation of EBITDA may or may not
be comparable to other similarly titled measures used by other companies.
33
2001 Compared to 2000
Financial Highlights (millions of dollars, except per share amounts)
Year Ended December 31,
-------------------------------------
2001 (a) 2000 (b) Change
-------- -------- ------
Operating revenues...................................... $ 14,988.3 $ 14,671.1 $ 317.2
Cost of sales........................................... (12,745.2) (13,076.9) 331.7
Refining operating expenses:
Cash (fixed and variable).............................. (845.5) (682.7) (162.8)
Depreciation and amortization.......................... (228.2) (166.2) (62.0)
Retail selling expenses:
Cash................................................... (5.8) (2.5) (3.3)
Depreciation and amortization.......................... (0.9) (0.3) (0.6)
Administrative expenses:
Cash................................................... (152.7) (124.1) (28.6)
Depreciation and amortization.......................... (8.6) (7.4) (1.2)
-------- ------- -----
Operating income........................................ 1,001.4 611.0 390.4
Other income (expense), net............................. (4.6) 0.3 (4.9)
Interest and debt expense, net.......................... (88.5) (76.3) (12.2)
Distributions on preferred securities of
subsidiary trust....................................... (13.4) (6.8) (6.6)
Income tax expense...................................... (331.3) (189.1) (142.2)
-------- ------- -----
Net income.............................................. $ 563.6 $ 339.1 $ 224.5
======== ======= =====
Earnings per common share -
assuming dilution...................................... $ 8.83 $ 5.60 $ 3.23
EBITDA (c).............................................. $ 1,221.1 $ 778.4 $ 442.7
Ratio of EBITDA to interest incurred (d)................ 12.3x 9.3x 3.0x
- -------------------------------------------------------------------------------------------------------
The following notes relate to references on pages 34 through 37.
(a) Includes the operations of Huntway and the operations related to the El
Paso Corpus Christi refinery and related refined product logistics business
beginning June 1, 2001 and excludes operations of UDS which were acquired
on December 31, 2001.
(b) Includes the operations related to the Benicia Refinery and the
Distribution Assets beginning May 16, 2000 and the operations related to
the Service Stations beginning June 16, 2000.
(c) A reconciliation of the amounts used for the calculation of EBITDA is
included in "Results of Operations - Corporate Expenses and Other."
(d) The ratio of EBITDA to interest incurred is calculated by dividing EBITDA
by interest and debt expense incurred.
(e) The Gulf Coast refining region includes the Corpus Christi, Texas City,
Houston and Krotz Springs Refineries; the Northeast refining region
includes the Paulsboro Refinery; and the West Coast refining region
includes the Benicia Refinery.
(f) The market reference differential for sour crude oil is based on 50% Arab
Medium and 50% Arab Light posted prices.
34
Operating Highlights
(millions of dollars, except per barrel and per gallon amounts)
Year Ended December 31,
------------------------------------
2001 (a) 2000 (b) Change
------- ------- ------
Refining:
Operating income................................ $ 1,160.8 $ 741.7 $ 419.1
Throughput volumes (thousand barrels per day)... 1,001 857 144
Throughput margin per barrel.................... $ 6.12 $ 5.07 $ 1.05
Operating costs per barrel:
Cash (fixed and variable)...................... $ 2.31 $ 2.18 $ 0.13
Depreciation and amortization.................. 0.63 0.53 0.10
---- ---- ----
Total operating costs per barrel............. $ 2.94 $ 2.71 $ 0.23
==== ==== ====
Charges:
Crude oils:
Sour......................................... 62% 55% 7%
Sweet........................................ 11 16 (5)
---- ---- --
Total crude oils............................ 73 71 2
Residual fuel oil.............................. 8 7 1
Other feedstocks and blendstocks............... 19 22 (3)
---- ---- --
Total charges................................. 100% 100% -%
==== ==== ==
Yields:
Gasolines and blendstocks...................... 53% 53% -%
Distillates.................................... 27 28 (1)
Petrochemicals................................. 3 3 -
Lubes and asphalts............................. 4 3 1
Other products................................. 13 13 -
---- ---- --
Total yields.................................. 100% 100% -%
==== ==== ==
Retail - U.S.:
Operating income................................ $ 1.9 $ 0.8 $ 1.1
Company-operated fuel sites (average)........... 11 10 1
Fuel volumes (gallons per day per site)......... 6,280 7,715 (1,435)
Fuel margin per gallon.......................... $ 0.302 $ 0.195 $ 0.107
Merchandise sales............................... $ 3.7 $ 2.0 $ 1.7
Merchandise margin (percentage of sales)........ 29.7% 25.9% 3.8%
Margin on miscellaneous sales................... $ - $ 0.1 $ (0.1)
Selling expenses................................ $ 5.8 $ 2.5 $ 3.3
35
Refining Operating Highlights by Region (e)
Year Ended December 31,
------------------------------------
2001 (a) 2000 (b) Change
-------- ------- ------
Gulf Coast:
Throughput volumes (thousand barrels per day)............ 648 577 71
Throughput margin per barrel............................. $ 5.70 $ 4.67 $ 1.03
Operating costs per barrel:
Cash (fixed and variable)............................... $ 2.10 $ 2.04 $ 0.06
Depreciation and amortization........................... 0.66 0.58 0.08
---- ---- ----
Total operating costs per barrel....................... $ 2.76 $ 2.62 $ 0.14
==== ==== ====
Northeast:
Throughput volumes (thousand barrels per day)............ 183 174 9
Throughput margin per barrel............................. $ 5.11 $ 3.83 $ 1.28
Operating costs per barrel:
Cash (fixed and variable)............................... $ 2.23 $ 2.25 $ (0.02)
Depreciation and amortization........................... 0.52 0.37 0.15
---- ---- ----
Total operating costs per barrel....................... $ 2.75 $ 2.62 $ 0.13
==== ==== ====
West Coast:
Throughput volumes (thousand barrels per day)............ 170 169 1
Throughput margin per barrel............................. $ 8.78 $ 9.42 $ (0.64)
Operating costs per barrel:
Cash (fixed and variable)............................... $ 3.20 $ 2.82 $ 0.38
Depreciation and amortization........................... 0.62 0.48 0.14
---- ---- ----
Total operating costs per barrel....................... $ 3.82 $ 3.30 $ 0.52
==== ==== ====
36
Average Market Reference Prices and Differentials (dollars per barrel)
Year Ended December 31,
------------------------------------
2001 (a) 2000 (b) Change
-------- -------- ------
Feedstocks:
WTI crude oil........................................ $ 25.93 $ 30.36 $ (4.43)
WTI less sour crude oil at U.S. Gulf Coast (f)....... $ 5.01 $ 3.52 $ 1.49
WTI less ANS crude oil............................... $ 2.69 $ 2.04 $ 0.65
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI.................. $ 5.07 $ 4.66 $ 0.41
No. 2 fuel oil less WTI............................ $ 3.01 $ 3.60 $ (0.59)
Propylene less WTI................................. $ (0.83) $ 4.88 $ (5.71)
U.S. Northeast:
Conventional 87 gasoline less WTI.................. $ 5.05 $ 5.62 $ (0.57)
No. 2 fuel oil less WTI............................ $ 3.83 $ 5.73 $ (1.90)
Lube oils less WTI................................. $ 26.83 $ 17.31 $ 9.52
U.S. West Coast:
CARB 87 gasoline less ANS.......................... $ 16.04 $ 14.74 $ 1.30
Low-sulfur diesel less ANS......................... $ 9.05 $ 10.63 $ (1.58)
General
Valero's net income was $563.6 million, or $8.83 per share, for the year ended
December 31, 2001 compared to net income of $339.1 million, or $5.60 per share,
for the year ended December 31, 2000.
Operating revenues increased $317.2 million, or 2%, to $15.0 billion during 2001
compared to 2000 due primarily to a 19% increase in average daily sales volumes,
offset to a large extent by a 14% decrease in the average sales price per
barrel. The increase in average daily sales volumes was due primarily to (i) the
full-year effect of volumes attributable to the Benicia Acquisition, (ii) an
increase in the sale of feedstocks and products purchased for resale, and (iii)
higher throughput volumes resulting from the contribution of the El Paso and
Huntway refineries acquired in the second quarter of 2001 and capacity
expansions at the Texas City and other refineries during 2001. The decrease in
average sales prices was due primarily to lower refined product prices resulting
from increased refined product inventories industry-wide and a decrease in crude
oil prices. Operating income increased $390.4 million, or 64%, to $1.0 billion
during 2001 compared to 2000 due primarily to a $419.1 million, or 57%, increase
in operating income from the refining segment, partially offset by a $29.8
million increase in administrative expenses (including related depreciation and
amortization expense).
Refining
Operating income for Valero's refining segment increased to $1.2 billion during
the year ended December 31, 2001 compared to $741.7 million for the year ended
December 31, 2000 due primarily to a 21% increase in throughput margin per
barrel, partially offset by a $224.8 million increase in refining operating
expenses, including depreciation and amortization expense. During 2001, refining
operating results benefited from the following factors:
o the full-year contribution from the Benicia Acquisition which
increased operating income by approximately $66 million;
37
o increased throughput volumes resulting from the Huntway and El Paso
Acquisitions completed in June 2001 and capacity expansions of the
crude oil units at the Texas City Refinery completed in February 2001;
o a significant improvement in sour crude oil discounts resulting from
an increase in supplies of heavier crude oil while demand for sweeter
crude oil increased to meet lower sulfur requirements for certain
refined products;
o higher lube oil margins resulting mainly from improved market
conditions;
o higher prices for No.6 fuel oil and other heavy products relative to
crude oil prices; and
o recognition of an $8.8 million benefit attributable to the acquisition
of UDS inventories on December 31, 2001 as discussed in Note 5 of
Notes to Consolidated Financial Statements.
Partially offsetting the above increases in operating income were (i) lower
distillate margins, when compared to exceptionally high margins in 2000, due to
strong demand and extremely low industry inventory levels in 2000 resulting from
cold weather and high natural gas prices which caused power producers to switch
to fuel oil to run their plants, (ii) a significant decrease in margins for
propylene and other petrochemical feedstocks, to negative levels in 2001, due to
slowing economic activity throughout the world, and (iii) an increase in natural
gas, hydrogen and methanol feedstock costs relative to crude oil.
Refining cash operating expenses were $162.8 million higher during the year
ended December 31, 2001 compared to the year ended December 31, 2000 due
primarily to the operations of the Corpus Christi Refinery and related refined
product logistics business acquired from El Paso in 2001 and increases in
employee salaries, benefits and variable compensation, maintenance costs and ad
valorem taxes, partially offset by reduced refinery energy costs. Refining
depreciation and amortization expense increased by $62.0 million from 2000 to
2001 due mainly to an increase in turnaround and catalyst amortization and
increased depreciation expense resulting from the 2001 acquisition of the El
Paso facilities and capital expansion projects.
Corporate Expenses and Other
Administrative expenses, including depreciation and amortization expense,
increased $29.8 million as a result of an increase in employee salaries,
benefits and variable compensation, and integration and early retirement costs
incurred in 2001 in connection with the UDS Acquisition. Partially offsetting
these increases in administrative expenses was the nonrecurrence in 2001 of
costs recorded in 2000 associated with certain litigation and other matters.
Other income (expense), net decreased $4.9 million from income of $0.3 million
during 2000 to expense of $4.6 million during 2001 due to lower equity income
from Valero's 20% equity interest in the Javelina off-gas processing plant in
Corpus Christi. The Javelina plant's results were impacted by higher natural gas
feedstock costs and lower product prices resulting from a weak petrochemical
market. Partially offsetting the reduced results from the Javelina plant were
lower costs related to the agreement entered into by Valero in September 1999 to
sell a portion of its accounts receivable.
Net interest and debt expense increased $12.2 million from 2000 to 2001 due to a
full year of interest expense during 2001 on borrowings incurred to fund the
Benicia Acquisition, including interest on the senior notes issued in June 2000,
and interest expense recognized on the capital lease obligations associated with
the El Paso Acquisition, partially offset by a decrease in bank borrowings
resulting from Valero's earnings and cash flow during 2001.
Distributions on preferred securities of subsidiary trust increased from $6.8
million in 2000 to $13.4 million in 2001 due to a full year of distributions on
the PEPS Units issued in June 2000 in connection with funding the Benicia
Acquisition.
38
Income tax expense increased from $189.1 million in 2000 to $331.3 million in
2001 due primarily to the significant increase in pre-tax income. The effective
income tax rate was 37% for 2001 compared to 36% for 2000 due to the impact of
higher state income taxes in 2001.
The following is a reconciliation of net income to EBITDA (in millions):
Year Ended December 31,
-------------------------
2001 2000
---- ----
Net income.................................. $ 563.6 $ 339.1
Interest and debt expense:
Incurred.................................. 99.1 83.7
Capitalized............................... (10.6) (7.4)
Income tax expense.......................... 331.3 189.1
Depreciation and amortization expense....... 237.7 173.9
------- -----
EBITDA................................... $ 1,221.1 $ 778.4
======= =====
OUTLOOK
During late January and early February of 2003, domestic crude oil inventories
declined to one of their lowest levels since 1976. This low level of crude oil
inventories, combined with the impact that the national oil workers' strike in
Venezuela had on crude oil and other feedstock supplies in the market, resulted
in a significant narrowing of sour crude oil discounts and resulted in higher
overall feedstock costs. This, in turn, caused sweet crude oil and intermediate
feedstock processing economics to be unfavorable and various refineries reduced
production. Valero reduced its refinery operating rates by as much as 15% early
in the first quarter of 2003. Since early February, the crude oil fundamentals
have improved with higher OPEC production levels and the partial resumption of
Venezuelan crude oil exports. The increased availability of sour crude oil on
world markets since early February has also resulted in a significant widening
in sour crude oil discounts.
In regard to refined products, the industry production cuts caused by poor
refining margins early in the first quarter of 2003, combined with a very large
number of scheduled turnarounds throughout the refining industry, resulted in
lower gasoline and distillate production, which contributed to a steep decline
in gasoline and distillate inventories. In addition, the extreme cold weather in
the northeast United States and eastern Canada further impacted distillate
inventories. In addition to the reduction of supply, the Venezuelan oil workers'
strike resulted in an increased demand for U.S. refined products by Latin
American and Caribbean countries, much of which is being supplied from the Gulf
Coast and the West Coast, including increased shipments from Valero.
Although gasoline margins in California remained weak in early 2003, CARB
gasoline margins increased from approximately $7 per barrel at the end of 2002
to over $20 per barrel by early March 2003. This strength in West Coast refining
margins is expected to continue as the supply of CARB gasoline is reduced as a
result of turnarounds, the effect of lower RVP restrictions effective March 1,
and a switch by several West Coast refiners to CARB gasoline blended with
ethanol.
As the effects of low inventory levels, the Venezuelan strike, continued cold
weather and turnaround activity have made their impact on the markets, refining
economics have improved significantly. In late February, Valero raised refinery
production levels back to normal levels as a result of higher refining margins.
During 2003, Valero expects refined product inventories to remain at
below-average levels, which should support continued strong refining margins. In
addition, Valero anticipates that the current favorable supply and demand trends
39
should support continued wide sour crude oil discounts. Unlike much of the
refining industry, Valero has a light schedule of turnaround activity during
2003. Due to the anticipated improvement in refining fundamentals and the low
number of scheduled turnarounds, as well as expected income contributions from
strategic projects completed during 2002 and additional synergies expected from
the UDS Acquisition, Valero expects that 2003 net income will be significantly
higher than 2002.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows for the Year Ended December 31, 2002
Net cash provided by operating activities for the year ended December 31, 2002
was $272.3 million compared to $905.5 million for the year ended December 31,
2001, a decrease of $633.2 million. The decrease in cash provided by operating
activities was due primarily to the unfavorable change in income as described
above under "Results of Operations" and an $80.1 million increase in the amount
of cash used to fund working capital and deferred charges and credits. Changes
in working capital for the year ended December 31, 2002 included:
o a significant increase in accounts receivable and accounts payable
resulting from increased commodity prices from December 31, 2001 to
December 31, 2002;
o an increase in receivables of approximately $200 million due to a
reduction in the amount of receivables sold under Valero's accounts
receivable sales facility;
o the receipt of approximately $141 million of income tax refunds, net
of payments; and
o a decrease in accrued expenses as a result of payments for
change-in-control benefits to former UDS employees and a decrease in
employee bonuses.
Valero's investing activities for the year ended December 31, 2002 provided net
cash of $248.6 million. Valero's investing activities included the receipt of
$300.9 million from the liquidation of its investment in the Diamond-Koch joint
venture and $925.0 million from the sale of the Golden Eagle Business, partially
offset by payments of $803.4 million for capital expenditures, deferred
turnaround and catalyst costs and earn-out payments and net cash requirements
related to the Golden Eagle Business of $183.5 million.
During 2002, operating and investing activities provided $520.9 million of cash,
which was used primarily to reduce Valero's debt by $412.9 million with a
resulting increase of $109.5 million in Valero's cash balance.
Cash Flows for the Year Ended December 31, 2001
Net cash provided by operating activities increased $304.2 million to $905.5
million during 2001 compared to 2000 due mainly to the significant increase in
net income discussed above under "Results of Operations," partially offset by an
increase in the amount of cash used to fund working capital. During 2001,
approximately $1.1 billion of cash was generated from earnings, of which $181.2
million was used for other operating activities, primarily working capital
requirements. During 2001, accounts payable decreased $237.6 million and
accounts receivable decreased $122.1 million primarily due to a decline in
various commodity prices from December 2000 to December 2001, partially offset
by an increase in volumes purchased and sold. Accounts payable also declined due
to Valero's redelivery to the U.S. Strategic Petroleum Reserve in 2001 of
approximately one million barrels of crude oil in settlement of a time exchange
of crude oil entered into in 2000.
Valero's investing activities for the year ended December 31, 2001 used net cash
of $3.3 billion. Valero's investing activities included the UDS, Huntway and El
Paso Acquisitions totaling $2.7 billion and payments of $591.0 million for
capital expenditures, deferred turnaround and catalyst costs and earn-out
payments.
40
Capital Investments
During the year ended December 31, 2002, Valero expended $779.5 million for
capital investments of which $627.7 million related to capital expenditures
(including $130 million for environmental projects) and $151.8 million related
to deferred turnaround and catalyst costs. Capital expenditures for the year
ended December 31, 2002 included:
o $99.4 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 December
31, 2002 totaled $162.0 million.
o $48.4 million to reconfigure the Three Rivers Refinery in response to
new low-sulfur regulations and to process a more sour crude oil slate.
Aggregate costs incurred for this project through December 31, 2002
totaled $74.4 million.
o $25.0 million to construct a cogeneration facility at the Benicia
Refinery to produce electric power and steam. Aggregate costs incurred
for this project totaled $64.9 million. The cogeneration facility
began operations in mid-October 2002.
o $69.4 million for retail projects including remodeling and re-imaging
numerous convenience stores and installation of automatic teller
machines in various stores.
In connection with Valero's acquisitions of the Paulsboro Refinery in 1998 and
Basis Petroleum, Inc. in 1997, the sellers are entitled to receive payments in
any of the five years and ten years, respectively, following these acquisitions
if certain average refining margins during any of those years exceed a specified
level. Any payments due under these earn-out arrangements are limited based on
annual and aggregate limits. In May 2002, Valero made an earn-out contingency
payment of $23.9 million to Salomon Inc in connection with Valero's acquisition
of Basis Petroleum, Inc. No earn-out amount was payable in 2002 related to the
Paulsboro Refinery acquisition. Based on estimated margin levels through May and
September 2003, earn-out payments of approximately $35 million and $11 million,
respectively, would be due to the sellers during 2003.
In September 2002, Valero executed a nonbinding letter of intent with El Paso
Energy Partners L.P. (EPN) to become a 50% partner in the Cameron Highway Oil
Pipeline Project, a crude oil pipeline construction project. When completed, the
Cameron Highway Oil Pipeline is expected to be a 390-mile pipeline that can
deliver up to 500,000 barrels per day of crude oil from major deepwater Gulf of
Mexico fields directly to major refining facilities and pipeline
interconnections in Port Arthur and Texas City, Texas. Valero and EPN plan to
fund the project through permanent project debt financing, which would provide a
significant portion of the project's capital requirements and be non-recourse to
the partners. Valero's participation is subject to negotiation and execution of
definitive agreements. Valero's equity investment in the project over the next
three years is estimated to be approximately $140 million, of which
approximately $110 million is expected to be spent during the second and third
quarters of 2003, subject to closing of certain financing agreements.
For 2003, Valero expects to incur approximately $1 billion for capital
investments, including approximately $900 million for capital expenditures
(approximately $500 million of which is for environmental projects) and
approximately $100 million for deferred turnaround and catalyst costs. The
capital expenditure estimate excludes approximately $170 million and $61
million, respectively, related to a coker facility at the Texas City Refinery
and the planned expansion of the former UDS headquarters facility, which will be
Valero's new corporate headquarters. The coker and headquarters facilities are
being funded through structured lease arrangements (see the discussion below and
Note 22 of Notes to Consolidated Financial Statements). The capital expenditure
estimate also excludes anticipated expenditures related to the earn-out
contingency agreements discussed above, the funding of the proposed Cameron
Highway Oil Pipeline Project, and the purchase of an office building that is
currently under a structured lease arrangement. Valero continuously evaluates
its capital budget and makes changes as economic conditions warrant.
41
Contractual Obligations
Valero's contractual obligations as of December 31, 2002 are summarized below
(in millions). Payments for long-term debt are at stated values and exclude debt
related to bank facilities, which are included in a separate table under the
caption "Other Commercial Commitments" below.
Payments due by period
-----------------------------------------------------------------
More
Years Years than 5
Total Year 1 2 - 3 4 - 5 years
----- ------ ------ ----- -----
Long-term debt and
capital lease obligations,
including current portion............. $ 4,261.8 $ 322.5 $ 399.8 $ 654.0 $ 2,885.5
Operating lease obligations............ 890.6 157.6 277.5 222.5 233.0
Purchase obligations................... 7,835.0 2,507.6 2,936.8 1,161.0 1,229.6
-------- ------- ------- ------- -------
Total................................ $ 12,987.4 $ 2,987.7 $ 3,614.1 $ 2,037.5 $ 4,348.1
======== ======= ======= ======= =======
Each of the components in the table above is described separately below.
Long-Term Debt
In April 2002, Valero issued $1.8 billion of notes under its $3.5 billion shelf
registration statement as follows:
o $300 million of 6.125% notes due April 15, 2007,
o $750 million of 6.875% notes due April 15, 2012, and
o $750 million of 7.5% notes due April 15, 2032.
The notes are unsecured and are redeemable, in whole or in part, at Valero's
option. Proceeds from this offering were used to repay all borrowings under
Valero's $1.5 billion bridge loan facility associated with the UDS Acquisition
and reduce borrowings under Valero's revolving bank credit facilities.
In June 2002, Valero L.P. and Valero Logistics Operations, L.P. filed a $500
million universal shelf registration statement with the Securities and Exchange
Commission (SEC). In July 2002, Valero Logistics Operations, L.P. issued $100
million of 6.875% senior notes due 2012 under the registration statement. The
notes are unsecured and are redeemable, in whole or in part, at Valero Logistics
Operations, L.P.'s option. The net proceeds from the offering were used to repay
$91.0 million outstanding under the Valero Logistics Operations, L.P. revolving
credit facility and for general partnership purposes.
In July 2002, $275 million of 8.625% guaranteed notes matured and were repaid
with borrowings under Valero's revolving bank credit facilities.
In November 2002, Valero issued under its shelf registration statement $50
million of 6.311% notes due November 30, 2007. Interest is payable
semi-annually. The notes are unsecured and are redeemable, in whole or in part,
at Valero's option.
In December 2002, Valero issued under its shelf registration statement $180
million of senior notes due January 15, 2013. The senior notes bear interest at
6.7%, payable semi-annually. The notes are unsecured and are redeemable, in
whole or in part, at Valero's option. Almost all of these notes were issued in
exchange for the $150 million of 6.75% notes issued to the Valero Pass-Through
Asset Trust 1997-1 in 1997 and to terminate an option held by a third party to
purchase the 6.75% notes on December 15, 2002.
None of Valero's agreements have rating agency triggers that would require
Valero to post additional collateral. However, in the event of a downgrade by
the rating agencies, borrowings under some of Valero's bank credit facilities,
structured leases and other arrangements would become more expensive. On March
6, 2003, Moody's Investors' Service downgraded its rating of Valero's senior
42
unsecured debt to Baa3 with a stable outlook from Baa2 with a negative outlook.
The reduction was attributed to high debt levels, expectations regarding the
sustainability of refining margins, and Valero's aggressive growth strategy. On
March 10, 2003, Standard & Poor's Ratings Services reaffirmed its rating on
Valero's senior unsecured debt at BBB with a negative outlook.
Operating Lease Obligations
Valero's operating lease obligations include leases for land, office facilities
and equipment, retail facilities and equipment, dock facilities, transportation
equipment, and various facilities and equipment used in the storage,
transportation, production and sale of refined products. Operating lease
obligations include all operating leases that have initial or remaining
noncancelable terms in excess of one year but exclude minimum rentals to be
received by Valero under subleases. Operating lease obligations also include
long-term operating lease commitments that have been funded through structured
lease arrangements with non-consolidated third-party entities as discussed below
under the caption "Off-Balance Sheet Arrangements" and in Note 22 of Notes to
Consolidated Financial Statements.
Purchase Obligations
A purchase obligation is an enforceable and legally binding agreement to
purchase goods or services that specifies significant terms, including (i) fixed
or minimum quantities to be purchased, (ii) fixed, minimum or variable price
provisions, and (iii) the approximate timing of the transaction. Valero has
various purchase obligations including industrial gas and chemical supply
arrangements (such as hydrogen supply arrangements), crude oil and other
feedstock supply arrangements and various throughput and terminalling
agreements. Valero enters into these contracts to ensure an adequate supply of
utilities, feedstock and storage to operate its refineries. Many of Valero's
purchase obligations are based on market prices or adjustments based on market
indices. Certain of these purchase obligations include fixed or minimum volume
requirements, while others are based on Valero's usage requirements. The
purchase obligation amounts included in the table above include agreements that
have remaining noncancelable terms in excess of one year as of December 31,
2002, and are based on expected quantities to be purchased and/or estimated
prices to be paid based on current market conditions. Valero has not made in the
past, nor does it expect to make in the future, payments for feedstock or
services that it has not received or will not receive, nor paid prices in excess
of then prevailing market conditions.
Other Commercial Commitments
Valero's other commercial commitments as of December 31, 2002 were as follows
(in millions):
Amount of Commitment Expiration Per Period
--------------------------------------------------------
Total
Amounts Years Years More Than
Committed Year 1 2 - 3 4 - 5 5 Years
--------- ------ ----- ----- -------
Borrowings under lines of credit:
5-year revolving credit facility....... $ 600.0 $ - $ - $ 600.0 $ -
364-day revolving credit facility...... 150.0 150.0 - - -
Uncommitted bank credit facilities..... 3.0 3.0 - - -
Letters of credit....................... 250.9 147.1 4.0 99.8 -
------- ----- ---- ----- ----
Total commercial commitments......... $ 1,003.9 $ 300.1 $ 4.0 $ 699.8 $ -
======= ===== ==== ===== ====
43
As of December 31, 2002, Valero's committed lines of credit included (in
millions):
Borrowing
Capacity Expiration
-------- ----------
364-day revolving credit facility............. $ 750.0 November 2003
5-year revolving credit facility.............. $ 750.0 December 2006
Revolving credit facility for Valero L.P...... $ 120.0 January 2006
Canadian revolving credit facility............ Cdn $ 115.0 July 2005
In September 2002, Valero amended the interest coverage ratio covenant in its
various bank credit facilities and structured lease arrangements. The amendment
provides that Valero's trailing four-quarter interest coverage ratio must not be
less than:
o 2.4 times for the fourth quarter of 2002 and the first quarter of
2003,
o 2.5 times for the second, third and fourth quarters of 2003, and
o 2.75 times thereafter.
In November 2002, Valero renewed its $750 million 364-day revolving bank credit
facility.
Under Valero's revolving bank credit facilities, Valero's debt-to-capitalization
ratio (net of cash) was 50.4% as of December 31, 2002. For purposes of this
computation, 50% of the $200 million of 8.32% Trust Originated Preferred
Securities assumed in the UDS Acquisition and 20% of the $172.5 million of
aggregate liquidation amount of trust preferred securities issued as part of the
PEPS Units were included as debt.
As of December 31, 2002, Valero had $147.1 million of letters of credit
outstanding under its uncommitted short-term bank credit facilities, $99.8
million of letters of credit outstanding under its committed facilities and
Cdn.$6.4 million of letters of credit outstanding under its Canadian facility.
In March 2003, the revolving credit facility for Valero L.P. was amended to
increase the borrowing capacity to $175 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.
Valero's refining and marketing operations have a concentration of customers in
the refining industry and customers who are refined product wholesalers and
retailers. These concentrations of customers may impact Valero's overall
exposure to credit risk, either positively or negatively, in that these
customers may be similarly affected by changes in economic or other conditions.
However, Valero believes that its portfolio of accounts receivable is
sufficiently diversified to the extent necessary to minimize potential credit
risk. Historically, Valero has not had any significant problems collecting its
accounts receivable.
Valero L.P
Effective March 18, 2003, Valero received approximately $500 million of proceeds
from Valero L.P. resulting from the contribution by Valero to Valero L.P. of
certain storage tanks and a refined products pipeline system and the redemption
by Valero L.P. of 3.8 million common units held by Valero, as discussed in Note
26 of Notes to Consolidated Financial Statements.
44
Equity
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 2002, Valero repurchased shares of its common stock under these programs
at a cost of $45.5 million. Through February 2003, Valero has not had any
significant additional common share repurchases under these programs.
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. For additional information regarding Valero's environmental
matters, including a discussion of capital expenditures related to environmental
regulations, see "Environmental Matters" in Items 1. & 2. Business & Properties.
OFF-BALANCE SHEET ARRANGEMENTS
Accounts Receivable Sales Facility
In connection with the UDS Acquisition, Valero assumed a $360 million revolving
accounts receivable sales facility, under which Valero could sell eligible
credit card and trade accounts receivable on an ongoing basis through a wholly
owned subsidiary to a third-party financial institution. Valero also had an
existing accounts receivable sales facility with a third-party financial
institution to sell on a revolving basis up to $100 million of eligible trade
accounts receivable as of December 31, 2001, which was increased during 2002 to
$150 million. On October 8, 2002, Valero renewed and amended its agreement to,
among other things, increase the size of its facility from $150 million to $250
million, incorporate credit card receivables into the program and extend the
maturity date to October 2005. The assumed UDS facility was terminated in
connection with the renewal and amendment of the Valero facility. Under Valero's
program, a wholly owned subsidiary of Valero sells an undivided percentage
ownership interest in the eligible receivables, without recourse, to a
third-party financial institution. Valero remains responsible for servicing the
transferred receivables and pays certain fees related to its sale of receivables
under the program. As of December 31, 2002, the amount of eligible receivables
sold to the third-party financial institution was $250 million.
45
Structured Lease Arrangements
As of December 31, 2002, Valero had various long-term operating lease
commitments that have been funded through structured lease arrangements with
non-consolidated third-party entities, which are summarized below (in millions):
Facility Amount Drawn on
Leased Facilities Amount December 31, 2002 Expiration
----------------- ------ ----------------- ----------
Office building.................... $ 22.9 $ 22.9 April 2003
Convenience stores................. 29.1 29.1 July 2003
Convenience stores................. 186.8 186.8 December 2003
Convenience stores, office
building and refining assets...... 138.1 138.1 June 2005
Coker facility..................... 300.0 123.7 August 2006
Refining assets and
corporate aircraft................ 64.3 64.3 September 2006
Corporate headquarters facility.... 170.0 76.6 February 2007
Valero entered into these structured lease arrangements with third-party
entities that constructed or purchased the related assets and then leased them
to Valero. The assets held by these third-party entities were funded through
borrowings by these entities and equity contributions equal to at least 3% of
the asset cost. Neither Valero, its affiliates nor any related parties hold any
interest in these entities. For each lease, Valero has the option to purchase
the leased assets at any time during the lease term for a price that
approximates fair value. After the initial lease term, the leases may be
extended by agreement of the parties. In the case of the headquarters facility
lease, if Valero exercises its renewal option at the end of the primary lease
term, Valero will be required to provide cash collateral in an amount equal to
the residual value guarantee, which is currently estimated to be approximately
$146 million. The various structured lease arrangements also permit Valero to
sell the leased properties to one or more third parties, in which case the
leases provide for maximum residual value guarantees ranging from 82% to 87% of
the appraised value of the leased properties at the end of the lease term, as
determined at the inception of the lease.
Valero uses these structured lease arrangements to provide additional liquidity
to fund its ongoing operations. Except for the proposed purchase of an office
building that is subject to a lease that expires in April 2003, Valero believes
that it is not reasonably likely that it will purchase these leased assets at
any time during their lease terms and would likely renew, to the extent that it
can, the leases for such assets under similar arrangements. However, there can
be no assurance regarding the availability of future structured lease
arrangements or whether such arrangements can be made available on terms
acceptable to Valero. See Note 1 of Notes to Consolidated Financial Statements
for a discussion of FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities," and its potential effect on Valero's consolidated financial
statements.
Guarantees
In connection with the sale of the Golden Eagle Business, Valero guaranteed
certain lease payment obligations related to an MTBE facility lease assumed by
Tesoro, which totaled approximately $46 million as of December 31, 2002.
Valero's structured lease arrangements provide for maximum residual value
guarantees ranging from 82% to 87% of the appraised value of the leased
properties at the end of the lease term, as determined at the inception of the
lease. As of December 31, 2002, the maximum residual value guarantee on Valero's
structured lease arrangments was approximately $541 million.
46
NEW ACCOUNTING PRONOUNCEMENTS
As discussed in Note 1 of Notes to Consolidated Financial Statements, certain
new financial accounting pronouncements have been issued which either have
already been reflected in the accompanying consolidated financial statements, or
will become effective for Valero's financial statements at various dates in the
future. The adoption of these pronouncements has not had, or is not expected to
have, a material effect on Valero's consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with United States
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. The following summary provides further information about Valero's
critical accounting policies and should be read in conjunction with Note 1 of
Notes to Consolidated Financial Statements, which summarizes Valero's
significant accounting policies.
Inventories
Inventories are stated at the lower of cost or market. The cost of refinery
feedstocks purchased for processing and produced products are determined under
the last-in, first-out (LIFO) method of inventory pricing. The cost of
feedstocks and products purchased for resale and the cost of materials, supplies
and convenience store merchandise are determined under the weighted average cost
method. Valero utilizes the dollar-value LIFO method and uses average purchase
prices during the year to value any increments to its LIFO inventory.
Property, Plant and Equipment
Valero records depreciation expense on its property, plant and equipment using
the composite method of depreciation. Under the composite method of
depreciation, the costs of minor property units, net of salvage value, retired
or abandoned are charged or credited to accumulated depreciation while gains or
losses on sales or other dispositions of major units are recorded in income.
Accounting for property, plant and equipment requires various judgments and
estimates, including a determination of remaining useful lives, salvage values
and the significance of dispositions in determining the accounting for gains and
losses.
In June 2001, the American Institute of Certified Public Accountants (AICPA)
issued an exposure draft of a proposed Statement of Position (SOP) entitled
"Accounting for Certain Costs and Activities Related to Property, Plant and
Equipment," in which accounting for depreciation and replacement of property,
plant and equipment was addressed. The exposure draft concluded that component
accounting for a replacement of property, plant and equipment should occur at
the time of replacement. If an entity replaces part of a property, plant and
equipment asset that has not previously been accounted for as a component, and
the replacement meets the definition of a component, then the entity should
capitalize the cost of the replacement, account for it as a separate component,
estimate the net book value of the replaced item, and charge the net book value
of the replaced item to depreciation expense in the period of replacement.
Therefore, a consequence of not previously applying component accounting is that
the net book value of the replaced item is charged to depreciation expense in
the period of the replacement, with net book value calculated using the expected
useful life of the total property, plant and equipment asset to which the
component relates. In addition, if the provisions of the exposure draft are
enacted and component rather than composite accounting is required, significant
additional estimates and judgments will be required due to the additional volume
of assets to be accounted for individually. In February 2003, the FASB and the
AICPA met to deliberate certain aspects of the proposed SOP. The status of the
proposed SOP remains unchanged. Valero is unable to estimate when or if the
proposed SOP will be enacted.
47
Goodwill and Other Intangible Assets
In connection with the UDS Acquisition, Valero recognized goodwill of $2.6
billion and intangible assets of approximately $279 million. FASB Statement No.
142, "Goodwill and Other Intangible Assets," requires that goodwill
andintangible assets that have indefinite useful lives are not to be amortized,
but instead must be tested for impairment annually or more frequently if events
or changes in circumstances indicate that the asset might be impaired.
Intangible assets that have finite useful lives should continue to be amortized
and should be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable.
Impairment testing requires that an entity determine the fair value of each of
its reporting units. In order to determine fair value, management must make
certain estimates and assumptions including, among other things, an assessment
of market conditions, projected cash flows, investment rates, interest/equity
rates and growth rates, that could significantly impact the reported value of
goodwill and other intangible assets. Due to the significant subjectivity of the
assumptions used to determine the fair value of a reporting unit, changes in
market conditions could result in significant impairment charges in the future,
thus affecting Valero's earnings.
Refinery Turnaround Costs
Refinery turnaround costs, which are incurred in connection with planned major
maintenance activities at Valero's refineries, are deferred when incurred and
amortized on a straight-line basis over the period of time estimated to lapse
until the next turnaround occurs. The frequency of refinery turnarounds varies
with each refinery operating unit. As of December 31, 2002, Valero had $185.0
million of refinery turnaround costs included in its consolidated balance sheet.
The AICPA's exposure draft of a proposed SOP entitled "Accounting for Certain
Costs and Activities Related to Property, Plant and Equipment," discussed above
under "Property, Pland and Equipment," also addressed accounting for the costs
of planned major maintenance activities. The exposure draft concluded that the
total cost of planned major maintenance activities cannot be deferred, but that
the individual costs incurred in such planned major maintenance activities
should be evaluated to determine if they represent the acquisition of additional
components or the replacement of existing components. All other costs incurred
in a planned major maintenance activity should be charged to expense as
incurred. If the provisions of the exposure draft are enacted and turnaround
costs are ultimately expensed as incurred, Valero's reported income would become
more volatile. In February 2003, the FASB and the AICPA met to deliberate
certain aspects of the proposed SOP. The status of the proposed SOP remains
unchanged. Valero is unable to estimate when or if the proposed SOP will be
enacted. Management of Valero estimates that if the provisions of the exposure
draft had been applicable during 2002, Valero's reported net income would have
been reduced by approximately $33 million for the year ended December 31, 2002.
Income Taxes
As part of the process of preparing consolidated financial statements, Valero
must assess the likelihood that its deferred income tax assets will be recovered
through future taxable income. To the extent Valero believes that recovery is
not likely, a valuation allowance must be established. Significant management
judgment is required in determining any valuation allowance recorded against
deferred income tax assets. Valero has recorded a valuation allowance as of
December 31, 2002 and 2001, due to uncertainties related to its ability to
utilize some of its deferred income tax assets, primarily consisting of certain
state net operating losses carried forward and foreign tax credits carried
forward, before they expire. The valuation allowance is based on Valero's
estimates of taxable income in the various jurisdictions in which it operates
and the period over which deferred income tax assets will be recoverable. If
actual results differ from the estimates or Valero adjusts the estimates in
future periods, Valero may need to revise the valuation allowance. The net
deferred income tax assets as of December 31, 2002 were $783.8 million, net of a
valuation allowance of $39.1 million.
48
Environmental Liabilities
Valero's operations are subject to environmental regulation by federal, state
and local authorities relating primarily to discharge of materials into the
environment, waste management and pollution prevention measures. Future
legislative action and regulatory initiatives could result in changes to
required operating permits, additional remedial actions or increased capital
expenditures and operating costs that cannot be assessed with certainty at this
time. Accruals for 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. Valero believes that it has adequately accrued for its environmental
exposures. However, environmental liabilities are difficult to assess and
estimate due to uncertainties related to 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.
Price Risk Management Activities
Valero's financial position and results of operations are affected by the type
of derivative instruments and the degree of hedge accounting utilized by
Valero's management to accommodate Valero's risk management strategies and
overall risk exposure levels.
Pension and Other Postretirement Benefit Obligations
Valero has significant pension and postretirement benefit liabilities and costs
that are developed from actuarial valuations. Inherent in these valuations are
key assumptions including discount rates, expected return on plan assets, future
compensation increases and health care cost trend rates. Changes in these
assumptions are primarily influenced by factors outside Valero's control. For
example, the discount rate assumption is based on Moody's published Aa corporate
bond rate as of the end of each year, while the expected return on plan assets
is based on a compounded return calculated for Valero by an outside consultant
using historical market index data from 1926 through 2001 with an asset
allocation of 65% equities and 35% bonds, representative of the asset mix in
Valero's pension plan. These assumptions can have a significant effect on the
amounts reported in Valero's consolidated financial statements. For example, a
0.25% decrease in the assumptions related to the discount rate or expected
return on plan assets or a 0.25% increase in the assumptions related to the
health care cost trend rate or rate of compensation increase would have the
following effects on the projected benefit obligation as of December 31, 2002
and net periodic benefit cost for the year ended December 31, 2003 (in
millions):
Other
Pension Postretirement
Benefits Benefits
-------- --------
Change in benefit obligation:
Discount rate......................... $ 33.1 $ 10.9
Compensation rate..................... 13.7 -
Health care cost trend rate........... - 10.3
Change in expense:
Discount rate......................... 4.9 1.2
Expected return on plan assets........ 1.1 -
Compensation rate..................... 2.9 -
Health care cost trend rate........... - 1.6
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COMMODITY PRICE RISK
Valero is exposed to market risks related to the volatility of crude oil and
refined product prices, as well as volatility in the price of natural gas used
in its refining operations. In order to reduce the risks of these price
fluctuations, Valero uses derivative commodity instruments to hedge a portion of
its refinery feedstock and refined product inventories and a portion of its
unrecognized firm commitments to purchase these inventories (fair value hedges).
Valero also uses derivative commodity instruments to hedge the price risk of
forecasted transactions such as forecasted feedstock and natural gas purchases
and refined product sales (cash flow hedges). In addition, Valero uses
derivative commodity instruments to manage its exposure to price volatility on a
portion of its refined product inventories and on certain forecasted feedstock
and refined product purchases that do not receive hedge accounting treatment.
These derivative instruments are considered economic hedges for which changes in
their fair value are recorded currently in cost of sales. Finally, Valero uses
derivative commodity instruments for trading purposes based on its fundamental
and technical analysis of market conditions.
The types of instruments used in Valero's hedging and trading activities
described above include swaps, futures and options. Valero's positions in
derivative commodity instruments are monitored and managed on a daily basis by a
risk control group to ensure compliance with Valero's stated risk management
policy which has been approved by Valero's Board of Directors.
The following tables provide information about Valero's derivative commodity
instruments as of December 31, 2002 and 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 or product
purchases and refined product sales,
o economic hedges held to:
o manage price volatility in refined product inventories, and
o manage price volatility in forecasted feedstock, natural gas and
refined product purchases, and
o trading activities held or issued for trading purposes.
Contract volumes are presented in thousands of barrels (for crude oil and
refined products) or in billions of British thermal units (for natural gas). The
weighted-average pay and receive prices represent amounts per barrel (for crude
oil and refined products) or amounts per million British thermal units (for
natural gas). Volumes shown for swaps represent notional volumes, which are used
to calculate amounts due under the agreements. The gain (loss) on swaps is equal
to the fair value amount and represents the excess of the receive price over the
pay price times the notional contract volumes. For futures and options, the gain
(loss) represents (i) the excess of the fair value amount over the contract
amount for long positions, or (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.
50
December 31, 2002
------------------------------------------------------------------------
Wtd Avg Wtd Avg
Contract Pay Receive Contract Fair Gain
Volumes Price Price Value Value (Loss)
------- ----- ----- ----- ----- ----
Fair Value Hedges:
Futures - long:
2003 (crude oil and refined products) 13,290 $ 31.23 N/A $ 415.0 $ 426.8 $ 11.8
Futures - short:
2003 (crude oil and refined products) 15,070 N/A $ 30.85 464.9 492.3 (27.4)
Cash Flow Hedges:
Swaps - long:
2003 (crude oil and refined products) 26,820 26.45 26.98 N/A 14.4 14.4
Swaps - short:
2003 (crude oil and refined products) 26,520 31.27 30.58 N/A (18.1) (18.1)
Futures - long:
2003 (crude oil and refined products) 16,556 30.22 N/A 500.4 516.6 16.2
Futures - short:
2003 (crude oil and refined products) 13,599 N/A 29.02 394.7 424.9 (30.2)
Economic Hedges:
Swaps - long:
2003 (crude oil and refined products) 4,716 1.19 0.81 N/A (1.8) (1.8)
Swaps - short:
2003 (crude oil and refined products) 21,651 3.00 3.18 N/A 3.8 3.8
Futures - long:
2003 (crude oil and refined products) 20,161 33.31 N/A 671.5 687.8 16.3
Futures - short:
2003 (crude oil and refined products) 20,178 N/A 32.21 649.9 675.8 (25.9)
Options - long:
2003 (crude oil and refined products) 5,414 3.73 N/A (0.4) (0.5) (0.1)
Options - short:
2003 (crude oil and refined products) 3,800 N/A 3.50 (0.9) (0.9) -
Trading Activities:
Swaps - long:
2003 (crude oil and refined products) 6,150 8.83 9.63 N/A 4.9 4.9
2004 (crude oil and refined products) 450 2.91 3.03 N/A 0.1 0.1
Swaps - short:
2003 (crude oil and refined products) 10,900 7.21 6.70 N/A (5.6) (5.6)
2004 (crude oil and refined products) 300 4.03 3.75 N/A (0.1) (0.1)
Futures - long:
2003 (crude oil and refined products) 8,866 30.80 N/A 273.0 286.1 13.1
2003 (natural gas) 950 4.78 N/A 4.5 4.4 (0.1)
Futures - short:
2003 (crude oil and refined products) 7,524 N/A 29.85 224.6 244.2 (19.6)
2003 (natural gas) 250 N/A 4.42 1.1 1.2 (0.1)
Options - long:
2003 (crude oil and refined products) 4,332 13.45 N/A (0.4) 2.1 2.5
2003 (natural gas) 400 3.00 N/A - - -
Options - short:
2003 (crude oil and refined products) 2,564 N/A 5.00 (2.7) 0.6 (3.3)
2003 (natural gas) 250 N/A 4.00 0.1 0.2 (0.1)
51
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 24.31 N/A 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 21.04 N/A 225.3 222.9 2.4
Options - short:
2002 (crude oil and refined products) 2,100 3.29 N/A 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 21.30 N/A 245.5 244.2 1.3
2002 (natural gas) 300 2.98 N/A 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 23.66 N/A 61.4 57.3 4.1
2002 (natural gas) 900 2.88 N/A 2.6 2.3 0.3
Options - short:
2002 (crude oil and refined products) 600 4.47 N/A 0.5 0.9 (0.4)
2002 (natural gas) 600 3.29 N/A 0.2 0.1 0.1
In addition to the above, as of December 31, 2001, Valero was the fixed price
payor under certain swap contracts held to hedge anticipated purchases of
refinery feedstocks and refined products that matured in August 2002, had
notional volumes totaling approximately 7.5 million barrels, and had a
weighted-average pay price of $20.11 per barrel. As of December 31, 2001, these
swaps had a weighted-average receive price of $20.53 per barrel and a net
after-tax gain recorded in other comprehensive income of approximately $17
million. In connection with the UDS Acquisition, Valero assumed certain swap
contracts under which it was the fixed price payor under contracts held to hedge
anticipated purchases of refinery feedstocks and refined products that matured
in June 2002, had notional volumes totaling approximately 6.4 million barrels,
and had a weighted average pay price of $22.20 per barrel. Since the UDS
contracts were acquired on December 31, 2001 at fair value, no amount was
recorded in other comprehensive income.
52
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 through the use of a combination of fixed and floating rate debt. In
addition, Valero utilizes interest rate swap agreements to manage a portion of
the exposure to changing interest rates by converting certain fixed-rate debt to
floating rate. In connection with the UDS Acquisition, Valero assumed certain
interest rate swap agreements entered into in order to manage interest rate
exposure on certain fixed-rate debt obligations.
The following table provides information about Valero's long-term debt and
interest rate derivative instruments (in millions, except interest rates), all
of which are sensitive to changes in interest rates. For long-term debt,
principal cash flows and related weighted-average interest rates by expected
maturity dates are presented. For interest rate swaps, the table presents
notional amounts and weighted-average interest rates by expected (contractual)
maturity dates. Notional amounts are used to calculate the contractual payments
to be exchanged under the contract. Weighted-average floating rates are based on
implied forward rates in the yield curve at the reporting date.
December 31, 2002
------------------------------------------------------------------------------------------
Expected Maturity Dates
------------------------------------------------------------------
There- Fair
2003 2004 2005 2006 2007 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
Long-term Debt:
Fixed rate................... $30.4 $1.9 $397.9 $302.0 $352.0 $2,885.5 $3,969.7 $4,081.0
Average interest rate...... 8.1% 5.8% 8.8% 7.4% 6.2% 7.2% 7.2%
Floating rate................ $150.0 - - $600.0 - - $750.0 $750.0
Average interest rate...... 2.7% - - 2.5% - - 2.5%
Interest Rate Swaps
Fixed to Floating:
Notional amount............ $ - $ - $150.0 $125.0 $225.0 $100.0 $600.0 $21.6
Average pay rate.......... 3.6% 4.4% 5.4% 6.2% 6.4% 6.0% 5.4%
Average receive rate...... 6.6% 6.6% 6.6% 6.7% 6.4% 6.9% 6.7%
December 31, 2001
------------------------------------------------------------------------------------------
Expected Maturity Dates
-----------------------------------------------------------------
There- Fair
2002 2003 2004 2005 2006 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
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%
53
FOREIGN CURRENCY RISK
Valero enters into foreign currency exchange and purchase contracts to manage
its exposure to exchange rate fluctuations on transactions related to its
Canadian operations. During May 2002, Valero entered into foreign currency
exchange contracts to hedge its exposure to exchange rate fluctuations on an
investment in its Canadian operations. Under these contracts, Valero sold $400
million of Canadian dollars and bought $253.4 million of U.S. dollars. As of
December 31, 2002, these contracts had a fair value of $6.1 million. The gain
recognized in income on these contracts, which was $6.1 million for the year
ended December 31, 2002, was offset by a loss of $2.4 million recognized in
income from the effect of the exchange rate fluctuation on the hedged investment
for the year. These contracts mature as follows (in millions):
Year Ending Notional
December 31, Amount
------------ ------
2003......... $ 50.9
2004......... 37.9
2005......... 31.7
2006......... 38.1
2007......... 94.8
----
Total........ $ 253.4
=====
As of December 31, 2002, Valero had commitments to purchase $33.8 million of
U.S. dollars. Valero's market risk was minimal on these contracts as they
matured on or before January 3, 2003.
54
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Valero Energy Corporation
We have audited the accompanying consolidated balance sheet of Valero Energy
Corporation and subsidiaries (the Company) as of December 31, 2002, and the
related consolidated statements of income, stockholders' equity, cash flows and
comprehensive income for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit. The consolidated
financial statements of the Company as of December 31, 2001 and for each of the
two years in the period ended December 31, 2001, were audited by other auditors
who have ceased operations and whose report dated March 5, 2002 expressed an
unqualified opinion on those statements before the revisions described below and
in Notes 20 and 27.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Valero Energy
Corporation and subsidiaries at December 31, 2002, and the consolidated results
of their operations and their cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States.
As discussed above, the consolidated financial statements of the Company as of
December 31, 2001, and for each of the two years in the period ended December
31, 2001, were audited by other auditors who have ceased operations. As
described in Notes 20 and 27, these consolidated financial statements have been
revised. We audited (i) the reclassification adjustments applied to revise the
segment disclosures in Note 20, and (ii) the reclassification adjustments
discussed in Note 27, that were applied to revise the 2001 and 2000 consolidated
financial statements. In our opinion, such reclassification adjustments are
appropriate and have been properly applied. However, we were not engaged to
audit, review, or apply any procedures to the 2001 and 2000 consolidated
financial statements of the Company other than with respect to such
reclassification adjustments and, accordingly, we do not express an opinion or
any other form of assurance on the 2001 and 2000 consolidated financial
statements taken as a whole.
/s/ ERNST & YOUNG LLP
San Antonio, Texas
March 19, 2003
55
THIS IS A COPY OF THE AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN
CONNECTION WITH THE VALERO ENERGY CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE
YEAR ENDED DECEMBER 31, 2001. THIS AUDIT REPORT HAS NOT BEEN REISSUED BY ARTHUR
ANDERSEN LLP IN CONNECTION WITH THIS FILING ON FORM 10-K AS ARTHUR ANDERSEN LLP
HAS CEASED OPERATIONS.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Valero Energy Corporation:
We have audited the accompanying consolidated balance sheets of Valero Energy
Corporation (a Delaware corporation) and subsidiaries as of December 31, 2001
and 2000, and the related consolidated statements of income, stockholders'
equity, cash flows and comprehensive income for each of the three years in the
period ended December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Valero Energy Corporation and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
March 5, 2002
56
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Millions of Dollars, Except Par Value)
December 31,
--------------------
2002 2001
---- ----
ASSETS
Current assets:
Cash and temporary cash investments.................................................. $ 378.9 $ 269.4
Restricted cash...................................................................... 30.3 76.6
Receivables, net..................................................................... 1,558.2 770.8
Inventories.......................................................................... 1,436.1 1,453.1
Current deferred income tax assets................................................... 95.3 -
Income taxes receivable.............................................................. - 176.7
Prepaid expenses and other current assets............................................ 37.6 85.6
Assets held for sale................................................................. - 1,303.6
-------- --------
Total current assets............................................................... 3,536.4 4,135.8
-------- --------
Property, plant and equipment, at cost................................................. 8,640.9 8,154.6
Less accumulated depreciation.......................................................... (1,228.9) (937.3)
-------- --------
Property, plant and equipment, net................................................... 7,412.0 7,217.3
-------- --------
Intangible assets, net................................................................. 341.1 333.9
Goodwill............................................................................... 2,580.0 2,210.5
Deferred charges and other assets...................................................... 595.7 502.3
-------- --------
Total assets...................................................................... $14,465.2 $ 14,399.8
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt and capital lease obligations.. $ 476.7 $ 505.7
Payable to UDS shareholders.......................................................... - 2,055.2
Accounts payable..................................................................... 1,825.0 1,390.2
Accrued expenses..................................................................... 294.2 420.9
Taxes other than income taxes........................................................ 368.1 320.2
Current deferred income tax liabilities.............................................. - 60.7
Income taxes payable................................................................. 42.7 -
-------- --------
Total current liabilities.......................................................... 3,006.7 4,752.9
-------- --------
Long-term debt, less current portion................................................... 4,494.1 2,517.4
-------- --------
Capital lease obligations.............................................................. - 287.9
-------- --------
Deferred income tax liabilities........................................................ 1,301.0 1,388.1
-------- --------
Other long-term liabilities............................................................ 866.6 762.8
-------- --------
Commitments and contingencies (Note 22)
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 at 2002 and 2001;
108,198,992 shares issued at 2002 and 2001......................................... 1.1 1.1
Additional paid-in capital........................................................... 3,436.7 3,468.6
Treasury stock, at cost; 1,061,714 and 4,001,683 shares
at 2002 and 2001, respectively..................................................... (42.0) (149.6)
Retained earnings.................................................................... 913.6 864.4
Accumulated other comprehensive income (loss)........................................ (1.1) 18.1
-------- --------
Total stockholders' equity......................................................... 4,308.3 4,202.6
-------- --------
Total liabilities and stockholders' equity......................................... $ 14,465.2 $ 14,399.8
======== ========
See Notes to Consolidated Financial Statements.
57
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Millions of Dollars, Except per Share Amounts)
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Operating revenues....................................... $ 26,976.2 $ 14,988.3 $ 14,671.1
-------- -------- --------
Costs and expenses:
Cost of sales........................................... 23,795.0 12,745.2 13,076.9
Refining operating expenses............................. 1,331.6 845.5 682.7
Retail selling expenses................................. 647.3 5.8 2.5
Administrative expenses................................. 282.1 152.7 124.1
Depreciation and amortization expense................... 449.3 237.7 173.9
-------- -------- --------
Total costs and expenses............................... 26,505.3 13,986.9 14,060.1
-------- -------- --------
Operating income......................................... 470.9 1,001.4 611.0
Other income (expense), net.............................. 8.6 (4.6) 0.3
Interest and debt expense:
Incurred................................................ (301.9) (99.1) (83.7)
Capitalized............................................. 16.2 10.6 7.4
Minority interest in net income of
consolidated partnership................................ (14.1) - -
Distributions on preferred securities
of subsidiary trusts.................................... (30.0) (13.4) (6.8)
-------- -------- --------
Income before income tax expense......................... 149.7 894.9 528.2
Income tax expense....................................... 58.2 331.3 189.1
-------- -------- --------
Net income............................................... $ 91.5 $ 563.6 $ 339.1
======== ======== ========
Earnings per common share................................ $ 0.86 $ 9.28 $ 5.79
Weighted average common shares outstanding
(in millions).......................................... 105.8 60.7 58.5
Earnings per common share - assuming dilution............ $ 0.83 $ 8.83 $ 5.60
Weighted average common equivalent shares outstanding
(in millions).......................................... 110.1 63.8 60.5
Dividends per share of common stock...................... $ 0.40 $ 0.34 $ 0.32
See Notes to Consolidated Financial Statements.
58
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Millions of Dollars)
Number of Retained Accumulated
Common Additional Earnings Other
Shares Common Paid-in (Accumulated Treasury Comprehensive
Issued Stock Capital Deficit) Stock Income (Loss)
------ ----- ------- ------- ----- -------------
(in millions)
Balance as of December 31, 1999.... 56.3 $ 0.6 $ 1,092.4 $ (3.4) $ (4.8) $ -
Net income....................... - - - 339.1 - -
Dividends on common stock........ - - (4.5) (14.2) - -
Proceeds from common stock
offering, net.................. 6.0 - 166.8 - - -
Shares repurchased and shares
issued in connection with
employee stock plans and other. - - 0.3 - (39.5) -
Issuance costs of PEPS Units..... - - (5.8) - - -
----- --- ------- ----- ----- ----
Balance as of December 31, 2000.... 62.3 0.6 1,249.2 321.5 (44.3) -
Net income....................... - - - 563.6 - -
Dividends on common stock........ - - - (20.7) - -
Issuance of common stock in
connection with
UDS Acquisition............... 45.9 0.5 2,064.0 - - -
Fair value of replacement stock
options issued in connection
with UDS Acquisition........... - - 120.1 - - -
Shares repurchased and shares
issued in connection with
employee stock plans and other. - - 35.3 - (105.3) -
Other comprehensive income....... - - - - - 18.1
----- --- ------- ----- ----- ----
Balance as of December 31, 2001.... 108.2 1.1 3,468.6 864.4 (149.6) 18.1
Net income....................... - - - 91.5 - -
Dividends on common stock........ - - - (42.3) - -
Shares repurchased and shares
issued in connection with
employee stock plans and other. - - (31.9) - 107.6 -
Other comprehensive loss......... - - - - - (19.2)
----- --- ------- ----- ----- ----
Balance as of December 31, 2002.... 108.2 $ 1.1 $ 3,436.7 $ 913.6 $ (42.0) $ (1.1)
===== === ======= ===== ===== ====
See Notes to Consolidated Financial Statements.
59
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income......................................................... $ 91.5 $ 563.6 $ 339.1
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization expense.......................... 449.3 237.7 173.9
Noncash interest expense and other income, net................. (22.8) 14.7 (0.8)
Minority interest in net income of consolidated partnership.... 14.1 - -
Deferred income tax expense.................................... 1.5 270.7 103.1
Changes in current assets and current liabilities.............. (208.8) (152.9) 3.5
Changes in deferred charges and credits and other, net......... (52.5) (28.3) (17.5)
------ ------- -------
Net cash provided by operating activities..................... 272.3 905.5 601.3
------ ------- -------
Cash flows from investing activities:
Capital expenditures............................................... (627.7) (393.6) (194.9)
Deferred turnaround and catalyst costs............................. (151.8) (142.4) (107.5)
Proceeds from liquidation of investment in Diamond-Koch............ 300.9 - -
Proceeds from disposition of the Golden Eagle Business............. 925.0 - -
Capital expenditures, deferred turnaround costs and
other cash flows related to the Golden Eagle Business............ (183.5) - -
UDS Acquisition, net of cash acquired.............................. - (1,829.6) -
Advance to UDS in connection with UDS Acquisition.................. - (703.0) -
Purchase of inventories in connection with El Paso Acquisition..... - (108.8) -
Huntway Acquisition, net of cash acquired.......................... - (75.8) -
Benicia Acquisition................................................ - - (889.7)
Earn-out payments in connection with acquisitions.................. (23.9) (55.0) -
Other investing activities, net.................................... 9.6 6.3 (1.9)
------ ------- -------
Net cash provided by (used in) investing activities............ 248.6 (3,301.9) (1,194.0)
------ ------- -------
Cash flows from financing activities:
Cash payment to UDS shareholders in connection
with UDS Acquisition.............................................. (2,055.2) - -
Financing required to fund cash portion of UDS Acquisition,
net of issuance costs............................................ - 2,052.6 -
Increase (decrease) in short-term debt, net........................ (47.0) 173.0 27.0
Long-term debt borrowings, net of issuance costs................... 4,517.4 543.1 1,899.3
Long-term debt repayments.......................................... (2,828.1) (18.5) (1,647.0)
Proceeds from common stock offering, net........................... - - 166.8
Cash distributions to minority
interest in consolidated partnership.............................. (13.7) - -
Issuance of common stock in connection
with employee benefit plans....................................... 102.0 78.4 17.4
Proceeds from offering of preferred securities
of subsidiary trust, net......................................... - - 166.7
Common stock dividends............................................. (42.3) (20.7) (18.7)
Purchase of treasury stock......................................... (45.5) (156.7) (64.3)
------ ------- -------
Net cash provided by (used in) financing activities............ (412.4) 2,651.2 547.2
------ ------- -------
Effect of foreign exchange rate changes on cash..................... 1.0 - -
------ ------- -------
Net increase (decrease) in cash and temporary cash investments...... 109.5 254.8 (45.5)
Cash and temporary cash investments at beginning of year............ 269.4 14.6 60.1
------ ------- -------
Cash and temporary cash investments at end of year.................. $ 378.9 $ 269.4 $ 14.6
====== ======= =======
See Notes to Consolidated Financial Statements.
60
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Millions of Dollars)
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Net income................................................. $ 91.5 $ 563.6 $ 339.1
---- ----- -----
Other comprehensive income (loss):
Foreign currency translation adjustment.................. 13.2 - -
---- ----- -----
Minimum pension liability adjustment,
net of income tax benefit of $7.7....................... (14.3) - -
---- ----- -----
Net gain (loss) on derivative instruments
designated and qualifying as cash flow hedges:
Statement No. 133 transition adjustment,
net of income tax expense of $15.2................... - 28.3 -
Net gain (loss) arising during the year,
net of income tax (expense) benefit of
$(40.8) and $19.4.................................... 75.7 (36.0) -
Net (gain) loss reclassified into income,
net of income tax expense (benefit) of
$50.5 and $(13.9).................................... (93.8) 25.8 -
---- ----- -----
Net gain (loss) on cash flow hedges.............. (18.1) 18.1 -
---- ----- -----
Other comprehensive income (loss)..................... (19.2) 18.1 -
---- ----- -----
Comprehensive income....................................... $ 72.3 $ 581.7 $ 339.1
==== ===== =====
See Notes to Consolidated Financial Statements.
61
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 (five in Texas, two in California and one each in Colorado,
Louisiana, New Jersey, Oklahoma and Quebec, Canada) with a combined throughput
capacity of approximately 1.9 million barrels per day. Valero markets refined
products through an extensive bulk and rack marketing network and a network of
approximately 4,100 retail outlets in the United States and eastern Canada under
various brand names including Diamond Shamrock(R), Shamrock(R), Ultramar(R),
Valero(R), Beacon(R), Total(R) and Exxon(R). Valero's operations are affected
by:
o company-specific factors, primarily refinery utilization rates and
refinery maintenance turnarounds;
o seasonal factors, such as the demand for refined products during the
summer driving season and heating oil during the winter season; and
o industry factors, such as movements in and the level of crude oil
prices, the demand for and prices of refined products, industry supply
capacity, and competitor refinery maintenance turnarounds.
These consolidated financial statements include the accounts of Valero and
subsidiaries in which Valero has a controlling interest. As of December 31,
2002, Valero owned 73.6% of Valero L.P., a limited partnership that owns and
operates crude oil and refined product pipeline, terminalling and storage assets
that support certain of Valero's refineries. Accordingly, these consolidated
financial statements include the accounts of Valero L.P. 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.
Use of Estimates
The preparation of financial statements in conformity with United States
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. On an ongoing basis, management reviews its estimates based on
currently available information. Changes in facts and circumstances may result
in revised estimates.
Cash and Temporary Cash Investments
Valero's temporary cash investments are highly liquid, low-risk debt instruments
which have a maturity of three months or less when acquired. Cash and temporary
cash investments exclude cash that is not available to Valero due to
restrictions related to its use. Such amounts are segregated in the consolidated
balance sheets in restricted cash.
Inventories
Inventories are carried at the lower of cost or market. The cost of refinery
feedstocks purchased for processing and produced products are determined under
the last-in, first-out (LIFO) method. Valero uses the dollar-value LIFO method
with any increments valued based on average purchase prices during the year. The
cost of feedstocks and products purchased for resale and the cost of materials,
supplies and convenience store merchandise are determined principally under the
weighted-average cost method.
62
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property, Plant and Equipment
Additions to property, plant and equipment, including capitalized interest and
certain costs allocable to construction and property purchases, are recorded at
cost.
The costs of minor property units (or components of property units), net of
salvage value, retired or abandoned are charged or credited to accumulated
depreciation under the composite method of depreciation. Gains or losses on
sales or other dispositions of major units of property are recorded in income.
Depreciation of property, plant and equipment, including amortization of assets
acquired under capital leases, is recorded primarily on a straight-line basis
over the estimated useful lives of the related facilities. Leasehold
improvements are amortized using the straight-line method over the shorter of
the lease term or the estimated useful life of the related asset.
Goodwill and Intangible Assets
Goodwill represents the excess of the cost of an acquired entity over the net of
the amounts assigned to the assets acquired and liabilities assumed. Intangible
assets are assets that lack physical substance (excluding financial assets). In
accordance with Statement of Financial Accounting Standard No. 142, "Goodwill
and Other Intangible Assets," issued by the Financial Accounting Standards Board
(FASB), goodwill acquired in a business combination completed after June 30,
2001 and intangible assets with indefinite useful lives are not amortized and
intangible assets with finite useful lives are amortized. Effective January 1,
2002, Valero adopted the provisions of Statement No. 142 resulting in no
significant impact to the consolidated financial statements. The provisions of
Statement No. 142 require that goodwill and intangible assets not subject to
amortization be tested for impairment annually or more frequently if events or
changes in circumstances indicate the asset might be impaired. Valero adopted
October 1st of each year as its annual valuation date for the impairment test.
Intangible assets are recorded at their fair values on the date of acquisition
and are amortized over their estimated useful lives.
Deferred Charges and Other Assets
Deferred charges and other assets include the following:
o refinery turnaround costs, which are incurred in connection with
planned major maintenance activities at Valero's refineries, are
deferred when incurred and amortized on a straight-line basis over the
period of time estimated to lapse until the next turnaround occurs;
o fixed-bed catalyst costs, which represent the cost of catalyst that is
changed out at periodic intervals when the quality of the catalyst has
deteriorated beyond its prescribed function, are deferred when
incurred and amortized on a straight-line basis over the estimated
useful life of the specific catalyst;
o investments in 50% or less owned entities, which are accounted for
using the equity method of accounting; and
o other noncurrent assets such as notes receivable, prefunded benefit
costs, debt issuance costs and various other costs.
Taxes Other than Income Taxes
Taxes other than income taxes includes primarily liabilities for ad valorem
taxes, excise taxes and payroll taxes.
63
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Income Taxes
Income taxes are accounted for under the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred amounts are measured using enacted tax rates expected to apply
to taxable income in the year those temporary differences are expected to be
recovered or settled.
Foreign Currency Translation
The functional currency of Valero's Canadian operations is the Canadian dollar.
The translation into U.S. dollars is performed for balance sheet accounts using
exchange rates in effect as of the balance sheet date and for revenue and
expense accounts using the weighted-average exchange rate during the year.
Adjustments resulting from this translation are reported in other comprehensive
income.
Revenue Recognition
Revenues are recorded when title to products sold has been transferred or when
services have been provided.
Product Shipping and Handling Costs
Costs incurred for shipping and handling of products are included in cost of
sales in the consolidated statements of income.
Impairment and Disposal of Long-Lived Assets
Effective January 1, 2002, Valero adopted Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment of long-lived assets and for
long-lived assets to be disposed of. Statement No. 144 supersedes:
o Statement No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of" and
o Accounting Principles Board (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" for segments of a business to be disposed of.
Long-lived assets (excluding goodwill, intangible assets with indeterminate
lives, and deferred tax assets) are tested for recoverability whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. The carrying amount of a long-lived asset is not recoverable if the
carrying value exceeds the sum of the undiscounted cash flows expected to result
from the use and eventual disposition of the asset. If an asset is not
recoverable, an impairment loss is recognized in an amount by which the carrying
amount of the long-lived asset exceeds its fair value, with fair value
determined based on discounted estimated net cash flows. There was no impact to
Valero's consolidated financial statements as a result of adoption of this
statement.
As of December 31, 2001, Valero classified certain long-lived assets held for
disposal as assets held for sale (see Note 6). Since these assets were committed
to be disposed of under a plan established prior to the adoption of Statement
No. 144, they were accounted for in accordance with Statement No. 121, APB
Opinion No. 30 and other relevant pronouncements that preceded Statement No.
144.
64
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 environmental liabilities have
not been reduced by possible recoveries from third parties of amounts payable by
Valero.
Price Risk Management Activities
Effective January 1, 2001, Valero adopted Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended. Statement No. 133
established accounting and reporting standards for derivative instruments and
for hedging activities. Under Statement No. 133, all derivative instruments are
recorded in the balance sheet as either assets or liabilities measured at their
fair value. Changes in a derivative's fair value are recognized currently in
income unless specific hedge accounting criteria are met. Statement No. 133
allows special hedge accounting for derivative instruments designated and
qualifying as a fair value hedge or a cash flow hedge. The gain or loss on a
derivative instrument designated and qualifying as a fair value hedge, as well
as the offsetting loss or gain on the hedged item attributable to the hedged
risk, are recognized currently in income in the same period. The effective
portion of the gain or loss on a derivative instrument designated and qualifying
as a cash flow hedge is reported as a component of other comprehensive income
and is reclassified into income in the same period or periods during which the
hedged forecasted transaction affects income. The remaining ineffective portion
of the gain or loss on the derivative instrument, if any, is recognized
currently in income. The adoption of this statement has not resulted in any
significant changes in Valero's business practices, including its hedging and
trading activities as described below; however, various system modifications
have been required.
When Valero enters into a derivative instrument, the derivative is designated as
a fair value hedge, a cash flow hedge, an economic hedge or a trading
instrument. For those derivatives designated as fair value or cash flow hedges,
Valero formally documents, at inception, the hedging relationship and its risk
management objective and strategy for undertaking the hedge as required by
Statement No. 133.
Valero accounts for its hedging relationships designated and qualifying as fair
value hedges or cash flow hedges in accordance with the requirements of
Statement No. 133. For Valero's economic hedging relationships (hedges not
designated as fair value or cash flow hedges) and for derivative instruments
entered into by Valero for trading purposes, the derivative instrument is
recorded at fair value and the gain or loss on the derivative instrument is
recognized currently in income.
Valero discontinues hedge accounting prospectively if (i) it is determined that
the derivative is no longer highly effective in offsetting changes in fair value
or cash flows attributable to the hedged risk, (ii) the derivative expires or is
sold, terminated, or exercised, or (iii) the derivative is no longer designated
as a hedging instrument. In any of these circumstances, Valero may designate
prospectively a new hedging relationship with a new hedging instrument or, in
the case of (i) or (iii), a different hedged item or hedged transaction.
When a cash flow hedge is discontinued, Valero continues to report the related
net derivative gain or loss in accumulated other comprehensive income until the
hedged forecasted transaction affects income, at which time the net derivative
65
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
gain or loss is reclassified into income. However, if it is probable that the
forecasted transaction will not occur either by the end of the originally
specified time period or within two months thereafter, Valero reclassifies the
related derivative gain or loss from accumulated other comprehensive income into
income immediately.
Financial Instruments
Valero's financial instruments include cash and temporary cash investments,
restricted cash, receivables, payables, debt, interest rate swaps, commodity
contracts, and foreign currency contracts. The estimated fair values of these
financial instruments approximate their carrying values as reflected in the
consolidated balance sheets, except for certain long-term debt as discussed in
Note 11. The fair value of Valero's debt, interest rate swaps, commodity
contracts and foreign currency contracts was estimated based on year-end quoted
market prices.
Stock-Based Compensation
Valero accounts for its employee stock compensation plans using the intrinsic
value method of accounting set forth in APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations as permitted by
Statement No. 123, "Accounting for Stock-Based Compensation." Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of Valero's common stock at the date of the grant over the
amount an employee must pay to acquire the stock.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation. Statement No. 148 also
amended the disclosure provisions to require prominent disclosure about the
effects on reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation and amended APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial reports. Statement No. 148 was effective for financial
statements for fiscal years ending after December 15, 2002. Since Valero has not
changed to the fair value based method of accounting for stock-based employee
compensation, there was no impact on Valero's financial position or results of
operations as a result of adopting this statement.
The weighted-average fair value of stock options granted during the years ended
December 31, 2002, 2001 and 2000 was $9.55, $11.60 and $9.64 per stock option,
respectively. The fair value of each stock option grant was estimated on the
grant date using the Black-Scholes option-pricing model with the following
assumptions:
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Risk-free interest rate............ 2.4% 4.4% 6.7%
Expected volatility................ 44.5% 46.1% 42.8%
Expected dividend yield............ 1.1% 1.2% 1.1%
Expected life (years).............. 3.1 3.1 3.1
Because Valero accounts for its employee stock compensation plans using the
intrinsic value method, no compensation cost has been recognized in the
statements of income for Valero's fixed stock option plans as all options
66
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
granted had an exercise price equal to the market value of the underlying common
stock on the date of grant. Had compensation cost for Valero's fixed stock
option plans been determined based on the grant-date fair value of awards for
the years ended December 31, 2002, 2001 and 2000 consistent with the method set
forth in Statement No. 123, Valero's net income and earnings per common share
for the years ended December 31, 2002, 2001 and 2000 would have been reduced to
the pro forma amounts indicated below (in millions, except per share amounts):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Net income, as reported........................... $ 91.5 $ 563.6 $ 339.1
Deduct: Compensation expense on
stock options determined under
fair value based method for all awards,
net of related tax effects...................... (13.0) (9.5) (7.8)
---- ----- -----
Pro forma net income.............................. $ 78.5 $ 554.1 $ 331.3
==== ===== =====
Earnings per common share:
As reported..................................... $ 0.86 $ 9.28 $ 5.79
Pro forma....................................... $ 0.74 $ 9.12 $ 5.66
Earnings per common share - assuming dilution:
As reported..................................... $ 0.83 $ 8.83 $ 5.60
Pro forma....................................... $ 0.71 $ 8.68 $ 5.47
For stock-based compensation awards other than fixed stock option awards, the
after-tax compensation cost reflected in net income for the years ended December
31, 2002, 2001 and 2000 was $9.0 million, $11.9 million and $8.8 million,
respectively.
Earnings per Common Share
Earnings per common share is computed by dividing net income by the
weighted-average number of common shares outstanding for the year. Earnings per
common share - assuming dilution reflects the potential dilution of Valero's
outstanding stock options and performance awards granted to employees in
connection with Valero's stock compensation plans, as well as the PEPS Units
discussed in Note 13.
Comprehensive Income
Comprehensive income consists of net income and other gains and losses affecting
stockholders' equity that, under United States generally accepted accounting
principles, are excluded from net income, such as foreign currency translation
adjustments, minimum pension liability adjustments and gains and losses related
to certain derivative instruments.
Business Combinations
Effective July 1, 2001, Valero adopted Statement No. 141, "Business
Combinations." All business combinations in the scope of Statement No. 141 are
accounted for using the purchase method. The provisions of Statement No. 141
apply to all business combinations initiated after June 30, 2001 and apply to
67
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
all business combinations accounted for using the purchase method for which the
date of acquisition is July 1, 2001 or later.
Guarantees
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (FIN 45). FIN 45 addresses the disclosures to be made by
a guarantor in its interim and annual financial statements about its obligations
under guarantees. These disclosure requirements were effective for financial
statements of interim and annual periods ending after December 15, 2002 and are
included in Note 22. FIN 45 also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The recognition and
measurement provisions of this interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002.
New Accounting Pronouncements
FASB Statement No. 143
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes financial accounting and
reporting standards for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The provisions of
this statement apply to legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction, development
and/or the normal operation of a long-lived asset, except for certain
obligations of lessees. Valero will adopt this statement effective January 1,
2003, and is continuing to evaluate the effect of the statement on its financial
position and results of operations. However, Valero currently estimates that the
adoption will not result in a significant effect on its financial position or
results of operations.
FASB Statement No. 146
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. Such costs include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operations, plant closings or other exit or disposal activities.
Statement No. 146 supercedes previous accounting guidance, principally Emerging
Issues Task Force (EITF) Issue No. 94-3. Under EITF Issue No. 94-3, a liability
for an exit cost was recognized at the date of the entity's commitment to an
exit or disposal plan. 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. Valero will adopt the provisions of Statement No. 146
for restructuring activities initiated after December 31, 2002.
FASB Interpretation No. 46
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which is an interpretation of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements." Interpretation No. 46
addresses consolidation of variable interest entities (VIE), which are entities
where control through voting equity interest is not clear and control should be
evaluated based on the investors' exposure to the economic risks and potential
rewards from the VIE's assets and activities (variable interest). A VIE is an
entity with either of the following characteristics: (a) the total equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support, or (b) the equity
investors lack any characteristic of a controlling financial interest, including
68
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
direct or indirect ability to make decisions that control the entity through
voting or similar rights, the investors' investment is subordinated to all other
interests, or return to equity investors is unlimited. An enterprise shall
consolidate a VIE if it is the primary beneficiary of the entity. The primary
beneficiary is the enterprise that absorbs a majority of the entity's expected
losses, receives a majority of its expected residual returns, or both, as a
result of holding a variable interest, which are the ownership, contractual, or
other pecuniary interests in an entity. Assets, liabilities and noncontrolling
interests of newly consolidated VIEs generally will be initially measured at
their fair value except for assets and liabilities transferred to a VIE by its
primary beneficiary, which will be measured at historical cost.
Interpretation No. 46 applies immediately to VIEs created after January 31,
2003, and to VIEs in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15, 2003
to VIEs in which an enterprise holds a variable interest created before February
1, 2003. Interpretation No. 46 may be applied prospectively with a cumulative
effect adjustment as of the date on which it is first adopted or by restating
previously issued financial statements for one or more years with a cumulative
effect adjustment as of the beginning of the first year restated. As of December
31, 2002, Valero held an interest in several potential VIEs and is in the
process of determining the effect of adoption on July 1, 2003.
Reclassifications
Certain previously reported amounts have been reclassified to conform to the
2002 presentation as described in Note 27.
2. ACQUISITIONS
Ultramar Diamond Shamrock Corporation
On December 31, 2001, Valero completed its acquisition of Ultramar Diamond
Shamrock Corporation (UDS), referred to as the UDS Acquisition. Under the terms
of the merger agreement, each outstanding share of UDS common stock, with
limited exceptions, was converted into the right to receive cash, Valero common
stock, or a combination of cash and Valero common stock at the shareholder's
election, subject to proration. Based on the exchange election results,
shareholders electing Valero common stock received, for each share of UDS common
stock, approximately 0.9265 shares of Valero common stock and $16.32 in cash.
Shareholders electing cash and non-electing shareholders received $49.47 in cash
for each UDS share. The average closing price of Valero common stock for the
10-day measurement period specified in the merger agreement (the 10-day trading
period ending three days prior to the merger) was $35.78. As a result, Valero
issued 45.9 million shares of Valero common stock and paid $2.1 billion of cash
to UDS shareholders.
UDS was an independent refiner and retailer of refined products and convenience
store merchandise in the central, southwest and northeast regions of the United
States and eastern Canada. UDS owned and operated seven refineries, including
two in Texas, two in California, and one each in Oklahoma, Colorado, and Quebec,
Canada, with a combined throughput capacity of approximately 850,000 barrels per
day. UDS 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. UDS's
operations, primarily in Canada, also included the marketing of refined products
through 86 cardlocks, which are card- or key-activated, self-service, unattended
stations that allow commercial, trucking and governmental fleets to buy gasoline
and diesel fuel 24 hours a day, and a retail home heating oil business that
sells heating oil to approximately 250,000 households. As a condition for the
69
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 related wholesale marketing
business, and 70 associated Beacon- and Ultramar-branded convenience stores
located throughout Northern California (see Note 6).
Financing of UDS Acquisition
Valero financed the $2.1 billion cash portion of the UDS Acquisition with
proceeds from a $1.5 billion bridge loan facility and borrowings under two new
$750 million revolving bank credit facilities. Valero finalized both the bridge
loan facility and the two revolving bank credit facilities prior to completing
the acquisition, with borrowings under these facilities made on January 7, 2002.
As of December 31, 2001, the cash consideration was recorded as payable to UDS
shareholders in the consolidated balance sheet.
On December 31, 2001, prior to the closing of the UDS Acquisition, UDS ceased
borrowing under its commercial paper program that had previously been used to
fund certain of its ongoing operations. As a result, Valero borrowed $703
million under its revolving bank credit facilities and uncommitted short-term
bank lines and loaned that amount to UDS for its use in repaying all amounts
outstanding under the commercial paper program. Since the transaction occurred
prior to the closing of the UDS Acquisition, the funds borrowed are included in
financing activities and the loan to UDS is reflected as advance to UDS in
connection with the UDS Acquisition in the consolidated statement of cash flows.
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,
which primarily process California crude oil to produce liquid asphalt for use
in road construction and repair and smaller amounts of gas oil, naphtha,
kerosene, distillate and bunker fuels. The purchase price, net of Huntway's cash
balance on the date of acquisition, was approximately $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 Refined Product Logistics Business
Effective June 1, 2001, Valero completed the acquisition of El Paso
Corporation's Corpus Christi, Texas refinery and related refined product
logistics business (El Paso Acquisition). As part of the acquisition, Valero
also purchased inventories for approximately $109 million and assumed certain
environmental liabilities, which were included in other long-term liabilities in
the consolidated balance sheets. The inventories were purchased with available
cash and the property, plant and equipment, net of assumed liabilities, were
acquired through capital lease obligations of approximately $286 million. On
February 28, 2003, Valero exercised an option under the capital leases to
purchase the leased facilities (see Notes 7, 22 and 26).
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 acquired and liabilities
assumed at the date of acquisition based on each asset's anticipated
contribution to the enterprise, pending the completion of independent appraisals
and other evaluations. During the second quarter of 2002, final allocations of
the purchase price for the Huntway and El Paso Acquisitions were completed.
70
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During the fourth quarter of 2002, the final allocation of the purchase price
for the UDS Acquisition was completed, with the exception of the effect on the
purchase price allocation of certain pre-acquisition tax matters as discussed
below. The excess of the purchase price over the fair values of the net assets
acquired in the UDS Acquisition was recorded as goodwill.
Certain pre-acquisition tax matters have not been finalized because additional
information is required. When these tax matters are resolved, the effect of such
matters will be recorded as purchase accounting adjustments. One of these tax
matters relates to the measurement of a pre-acquisition contingency related to a
UDS franchise tax matter covering 1984 through 1997 which has not been
finalized, due principally to a change in outside counsel that was beyond
Valero's control. Valero has received an assessment of approximately $105
million with respect to this matter, including interest and penalties.
Management believes the purchase price allocation with respect to this matter
will be finalized during the first half of 2003.
The final purchase price allocations for the Huntway, El Paso and UDS
Acquisitions are summarized below (in millions):
Huntway El Paso UDS
------- ------- ---
Current assets, excluding assets held for sale...... $ 34.1 $ 108.8 $ 1,545.3
Assets held for sale................................ - - 1,099.0
Property, plant and equipment....................... 58.0 324.4 3,772.1
Intangible assets................................... - - 278.6
Goodwill............................................ - - 2,550.1
Deferred charges and other assets................... 0.2 - 72.8
Current liabilities, less current portion
of long-term debt and advance from Valero.......... (12.2) (1.5) (1,440.8)
Advance from Valero................................. - - (703.0)
Long-term debt assumed,
including current portion.......................... - - (1,276.3)
Capital lease obligations........................... - (285.5) -
Deferred income tax liabilities..................... (1.1) - (608.7)
Other long-term liabilities......................... (1.1) (37.4) (695.8)
Minority interest in consolidated partnership....... - - (115.6)
Company-obligated preferred securities
of subsidiary trust................................ - - (200.0)
---- ----- -------
Total purchase price............................ 77.9 108.8 4,277.7
Less unrestricted cash acquired..................... (2.1) - (262.2)
---- ----- -------
Purchase price, excluding
unrestricted cash acquired..................... $ 75.8 $ 108.8 $ 4,015.5
==== ===== =======
71
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
There were no significant adjustments to the preliminary purchase price
allocations for the Huntway and El Paso Acquisitions. Various adjustments were
made to the preliminary purchase price allocation for the UDS Acquisition,
including:
o the balance of assets held for sale was adjusted to reflect the
difference between the net cash received by Valero from the
liquidation of Valero's investment in Diamond-Koch and the disposition
of the Golden Eagle Business and the amount originally recorded as
assets held for sale as of December 31, 2001 (see Note 6); and
o other long-term liabilities were increased to reflect unfavorable
lease obligations and additional accruals to conform the assessment of
environmental liabilities resulting from the UDS Acquisition to
Valero's policy on accounting for environmental liabilities.
The operating results of the Huntway and El Paso Acquisitions were included in
the consolidated statements of income beginning June 1, 2001. The operating
results of the UDS Acquisition were included in the consolidated statement of
income beginning January 1, 2002.
Benicia Acquisition
During the second quarter of 2000, Valero completed the acquisition of certain
assets from ExxonMobil in the State of California. The acquired assets and
related operations are referred to as the Benicia Acquisition and included:
o the 165,000 barrel-per-day Benicia refinery located in the San
Francisco Bay area and all tangible assets used in the operations of
the refinery (Benicia Refinery);
o 80 Exxon-branded California retail service stations (Service
Stations); and
o branded supplier relationships with over 260 Exxon-branded service
stations (Distribution Assets).
The purchase price for the Benicia Acquisition was $895 million, plus
approximately $150 million for refinery inventories acquired in the transaction
(based on market prices at the time of closing) and certain costs incurred in
connection with the acquisition. The Benicia Acquisition was funded through a
$400 million senior notes offering, a $172.5 million offering of premium equity
participating security units (PEPS Units), a common stock offering totaling
approximately $174.2 million and borrowings under Valero's existing bank credit
facilities. See Notes 11, 13 and 14 for details regarding the senior notes, PEPS
Units and common stock offerings, respectively. In addition, Valero entered into
a $155 million structured lease arrangement for the Service Stations and the
Benicia Refinery's dock facility (see Note 22).
The Service Stations included 10 company-operated service stations and
approximately 70 dealer-operated service stations subleased from Valero, all of
which have been rebranded to the Valero brand. In July 2000, the dealers were
offered an option to purchase at fair value the service stations that they were
leasing and enter into a new fuels purchase agreement with Valero for a term of
15 years. In connection with this option, these dealers purchased 49 service
stations. As a result, the value attributable to the Service Stations was
reduced by $72 million.
72
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Benicia Acquisition was accounted for using the purchase method. The
consolidated statements of income include the results of operations related to
the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the
results of operations related to the Service Stations beginning June 16, 2000.
During the year following the Benicia Acquisition, independent appraisals and
other evaluations were completed and the final purchase price allocation was as
follows (in millions):
Current assets............................... $ 186.5
Property, plant and equipment................ 688.6
Intangible assets............................ 35.0
Deferred charges and other assets............ 3.7
Current liabilities.......................... (7.9)
Other long-term liabilities.................. (16.2)
-----
Final purchase price........................ $ 889.7
=====
Pro Forma Financial Information
The following unaudited pro forma financial information assumes that the UDS,
Huntway and El Paso Acquisitions occurred at the beginning of 2001 and 2000, and
that the Benicia Acquisition and the senior notes, PEPS Units and common stock
offerings occurred at the beginning of 2000. 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 and 2000,
o approximately $795 million of the cash proceeds from the sale of the
Golden Eagle Business was used to pay down debt, and
o approximately $130 million of the cash proceeds from the sale of the
Golden Eagle Business was used to repurchase 2.9 million shares of
common stock at $44.99 per share.
This pro forma information is not necessarily indicative of the results of
future operations (in millions, except per share amounts).
Year Ended December 31,
-----------------------
2001 2000
---- ----
Operating revenues.................... $ 27,182.6 $ 29,816.6
Operating income...................... 1,868.3 1,408.8
Net income............................ 972.3 679.4
Earnings per common share............. 9.37 6.50
Earnings per common share
- assuming dilution.................. 8.98 6.36
3. RESTRICTED CASH
Restricted cash includes 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 environmental remediation costs related to
the Alma Refinery that was shut down by UDS in 1999. During 2002, $46.4 million
was paid to UDS officers and key employees in connection with the UDS
Acquisition.
73
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. RECEIVABLES
Receivables consisted of the following (in millions):
December 31,
------------
2002 2001
---- ----
Accounts receivable...................... $ 1,546.7 $ 705.9
Notes receivable......................... 9.0 66.9
Other.................................... 25.9 9.3
------- -----
1,581.6 782.1
Allowance for doubtful accounts.......... (23.4) (11.3)
------- -----
Receivables, net........................ $ 1,558.2 $ 770.8
======= =====
The changes in allowance for doubtful accounts consisted of the following (in
millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Balance as of beginning of year................ $ 11.3 $ 5.6 $ 3.0
Increase in allowance charged to expense..... 14.5 2.0 2.9
Reclassification of allowance
resulting from termination of
UDS accounts receivable sales facility.... 12.0 - -
Huntway Acquisition.......................... - 0.6 -
UDS Acquisition.............................. - 3.4 -
Accounts charged against the allowance,
net of recoveries......................... (14.4) (0.3) (0.3)
---- ---- ---
Balance as of end of year...................... $ 23.4 $ 11.3 $ 5.6
==== ==== ===
In connection with the UDS Acquisition, Valero assumed a $360 million revolving
accounts receivable sales facility, under which Valero could sell eligible
credit card and trade accounts receivable on an ongoing basis through a wholly
owned subsidiary to a third-party financial institution. Valero also had an
existing accounts receivable sales facility with a third-party financial
institution to sell on a revolving basis up to $100 million of eligible trade
accounts receivable as of December 31, 2001, which was increased during 2002 to
$150 million. On October 8, 2002, Valero renewed and amended its agreement to,
among other things, increase the size of its facility from $150 million to $250
million, incorporate credit card receivables into the program and extend the
maturity date to October 2005. The assumed UDS facility was terminated in
connection with the renewal and amendment of the Valero facility.
Under Valero's existing program, a wholly owned subsidiary of Valero sells an
undivided percentage ownership interest in the eligible receivables, without
recourse, to a third-party financial institution. Valero remains responsible for
servicing the transferred receivables and pays certain fees related to its sale
of receivables under the program. Under the facility, Valero retains the
residual interest in the designated pool of receivables. This retained interest,
which is included in receivables, net in the consolidated balance sheets, is
recorded at fair value. Due to (i) a short average collection cycle for such
receivables, (ii) Valero's collection experience history, and (iii) the
74
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
composition of the designated pool of trade and credit card accounts receivable
that are part of this program, the fair value of Valero's retained interest
approximates the total amount of the designated pool of accounts receivable
reduced by the amount of accounts receivable sold to the third-party financial
institution under the program.
The costs incurred by Valero related to these programs, which were included in
other income (expense), net in the consolidated statements of income, were $6.8
million, $2.3 million and $6.8 million for the years ended December 31, 2002,
2001 and 2000, respectively. Proceeds from collections under these revolving
accounts receivable sales facilities of $8.5 billion, $1.8 billion and $2.9
billion were reinvested in the programs by the third-party financial
institutions for the years ended December 31, 2002, 2001 and 2000, respectively.
However, the third-party financial institutions' interests in Valero's accounts
receivable were never in excess of the sales facility limits at any time under
these programs. No accounts receivable included in this program were written off
during 2002, 2001 or 2000.
As of December 31, 2002 and 2001, $1.1 billion and $420 million, respectively,
of Valero's accounts receivable comprised the designated pools of trade and
credit card accounts receivable included in these programs. Of these amounts,
$250 million and $373 million was sold to the third-party financial institutions
and the remaining amount was retained by Valero as of December 31, 2002 and
2001, respectively.
5. INVENTORIES
Inventories consisted of the following (in millions):
December 31,
------------
2002 2001
---- ----
Refinery feedstocks.................... $ 488.3 $ 513.4
Refined products and blendstocks....... 731.8 727.8
Convenience store merchandise.......... 87.1 87.9
Materials and supplies................. 128.9 124.0
------- -------
Inventories......................... $ 1,436.1 $ 1,453.1
======= =======
Refinery feedstock and refined product and blendstock inventory volumes totaled
54.8 million barrels and 57.0 million barrels as of December 31, 2002 and 2001,
respectively. The reduction of inventory volumes during 2002 resulted in a
liquidation of LIFO inventory layers carried at lower costs which prevailed in
prior years. The effect of the liquidation was to decrease cost of sales by
approximately $39 million. There were no liquidations of LIFO inventories during
the years ended December 31, 2001 and 2000.
As of December 31, 2002, the replacement cost of LIFO inventories exceeded their
LIFO carrying values by approximately $586 million.
In determining the carrying value of Valero's inventories as of December 31,
2001, Valero recognized a net reduction in cost of sales of $8.8 million
resulting from the effect of the valuation of inventories acquired in the UDS
Acquisition. This reduction in cost of sales was attributable to:
o a $101.4 million reduction in cost of sales due to the valuation of
the 2001 LIFO inventory increment, resulting primarily from the
December 31, 2001 UDS Acquisition, under Valero's pricing methodology
75
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of average purchase prices during the year (which were significantly
in excess of the December 31, 2001 prices at which the UDS inventories
were acquired), and
o a $92.6 million increase in cost of sales resulting from the
write-down of LIFO inventories to market value as of December 31,
2001.
As a result of the inventory write-down, the replacement cost of LIFO
inventories approximated their carrying values as of December 31, 2001.
6. ASSETS HELD FOR SALE
Golden Eagle Business
In conjunction with the UDS Acquisition, the FTC approved a consent decree
requiring the 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 those assets overseen by an independent
trustee approved by the FTC.
Those assets and their related operations were referred to as the Golden Eagle
Business and included:
o the 168,000 barrel-per-day Golden Eagle Refinery located in the San
Francisco Bay area and all tangible assets used in the operation of
the refinery including docks, tanks and pipelines;
o the wholesale marketing business generally associated with the Golden
Eagle Refinery production, which included sales primarily to unbranded
customers located in the northern half of California and Reno, Nevada;
and
o 70 Beacon- and Ultramar-branded convenience stores located in Northern
California, including land, buildings, pump equipment, underground
storage tanks and various store equipment.
Assets held for sale as of December 31, 2001 included the amount expected to be
realized from the disposition of the Golden Eagle Business. The amount recorded
was based on an agreement for the sale of the Golden Eagle Business to Tesoro
Refining and Marketing Company (Tesoro) discussed below and expected cash flows
from operations of the Golden Eagle Business from January 1, 2002 through the
anticipated date of sale. Pursuant to the sale agreement, Valero agreed to sell
the Golden Eagle Business to Tesoro for $1.075 billion, which included an
estimated $130 million for refinery feedstock and refined product inventories.
On May 17, 2002, the sale of the Golden Eagle Business was completed. Valero
received cash proceeds of $925 million and two ten-year junior subordinated
notes with face amounts totaling $150 million as follows:
o a $100 million note, due July 17, 2012, which is non-interest bearing
for the first five years and carries a 7.5% interest rate for the
remaining five-year period, and
o a $50 million note, due July 17, 2012, which bears no interest during
the first year and bears interest at approximately 7.5% for years two
through ten.
The two notes were recorded with an initial fair value of $58.9 million using a
discount rate of 16%, which represented Valero's best estimate of the fair value
of the notes at the closing date of the sale. The discount is being amortized
over the life of the notes and is reported as interest income in other income
(expense), net in the consolidated statement of income. The notes receivable are
included in Valero's consolidated balance sheet in deferred charges and other
assets.
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,
76
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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.
Valero applied the consensus reached in Emerging Issues Task Force Issue No.
87-11 in accounting for this transaction as the disposal activities were
initiated prior to January 1, 2002.
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.
7. PROPERTY, PLANT AND EQUIPMENT
Major classes of property, plant and equipment, which includes capital lease
assets, consisted of the following (in millions):
December 31,
Estimated ------------
Useful Lives 2002 2001
------------ ---- ----
Land................................................. $ 268.0 $ 196.5
Crude oil processing facilities...................... 20 - 31 years 6,261.4 5,726.9
Butane processing facilities......................... 30 years 243.7 243.7
Pipeline and terminal facilities..................... 28 - 33 years 494.3 605.1
Retail facilities.................................... 3 - 13 years 526.7 573.9
Other................................................ 2 - 44 years 373.2 325.2
Construction in progress............................. 473.6 483.3
------- -------
Property, plant and equipment....................... $ 8,640.9 $ 8,154.6
======= =======
As of December 31, 2002 and 2001, Valero had crude oil processing facilities and
pipeline and terminal facilities under capital leases totaling $308.2 million
and $318.7 million, net of accumulated amortization of $16.3 million and $6.0
million, respectively. On February 28, 2003, Valero exercised its option under
the capital leases to purchase the leased facilities as described in Note 26.
Depreciation expense for the years ended December 31, 2002, 2001 and 2000 was
$316.3 million, $137.7 million and $112.1 million, respectively.
77
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. INTANGIBLE ASSETS
Intangible assets consisted of the following (in millions):
December 31, 2002 December 31, 2001
----------------- -----------------
Gross Accumulated Gross Accumulated
Cost Amortization Cost Amortization
---- ------------ ---- ------------
Intangible assets subject to amortization:
Customer lists..................................... $ 101.2 $ (6.7) $ 90.0 $ -
Canadian retail operations......................... 98.4 (2.4) 97.9 -
U.S. retail operations............................. 91.1 (16.1) 77.2 (6.5)
Air emission credits............................... 53.6 (4.6) 50.0 -
Royalties and licenses............................. 35.4 (8.8) 32.3 (7.0)
----- ---- ----- -----
Intangible assets subject to amortization......... $ 379.7 $ (38.6) $ 347.4 $(13.5)
===== ==== ===== ====
The gross cost as of December 31, 2001 for the customer lists, Canadian retail
operations, air emission credits, and $18.6 million of the U.S. retail
operations, related to assets acquired on December 31, 2001 in the UDS
Acquisition; therefore, no amortization expense was incurred for these
intangible assets for the year ended December 31, 2001. All of Valero's
intangible assets are subject to amortization.
In connection with the Benicia Acquisition, Valero received the exclusive rights
to offer the Exxon brand throughout the state of California (except for the San
Francisco Bay area) for a ten-year period. The value assigned to this right was
$35 million and is being amortized over the ten-year term of the rights
agreement.
Amortization expense for intangible assets was $25.1 million and $6.0 million
for the years ended December 31, 2002 and 2001, respectively. The estimated
aggregate amortization expense for the years ending December 31, 2003 through
2007 is approximately $26 million per year.
9. GOODWILL
The changes in the carrying amount of goodwill were as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001
---- ----
Balance as of beginning of year..................... $ 2,210.5 $ -
Purchase price allocation and adjustments
related to the UDS Acquisition (see Note 2)....... 339.6 2,210.5
Earn-out payments in connection with
other acquisitions (see Note 22).................. 29.9 -
------- -------
Balance as of end of year........................... $ 2,580.0 $ 2,210.5
======= =======
Because the goodwill resulted from the UDS Acquisition on December 31, 2001,
subsequent to the effective date of FASB Statement No. 142, no amortization of
goodwill is reflected in Valero's consolidated financial statements for any year
presented. All of the goodwill was allocated to the refining segment.
78
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Valero completed its annual test for impairment of goodwill in the fourth
quarter of 2002. Based on the results of the test, there was no impairment of
goodwill.
10. ACCRUED EXPENSES
Accrued expenses consisted of the following (in millions):
December 31,
------------
2002 2001
---- ----
Accrued employee benefit costs.......... $ 78.8 $ 147.6
Change-in-control benefits.............. - 60.8
Accrued interest expense................ 61.4 42.4
Accrued environmental costs............. 30.5 33.5
Derivative liabilities.................. 25.8 27.6
Accrued acquisition costs............... 10.9 26.2
Other................................... 86.8 82.8
----- -----
Accrued expenses..................... $ 294.2 $ 420.9
===== =====
The decrease in accrued employee benefit costs is due mainly to lower bonus
accruals as of December 31, 2002 as a result of the lower level of operating
income recognized during 2002. The decrease in change-in-control benefits was a
result of benefits paid in early 2002 to UDS officers and key employees in
connection with the UDS Acquisition. Included in other accrued expenses are
amounts primarily related to various accruals for refining, retail and corporate
expenses.
79
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. DEBT
Long-term debt balances, at stated values, consisted of the following (in
millions):
December 31,
------------
Maturity 2002 2001
-------- ---- ----
Industrial revenue bonds:
Tax-exempt Revenue Refunding Bonds:
Series 1997A, 5.45%...................... 2027 $ 24.4 $ 24.4
Series 1997B, 5.40%...................... 2018 32.8 32.8
Series 1997C, 5.40%...................... 2018 32.8 32.8
Series 1997D, 5.125%..................... 2009 8.5 8.5
Tax-exempt Waste Disposal Revenue Bonds:
Series 1997, 5.6%........................ 2031 25.0 25.0
Series 1998, 5.6%........................ 2032 25.0 25.0
Series 1999, 5.7%........................ 2032 25.0 25.0
Series 2001, 6.65%....................... 2032 18.5 18.5
CORE notes, 6.311%........................... 2007 50.0 -
6.125% notes................................. 2007 300.0 -
6.75% notes.................................. 2032 - 150.0
6.875% notes................................. 2012 750.0 -
7.375% notes................................. 2006 300.0 300.0
7.50% notes.................................. 2032 750.0 -
8.375% notes................................. 2005 200.0 200.0
8.75% notes................................. 2030 200.0 200.0
8.625% Guaranteed Notes...................... - - 275.0
Medium-term Notes:
7.44% (average rate)........................ 2005 46.0 46.0
8.0%........................................ 2005 150.0 150.0
8.45% (average rate)........................ 2003 24.0 24.0
Debentures:
7.25% (non-callable)........................ 2010 25.0 25.0
7.65% (putable July 1, 2006)................ 2026 100.0 100.0
8.00% (callable April 1, 2003).............. 2023 100.0 100.0
8.75% (non-callable)........................ 2015 75.0 75.0
Senior Notes:
6.70%....................................... 2013 180.0 -
6.75% (putable October 15, 2009;
callable thereafter)...................... 2037 100.0 100.0
6.875%...................................... 2012 100.0 -
7.20% (callable)............................ 2017 200.0 200.0
7.45% (callable)............................ 2097 100.0 100.0
$750 million revolving bank credit and
letter of credit facility.................. 2006 600.0 525.0
$750 million revolving bank credit facility.. 2003 150.0 -
Other........................................ Various 27.7 59.8
Net unamortized premium (discount)
(including fair market value adjustments)... (44.0) 1.3
------- -------
Total debt............................... 4,675.7 2,823.1
Less current portion, including
unamortized premium of $1.2 and $7.6........ (181.6) (305.7)
------- -------
Long-term debt, less current portion...... $ 4,494.1 $ 2,517.4
======= =======
80
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2002, Valero also had $3 million outstanding under an
uncommitted short-term bank credit facility with an interest rate of 2.75%. In
addition, Valero had $147.1 million of letters of credit outstanding under
uncommitted short-term facilities. Valero's uncommitted credit facilities have
no commitment or other fees, no compensating balance requirements and are
unsecured and unrestricted as to use.
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, respectively, 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.
Valero will also be charged various fees and expenses in connection with these
facilities, including facility fees and various letter of credit fees. The
interest rates and fees under these facilities are subject to adjustment based
upon the credit ratings assigned to Valero's long-term debt. These facilities
include certain restrictive covenants, including a coverage ratio and a
debt-to-capitalization ratio. As of December 31, 2002, borrowings under these
committed facilities were $750 million while letters of credit outstanding were
approximately $99.8 million.
A Canadian subsidiary of Valero has a committed revolving credit facility under
which it may borrow and obtain letters of credit up to Cdn. $115 million. As of
December 31, 2002, Valero had Cdn. $6.4 million of letters of credit outstanding
under the Canadian revolving credit facility. Valero L.P. has a revolving credit
facility under which it could borrow up to $120 million as of December 31, 2002
(subsequently amended in March 2003 to increase the facility to $175 million).
As of December 31, 2002, there were no amounts outstanding under the Valero L.P.
revolving credit facility.
On April 15, 2002, Valero issued $1.8 billion of notes under its $3.5 billion
shelf registration statement as follows:
o $300 million of 6.125% notes due April 15, 2007,
o $750 million of 6.875% notes due April 15, 2012, and
o $750 million of 7.5% notes due April 15, 2032.
The notes are unsecured and are redeemable, in whole or in part, at Valero's
option. Proceeds from this offering were used to repay all borrowings under
Valero's $1.5 billion bridge loan facility associated with the UDS Acquisition
and reduce borrowings under Valero's revolving bank credit facilities.
In June 2002, Valero L.P. and Valero Logistics Operations, L.P., indirect
subsidiaries of Valero as of December 31, 2002, filed a $500 million universal
shelf registration statement with the Securities and Exchange Commission (SEC).
In July 2002, Valero Logistics Operations, L.P. issued $100 million of 6.875%
senior notes due 2012 under the registration statement. The notes are unsecured
and are redeemable, in whole or in part, at Valero Logistics Operations, L.P.'s
option. The net proceeds from the offering were used to repay $91.0 million
outstanding under the Valero Logistics Operations, L.P. revolving credit
facility and for general partnership purposes.
81
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In July 2002, $275 million of 8.625% guaranteed notes matured and were repaid
with borrowings under Valero's revolving bank credit facilities.
In September 2002, Valero amended the interest coverage ratio covenant in its
various bank credit facilities and structured lease arrangements. The amendment
provides that Valero's trailing four-quarter coverage ratio must not be less
than:
o 2.4 times for the fourth quarter of 2002 and the first quarter of
2003,
o 2.5 times for the second, third and fourth quarters of 2003, and
o 2.75 times thereafter.
In November 2002, Valero renewed its $750 million 364-day revolving bank credit
facility.
Also in November 2002, Valero issued under its shelf registration statement $50
million of 6.311% notes due November 30, 2007. Interest is payable
semi-annually. The notes are unsecured and are redeemable, in whole or in part,
at Valero's option.
In December 2002, Valero issued under its shelf registration statement $180
million of 6.7% senior notes due January 15, 2013. Interest is payable
semi-annually. The notes are unsecured and are redeemable, in whole or in part,
at Valero's option. Almost all of these notes were issued in exchange for the
$150 million of 6.75% notes issued to the Valero Pass-Through Asset Trust 1997-1
in 1997 and to terminate an option held by a third party to purchase the 6.75%
notes on December 15, 2002.
In connection with the UDS Acquisition, Valero assumed various debt obligations
including 8.625% guaranteed notes, medium-term notes, debentures, senior notes,
and various notes payable which were recorded at a fair value of $1.3 billion.
Generally, the UDS debt obligations are unsecured with interest payable
semi-annually.
The aggregate stated maturities of long-term debt as of December 31, 2002 were
as follows (in millions):
2003..................................................... $ 180.4
2004..................................................... 1.9
2005..................................................... 397.9
2006..................................................... 902.0
2007..................................................... 352.0
Thereafter............................................... 2,885.5
Unamortized discount..................................... (44.0)
-------
Total.................................................. $ 4,675.7
=======
Amounts due in 2003 include $150.0 million borrowed under Valero's 364-day
revolving bank credit facility.
82
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2002 and 2001, the estimated fair value of Valero's long-term
debt, including current portion, was as follows (in millions):
December 31,
------------
2002 2001
---- ----
Carrying amount........................ $ 4,675.7 $ 2,823.1
Fair value............................. 4,831.0 2,873.2
12. OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following (in millions):
December 31,
------------
2002 2001
---- ----
Employee benefit plan liabilities............... $ 418.8 $ 387.4
Environmental liabilities....................... 191.5 137.3
Unfavorable lease obligations................... 145.9 136.7
Captive insurance reserves...................... 49.9 47.1
Other........................................... 60.5 54.3
---- ------
Other long-term liabilities................ $ 866.6 $ 762.8
===== =====
Employee benefit plan liabilities include the long-term obligation for Valero's
pension and other postretirement benefit plans as discussed in Note 21.
Environmental liabilities reflect the long-term portion of Valero's estimated
remediation costs for environmental assessments as discussed in Note 23.
Unfavorable lease obligations reflect the fair value of liabilities assumed in
connection with the UDS Acquisition related to lease agreements for retail
facilities and vessel charters.
13. COMPANY-OBLIGATED PREFERRED SECURITIES OF SUBSIDIARY TRUSTS
Company-obligated preferred securities of subsidiary trusts include:
o $172.5 million of Premium Equity Participating Security Units (PEPS
Units) which are mandatorily redeemable, and
o $200 million of Trust Originated Preferred Securities (TOPrS) which
are redeemable at Valero's option.
Premium Equity Participating Security Units
On June 28, 2000, Valero issued $172.5 million of 7 3/4% PEPS Units in a public
offering (6,900,000 units at $25.00 per unit). The net proceeds received by
Valero from this offering, which were used to fund the Benicia Acquisition, were
approximately $167 million. Each PEPS Unit consists of a purchase contract for
shares of Valero common stock and a trust preferred security.
Each purchase contract obligates the holder to purchase from Valero on August
18, 2003, for a price of $25.00 per contract, the following number of shares of
Valero common stock based on the average closing price of Valero's common stock
83
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
over the 20-day trading period ending on the third trading day prior to August
18, 2003:
o 0.71531 shares if the average closing price equals or exceeds $34.95;
o a number of shares having a value equal to $25.00 if the average
closing price is less than $34.95 but greater than $29.125; and
o 0.85837 shares if the average closing price is less than or equal to
$29.125.
The holder has the option to settle a purchase contract early for a price of
$25.00 in exchange for 0.71531 shares of Valero common stock.
Each trust preferred security represents an undivided interest in the assets of
VEC Trust I, a wholly owned subsidiary trust of Valero, has a stated liquidation
amount of $25.00 and matures on August 18, 2005. The trust preferred security is
pledged as collateral to secure the PEPS Unit holder's obligation to purchase
Valero common stock under the related purchase contract. VEC Trust I pays a cash
distribution on each trust preferred security at the annual rate of 7.75% of the
$25.00 stated liquidation amount prior to August 18, 2003, and from August 18,
2003 until August 18, 2005, at a reset rate that may be less than, equal to or
greater than this amount. The cash distribution payments are made quarterly on
February 18, May 18, August 18 and November 18 of each year.
The assets of VEC Trust I consist solely of Valero senior deferrable notes
maturing on August 18, 2005. VEC Trust I's sole source of funds for
distributions on the trust preferred securities is the interest payments it
receives from Valero on the senior deferrable notes. Valero has the right to
defer interest on the senior deferrable notes until August 18, 2003, in which
case distributions on the trust preferred securities would also be deferred. Any
deferred distributions will accumulate and compound quarterly at the rate of
7.75% per year. Valero guarantees the payment of distributions on the trust
preferred securities to the extent interest is paid on the senior deferrable
notes. Distributions on the trust preferred securities, whether paid or
accumulated, are reflected in distributions on preferred securities of
subsidiary trust in the consolidated statements of income.
In August 2003, pursuant to the purchase contract that is part of each PEPS
Unit, the holders of PEPS Units will be obligated to purchase shares of common
stock from Valero for $25 per purchase contract, which will result in the
receipt of $172.5 million of cash by Valero in exchange for the issuance of
common stock at a price based on the 20-day trading period described above.
Holders of PEPS Units may settle their purchase contracts by paying cash to
Valero or by remarketing their pledged trust preferred securities and using the
proceeds from the remarketing to settle the purchase contracts. The distribution
rate on the trust preferred securities will be reset on August 18, 2003 based on
the price for which the trust preferred securities are remarketed.
Prior to the issuance of shares of Valero common stock upon settlement of the
purchase contracts, the PEPS Units are reflected in Valero's earnings per common
share - assuming dilution calculations using the treasury stock method.
Consequently, the PEPS Units will have a dilutive effect on earnings per share
for reporting periods during which the average market price per share of Valero
common stock exceeds $34.95. For reporting periods during which the average
market price per share of Valero common stock is $34.95 or less, the PEPS Units
will have a dilutive effect on earnings per common share - assuming dilution
only when that average market price per share is above the average closing price
for the 20-day trading period ending on the third trading day prior to the end
of the reporting period.
84
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Trust Originated Preferred Securities
On June 25, 1997, UDS Capital I (the Trust) issued $200 million of 8.32% Trust
Originated Preferred Securities (TOPrS) in an underwritten public offering
(8,000,000 units at $25.00 per unit). The TOPrS became redeemable on June 30,
2002 at the option of the Trust, in whole or in part, at a redemption price of
$25.00 per security. Distributions on the TOPrS are cumulative and payable
quarterly in arrears, on March 31, June 30, September 30 and December 31, if and
when the Trust has funds available for distribution, at the annual rate of 8.32%
of the liquidation amount of $25.00 per TOPrS.
As a result of the UDS Acquisition, the Trust is a wholly owned subsidiary of
Valero. Valero has guaranteed, on a subordinated basis, the dividend payments
due on the TOPrS if and when declared.
14. STOCKHOLDERS' EQUITY
Authorized Shares
On September 27, 2001, Valero's stockholders approved an increase in the number
of authorized shares of common stock from 150 million shares to 300 million
shares. Effective December 31, 2001, Valero's Restated Certificate of
Incorporation was amended to reflect the increase in the number of authorized
shares of Valero common stock.
Valero also has 20 million shares of preferred stock authorized with a par value
of $0.01 per share. As of December 31, 2002 and 2001, there were no outstanding
shares of preferred stock.
Exchange of UDS Shares
In connection with the UDS Acquisition, Valero issued 45.9 million shares of
Valero common stock and vested 5.8 million employee stock options in the
exchange, which increased stockholders' equity by a total of approximately $2.2
billion.
Common Stock Offering
On June 28, 2000, Valero issued to the public 5,980,000 shares of its common
stock at $29.125 per share. Valero received net proceeds of approximately $167
million from this offering, which were used to fund the Benicia Acquisition.
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 years ended December 31, 2002, 2001 and 2000, Valero repurchased
shares of its common stock under these programs at a cost of $45.5 million,
$156.7 million and $64.3 million, respectively.
85
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15. EARNINGS PER SHARE
The computation of earnings per share amounts is as follows (dollars and shares
in millions, except per share amounts):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Earnings per Common Share:
Net income applicable to common shares............... $ 91.5 $ 563.6 $ 339.1
==== ===== =====
Weighted-average common shares outstanding........... 105.8 60.7 58.5
===== ==== ====
Earnings per common share ........................... $ 0.86 $ 9.28 $ 5.79
==== ==== ====
Earnings per Common Share - Assuming Dilution:
Net income available to
common equivalent shares............................ $ 91.5 $ 563.6 $ 339.1
==== ===== =====
Weighted-average common shares outstanding........... 105.8 60.7 58.5
Effect of dilutive securities:
Stock options..................................... 2.9 1.9 1.3
Performance awards and other benefit plans........ 1.3 1.0 0.7
PEPS Units........................................ 0.1 0.2 -
----- ---- ----
Weighted-average common equivalent
shares outstanding................................ 110.1 63.8 60.5
===== ==== ====
Earnings per common share -
assuming dilution................................. $ 0.83 $ 8.83 $ 5.60
==== ==== ====
86
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net income is
adjusted by, among other things, changes in current assets and current
liabilities as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Decrease (increase) in current assets:
Restricted cash................................. $ 46.3 $ - $ -
Receivables, net................................ (777.4) 166.6 (213.3)
Inventories..................................... 20.3 (66.5) (70.4)
Income taxes receivable......................... 169.4 (44.5) -
Prepaid expenses and other current assets....... 23.3 5.9 (10.3)
Increase (decrease) in current liabilities:
Accounts payable................................ 402.9 (237.6) 189.9
Accrued expenses................................ (161.1) 33.1 49.7
Taxes other than income taxes................... 39.1 6.9 21.6
Income taxes payable............................ 28.4 (16.8) 36.3
----- ------ -----
Changes in current assets and
current liabilities........................ $(208.8) $(152.9) $ 3.5
===== ===== =====
These changes in current assets and current liabilities differ from changes
between amounts reflected in the applicable consolidated balance sheets for the
respective periods for the following reasons. The amounts shown above exclude
changes in cash and temporary cash investments, assets held for sale, current
deferred income tax assets and liabilities, and short-term debt and current
portion of long-term debt and capital lease obligations. Also excluded from the
table above are the current assets and current liabilities acquired in
connection with the UDS, Huntway and El Paso Acquisitions in 2001 and the
Benicia Acquisition in 2000, which are reflected separately in the consolidated
statements of cash flow, and the effect of certain noncash investing activities
discussed below. In addition, certain differences between consolidated balance
sheet changes and statement of cash flow changes reflected above result from
translating foreign currency denominated amounts at different exchange rates.
Noncash investing activities for the year ended December 31, 2002 included:
o the adjustment to goodwill and assets held for sale to reflect the
difference between estimated and actual proceeds received on the
liquidation of the investment in Diamond-Koch and the disposition of
the Golden Eagle Business;
o the receipt of $150 million of notes from Tesoro with an estimated
fair value of $58.9 million in connection with the disposition of the
Golden Eagle Business; and
o various adjustments to property, plant and equipment, goodwill and
certain current and other noncurrent assets and liabilities resulting
from adjustments to the purchase price allocations related to the
Huntway, El Paso and UDS Acquisitions.
87
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Noncash investing and financing activities for 2001 included:
o the issuance of $2.1 billion of common stock and $120 million of
vested employee stock options as partial consideration for the UDS
Acquisition,
o the recognition of capital lease obligations of approximately $286
million related to the El Paso Acquisition, and
o various adjustments to property, plant and equipment and certain
current assets and current and noncurrent liabilities resulting from
the final purchase price allocation related to the Benicia
Acquisition.
Noncash investing and financing activities for the year ended December 31, 2000
included various adjustments to property, plant and equipment and certain
current assets and current liabilities resulting from the preliminary purchase
price allocation related to the Benicia Acquisition.
Cash flows related to interest and income taxes were as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Interest paid (net of amount capitalized)........... $ 262.0 $ 78.8 $ 71.8
Income taxes paid................................... 31.6 124.8 49.6
Income tax refunds received......................... 172.7 2.5 0.6
17. PRICE RISK MANAGEMENT ACTIVITIES
Commodity Price Risk
Valero is exposed to market risks related to the volatility of crude oil and
refined product prices, as well as volatility in the price of natural gas used
in its refining operations. To reduce the impact of this price volatility,
Valero uses derivative commodity instruments (swaps, futures and options) to
manage its exposure to:
o changes in the fair value of a portion of its refinery feedstock and
refined product inventories and a portion of its unrecognized firm
commitments to purchase these inventories (fair value hedges);
o changes in cash flows of certain forecasted transactions such as
forecasted feedstock purchases, natural gas purchases and refined
product sales (cash flow hedges); and
o price volatility on a portion of its refined product inventories and
on certain forecasted feedstock and refined product purchases that are
not designated as either fair value or cash flow hedges (economic
hedges).
In addition, Valero uses derivative commodity instruments for trading purposes
based on its fundamental and technical analysis of market conditions.
Interest Rate Risk
Valero is exposed to market risk for changes in interest rates related to
certain of its long-term debt obligations. Interest rate swap agreements are
used to manage a portion of the exposure to changing interest rates by
converting certain fixed-rate debt to floating rate debt.
88
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Foreign Currency Risk
Valero is exposed to exchange rate fluctuations on transactions related to its
Canadian operations. To manage its exposure to these exchange rate fluctuations,
Valero uses foreign currency exchange and purchase contracts. These contracts
are not designated as hedging instruments.
During May 2002, Valero entered into foreign currency exchange contracts to
hedge its exposure to exchange rate fluctuations on an investment in its
Canadian operations. Under these contracts, Valero sold $400 million of Canadian
dollars and bought $253.4 million of U.S. dollars. These contracts mature
annually at various amounts from 2003 through 2007. As of December 31, 2002,
these contracts had a fair value of $6.1 million, which are included in prepaid
expenses and other current assets and deferred charges and other assets. The
gain recognized in income on these contracts, which was $6.1 million for the
year ended December 31, 2002, was substantially offset by a loss of $2.4 million
recognized in income from the effect of the exchange rate fluctuation on the
hedged investment for the year.
As of December 31, 2002, Valero had commitments to purchase $33.8 million of
U.S. dollars. Valero's market risk was minimal on these contracts as they
matured on or before January 3, 2003.
Impact of Adoption
The impact of adopting Statement No. 133 as of January 1, 2001 was as follows
(debit (credit) in millions):
Inventories................................................... $ 3.2
Deferred charges, deferred credits and other.................. 42.8
Accounts payable.............................................. (2.5)
Deferred income tax liabilities............................... (15.2)
Other comprehensive income, net of income tax expense......... (28.3)
Current Period Disclosures
The net gain (loss) recognized in income representing the amount of hedge
ineffectiveness was as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001
---- ----
Fair value hedges........................... $ (1.2) $ (3.4)
Cash flow hedges............................ 29.3 (20.8)
The above amounts were included in cost of sales in the consolidated statements
of income. No component of the derivative instruments' gains or losses was
excluded from the assessment of hedge effectiveness. No amounts were recognized
in income for hedged firm commitments that no longer qualify as fair value
hedges.
For cash flow hedges, gains and losses currently reported in accumulated other
comprehensive income (loss) in the consolidated balance sheets will be
reclassified into income when the forecasted transactions affect income. The
estimated amount of existing net gain included in accumulated other
comprehensive income (loss) as of December 31, 2002 that is expected to be
reclassified into income within the next 12 months is less than $50,000. As of
December 31, 2002, the maximum length of time over which Valero was hedging its
89
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
exposure to the variability in future cash flows for forecasted transactions was
two years, with the majority of the transactions maturing in less than one year.
For the years ended December 31, 2002 and 2001, there were no amounts
reclassified from accumulated other comprehensive income (loss) into income as a
result of the discontinuance of cash flow hedge accounting.
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.
18. PREFERRED SHARE PURCHASE RIGHTS
Each outstanding share of Valero's common stock is accompanied by one preferred
share purchase right (Right). With certain exceptions, each Right entitles the
registered holder to purchase from Valero one one-hundredth of a share of
Valero's Junior Participating Preferred Stock, Series I at a price of $100 per
one one-hundredth of a share, subject to adjustment for certain recapitalization
events.
The Rights are transferable only with the common stock until the earlier of:
(i). 10 days following a public announcement that a person or group of
affiliated or associated persons (Acquiring Person) has acquired
beneficial ownership of 15% or more of the outstanding shares of
Valero's common stock,
(ii).10 business days (or later date as may be determined by Valero's
Board of Directors) following the initiation of a tender offer or
exchange offer that would result in an Acquiring Person having
beneficial ownership of 15% or more of Valero's outstanding
common stock (the earlier of the date of the occurrence of (i) or
(ii) being called the Rights Separation Date), or
(iii). the earlier redemption or expiration of the Rights.
The Rights are not exercisable until the Rights Separation Date. At any time
prior to the acquisition by an Acquiring Person of beneficial ownership of 15%
or more of Valero's outstanding common stock, Valero's Board of Directors may
redeem the Rights at a price of $0.01 per Right. The Rights will expire on June
30, 2007, unless extended or the Rights are earlier redeemed or exchanged by
Valero.
If after the Rights Separation Date, Valero is acquired in a merger or other
business combination transaction, or if 50% or more of its consolidated assets
or earning power is sold, each holder of a Right will have the right to receive,
upon the exercise of the Right at its then current exercise price, that number
of shares of common stock of the acquiring company which at the time of the
transaction will have a market value of two times the exercise price of the
Right. In the event that any Acquiring Person becomes the beneficial owner of
15% or more of Valero's outstanding common stock, each holder of a Right, other
than Rights beneficially owned by the Acquiring Person (which will thereafter be
void), will thereafter have the right to receive upon exercise that number of
shares of common stock having a market value of two times the exercise price of
the Right.
90
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At any time after an Acquiring Person acquires beneficial ownership of 15% or
more of Valero's outstanding common stock and prior to the acquisition by the
Acquiring Person of 50% or more of Valero's outstanding common stock, Valero's
Board of Directors may exchange the Right (other than Rights owned by the
Acquiring Person which have become void), at an exchange ratio of one share of
common stock, or one one-hundredth of a share of Junior Preferred Stock, per
Right (subject to adjustment).
Until a Right is exercised, the holder will have no rights as a stockholder of
Valero including, without limitation, the right to vote or to receive dividends.
The Rights may have certain anti-takeover effects. The Rights will cause
substantial dilution to any Acquiring Person that attempts to acquire Valero on
terms not approved by Valero's Board of Directors, except pursuant to an offer
conditioned on a substantial number of Rights being acquired. The Rights should
not interfere with any merger or other business combination approved by Valero's
Board of Directors since the Rights may be redeemed by Valero prior to the time
that an Acquiring Person has acquired beneficial ownership of 15% or more of
Valero's outstanding common stock.
19. INCOME TAXES
Components of income tax expense were as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Current:
U.S. federal....................... $ (8.2) $ 56.2 $ 80.0
U.S. state......................... 0.8 4.4 6.0
Canada............................. 64.1 - -
---- ----- -----
Total current..................... 56.7 60.6 86.0
---- ----- -----
Deferred:
U.S. federal....................... 24.2 246.6 102.1
U.S. state......................... 3.2 24.1 1.0
Canada............................. (25.9) - -
---- ----- -----
Total deferred.................... 1.5 270.7 103.1
---- ----- -----
Income tax expense............... $ 58.2 $ 331.3 $ 189.1
==== ===== =====
91
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For the year ended December 31, 2002, income before income tax expense from U.S.
operations and Canadian operations was $44.0 million and $105.7 million,
respectively. The following is a reconciliation of total income tax expense to
income taxes computed by applying the statutory federal income tax rate (35% for
all years presented) to income before income taxes (in millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
U.S. federal income tax expense
at the statutory rate....................... $ 52.4 $ 313.2 $ 184.9
U.S. state income taxes,
net of federal income tax effect............ 2.5 18.5 4.5
Canadian operations............................ 1.2 - -
General business tax credit.................... (0.9) (1.0) (3.0)
Other, net..................................... 3.0 0.6 2.7
---- ----- -----
Income tax expense........................ $ 58.2 $ 331.3 $ 189.1
==== ===== =====
The tax effects of significant temporary differences representing deferred
income tax assets and liabilities were as follows (in millions):
December 31,
------------
2002 2001
---- ----
Deferred income tax assets:
Tax credit carryforwards....................... $ 141.4 $ 92.6
Net operating losses........................... 323.0 21.8
Compensation and employee
benefit liabilities........................... 162.8 107.5
Accrued liabilities............................ 123.7 110.9
Other assets................................... 72.0 84.5
------- -------
Total deferred income tax assets.............. 822.9 417.3
Less: Valuation allowance...................... (39.1) (24.0)
------- -------
Net deferred income tax assets................ 783.8 393.3
------- -------
Deferred income tax liabilities:
Turnarounds.................................... (103.9) (97.0)
Depreciation................................... (1,564.4) (1,477.3)
Equity investment in Diamond-Koch, L.P......... - (75.5)
Inventories.................................... (105.6) (55.1)
Other.......................................... (215.6) (137.2)
------- -------
Total deferred income tax liabilities......... (1,989.5) (1,842.1)
------- -------
Net deferred income tax liabilities............. $ (1,205.7) $ (1,448.8)
======= =======
92
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
As of December 31, 2002, Valero had the following U.S. federal and state income
tax credit and loss carryforwards (in millions):
Amount Expiration
------ ----------
Alternative minimum tax (AMT) credit.......... $ 108.7 Indefinite
U.S. federal income tax credits............... 2.0 2003 through 2017
U.S. state income tax credits................. 22.9 2003 through 2012
Foreign tax credit............................ 30.7 2006
U.S. federal net operating losses (NOL)....... 798.3 2011 through 2022
U.S. state NOL................................ 1,434.2 2003 through 2022
Approximately $17 million of the AMT credit, $1 million of the U.S. federal
income tax credits, and $20 million of the U.S. federal NOL carryforwards are
subject to annual U.S. federal income tax limitations.
Valero has recorded a valuation allowance as of December 31, 2002 and 2001, due
to uncertainties related to its ability to utilize some of its deferred income
tax assets, primarily consisting of certain state net operating losses carred
forward and foreign tax credits carried forward, before they expire. The
valuation allowance is based on Valero's estimates of taxable income in the
various jurisdictions in which it operates and the period over which deferred
income tax assets will be recoverable. The realization of net deferred income
tax assets recorded as of December 31, 2002 is dependent upon Valero's ability
to generate future taxable income in both the U.S. and Canada. Although
realization is not assured, Valero believes it is more likely than not that the
net deferred income tax assets will be realized.
U.S. federal deferred income taxes or Canadian withholding taxes have not been
provided for on the undistributed earnings of Valero's Canadian subsidiaries
based on the determination that those earnings will be indefinitely reinvested.
As of December 31, 2002, the cumulative undistributed earnings of these
subsidiaries were approximately $80 million. If those earnings were not
considered indefinitely reinvested, U.S. federal deferred income taxes and
Canadian withholding taxes would have been recorded after consideration of
foreign tax credits.
Valero's separate tax years through 1998 and UDS's tax years through 1994 and
for 1998 are closed to adjustment by the Internal Revenue Service. UDS's
separate tax years 1995 through 1997 are currently under examination. Valero
believes that adequate provisions for income taxes have been reflected in the
consolidated financial statements.
93
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20. SEGMENT INFORMATION
Prior to the UDS Acquisition, Valero had one reportable segment, the refining
and marketing of refined products. Beginning January 1, 2002, Valero has two
reportable segments, refining and retail, because of Valero's acquisition of UDS
on December 31, 2001, and its significant retail operations. Valero's refining
segment includes refining operations, wholesale marketing, product supply and
distribution, and transportation operations. The retail segment includes
company-operated convenience stores, Canadian dealers/jobbers and truckstop
facilities, cardlock facilities and home heating oil operations. Operations that
are not included in either of the two reportable segments are included in the
corporate category. Segment information for the years ended December 31, 2001
and 2000 have been reclassified to conform to the 2002 reportable segment
presentation.
The reportable segments are strategic business units that offer different
products and services. They are managed separately as each business requires
unique technology and marketing strategies. Performance is evaluated based on
operating income. Intersegment sales are generally derived from transactions
made at prevailing market rates.
Refining Retail Corporate Total
-------- ------ --------- -----
(in millions)
Year ended December 31, 2002:
Operating revenues from external customers..... $ 21,809.8 $ 5,166.4 $ - $ 26,976.2
Intersegment revenues.......................... 2,586.5 - - 2,586.5
Operating income (loss)........................ 642.4 128.5 (300.0) 470.9
Year ended December 31, 2001:
Operating revenues from external customers..... 14,944.0 44.3 - 14,988.3
Intersegment revenues.......................... 27.6 - - 27.6
Operating income (loss)........................ 1,160.8 1.9 (161.3) 1,001.4
Year ended December 31, 2000:
Operating revenues from external customers..... 14,643.2 27.9 - 14,671.1
Intersegment revenues.......................... 14.9 - - 14.9
Operating income (loss)........................ 741.7 0.8 (131.5) 611.0
94
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Valero's principal products include conventional, reformulated and CARB
gasolines, low-sulfur diesel, and oxygenates and other gasoline blendstocks.
Valero also produces a substantial slate of middle distillates, jet fuel and
petrochemicals, in addition to lube oils and asphalt. Operating revenues from
external customers for Valero's principal products for the years ended
December 31, 2002, 2001 and 2000 were as follows (in millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Refining:
Gasolines and blendstocks................. $ 11,376.3 $ 8,402.4 $ 7,805.9
Distillates............................... 5,378.4 3,368.9 3,747.1
Petrochemicals............................ 462.9 301.9 386.9
Lubes and asphalts........................ 888.9 410.0 295.3
Other products and revenues............... 3,703.3 2,460.8 2,408.0
-------- -------- --------
Total refining operating revenues........ 21,809.8 14,944.0 14,643.2
-------- -------- --------
Retail:
Fuel sales (gasoline and diesel).......... 3,677.6 40.1 25.6
Merchandise sales and other............... 1,294.6 4.2 2.3
Home heating oil.......................... 194.2 - -
-------- -------- --------
Total retail operating revenues.......... 5,166.4 44.3 27.9
-------- -------- --------
Consolidated operating revenues.......... $ 26,976.2 $ 14,988.3 $ 14,671.1
======== ======== ========
Operating revenues by geographic area for the year ended December 31, 2002 are
shown in the table below (in millions). For the years ended December 31, 2001
and 2000, Valero had no significant amount of export sales. The geographic area
is based on location of customer.
United States........................................ $ 23,286.0
Canada............................................... 2,984.2
Other foreign countries.............................. 706.0
--------
Consolidated operating revenues................... $ 26,976.2
========
For the year ended December 31, 2002, no customer accounted for more than 10% of
Valero's consolidated operating revenues. During the years ended December 31,
2001 and 2000, $1.6 billion (10.6%) and $1.7 billion (11.7%), respectively, of
Valero's consolidated operating revenues were derived from sales to one customer
in the refining segment.
Long-lived assets include property, plant and equipment, intangible assets and
certain long-lived assets included in deferred charges and other assets.
Geographic information by country for long-lived assets consisted of the
following (in millions):
December 31,
------------
2002 2001
---- ----
United States............................ $ 6,973.1 $ 6,745.4
Canada................................... 1,004.1 1,024.4
------- -------
Consolidated long-lived assets......... $ 7,977.2 $ 7,769.8
======= =======
95
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Total assets by reportable segment were as follows (in millions):
December 31,
------------
2002 2001
---- ----
Refining................................. $ 12,661.7 $ 12,573.9
Retail................................... 1,085.1 1,165.4
Corporate................................ 718.4 660.5
-------- --------
Total consolidated assets............... $ 14,465.2 $ 14,399.8
======== ========
The entire balance of goodwill as of December 31, 2002 and 2001 has been
included in the total assets of the refining reportable segment.
21. EMPLOYEE BENEFIT PLANS
Pension Plans and Postretirement Benefits Other Than Pensions
Valero has several qualified non-contributory defined benefit plans (the
Qualified Plans) including plans assumed in the UDS Acquisition, some of which
were subject to collective bargaining agreements. The Qualified Plans cover
substantially all employees in the United States and generally provide eligible
employees with retirement income based on years of service and compensation
during specific periods. Effective March 1 and April 1, 2002, certain classes of
former UDS retail employees ceased accruing benefits under Valero's qualified
pension plan.
Valero also has various nonqualified supplemental executive retirement plans
(Supplemental Plans), including those assumed in the UDS Acquisition, which
provide additional pension benefits to executive officers and certain other
employees. The Supplemental Plans and the Qualified Plans are collectively
referred to as the Pension Plans.
Approximately $32 million and $19 million of the Qualified Plans' assets were
invested in Valero common stock as of December 31, 2002 and 2001, respectively.
The balance of the assets are invested in domestic and foreign equities,
corporate bonds, government securities and money market funds.
In connection with the UDS Acquisition, Valero approved the establishment of a
supplement to the pension plan (the 2001 Voluntary Early Retirement Window)
which permitted certain employees to retire from employment during 2002. There
were 100 employees who accepted the 2001 Voluntary Early Retirement Window
option.
Valero also provides certain health care and life insurance benefits for retired
employees, referred to as postretirement benefits other than pensions.
Substantially all of Valero's employees may become eligible for these benefits
if, while still working for Valero, they either reach normal retirement age or
take early retirement. Valero offers health care benefits through a self-insured
plan and a health maintenance organization while life insurance benefits are
provided through an insurance company. Valero funds its postretirement benefits
other than pensions on a pay-as-you-go basis. Individuals who became Valero
employees as a result of an acquisition by Valero became eligible for other
postretirement benefits under Valero's plan as determined by terms of the
acquisition agreement.
96
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The changes in benefit obligation, changes in plan assets, funded status and
amounts recognized in Valero's consolidated balance sheets for Valero's Pension
Plans and other postretirement benefits were as follows (in millions):
Other Postretirement
Pension Benefits Benefits
----------------- --------------------
2002 2001 2002 2001
---- ---- ---- ----
Change in benefit obligation:
Benefit obligation at beginning of year......... $ 690.2 $ 188.3 $ 193.3 $ 62.7
Service cost................................... 41.0 15.2 8.7 4.7
Interest cost.................................. 44.0 15.4 16.3 6.6
UDS Acquisition................................ - 389.5 - 98.3
Huntway Acquisition............................ - - - 1.1
El Paso Acquisition............................ - - - 5.5
Benicia Acquisition............................ - - - 3.1
Sale of Golden Eagle Business.................. (6.8) - (5.0) -
Participant contributions...................... 0.1 - 1.4 0.2
Plan amendments................................ (11.6) 41.3 37.1 (26.7)
2001 Voluntary Early Retirement Window......... - 2.5 - 0.6
Benefits paid.................................. (88.7) (6.8) (9.8) (2.4)
Actuarial loss................................. 49.1 44.8 51.8 39.6
----- ----- ----- -----
Benefit obligation at end of year............... $ 717.3 $ 690.2 $ 293.8 $ 193.3
===== ===== ===== =====
Change in plan assets:
Fair value of plan assets at beginning of year.. $ 396.4 $ 182.2 $ - $ -
Actual return on plan assets................... (28.5) (14.0) - -
Valero contributions........................... 101.5 18.5 8.4 2.2
Participant contributions...................... 0.1 - 1.4 0.2
UDS Acquisition................................ - 216.5 - -
Benefits paid.................................. (88.7) (6.8) (9.8) (2.4)
----- ----- ---- ----
Fair value of plan assets at end of year........ $ 380.8 $ 396.4 $ - $ -
===== ===== ==== ====
Reconciliation of funded status:
Fair value of plan assets at end of year........ $ 380.8 $ 396.4 $ - $ -
Less: Benefit obligation at end of year......... 717.3 690.2 293.8 193.3
----- ----- ----- -----
Funded status at end of year.................... (336.5) (293.8) (293.8) (193.3)
Unrecognized net loss.......................... 182.5 69.6 97.9 49.0
Unrecognized prior service cost................ 31.9 46.4 14.0 (21.9)
Unrecognized net transition asset.............. (0.3) (0.5) - -
----- ----- ----- -----
Accrued benefit cost............................ $(122.4) $(178.3) $(181.9) $(166.2)
===== ===== ===== =====
97
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Postretirement
Pension Benefits Benefits
---------------- --------------------
2002 2001 2002 2001
---- ---- ---- ----
Amounts recognized in the consolidated
balance sheets:
Prepaid benefit cost........................ $ 30.5 $ 21.3 $ - $ -
Intangible asset............................ 26.9 32.8 - -
Accrued benefit liability................... (201.8) (232.4) (181.9) (166.2)
Accumulated other comprehensive loss........ 22.0 - - -
----- ----- ----- -----
Accrued benefit cost........................... $(122.4) $(178.3) $(181.9) $(166.2)
===== ===== ===== =====
The projected benefit obligation, accumulated benefit obligation and fair value
of plan assets for the Pension Plans with accumulated benefit obligations in
excess of plan assets were as follows (in millions):
December 31,
------------
2002 2001
---- ----
Projected benefit obligation..................... $ 648.4 $ 620.1
Accumulated benefit obligation................... 523.5 475.3
Fair value of plan assets........................ 323.4 331.5
The components of net periodic benefit cost were as follows (in millions):
Other Postretirement
Pension Benefits Benefits
----------------------------- -------------------------------
2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ----
Components of net periodic benefit cost:
Service cost............................. $ 41.0 $ 15.2 $ 11.0 $ 8.7 $ 4.7 $ 2.2
Interest cost............................ 44.0 15.4 12.3 16.3 6.6 3.4
Expected return on plan assets........... (37.2) (16.9) (15.7) - - -
2001 Voluntary Early
Retirement Window...................... - 2.5 - - 0.6 -
Amortization of:
Transition obligation (asset).......... (0.1) (0.2) (0.2) - 0.3 0.3
Prior service cost..................... 2.9 1.0 0.9 1.2 0.1 0.1
Net loss............................... 1.9 1.0 - 2.8 1.2 -
---- ---- ---- ---- ---- ---
Net periodic benefit cost.................. $ 52.5 $ 18.0 $ 8.3 $ 29.0 $ 13.5 $ 6.0
==== ==== ==== ==== ==== ===
98
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Amortization of prior service cost as shown in the above table is based on the
average remaining service period of employees expected to receive benefits under
the plan. The weighted-average assumptions used in computing the actuarial
present value of the pension benefit and other postretirement benefit
obligations for the years ended December 31, 2002 and 2001 were as follows:
Other Postretirement
Pension Benefits Benefits
---------------- --------------------
2002 2001 2002 2001
---- ---- ---- ----
Weighted-average assumptions:
Discount rate................................ 6.50% 7.00% 6.50% 7.00%
Expected long-term rate of return
on plan assets............................. 8.50% 8.75% - -
Rate of compensation increase................ 4.84% 5.62% - -
For the December 31, 2002 measurement, the health care cost trend rate was
assumed to be 10% in 2002 and 2003, then decrease 1% per year to an ultimate
rate of 5.25% in 2008 and beyond. For the December 31, 2001 measurement, the
health care cost trend rate was assumed to decrease 1% per year from the 2001
rate of 10% to an ultimate rate of 5.5% in 2006 and beyond. Assumed health care
cost trend rates have a significant effect on the amounts reported for health
care plans. A one percentage-point change in assumed health care cost trend
rates would have the following effects on other postretirement benefits (in
millions):
1% Increase 1% Decrease
----------- -----------
Effect on total of service and interest cost components...... $ 5.1 $ (4.0)
Effect on other postretirement benefit obligation............ 41.9 (34.0)
Profit-Sharing/Savings Plans
Valero Energy Corporation Thrift Plan
Valero is the sponsor of the Valero Energy Corporation Thrift Plan, which is a
qualified employee profit-sharing plan. Participation in the Thrift Plan is
voluntary and is open to Valero employees who become eligible to participate
upon the completion of one month of continuous service. This service may include
prior employment with other companies acquired by Valero.
Through December 31, 2001, participants could make basic contributions from 2%
up to 8% of their total annual compensation. In addition, participants who made
a basic contribution of 8% could also make a supplemental contribution of up to
14% of their total annual compensation. Valero made an employer contribution to
the Thrift Plan equal to 75% of the participant's basic contributions up to 8%
of the base annual compensation. The Thrift Plan provided that if Valero's
return on equity for a given year was equal to or greater than 10%, then
Valero's employer contribution would be equal to 100% of a participant's basic
contributions relating to the participant's base annual salary for the 12-month
period beginning February 1 for the calendar year following the year in which
the 10% return was achieved. In January 2001, the compensation committee of
Valero's Board of Directors approved an increase in Valero's employer
contribution from 75% to 100% for the 12-month period beginning February 1,
2001.
Effective January 1, 2002, the Thrift Plan was amended to provide that
participants would be able to make a supplemental contribution of up to 22% of
their total annual compensation and the maximum match by Valero would be 75% of
99
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
each participant's basic contributions up to 8% based on the participant's total
annual compensation, including overtime and cash bonuses. However, employer
contributions were equal to 100% of employee contributions up to 8% between
January 1 and February 1, 2002.
Valero's contributions to the Thrift Plan for the years ended December 31, 2002,
2001 and 2000 were $20.9 million, $13.5 million and $8.2 million, respectively.
Valero Savings Plan
In connection with the UDS Acquisition, Valero became the plan sponsor of the
Valero Savings Plan (formerly the UDS 401(k) Retirement Savings Plan). The
Savings Plan is a defined contribution plan that previously covered all eligible
employees of UDS. Under the Savings Plan, participants can contribute from 1% to
15% of their compensation. Effective January 1, 2002, the company matching
contributions for certain non-store employees of UDS was changed to 75% of up to
8% of employee contributions. Effective April 1, 2002, certain non-store
employees of UDS were no longer eligible to participate in the Savings Plan, but
became eligible to participate in the Valero Energy Corporation Thrift Plan.
Valero's contribution to the Savings Plan for the year ended December 31, 2002
was $3.7 million. There were no contributions to the Savings Plan for the years
ended December 31, 2001 and 2000 as Valero was not a sponsor of the plan for
those years.
Stock Compensation Plans
Valero has various fixed and performance-based stock compensation plans, which
are summarized as follows:
o The Executive Stock Incentive Plan (ESIP) authorizes the grant of
various stock and stock-related awards to executive officers and other
key employees. Awards available under the ESIP include options to
purchase shares of common stock, performance awards that vest upon the
achievement of an objective performance goal, and restricted stock
which vests over a period determined by Valero's compensation
committee. As of December 31, 2002, a total of 1,968,267 shares of
Valero common stock remain available to be awarded under the ESIP.
o A non-qualified stock option plan grants options to purchase shares of
common stock to key officers, employees and prospective employees. As
of December 31, 2002, a total of 163,459 shares of Valero common stock
remain available to be awarded under this plan.
o The Executive Incentive Bonus Plan provides bonus compensation to key
employees based on individual contributions to company profitability.
Bonuses are payable either in cash, Valero common stock, or both. As
of December 31, 2002, a total of 200,000 shares of Valero common stock
remain authorized to be issued under this plan.
o A non-employee director stock option plan provides non-employee
directors of Valero automatic annual grants of stock options to
purchase Valero's common stock. As of December 31, 2002, a total of
116,000 shares of Valero common stock remain available to be awarded
under this plan.
o A restricted stock plan for non-employee directors provides
non-employee directors a grant of Valero's common stock valued at
$45,000 that vests in three equal annual installments, with similar
grants issued after full vesting of prior grants. As of December 31,
2002, a total of 75,942 shares of Valero common stock remain available
to be awarded under this plan.
o Valero GP, LLC's 2000 Long-Term Incentive Plan and 2002 Unit Option
Plan provide for grants of restricted common units of Valero L.P. and
options to purchase common units of Valero L.P., respectively.
Generally, these restricted common unit and option awards vest in
three equal annual installments. As of December 31, 2002, a total of
100
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
194,750 units and 23,800 units of Valero L.P. common units remain
available to be awarded under the 2000 Long-Term Incentive Plan and
2002 Unit Option Plan, respectively.
The number and weighted-average grant-date fair value of shares of Valero common
stock granted under the above-noted plans (other than shares related to stock
options which are presented in a separate table below) during the years ended
December 31, 2002, 2001 and 2000 were as follows:
2002 2001 2000
---------------------- ------------------------ ------------------------
Weighted- Weighted- Weighted-
Average Average Average
Shares Grant-Date Shares Grant-Date Shares Grant-Date
Granted Fair Value Granted Fair Value Granted Fair Value
------- ---------- ------- ---------- ------- ----------
ESIP:
Restricted stock.............. 4,500 $ 37.98 8,000 $ 37.52 17,619 $29.14
Performance awards............ 187,200 40.44 132,400 34.13 146,100 21.81
Executive Incentive
Bonus Plan.................... 119,449 41.39 251,624 36.72 134,362 21.81
Non-employee director
restricted stock plan......... 2,190 41.12 1,932 37.79 1,608 28.00
Valero GP, LLC:
Restricted units.............. 55,250 40.95 - - - -
Unit option awards............ 176,200 37.08 - - - -
Under the terms of the ESIP, the stock option plan and the non-employee director
stock option plan, the exercise price of options granted will not be less than
the fair market value of Valero's common stock at the date of grant. Stock
options become exercisable pursuant to the individual written agreements between
Valero and the participants, usually in three equal annual installments
beginning one year after the date of grant, with unexercised options generally
expiring ten years from the date of grant. Upon completion of the UDS
Acquisition, all UDS stock options held by employees and non-employee directors
of UDS became vested and were converted to Valero stock options, which had a
fair value of $120 million.
101
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
A summary of the status of Valero's stock option plans, including stock options
granted under the ESIP, the stock option plan (which includes UDS stock options
converted to Valero stock options), and the non-employee director stock option
plan is presented in the table below.
Number of Weighted-Average
Stock Options Exercise Price
------------- --------------
Outstanding as of December 31, 1999............. 7,061,575 $ 20.86
Granted........................................ 1,854,460 28.00
Exercised...................................... (1,215,573) 19.11
Forfeited...................................... (176,763) 22.58
----------
Outstanding as of December 31, 2000............. 7,523,699 22.86
Granted........................................ 2,496,016 34.25
Exercised...................................... (828,178) 22.67
Forfeited...................................... (104,346) 22.04
Conversion of UDS stock options................ 5,836,933 22.66
----------
Outstanding as of December 31, 2001............. 14,924,124 24.71
Granted........................................ 2,360,342 30.53
Exercised...................................... (2,520,764) 20.66
Forfeited...................................... (81,298) 33.33
----------
Outstanding as of December 31, 2002............. 14,682,404 26.29
==========
Stock options exercisable as of December 31:
2000........................................... 4,212,683 21.10
2001........................................... 11,046,525 22.36
2002........................................... 10,179,931 24.02
The following table summarizes information about stock options outstanding under
the ESIP, the stock option plan and the non-employee director stock option plan
as of December 31, 2002:
Options Outstanding Options Exercisable
- ------------------------------------------------------------------ --------------------------------
Weighted-
Average
Remaining Weighted Weighted-
Range of Number Life Average Number Average
Exercise Price Outstanding In Years Exercise Price Exercisable Exercise Price
-------------- ------------ -------- -------------- ----------- --------------
$11.47 - $14.10 613,457 1.57 $ 12.75 613,457 $ 12.75
$15.23 - $19.85 1,102,483 5.35 17.29 1,101,817 17.29
$20.03 - $24.91 5,494,312 6.05 22.47 5,492,646 22.47
$25.44 - $29.94 1,730,632 7.27 27.93 1,157,038 27.89
$30.06 - $34.91 5,032,851 8.76 31.86 1,306,251 32.85
$35.00 - $39.78 612,505 8.79 37.20 472,513 36.98
$40.20 - $49.05 96,164 9.03 44.50 36,209 43.28
---------- ----------
$11.47 - $49.05 14,682,404 7.02 26.29 10,179,931 24.02
========== ==========
102
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
22. COMMITMENTS AND CONTINGENCIES
Leases
Valero has long-term operating lease commitments for land, office facilities,
retail facilities and related equipment, transportation equipment, dock
facilities and various facilities and equipment used in the storage,
transportation, production and sale of refinery feedstocks and refined products.
In connection with the UDS Acquisition, Valero assumed various operating leases
for convenience stores, transportation equipment, time charters for ocean-going
tankers and coastal vessels, office facilities and other assets with terms
expiring at various dates through 2053.
Certain leases for production equipment and feedstock and refined product
storage facilities provide for various contingent payments based on, among other
things, throughput volumes in excess of a base amount. Certain leases for
vessels contain renewal options and escalation clauses, which vary by charter,
and provisions for the payment of chartering fees, which either vary based on
usage or provide for payments, in addition to established minimums, that are
contingent on usage. Leases for convenience stores may also include provisions
for contingent rental payments based on sales volumes. In most cases, Valero
expects that in the normal course of business, its leases will be renewed or
replaced by other leases.
The El Paso Acquisition was acquired, in part, through capital lease agreements
entered into with certain wholly owned subsidiaries of El Paso. As of December
31, 2002, Valero had not yet exercised its option to purchase the assets subject
to the capital leases. Accordingly, the table below reflects a capital lease
obligation to El Paso. The lease agreements required Valero to make annual lease
payments of $18.5 million for each of the first two years. On February 28, 2003,
Valero exercised its option to purchase the leased facilities for $289.3 million
as further described in Note 26.
Valero's future minimum rental payments and minimum rentals to be received under
subleases for operating leases having initial or remaining noncancelable lease
terms in excess of one year and for the capital leases related to the El Paso
Acquisition, as of December 31, 2002, were as follows (in millions):
Operating Capital
Leases Leases
------ -------
2003...................................... $ 157.6 $ 298.6
2004...................................... 148.8 -
2005...................................... 128.7 -
2006...................................... 115.3 -
2007...................................... 107.2 -
Remainder................................. 233.0 -
----- ------
Gross minimum rental payments............ 890.6 298.6
Less minimum rentals to be received
under subleases.......................... (21.2) -
----- ------
Net minimum rental payments.............. $ 869.4 298.6
=====
Less interest expense..................... (6.5)
-----
Capital lease obligations................ $ 292.1
=====
103
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Included in the table above are long-term operating lease commitments that have
been funded through structured lease arrangements with non-consolidated
third-party entities. These leases are for land, office facilities and
equipment, retail facilities and equipment, dock facilities, transportation
equipment, and various facilities and equipment used in the production of
refined products. The non-consolidated third-party entities constructed or
purchased the related assets and then leased them to Valero. The assets held by
these third-party entities were funded through borrowings by these entities and
equity contributions equal to at least 3% of the asset cost. Neither Valero, its
affiliates nor any related parties hold any interest in these entities. For each
lease, Valero has the option to purchase the leased assets at any time during
the lease term for a price that approximates fair value. After the initial lease
term, the leases may be extended by agreement of the parties. Alternatively,
Valero may arrange for the sale of the leased properties to one or more third
parties, in which case the leases provide for a maximum residual value guarantee
ranging from 82% to 87% of the appraised value of the leased properties at the
end of the lease term, as determined at the inception of the lease. As of
December 31, 2002, the total amount drawn on these structured lease arrangements
was approximately $642 million.
In addition to the above-noted structured lease arrangements, in August 2001,
Valero entered into a $300 million structured lease arrangement to fund the
construction of a new 45,000 barrel-per-day coker facility at its Texas City
Refinery. This structured lease has a lease term that expires in August 2006 and
will be accounted for as an operating lease upon completion of construction of
the coker facility. Valero has an option to purchase the leased property at any
time during the lease term for a price that approximates fair value. After the
initial lease term, Valero may renew the lease for up to two additional one-year
periods followed by one additional nine-month period, subject to the lessor's
approval, or Valero may arrange for the sale of the leased property to a third
party, in which case the lease provides for a maximum residual value guarantee
equal to approximately 82% of the property's construction cost. The sale option
can also be exercised at the end of any renewal period. If Valero elects the
sale option, the lessor has the right to require Valero to extend the lease term
for up to one additional year, in which case the maximum residual value
guarantee percentages will be reduced.
In February 2002, Valero entered into a $170 million structured lease
arrangement 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 beginning in
February 2002, 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
approximately $146 million.
104
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Consolidated rental expense for all operating leases was as follows (in
millions):
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Minimum rental expense............... $ 230.9 $ 92.0 $ 72.0
Contingent rental expense............ 12.4 - -
----- ---- ----
Gross rental expense............... 243.3 92.0 72.0
Less sublease rental income.......... (8.4) - -
----- ---- ----
Net rental expense................. $ 234.9 $ 92.0 $ 72.0
===== ==== ====
Other Commitments
Valero has various purchase obligations under certain industrial gas and
chemical supply arrangements (such as hydrogen supply arrangements), crude oil
and other feedstock supply arrangements and various throughput and terminalling
agreements. Valero enters into these contracts to ensure an adequate supply of
utilities, feedstock and storage to operate its refineries. Many of Valero's
purchase obligations are based on market prices or adjustments based on market
indices. Certain of these purchase obligations include fixed or minimum volume
requirements, while others are based on Valero's usage requirements. The
purchase obligations reflected below include agreements that have remaining
noncancelable terms in excess of one year as of December 31, 2002, and are based
on expected quantities to be purchased and/or estimated prices to be paid based
on current market conditions. These purchase obligations are not reflected in
the consolidated balance sheets. Estimated future annual purchase obligations as
of December 31, 2002 were as follows (in millions):
2003........................................ $ 2,507.6
2004........................................ 1,756.3
2005........................................ 1,180.5
2006........................................ 598.8
2007........................................ 562.2
Remainder................................... 1,229.6
-------
$ 7,835.0
=======
Guarantees
In connection with the sale of the Golden Eagle Business, Valero guaranteed
certain lease payment obligations related to an MTBE facility lease assumed by
Tesoro, which totaled approximately $46 million as of December 31, 2002.
Valero's structured lease arrangements provide for maximum residual value
guarantees ranging from 82% to 87% of the appraised value of the leased
properties at the end of the lease term, as determined at the inception of the
lease. As of December 31, 2002, the maximum residual value guarantee on Valero's
structured lease arrangements was approximately $541 million.
Contingent Earn-Out Agreements
In connection with Valero's acquisitions of the Paulsboro Refinery in 1998 and
Basis Petroleum, Inc. in 1997, the sellers are entitled to receive payments in
any of the five years and ten years, respectively, following these acquisitions
if certain average refining margins during any of those years exceed a specified
level.
105
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Payments due under the earn-out arrangement for the Paulsboro Refinery,
determined in September of each year, are limited to $20 million annually and
$50 million in the aggregate. No earn-out payments were due for the years ended
September 16, 2002 and 2000, and an earn-out amount of $20.0 million was paid
for the year ended September 16, 2001.
Payments due under the earn-out arrangement for the acquisition of Basis,
determined as of May 1 of each year, are limited to $35 million annually and
$200 million in the aggregate. No earn-out amounts were due for the year ended
May 1, 2000, and earn-out payments for the years ended May 1, 2002 and 2001 were
$23.9 million and $35.0 million, respectively. Aggregate earn-out payments
through December 31, 2002 totaled $69.2 million.
Valero accounts for any payments under these arrangements as an additional cost
of the respective acquisition, of which $59.3 million has been attributed to
property, plant and equipment and is being depreciated over the remaining lives
of the assets to which the additional cost is allocated and $29.9 million has
been attributed to goodwill and is not being amortized.
23. 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 described in Note 12, were
as follows (in millions):
December 31,
------------
2002 2001 2000
---- ---- ----
Balance as of beginning of year................. $ 170.8 $ 19.0 $ 20.9
UDS Acquisition................................ 60.2 119.7 -
Additions to accrual, net...................... 19.1 35.4 (0.7)
Payments, net of third-party recoveries........ (28.1) (3.3) (1.2)
----- ----- ----
Balance as of end of year....................... $ 222.0 $ 170.8 $ 19.0
===== ===== ====
In connection with its various acquisitions, Valero assumed several
environmental liabilities including, but not limited to, certain remediation
obligations, site restoration costs and certain liabilities relating to soil and
groundwater contamination.
In 2000, the U.S. Environmental Protection Agency (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 has completed its response to the
request. Several other refiners have reached settlements with the EPA regarding
this enforcement initiative. Though Valero has not been named in any proceeding,
106
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
it also has been discussing the possibility of settlement with the EPA regarding
this initiative. Based in part upon announced settlements and evaluation of its
relative position, Valero expects to incur penalties and related expenses in
connection with a potential settlement of this enforcement initiative. Valero
believes that any potential settlement penalties will be immaterial to its
financial position. However, Valero believes that any potential settlement with
the EPA in this matter will require various capital improvements or changes in
operating parameters, or both, at some or all of its refineries which could be
material in the aggregate.
Valero believes that it has adequately provided for its environmental exposures
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.
24. LITIGATION MATTERS
Unocal
In 2002, Union Oil Company of California (Unocal) sued Valero alleging patent
infringement. 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 2001, the Federal Trade Commission began 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). On March 4, 2003, the FTC announced that it was filing a
complaint against Unocal for antitrust violations. The FTC's complaint seeks an
injunction against any future patent enforcement activity by Unocal. Each of the
'393 and '126 patents is being reexamined by the PTO. The PTO has issued notices
of rejection of all claims of each of these patents. These rejections are
subject to additional proceedings, including administrative appeal by Unocal,
followed by an appeal in federal district court or the court of appeals.
Ultimate invalidation would preclude Unocal from pursuing claims based on the
'393 or '126 patents. Unocal's patent lawsuit against Valero is indefinitely
stayed as a result of the PTO reexamination proceedings. Notwithstanding the
judgment against the other refiners in the previous litigation, Valero believes
that it has several strong defenses to Unocal's lawsuit, including those arising
from Unocal's misconduct, and Valero believes it will prevail in the lawsuit.
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 is a defendant in various cases alleging MTBE contamination in
groundwater in New York and California. The plaintiffs generally allege that
refiners and manufacturers of gasoline containing MTBE are liable for
manufacturing a defective product. In California, the lawsuits have been filed
by local water providers, including the City of Santa Monica, the City of Dinuba
and Fruitridge Vista Water Company. In New York, a lawsuit has been filed by the
Suffolk County Water Authority. These cases are primarily based on a product
liability/product defect theory and seek individual, unquantified compensatory
and punitive damages and attorneys' fees. Valero believes it is unlikely that
107
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
the final outcome of any one of these suits filed by local water providers 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.
25. QUARTERLY RESULTS OF OPERATIONS (Unaudited)
Valero's results of operations by quarter for the years ended December 31, 2002
and 2001 were as follows (in millions, except per share amounts):
2002 Quarter Ended (a)
-----------------------------------------------------------------------
March 31 June 30 September 30 December 31 Total
-------- ------- ------------ ----------- -----
Operating revenues...... $ 5,122.4 $ 6,552.4 $ 7,191.7 $ 8,109.7 $ 26,976.2
Operating income........ 0.2 100.1 130.3 240.3 470.9
Net income (loss)....... (38.6) 11.3 29.8 89.0 91.5
Earnings (loss) per
common share.......... (0.37) 0.11 0.28 0.83 0.86
Earnings (loss) per
common share -
assuming dilution..... (0.37) 0.10 0.27 0.81 0.83
2001 Quarter Ended (b)
--------------------------------------------------------------------------
March 31 June 30 (b) September 30 December 31 Total
-------- ----------- ------------ ----------- -----
Operating revenues..... $ 3,769.3 $ 4,499.1 $ 3,858.7 $ 2,861.2 $ 14,988.3
Operating income....... 237.1 464.2 188.4 111.7 1,001.4
Net income............. 136.1 274.8 101.1 51.6 563.6
Earnings per
common share.......... 2.23 4.50 1.66 0.86 9.28
Earnings per
common share -
assuming dilution..... 2.13 4.23 1.58 0.82 8.83
- --------------------------------------------------------------
(a) Includes the operations of UDS beginning January 1, 2002.
(b) Includes the operations of the Huntway and El Paso Acquisitions beginning
June 1, 2001 but excludes the operations of UDS since the UDS Acquisition
was completed on December 31, 2001.
108
26. SUBSEQUENT EVENTS
Cash Dividends and Distributions
On January 23, 2003, Valero's Board of Directors declared a regular quarterly
cash dividend of $0.10 per common share payable March 12, 2003 to holders of
record at the close of business on February 12, 2003.
On January 24, 2003, Valero L.P. declared a quarterly cash distribution of $0.70
per unit payable on February 14, 2003 to unitholders of record on February 5,
2003. The total distribution is expected to be approximately $14.1 million of
which approximately $3.6 million is payable to minority unitholders.
Exercise of El Paso Acquisition Purchase Option
On February 28, 2003, Valero exercised its option to purchase the East Plant of
the Corpus Christi Refinery and related refined product logistics business under
its capital leases with El Paso Corporation. In connection with the exercise,
the original purchase price for the assets was reduced by approximately $5
million to $289.3 million and the lease payment of approximately $5 million due
in the first quarter of 2003 was avoided.
Issuance of Valero L.P. Common Units and Private Placement of Debt
Effective March 18, 2003, Valero L.P. issued 5,750,000 common units to the
public for aggregate proceeds of approximately $211 million and completed a
private placement of $250 million of debt. The net proceeds from those
offerings, combined with borrowings under Valero L.P.'s credit facility, were
used to fund a redemption of common units from Valero and the acquisition of
certain storage tanks and a pipeline system from Valero discussed further below.
Redemption of Valero L.P. Common Units and Amendment of Valero L.P.'s
Partnership Agreement
Subsequent to the equity and debt offerings by Valero L.P. discussed above,
Valero L.P. redeemed approximately 3.8 million of its common units from
subsidiaries of Valero, effectively reducing Valero's ownership of Valero L.P.
from approximately 73 percent to approximately 49 percent. At the same time,
Valero L.P. also amended its partnership agreement to state that the general
partner of Valero L.P. may be removed by the vote of the holders of at least 58
percent of Valero L.P.'s common and subordinated units, excluding the units held
by affiliates of its general partner. As a result of the partnership agreement
changes and the issuance and redemption of Valero L.P. common units, Valero will
cease consolidation of Valero L.P.
Contribution of Storage Tanks and South Texas Pipeline System
Subsequent to the equity and debt offerings and the common unit redemption by
Valero L.P. discussed above, Valero contributed to Valero L.P. 58 crude oil and
intermediate feedstock storage tanks located at Valero's Corpus Christi, Texas
City and Benicia Refineries for approximately $200 million in cash. The storage
tanks have a capacity of about 11 million barrels. Valero also contributed to
Valero L.P. a refined products pipeline system for approximately $150 million in
cash. The three-pipeline system connects Valero's Corpus Christi and Three
Rivers Refineries to markets in Houston, San Antonio and the Texas Rio Grande
Valley. In connection with the contribution of these assets, Valero entered into
certain throughput, handling, terminalling and service agreements with Valero
L.P.
109
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
27. RECLASSIFICATIONS TO 2001 AND 2000 CONSOLIDATED FINANCIAL STATEMENTS
Certain amounts in the 2001 and 2000 consolidated financial statements, as set
forth in the table below, were reclassified to conform to the 2002 presentation
(in millions):
2001 Reclassification As Revised
---- ---------------- ----------
Balance Sheet
Receivables, net.............................. $ 785.6 $ (14.8) $ 770.8
Income taxes receivable....................... 132.2 44.5 176.7
Prepaid expenses and other current assets..... 92.6 (7.0) 85.6
Property, plant and equipment, at cost........ 8,197.8 (43.2) 8,154.6
Intangible assets, net........................ 366.7 (32.8) 333.9
Deferred charges and other assets............. 426.3 76.0 502.3
Accounts payable.............................. 1,374.5 15.7 1,390.2
Accrued expenses.............................. 413.9 7.0 420.9
The balance sheet reclassifications principally reflect the conforming of Valero
and UDS account classifications, which resulted in no change to working capital.
In addition, revisions have been made to the 2001 and 2000 consolidated
statements of cash flows and the 2001 amounts included in Notes 4, 7, 8 and 10
to conform to these reclassifications (in millions).
2001 Reclassification As Revised
---- ---------------- -----------
Income Statement
Cost of sales (Cost of sales and
operating expenses in 2001).................... $ 13,684.0 $ (938.8) $ 12,745.2
Refining operating expenses..................... - 845.5 845.5
Retail selling expenses......................... - 5.8 5.8
Administrative expenses (Selling and
administrative expenses in 2001)............... 165.2 (12.5) 152.7
Depreciation and amortization expense
(Depreciation expense in 2001)................. 137.7 100.0 237.7
2000 Reclassification As Revised
---- ---------------- ----------
Income Statement
Cost of sales (Cost of sales and
operating expenses in 2000).................... $ 13,817.5 $ (740.6) $ 13,076.9
Refining operating expenses..................... - 682.7 682.7
Retail selling expenses......................... - 2.5 2.5
Administrative expenses (Selling and
administrative expenses in 2000)............... 130.5 (6.4) 124.1
Depreciation and amortization expense
(Depreciation expense in 2000).................. 112.1 61.8 173.9
110
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The income statement reclassifications principally reflect the separate
presentation of amounts previously included in cost of sales and operating
expenses. Refining operating expenses and retail selling expenses have been
separately presented, consistent with Valero's 2002 segment disclosures, and
amortization expense has been combined with depreciation expense.
111
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have not been any changes in or disagreements with Valero's independent
accountants since the date of Valero's dismissal of Arthur Andersen LLP and
appointment of Ernst & Young LLP as Valero's independent auditor on March 12,
2002. That change was reported by Valero in a Current Report dated March 12,
2002, and filed with the SEC on March 14, 2002 (Form 8-K) and April 3, 2002
(Form 8-K/A). Because the change in accountants was "previously reported" (as
that term is defined in Rule 12b-2 under the Securities Exchange Act of 1934) on
Form 8-K, the matter is not further disclosed in this report (per Instruction 1
to Item 304 of Regulation S-K).
PART III
ITEMS 10-13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information about directors and executive officers required by Items 10
through 13 of Form 10-K is incorporated herein by reference to Valero's
definitive Proxy Statement for the 2003 Annual Meeting of Stockholders which
Valero will file with the Commission before April 30, 2003. Certain information
required by Item 401 of Regulation S-K concerning Valero's executive officers
appears in Part I of this report.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Valero's
principal executive officer and principal financial officer have evaluated
Valero's disclosure controls and procedures (as defined in Rule 13a-14(c) under
the Securities Exchange Act of 1934) as of a date within 90 days of the filing
date of this Annual Report on Form 10-K. Based on that evaluation, these
officers concluded that the design and operation of Valero's disclosure controls
and procedures are effective in ensuring that information required to be
disclosed by Valero in the reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
(b) Changes in internal controls. There have been no significant
changes in Valero's internal controls, or in other factors that could
significantly affect internal controls, subsequent to the date of the certifying
officers' certifications pursuant to Rule 13a-14 included with Valero's Form
10-Q for the quarter ended September 30, 2002.
112
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements. The following Consolidated Financial Statements
of Valero Energy Corporation and its subsidiaries are included in Part II, Item
8 of this Form 10-K:
Page
----
Report of independent auditors................................................................ 55
Report of independent public accountants...................................................... 56
Consolidated balance sheets as of December 31, 2002 and 2001.................................. 57
Consolidated statements of income for the years ended December 31, 2002, 2001 and 2000........ 58
Consolidated statements of stockholders' equity for the years ended
December 31, 2002, 2001 and 2000............................................................ 59
Consolidated statements of cash flows for the years ended December 31, 2002, 2001 and 2000.... 60
Consolidated statements of comprehensive income for the years ended
December 31, 2002, 2001 and 2000............................................................ 61
Notes to consolidated financial statements.................................................... 62
2. Financial Statement Schedules and Other Financial Information. No
financial statement schedules are submitted because either they are inapplicable
or because the required information is included in the Consolidated Financial
Statements or notes thereto.
3. Exhibits. Filed as part of this Form 10-K are the following
exhibits:
2.1 Agreement and Plan of Merger, dated as of May 6, 2001, by and
among Valero Energy Corporation and Ultramar Diamond Shamrock
Corporation - incorporated by reference from Exhibit 2.1 to
Valero's Current Report on Form 8-K dated May 6, 2001, and filed
May 10, 2001.
2.2 Sale and Purchase Agreement for Golden Eagle Refining and
Marketing Assets, dated February 4, 2002, between Ultramar Inc.
and Tesoro Refining and Marketing Company, including First
Amendment dated February 20, 2002 - incorporated by reference
from Exhibit 2.2 to Valero's Annual Report on Form 10-K for the
year ended December 31, 2001.
2.3 Sale and Purchase Agreement For Exxon California Refining and
Marketing Assets, dated March 2, 2000, between ExxonMobil
Corporation and Valero Refining Company-California - incorporated
by reference from Exhibit 2.7 to Valero's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2000.
2.4 First Amendment dated May 14, 2000, to the Sale and Purchase
Agreement For Exxon California Refining and Marketing Assets
between Exxon Mobil Corporation and Valero Refining
Company-California - incorporated by reference from Exhibit 2.1
to Valero's Current Report on Form 8-K dated May 15, 2000, and
filed May 30, 2000.
2.5 Refinery Lease Agreement dated May 25, 2001 between Coastal
Refining & Marketing, Inc. and Valero Refining Company-Texas -
incorporated by reference from Exhibit 10.16 to Valero's Annual
Report on Form 10-K for the year ended December 31, 2001.
113
*2.6 First Amendment dated February 28, 2003 between El Paso Merchant
Energy-Petroleum Company (formerly known as Coastal Refining &
Marketing, Inc.) and Valero Refining-Texas, L.P.
(successor-by-conversion to Valero Refining Company-Texas) to
Refinery Lease Agreement dated May 25, 2001.
2.7 Pipeline and Terminal Lease Agreement dated May 25, 2001 among
Coastal Liquids Partners, L.P.; Valero Marketing and Supply
Company; and Valero Pipeline Company - incorporated by reference
from Exhibit 10.17 to Valero's Annual Report on Form 10-K for the
year ended December 31, 2001.
*2.8 First Amendment dated February 28, 2003 among Coastal Liquids
Partners, L.P.; Valero Marketing and Supply Company; and Valero
Pipeline Company to Pipeline and Terminal Lease Agreement dated
May 25, 2001.
3.1 Amended and Restated Certificate of Incorporation of Valero
Energy Corporation - incorporated by reference from Exhibit 3.1
to Valero's Registration Statement on Form S-1 (File No.
333-27013), filed May 13, 1997.
3.2 Amendment to Restated Certificate of Incorporation of Valero
Energy Corporation - incorporated by reference from Exhibit 3.1
to Valero's Current Report on Form 8-K dated December 31, 2001,
and filed January 11, 2002.
3.3 Amended and Restated By-Laws of Valero Energy Corporation -
incorporated by reference from Exhibit 3.3 to Valero's Annual
Report on Form 10-K for the year ended December 31, 2001.
4.1 Rights Agreement between Valero Refining and Marketing Company
and Harris Trust and Savings Bank, as Rights Agent - incorporated
by reference from Exhibit 4.1 to Valero's Registration Statement
on Form S-8 (File No. 333-31709), filed July 21, 1997.
4.2 Amended and Restated Declaration of Trust, dated as of June 28,
2000, of VEC Trust I (including Form of Preferred Security) -
incorporated by reference from Exhibit 4.1 to Valero's Current
Report on Form 8-K dated June 28, 2000, and filed June 30, 2000.
4.3 Valero Energy Corporation Guarantee Agreement, dated as of June
28, 2000, relating to VEC Trust I (including Form of Preferred
Security) - incorporated by reference from Exhibit 4.3 to
Valero's Current Report on Form 8-K dated June 28, 2000, and
filed June 30, 2000.
4.4 Purchase Contract Agreement, dated as of June 28, 2000, between
Valero Energy Corporation and The Bank of New York - incorporated
by reference from Exhibit 4.4 to Valero's Current Report on Form
8-K dated June 28, 2000, and filed June 30, 2000.
4.5 Pledge Agreement, dated as of June 28, 2000, among Valero Energy
Corporation, Bank One Trust Company, N.A. and The Bank of New
York - incorporated by reference from Exhibit 4.5 to Valero's
Current Report on Form 8-K dated June 28, 2000, and filed June
30, 2000.
114
4.6 Indenture, dated as of December 12, 1997, between Valero Energy
Corporation and The Bank of New York - incorporated by reference
from Exhibit 3.4 to Valero's Registration Statement on Form S-3
(File No. 333-56599), filed June 11, 1998.
4.7 First Supplemental Indenture, dated as of June 28, 2000, between
Valero Energy Corporation and The Bank of New York (including
Form of 7 3/4% Senior Deferrable Note due 2005) - incorporated by
reference from Exhibit 4.6 to Valero's Current Report on Form 8-K
dated June 28, 2000, and filed June 30, 2000.
4.8 Remarketing Agreement, dated as of June 28, 2000, among Valero
Energy Corporation, VEC Trust I and Morgan Stanley & Co.
Incorporated - incorporated by reference from Exhibit 4.8 to
Valero's Current Report on Form 8-K dated June 28, 2000, and
filed June 30, 2000.
4.9 Officer's Certificate delivered pursuant to Sections 102, 301 and
303 of the Indenture dated as of December 12, 1997, providing for
the terms of the Notes by Valero Energy Corporation (including
Form of Note) - incorporated by reference from Exhibit 4.9 to
Valero's Current Report on Form 8-K dated June 28, 2000, and
filed June 30, 2000.
4.10 Officer's Certificate dated as of April 15, 2002, delivered
pursuant to Sections 102, 301 and 303 of the Indenture dated as
of December 12, 1997, providing for the terms of Valero's
publicly offered 6 1/8% Notes due 2007, 6 7/8% Notes due 2012,
and 7 1/2% Notes due 2032 (including Form of Notes) -
incorporated by reference from Exhibit 4.1 to Valero's Current
Report on Form 8-K dated April 10, 2002, and filed April 15,
2002.
4.11 Terms of Valero's 6.311% Notes due 2007 issued to Core Bond
Products LLC, as depositor of the Core Investment Grade Bond
Trust I (including Form of Notes) - incorporated by reference
from Exhibit 4.1 to Valero's Current Report on Form 8-K dated
November 15, 2002, and filed November 18, 2002.
4.12 Terms of Valero's publicly offered 6.7% Notes due 2013 (including
Form of Notes) - incorporated by reference from Exhibit 4.1 to
Valero's Current Report on Form 8-K dated December 10, 2002, and
filed December 16, 2002.
+10.1 Valero Energy Corporation Executive Incentive Bonus Plan, as
amended, dated as of April 23, 1997 - incorporated by reference
from Exhibit 10.1 to Valero's Registration Statement on Form S-1
(File No. 333-27013), filed May 13, 1997.
+10.2 Valero Energy Corporation Executive Stock Incentive Plan, as
amended, dated as of April 23, 1997 - incorporated by reference
from Exhibit 10.2 to Valero's Registration Statement on Form S-1
(File No. 333-27013), filed May 13, 1997.
+10.3 Valero Energy Corporation Restricted Stock Plan for Non-Employee
Directors, as amended, dated as of April 23, 1997 - incorporated
by reference from Exhibit 10.4 to Valero's Registration Statement
on Form S-1 (File No. 333-27013), filed May 13, 1997.
+10.4 Valero Energy Corporation Non-Employee Director Stock Option
Plan, as amended, dated as of April 23, 1997 - incorporated by
reference from Exhibit 10.5 to Valero's Registration Statement on
Form S-1 (File No. 333-27013), filed May 13, 1997.
115
+10.5 Valero Energy Corporation 2001 Executive Stock Incentive Plan,
dated as of May 10, 2001 - incorporated by reference from
Appendix A to Valero's Definitive Proxy Statement on Schedule
14A, filed March 28, 2001.
+10.6 Form of Indemnity Agreement between Valero Refining and Marketing
Company and William E. Greehey - incorporated by reference from
Exhibit 10.8 to Valero's Registration Statement on Form S-1 (File
No. 333-27013), filed May 13, 1997.
+10.7 Schedule of Indemnity Agreements - incorporated by reference from
Exhibit 10.9 to Valero's Registration Statement on Form S-1 (File
No. 333-27013), filed May 13, 1997.
*+10.8 Change of Control Agreement (Tier I) dated March 19, 2003,
between Valero Energy Corporation and William E. Greehey.
*+10.9 Form of Change of Control Agreement (Tier II) dated March
19, 2003, between Valero Energy Corporation and Gregory C. King.
*+10.10 Schedule of Change of Control Agreements (Tier II).
+10.11 Employment Agreement dated March 25, 1999, effective as of
April 29, 1999 between Valero Energy Corporation and William E.
Greehey - incorporated by reference from Exhibit 10.18 to
Valero's Quarterly Report on Form 10-Q for the quarter ended June
30, 1999.
+10.12 Extension of Employment Agreement dated January 30, 2001,
between Valero Energy Corporation and William E. Greehey -
incorporated by reference from Exhibit 10.15 to Valero's Annual
Report on Form 10-K for the year ended December 31, 2000.
+10.13 Amendment dated October 3, 2002 to Employment Agreement dated
March 25, 1999, between Valero Energy Corporation and William E.
Greehey - incorporated by reference from Exhibit 10.1 to Valero's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002.
*12.1 Statement of Computation of Ratio of Earnings to Fixed Charges
*21.1 Valero Energy Corporation subsidiaries.
*23.1 Consent of Ernst & Young LLP, dated March 19, 2003.
*24.1 Power of Attorney, dated March 20, 2003 (set forth on the
signature page of this Form 10-K).
*99.1 Certification of William E. Greehey under Section 906 of the
Sarbanes-Oxley Act of 2002.
*99.2 Certification of John D. Gibbons under Section 906 of the
Sarbanes-Oxley Act of 2002.
--------------
* Filed herewith
+ Identifies management contracts or compensatory plans or arrangements
required to be filed as an exhibit hereto pursuant to Item 14(c) of Form
10-K.
116
Copies of exhibits filed as a part of this Form 10-K may be obtained by
stockholders of record at a charge of $.15 per page, minimum $5.00 each request.
Direct inquiries to Jay D. Browning, Vice President and Corporate Secretary,
Valero Energy Corporation, P.O. Box 500, San Antonio, Texas 78292.
Pursuant to paragraph 601(b)(4)(iii)(A) of Regulation S-K, the registrant has
omitted from the foregoing listing of exhibits, and hereby agrees to furnish to
the Commission upon its request, copies of certain instruments, each relating to
long-term debt not exceeding 10% of the total assets of the registrant and its
subsidiaries on a consolidated basis.
(b) Reports on Form 8-K. Valero filed the following Current Reports on Form
8-K during the quarter ended December 31, 2002.
(i) On November 18, 2002, Valero filed a Current Report on
Form 8-K dated November 15, 2002 reporting Item 5 (Other Events) in
connection with Valero's execution of a placement agency agreement for
the public offering of $50,000,000 aggregate principal amount of its
6.311% Notes due 2007 to Core Bond Products LLC, as depositor of the
Core Investment Grade Bond Trust I. The issuance and sale of the notes
closed on November 20, 2002. Financial statements were not filed with
this report.
(ii) On December 16, 2002, Valero filed a Current Report on
Form 8-K dated December 10, 2002 reporting Item 5 (Other Events) in
connection with Valero's execution of an underwriting agreement for the
public offering of $180,000,000 aggregate principal amount of its 6.7%
Notes due 2013. The issuance and sale of the notes closed on December
16, 2002. Financial statements were not filed with this report.
Undertakings. For the purposes of complying with the rules governing Form S-8
under the Securities Act of 1933, the undersigned registrant hereby undertakes
as follows, which undertaking shall be incorporated by reference into
registrant's Registration Statements on Form S-8 No. 333-31709 (filed July 21,
1997), No. 333-31721 (filed July 21, 1997), No. 333-31723 (filed July 21, 1997),
No. 333-31727 (filed July 21, 1997), No. 333-81844 (filed January 31, 2002), and
No. 333-81858 (filed January 31, 2002):
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question of whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
117
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By /s/ William E. Greehey
----------------------------------------
(William E. Greehey)
Chairman of the Board and
Chief Executive Officer
Date: March 20, 2003
118
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
hereby constitutes and appoints William E. Greehey, John D. Gibbons and Jay D.
Browning, or any of them, each with power to act without the other, his true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all subsequent amendments and supplements to this
Annual Report on Form 10-K, and to file the same, or cause to be filed the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto each said attorney-in-fact and
agent full power to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and
purposes as he might or could do in person, hereby qualifying and confirming all
that said attorney-in-fact and agent or his substitute or substitutes may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Chairman of the Board and
Chief Executive Officer
/s/ William E. Greehey (Principal Executive Officer) March 20, 2003
- -------------------------------
(William E. Greehey)
Executive Vice President
and Chief Financial Officer
(Principal Financial and
/s/ John D. Gibbons Accounting Officer) March 20, 2003
- -------------------------------
(John D. Gibbons)
/s/ E. Glenn Biggs Director March 20, 2003
- -------------------------------
(E. Glenn Biggs)
/s/ W.E. Bradford Director March 20, 2003
- -------------------------------
(W.E. Bradford)
/s/ Ronald K. Calgaard Director March 20, 2003
- -------------------------------
(Ronald K. Calgaard)
/s/ Jerry D. Choate Director March 20, 2003
- -------------------------------
(Jerry D. Choate)
/s/ W.H. Clark Director March 20, 2003
- -------------------------------
(W.H. Clark)
/s/ Robert G. Dettmer Director March 20, 2003
- -------------------------------
(Robert G. Dettmer)
/s/ Ruben M. Escobedo Director March 20, 2003
- -------------------------------
(Ruben M. Escobedo)
/s/ Bob Marbut Director March 20, 2003
- -------------------------------
(Bob Marbut)
/s/ Susan Kaufman Purcell Director March 20, 2003
- -------------------------------
(Susan Kaufman Purcell)
119
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, William E. Greehey, the principal executive officer of Valero Energy
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Valero Energy
Corporation (the "registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/ William E. Greehey
-------------------------------
William E. Greehey
Chief Executive Officer
120
CERTIFICATION PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, John D. Gibbons, the principal financial officer of Valero Energy
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Valero Energy
Corporation (the "registrant");
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/John D. Gibbons
---------------------------------------------------
John D. Gibbons
Executive Vice President and Chief Financial Officer
121
EXHIBIT 2.6
FIRST AMENDMENT TO REFINERY LEASE AGREEMENT
This First Amendment, dated February 28, 2003, between El Paso Merchant
Energy-Petroleum Company, formerly know as Coastal Refining & Marketing, Inc., a
Delaware corporation ("Lessor"), and Valero Refining - Texas, L.P., a Texas
limited partnership (and successor by conversion to Valero Refining Company -
Texas, a Texas corporation, "Lessee"), to the Refinery Lease Agreement (the
"Lease") dated May 25, 2001, between Lessor and Lessee. All capitalized terms
used herein which are defined in the Lease Agreement shall have the meaning set
forth therein unless otherwise specifically provided herein.
WHEREAS, Lessor and Lessee desire for Lessee to exercise the Option at
an earlier date than provided in the Lease and Lessor and Lessee are both
agreeable to such earlier exercise on the terms and conditions set forth in this
Amendment; and
WHEREAS, Lessor and Lessee desire to make certain modifications to the
Lease to provide for the earlier exercise of the Option.
NOW, THEREFORE, in consideration of the premises and material
agreements herein contained and other good and valuable considerations, the
receipt and sufficiency of which is hereby acknowledged, the parties hereto
agree as follows:
Section 1. Consent to Early Exercise of Option. Notwithstanding the first
section of Section 6.3 of the Lease, Lessor agrees that Lessee may exercise the
Option on the date hereof; Lessee by execution of this Amendment is giving the
Option Notice required by Section 6.3 and Lessor by executing this Amendment,
agrees that the Lessee has duly and timely given the Option Notice required by
Section 6.3 as of the date hereof.
Section 2. Purchase Price. Lessor and Lessee agree that the entry for Lease
Year 2 on Schedule 6.2 (Fixed Price Purchase Option) shall be amended to delete
the reference to "n/a" and the following shall be inserted in lieu thereof:
"227,263,725", so that the Purchase Price for exercise of the Option in
accordance herewith shall be $227,263,725. In determining this amended Purchase
Price for the exercise of the Option in Lease Year 2, Lessor and Lessee have
taken into consideration all Lease Payments made and no refund of any Lease
Payment shall be owed by Lessor to Lessee nor shall any additional Lease
Payments be due or owing as of or after the Option Closing Date. Accordingly,
notwithstanding the provisions of Section 6.2 of the Lease, the Purchase Price
provided in Section 2 hereof shall also be the Option Closing Payment.
Notwithstanding the provisions of Section 6.3 of the Lease, the Option Closing
Date shall be February 28, 2003.
Section 3. Remaining Option Provision; Other Amendments.
(a) Except as provided in Sections 1 and 2 hereof, the terms of the
exercise of the Option shall remain the same and shall be as set forth in
Article 6 of the Lease.
1
(b) Section 10.5 of the Lease is amended to reserve the right of Lessor to
grant easements, rights-of-way and access rights to EPGT Texas Pipeline, L.P., a
Delaware limited partnership, and EPN Gulf Coast, L.P. , a Delaware limited
partnership, with respect to the natural gas and liquids pipelines and related
facilities owned by such partnerships that are currently located on the Leased
Property, all on the same terms and conditions that Lessor reserves the right to
grant easements, rights-of-way and access rights with respect to the LPG/Crude
Property under Section 10.5.
Section 4. Entire Agreement; No Further Amendment. This Amendment
constitutes the entire agreement among the parties with respect to the subject
matter hereof. Except as modified hereby, the Lease remains in full force and
effect without other amendments or modifications. For all purposes of this
Amendment, the provisions of Sections 21.6, 21.7, 21.9, 21.10, 21.11, 21.12 and
21.13 of the Lease shall apply hereto as if incorporated herein by reference.
Section 5. Governing Law. This Amendment and the rights of the parties
hereunder shall be governed by and interpreted in accordance with the laws of
the State of Texas without giving effect to principles thereof relating to
conflicts of law rules that would direct the application of the laws of another
jurisdiction.
Section 6. Counterparts. This Amendment may be executed in several
counterparts, each of which shall be deemed an original but all of which shall
constitute one and the same instrument.
LESSOR:
EL PASO MERCHANT ENERGY -
PETROLEUM COMPANY
By:
---------------------------------------------
Name: Robert W. Haugen
Title: Vice President
LESSEE:
VALERO REFINING - TEXAS, L.P.
By: Valero Corporate Services Company,
Its General Partner
By:
-------------------------------------------
Name: Michael S. Ciskowski
Title: Senior Vice President
2
EXHIBIT 2.8
FIRST AMENDMENT TO PIPELINE AND TERMINAL LEASE AGREEMENT
This First Amendment, dated February 28, 2003, among Coastal Liquids
Partners, L.P., a Delaware limited partnership ("Lessor"), and Valero Marketing
and Supply Company, a Delaware corporation ("VMSC"), and Valero Pipeline
Company, a Delaware corporation ("VPC" and, together with VMSC, "Lessee"), to
the Pipeline and Terminal Lease Agreement (the "Lease") dated May 25, 2001,
between Lessor and Lessee. All capitalized terms used herein which are defined
in the Lease shall have the meaning set forth therein unless otherwise
specifically provided herein.
WHEREAS, Lessor and Lessee desire for Lessee to exercise the Option at
an earlier date than provided in the Lease and Lessor and Lessee are both
agreeable to such earlier exercise on the terms and conditions set forth in this
Amendment; and
WHEREAS, Lessor and Lessee desire to make certain modifications to the
Lease to provide for the earlier exercise of the Option.
NOW, THEREFORE, in consideration of the premises and material
agreements herein contained and other good and valuable considerations, the
receipt and sufficiency of which are hereby acknowledged, the parties hereto
agree as follows:
Section 1. Consent to Early Exercise of Option. Notwithstanding the first
section of Section 6.3 of the Lease, Lessor agrees that Lessee may exercise the
Option on the date hereof; Lessee by execution of this Amendment is giving the
Option Notice required by Section 6.3 and Lessor, by executing this Amendment,
agrees that the Lessee has duly and timely given the Option Notice required by
Section 6.3 as of the date hereof.
Section 2. Purchase Price. Lessee and Lessor agree that the entry for Lease
Year 2 on Schedule 6.2 (Fixed Price Purchase Option) shall be amended to delete
the reference to "n/a" and the following shall be inserted in lieu thereof:
"61,986,275", so that the Purchase Price for exercise of the Option in
accordance herewith shall be $61,986,275. In determining this amended Purchase
Price for the exercise of the Option in Lease Year 2, Lessor and Lessee have
taken into consideration all Lease Payments made and no refund of any Lease
Payment shall be owed by Lessor to Lessee nor shall any additional Lease
Payments be due or owing as of or after the Option Closing Date. Accordingly,
notwithstanding the provisions of Section 6.2 of the Lease, the Purchase Price
provided in Section 2 hereof shall also be the Option Closing Payment.
Notwithstanding the provisions of Section 6.3 of the Lease, the Option Closing
Date shall be February 28, 2003.
Section 3. Remaining Option Provision; Other Covenants.
(a) Except as provided in Sections 1 and 2 hereof, the terms of the
exercise of the Option shall remain the same and shall be as set forth in
Article 6 of the Lease.
1
(b) Attached hereto as Exhibit 1 is a listing of those Pipeline System
Interests (the "Schedule 10.3 Properties") with respect to which a further
delineation is required to be made of the interests in properties (including fee
and non-fee interests), easements, leases, subleases and property use rights
that are contemplated or required to be reserved by, granted to or inure to the
benefit of Lessee, Lessor, El Paso South Texas, L.P. or their respective
Affiliates, successors or assigns pursuant to Schedule 10.3 to the Lease (the
"Schedule 10.3 Interests"). At the Option Closing, Lessor will convey the
Pipeline System Properties to Lessee, excepting and reserving therefrom the
Schedule 10.3 Interests that are contemplated or required to be reserved by,
granted to or inure to the benefit of Lessor, El Paso South Texas, L.P. or their
respective Affiliates, successors or assigns pursuant to Schedule 10.3 to the
Lease. Lessor and Lessee shall (i) act in good faith and use commercially
reasonable best efforts to further delineate the Schedule 10.3 Interests as
expeditiously as possible, (ii) immediately following the further delineation of
the Schedule 10.3 Interests pursuant to clause (i) above, prepare, execute,
acknowledge, deliver and record deeds, easements, leases, subleases, access
license agreements and other agreements expressly and definitively reserving,
granting or otherwise creating or providing for the Schedule 10.3 Interests to
or for the benefit of Lessee, Lessor, El Paso South Texas, L.P. or their
respective Affiliates, successors or assigns, all as contemplated by Schedule
10.3 of the Lease, and (iii) prepare, execute, acknowledge, deliver and record
such amendments to the conveyances of the Schedule 10.3 Properties to Lessee as
will properly reflect the matters provided in clauses (i) and (ii) above.
(c) Attached hereto as Exhibit 2 is a listing of those Pipeline System
Interests (the "Special Interests") that are subject to certain Restrictions
that are required to be satisfied prior to the effectiveness of the conveyance
thereof to Lessee pursuant to the exercise of the Option or with respect to
which Lessee desires that certain alleged title issues be satisfied prior to
recording the conveyance thereof to Lessee pursuant to the exercise of the
Option (collectively the "Requested Actions"). At the Option Closing, Lessor
will execute, acknowledge and deliver conveyances of the Special Interests to
Lessee; provided, however, (i) any such conveyance of a Special Interest that is
subject to Restrictions that preclude conveyance to Lessee shall not become
effective or be recorded until such time as such Restrictions have been
satisfied with respect to the conveyance of such Special Interest from Lessor to
Lessee and (ii) any such conveyance of a Special Interest that is subject to a
Requested Action that does not constitute a Restriction shall not be recorded
until such time as such Requested Action has been satisfied or such earlier time
as Lessee, at its option, elects to record such conveyance. Except for any
Restrictions, Lessor and Lessee have not agreed that the Requested Actions
constitute conditions to the transfer of the Special Interests, the delay in the
recording of such Special Interests being done as an accommodation by Lessor to
Lessee. Once all Restrictions and Requested Actions with respect to a Special
Interest have been satisfied, Lessee will promptly record the conveyance of such
Special Interest from Lessor to Lessee. Until such time as (i) all Restrictions
with respect to the conveyance of a Special Interest from Lessor to Lessee that
preclude conveyance to Lessee have been satisfied and (ii) the conveyance of
such Special Interest from Lessor to Lessee is recorded in accordance with the
foregoing conditions, such Special Interest shall continue to be subject to all
applicable provisions of the Lease and the Lease shall remain in full force and
effect with respect to such Special Interest (excluding, however, any obligation
to make any further Lease Payments, but not excluding the obligation to pay
Supplemental Rent and to pay or perform other obligations under the Lease with
respect to such Special Interest).
2
At such time as the conveyance of a Special Interest from Lessor to Lessee is
recorded in accordance with the foregoing conditions, such Special Interest
shall no longer be subject to the Lease. Subject to the terms of the Lease,
Lessor and Lessee shall act in good faith and use commercially reasonable best
efforts to satisfy the Restrictions and to satisfy and complete the Requested
Actions as expeditiously as possible. The identification of Restrictions or
Requested Actions, the retention of the Special Interests and the Lessor's and
Lessee's undertakings to complete or satisfy the Restrictions and Requested
Actions pursuant to this Section 3(c) shall not increase, release, waive, amend
or otherwise affect the respective rights, obligations, remedies and defenses of
Lessor and Lessee under the Lease or constitute or imply any agreement by Lessor
that any title defect exists with respect to any Special Interest.
Section 4. Entire Agreement; No Further Amendment. This Amendment
constitutes the entire agreement among the parties with respect to the subject
matter hereof. Except as modified hereby, the Lease remains in full force and
effect without other amendments or modifications. For all purposes of this
Amendment, the provisions of Sections 21.6, 21.7, 21.9, 21.10, 21.11, 21.12 and
21.13 of the Lease shall apply hereto as if incorporated herein by reference.
Section 5. Governing Law. This Amendment and the rights of the parties
hereunder shall be governed by and interpreted in accordance with the laws of
the State of Texas without giving effect to principles thereof relating to
conflicts of law rules that would direct the application of the laws of another
jurisdiction.
Section 6. Counterparts. This Amendment may be executed in several
counterparts, each of which shall be deemed an original but all of which shall
constitute one and the same instrument.
Section 7. VPC Option Exercise. VMSC and VPC jointly and severally
represent, warrant, acknowledge and confirm to Lessor (i) that VMSC and VPC have
elected to have VPC exercise the Option in its entirety such that all of the
Leased Property shall be conveyed directly to VPC in accordance with the
provisions of the Lease and (ii) that VMSC hereby waives any right to exercise
(in whole or in part) the Option.
LESSOR:
COASTAL LIQUIDS PARTNERS, L.P.
By: El Paso Merchant Energy-Petroleum Company,
Its General Partner
By:
-----------------------------------------
Name: Robert W. Haugen
Title: Vice President
VPC:
VALERO PIPELINE COMPANY
By:
------------------------------------------------------
Name: Michael S. Ciskowski
Title: Senior Vice President
VMSC:
VALERO MARKETING AND SUPPLY COMPANY
By:
------------------------------------------------------
Name: Michael S. Ciskowski
Title: Senior Vice President
3
EXHIBIT 10.8
Change of Control
Severance AGREEMENT
AGREEMENT, dated as of the 19th day of March, 2003 (this "Agreement"), by
and between Valero Energy Corporation, a Delaware corporation (the "Company"),
and William E. Greehey (the "Executive").
WHEREAS, the Board of Directors of the Company (the "Board"), has
determined that it is in the best interests of the Company and its stockholders
to assure that the Company will have the continued dedication of the Executive,
notwithstanding the possibility, threat or occurrence of a Change of Control (as
defined herein). The Board believes it is imperative to diminish the inevitable
distraction of the Executive by virtue of the personal uncertainties and risks
created by a pending or threatened Change of Control and to encourage the
Executive's full attention and dedication to the current Company in the event of
any threatened or pending Change of Control, and to provide the Executive with
compensation and benefits arrangements upon a Change of Control that ensure that
the compensation and benefits expectations of the Executive will be satisfied
and that are competitive with those of other corporations. Therefore, in order
to accomplish these objectives, the Board has caused the Company to enter into
this Agreement.
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
Section 1. Certain Definitions. (a) "Effective Date" means the first date
during the Change of Control Period (as defined herein) on which a Change of
Control occurs. Notwithstanding anything in this Agreement to the contrary, if a
Change of Control occurs and if the Executive's employment with the Company is
terminated prior to the date on which the Change of Control occurs, and if it is
reasonably demonstrated by the Executive that such termination of employment (1)
was at the request of a third party that has taken steps reasonably calculated
to effect a Change of Control or (2) otherwise arose in connection with or
anticipation of a Change of Control, then "Effective Date" means the date
immediately prior to the date of such termination of employment.
(b) "Change of Control Period" means the period commencing on the date
hereof and ending on the third anniversary of the date hereof; provided,
however, that, commencing on the date one year after the date hereof, and on
each annual anniversary of such date (such date and each annual anniversary
thereof, the "Renewal Date"), unless previously terminated, the Change of
Control Period shall be automatically extended so as to terminate three years
from such Renewal Date, unless, at least 60 days prior to the Renewal Date, the
Company shall give notice to the Executive that the Change of Control Period
shall not be so extended.
(c) "Affiliated Company" means any company controlled by, controlling or
under common control with the Company.
(d) "Change of Control" means:
(1) The acquisition by any individual, entity or group (within the meaning
of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the
1
meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of
either (A) the then-outstanding shares of common stock of the Company (the
"Outstanding Company Common Stock") or (B) the combined voting power of the
then-outstanding voting securities of the Company entitled to vote generally in
the election of directors (the "Outstanding Company Voting Securities");
provided, however, that, for purposes of this Section 1(d)(1), the following
acquisitions of Outstanding Company Common Stock or of Outstanding Company
Voting Securities shall not constitute a Change of Control: (i) any acquisition
directly from the Company, (ii) any acquisition by the Company, (iii) any
acquisition by any employee benefit plan (or related trust) sponsored or
maintained by the Company or any Affiliated Company or (iv) any acquisition by
any corporation pursuant to a transaction that complies with Sections
1(d)(3)(A), 1(d)(3)(B) and 1(d)(3)(C);
(2) Individuals who, as of the date hereof, constitute the Board (the
"Incumbent Board") cease for any reason to constitute at least a majority of the
Board; provided, however, that any individual becoming a director subsequent to
the date hereof whose election, or nomination for election by the Company's
stockholders, was approved by a vote of at least a majority of the directors
then comprising the Incumbent Board shall be considered as though such
individual were a member of the Incumbent Board, but excluding, for this
purpose, any such individual whose initial assumption of office occurs as a
result of an actual or threatened election contest with respect to the election
or removal of directors or other actual or threatened solicitation of proxies or
consents by or on behalf of a Person other than the Board;
(3) Consummation of a reorganization, merger, statutory share exchange or
consolidation or similar corporate transaction involving the Company or any of
its subsidiaries, a sale or other disposition of all or substantially all of the
assets of the Company (each, a "Business Combination"), in each case unless,
following such Business Combination, (A) all or substantially all of the
individuals and entities that were the beneficial owners of the Outstanding
Company Common Stock and the Outstanding Company Voting Securities immediately
prior to such Business Combination beneficially own, directly or indirectly,
more than 50% of the then-outstanding shares of common stock and the combined
voting power of the then-outstanding voting securities entitled to vote
generally in the election of directors, as the case may be, of the corporation
resulting from such Business Combination (including, without limitation, a
corporation that, as a result of such transaction, owns the Company or all or
substantially all of the Company's assets either directly or through one or more
subsidiaries) in substantially the same proportions as their ownership
immediately prior to such Business Combination of the Outstanding Company Common
Stock and the Outstanding Company Voting Securities, as the case may be, (B) no
Person (excluding any corporation resulting from such Business Combination or
any employee benefit plan (or related trust) of the Company or such corporation
resulting from such Business Combination) beneficially owns, directly or
indirectly, 20% or more of, respectively, the then-outstanding shares of common
stock of the corporation resulting from such Business Combination or the
combined voting power of the then-outstanding voting securities of such
corporation, except to the extent that such ownership existed prior to the
Business Combination, and (C) at least a majority of the members of the board of
directors of the corporation resulting from such Business Combination were
members of the Incumbent Board at the time of the execution of the initial
agreement or of the action of the Board providing for such Business Combination;
or
2
(4) Approval by the stockholders of the Company of a complete liquidation
or dissolution of the Company.
Section 2. Employment Period. The Company hereby agrees to continue the
Executive in its employ, subject to the terms and conditions of this Agreement,
for the period commencing on the Effective Date and ending on the third
anniversary of the Effective Date (the "Employment Period"). The Employment
Period shall terminate upon the Executive's termination of employment for any
reason.
Section 3. Terms of Employment. (a) Position and Duties. (1) During the
Employment Period, (A) the Executive's position (including status, offices,
titles and reporting requirements), authority, duties and responsibilities shall
be at least commensurate in all material respects with the most significant of
those held, exercised and assigned at any time during the 120-day period
immediately preceding the Effective Date and (B) the Executive's services shall
be performed at the office where the Executive was employed immediately
preceding the Effective Date or at any other location less than 35 miles from
such office.
(2) During the Employment Period, and excluding any periods of vacation and
sick leave to which the Executive is entitled, the Executive agrees to devote
reasonable attention and time during normal business hours to the business and
affairs of the Company and, to the extent necessary to discharge the
responsibilities assigned to the Executive hereunder, to use the Executive's
reasonable best efforts to perform faithfully and efficiently such
responsibilities. During the Employment Period, it shall not be a violation of
this Agreement for the Executive to (A) serve on corporate, civic or charitable
boards or committees, (B) deliver lectures, fulfill speaking engagements or
teach at educational institutions and (C) manage personal investments, so long
as such activities do not significantly interfere with the performance of the
Executive's responsibilities as an employee of the Company in accordance with
this Agreement. It is expressly understood and agreed that, to the extent that
any such activities have been conducted by the Executive prior to the Effective
Date, the continued conduct of such activities (or the conduct of activities
similar in nature and scope thereto) subsequent to the Effective Date shall not
thereafter be deemed to interfere with the performance of the Executive's
responsibilities to the Company.
(b) Compensation. (1) Base Salary. During the Employment Period, the
Executive shall receive an annual base salary (the "Annual Base Salary") at an
annual rate at least equal to 12 times the highest monthly base salary paid or
payable, including any base salary that has been earned but deferred, to the
Executive by the Company and the Affiliated Companies in respect of the 12-month
period immediately preceding the month in which the Effective Date occurs. The
Annual Base Salary shall be paid at such intervals as the Company pays executive
salaries generally. During the Employment Period, the Annual Base Salary shall
be reviewed at least annually, beginning no more than 12 months after the last
salary increase awarded to the Executive prior to the Effective Date. Any
increase in the Annual Base Salary shall not serve to limit or reduce any other
obligation to the Executive under this Agreement. The Annual Base Salary shall
not be reduced after any such increase and the term "Annual Base Salary" shall
refer to the Annual Base Salary as so increased.
3
(2) Annual Bonus. In addition to the Annual Base Salary, the Executive
shall be awarded, for each fiscal year ending during the Employment Period, an
annual bonus (the "Annual Bonus") in cash at least equal to the Executive's
highest bonus earned under the Company's annual incentive bonus plans, or any
comparable bonus under any predecessor or successor plan or plans, for the last
three full fiscal years prior to the Effective Date (or for such lesser number
of full fiscal years prior to the Effective Date for which the Executive was
eligible to earn such a bonus, and annualized in the case of any bonus earned
for a partial fiscal year) (the "Recent Annual Bonus"). (If the Executive has
not been eligible to earn such a bonus for any period prior to the Effective
Date, the "Recent Annual Bonus" shall mean the Executive's target annual bonus
for the year in which the Effective Date occurs.) Each such Annual Bonus shall
be paid no later than the end of the third month of the fiscal year next
following the fiscal year for which the Annual Bonus is awarded, unless the
Executive shall elect to defer the receipt of such Annual Bonus.
(3) Incentive, Savings and Retirement Plans. During the Employment Period,
the Executive shall be entitled to participate in all incentive, savings and
retirement plans, practices, policies, and programs applicable generally to
other peer executives of the Company and the Affiliated Companies, but in no
event shall such plans, practices, policies and programs provide the Executive
with incentive opportunities (measured with respect to both regular and special
incentive opportunities, to the extent, if any, that such distinction is
applicable), savings opportunities and retirement benefit opportunities, in each
case, less favorable, in the aggregate, than the most favorable of those
provided by the Company and the Affiliated Companies for the Executive under
such plans, practices, policies and programs as in effect at any time during the
120-day period immediately preceding the Effective Date or, if more favorable to
the Executive, those provided generally at any time after the Effective Date to
other peer executives of the Company and the Affiliated Companies.
(4) Welfare Benefit Plans. During the Employment Period, the Executive
and/or the Executive's family, as the case may be, shall be eligible for
participation in and shall receive all benefits under welfare benefit plans,
practices, policies and programs provided by the Company and the Affiliated
Companies (including, without limitation, medical, prescription, dental, vision,
disability, employee life, group life, accidental death and travel accident
insurance plans and programs) to the extent applicable generally to other peer
executives of the Company and the Affiliated Companies, but in no event shall
such plans, practices, policies and programs provide the Executive with benefits
that are less favorable, in the aggregate, than the most favorable of such
plans, practices, policies and programs in effect for the Executive at any time
during the 120-day period immediately preceding the Effective Date or, if more
favorable to the Executive, those provided generally at any time after the
Effective Date to other peer executives of the Company and the Affiliated
Companies.
(5) Expenses. During the Employment Period, the Executive shall be entitled
to receive prompt reimbursement for all reasonable expenses incurred by the
Executive in accordance with the most favorable policies, practices and
procedures of the Company and the Affiliated Companies in effect for the
Executive at any time during the 120-day period immediately preceding the
Effective Date or, if more favorable to the Executive, as in effect generally at
any time thereafter with respect to other peer executives of the Company and the
Affiliated Companies.
4
(6) Fringe Benefits. During the Employment Period, the Executive shall be
entitled to fringe benefits, including, without limitation, tax and financial
planning services, payment of club dues, and, if applicable, use of an
automobile and payment of related expenses, in accordance with the most
favorable plans, practices, programs and policies of the Company and the
Affiliated Companies in effect for the Executive at any time during the 120-day
period immediately preceding the Effective Date or, if more favorable to the
Executive, as in effect generally at any time thereafter with respect to other
peer executives of the Company and the Affiliated Companies.
(7) Office and Support Staff. During the Employment Period, the Executive
shall be entitled to an office or offices of a size and with furnishings and
other appointments, and to exclusive personal secretarial and other assistance,
at least equal to the most favorable of the foregoing provided to the Executive
by the Company and the Affiliated Companies at any time during the 120-day
period immediately preceding the Effective Date or, if more favorable to the
Executive, as provided generally at any time thereafter with respect to other
peer executives of the Company and the Affiliated Companies.
(8) Vacation. During the Employment Period, the Executive shall be entitled
to paid vacation in accordance with the most favorable plans, policies, programs
and practices of the Company and the Affiliated Companies as in effect for the
Executive at any time during the 120-day period immediately preceding the
Effective Date or, if more favorable to the Executive, as in effect generally at
any time thereafter with respect to other peer executives of the Company and the
Affiliated Companies.
(9) Immediate Vesting of Outstanding Equity Incentive Awards.
Notwithstanding any provision in the Company's stock incentive plans or the
award agreements thereunder, effective immediately upon the occurrence of a
Change of Control, (A) all stock options (incentive or non-qualified)
outstanding as of the date of such Change of Control, which are not then
exercisable and vested, shall become fully exercisable and vested to the full
extent of the original grant and, following the Executive's termination of
employment for any reason, shall remain exercisable for the remainder of the
original option term; (B) all restrictions and deferral limitations applicable
to any restricted stock awards outstanding as of the date of such Change of
Control shall lapse, and such restricted stock awards shall become free of all
restrictions and become fully vested and transferable to the full extent of the
original grant; and (C) all performance share awards outstanding as of the date
of such Change of Control for any outstanding performance periods shall fully
vest and be earned and payable in full based on the deemed achievement of
performance at 200% of target level for the entire performance period.
Section 4. Termination of Employment. (a) Death or Disability. The
Executive's employment shall terminate automatically if the Executive dies
during the Employment Period. If the Company determines in good faith that the
Executive has a Disability (as defined herein) that has occurred during the
Employment Period (pursuant to the definition of "Disability"), it may give to
the Executive written notice in accordance with Section 11(b) of its intention
to terminate the Executive's employment. In such event, the Executive's
employment with the Company shall terminate effective on the 30th day after
receipt of such notice by the Executive (the "Disability Effective Date"),
provided that, within the 30 days after such receipt, the Executive shall not
have returned to full-time performance of the Executive's duties. "Disability"
5
means the absence of the Executive from the Executive's duties with the Company
on a full-time basis for 180 consecutive business days as a result of incapacity
due to mental or physical illness that is determined to be total and permanent
by a physician selected by the Company or its insurers and acceptable to the
Executive or the Executive's legal representative.
(b) Cause. The Company may terminate the Executive's employment during the
Employment Period for Cause. "Cause" means:
(1) the willful and continued failure of the Executive to perform
substantially the Executive's duties (as contemplated by Section
3(a)(1)(A)) with the Company or any Affiliated Company (other than any such
failure resulting from incapacity due to physical or mental illness or
following the Executive's delivery of a Notice of Termination for Good
Reason), after a written demand for substantial performance is delivered to
the Executive by the Board or the Chief Executive Officer of the Company
that specifically identifies the manner in which the Board or the Chief
Executive Officer of the Company believes that the Executive has not
substantially performed the Executive's duties, or
(2) the willful engaging by the Executive in illegal conduct or gross
misconduct that is materially and demonstrably injurious to the Company.
For purposes of this Section 4(b), no act, or failure to act, on the part
of the Executive shall be considered "willful" unless it is done, or omitted to
be done, by the Executive in bad faith or without reasonable belief that the
Executive's action or omission was in the best interests of the Company. Any
act, or failure to act, based upon authority given pursuant to a resolution duly
adopted by the Board or upon the instructions of the Chief Executive Officer of
the Company or a senior officer of the Company or based upon the advice of
counsel for the Company shall be conclusively presumed to be done, or omitted to
be done, by the Executive in good faith and in the best interests of the
Company. The cessation of employment of the Executive shall not be deemed to be
for Cause unless and until there shall have been delivered to the Executive a
copy of a resolution duly adopted by the affirmative vote of not less than
three-quarters of the entire membership of the Board at a meeting of the Board
called and held for such purpose (after reasonable notice is provided to the
Executive and the Executive is given an opportunity, together with counsel for
the Executive, to be heard before the Board), finding that, in the good faith
opinion of the Board, the Executive is guilty of the conduct described in
Section 4(b)(1) or 4(b)(2), and specifying the particulars thereof in detail.
(c) Good Reason. The Executive's employment may be terminated by the
Executive for Good Reason or by the Executive voluntarily without Good Reason.
"Good Reason" means:
(1) the assignment to the Executive of any duties inconsistent in
any respect with the Executive's position (including status, offices,
titles and reporting requirements), authority, duties or
responsibilities as contemplated by Section 3(a)(1)(A), or any other
action by the Company that results in a diminution in such position,
authority, duties or responsibilities, excluding for this purpose an
isolated, insubstantial and inadvertent action not taken in bad faith
and that is remedied by the Company promptly after receipt of notice
thereof given by the Executive;
6
(2) any failure by the Company to comply with any of the
provisions of Section 3(b), other than an isolated, insubstantial and
inadvertent failure not occurring in bad faith and that is remedied by
the Company promptly after receipt of notice thereof given by the
Executive;
(3) the Company's requiring the Executive (i) to be based at any
office or location other than as provided in Section 3(a)(1)(B), (ii)
to be based at a location other than the principal executive offices
of the Company if the Executive was employed at such location
immediately preceding the Effective Date, or (iii) to travel on
Company business to a substantially greater extent than required
immediately prior to the Effective Date;
(4) any purported termination by the Company of the Executive's
employment otherwise than as expressly permitted by this Agreement; or
(5) any failure by the Company to comply with and satisfy Section
10(c).
For purposes of this Section 4(c), any good faith determination of Good
Reason made by the Executive shall be conclusive. The Executive's mental or
physical incapacity following the occurrence of an event described above in
clauses (1) through (5) shall not affect the Executive's ability to terminate
employment for Good Reason.
(d) Notice of Termination. Any termination by the Company for Cause, or by
the Executive for Good Reason, shall be communicated by Notice of Termination to
the other party hereto given in accordance with Section 11(b). "Notice of
Termination" means a written notice that (1) indicates the specific termination
provision in this Agreement relied upon, (2) to the extent applicable, sets
forth in reasonable detail the facts and circumstances claimed to provide a
basis for termination of the Executive's employment under the provision so
indicated, and (3) if the Date of Termination (as defined herein) is other than
the date of receipt of such notice, specifies the Date of Termination (which
Date of Termination shall be not more than 30 days after the giving of such
notice). The failure by the Executive or the Company to set forth in the Notice
of Termination any fact or circumstance that contributes to a showing of Good
Reason or Cause shall not waive any right of the Executive or the Company,
respectively, hereunder or preclude the Executive or the Company, respectively,
from asserting such fact or circumstance in enforcing the Executive's or the
Company's respective rights hereunder.
(e) Date of Termination. "Date of Termination" means (1) if the Executive's
employment is terminated by the Company for Cause, or by the Executive for Good
Reason, the date of receipt of the Notice of Termination or any later date
specified in the Notice of Termination, as the case may be, (2) if the
Executive's employment is terminated by the Company other than for Cause or
Disability, the Date of Termination shall be the date on which the Company
notifies the Executive of such termination, and (3) if the Executive's
employment is terminated by reason of death or Disability, the Date of
Termination shall be the date of death of the Executive or the Disability
Effective Date, as the case may be.
7
Section 5. Obligations of the Company upon Termination. (a) Good Reason;
Other Than for Cause, Death or Disability. If, during the Employment Period, the
Company terminates the Executive's employment other than for Cause or Disability
or the Executive terminates employment for Good Reason:
(1) the Company shall pay to the Executive, in a lump sum in cash
within 30 days after the Date of Termination, the aggregate of the
following amounts:
(A) the sum of (i) the Executive's Annual Base Salary through the
Date of Termination, (ii) the product of (x) the Recent Annual Bonus
and (y) a fraction, the numerator of which is the number of days in
the current fiscal year through the Date of Termination and the
denominator of which is 365, and (iii) any accrued vacation pay, in
each case, to the extent not theretofore paid (the sum of the amounts
described in subclauses (i), (ii) and (iii), the "Accrued
Obligations");
(B) the amount equal to the product of (i) three and (ii) the sum
of (x) the Executive's Annual Base Salary and (y) the Recent Annual
Bonus;
(C) an amount equal to the excess of (i) the actuarial equivalent
of the benefit under the Company's qualified defined benefit
retirement plan (the "Retirement Plan") (utilizing actuarial
assumptions no less favorable to the Executive than those in effect
under the Retirement Plan immediately prior to the Effective Date) and
any excess or supplemental retirement plan in which the Executive
participates (collectively, the "SERP") that the Executive would
receive if the Executive's employment continued for three years after
the Date of Termination, assuming for this purpose that (x) the
Executive's age and service credit increase during the three-year
period, (y) all accrued benefits are fully vested and (z) the
Executive's compensation in each of the three years is that required
by Sections 3(b)(1) and 3(b)(2), over (ii) the actuarial equivalent of
the Executive's actual benefit (paid or payable), if any, under the
Retirement Plan and the SERP as of the Date of Termination; and
(D) an amount equal to the sum of the Company matching or other
Company contributions under the Company's qualified defined
contribution plans and any excess or supplemental defined contribution
plans in which the Executive participates that the Executive would
receive if the Executive's employment continued for three years after
the Date of Termination, assuming for this purpose that (x) the
Executive's benefits under such plans are fully vested, (y) the
Executive's compensation in each of the three years is that required
by Sections 3(b)(1) and 3(b)(2) and (z) to the extent that the Company
contributions are determined based on the contributions or deferrals
of the Executive, that the Executive's contribution or deferral
elections, as appropriate, are those in effect immediately prior the
Date of Termination; and
(2) for three years after the Executive's Date of Termination, or such
longer period as may be provided by the terms of the appropriate plan,
8
program, practice or policy, the Company shall continue benefits to the
Executive and/or the Executive's family at least equal to those that would
have been provided to them in accordance with the plans, programs,
practices and policies described in Section 3(b)(4) and 3(b)(6) if the
Executive's employment had not been terminated or, if more favorable to the
Executive, as in effect generally at any time thereafter with respect to
other peer executives of the Company and the Affiliated Companies and their
families, provided, however, that, if the Executive becomes reemployed with
another employer and is eligible to receive the benefits described in
Section 3(b)(4) under another employer provided plan, the medical and other
welfare benefits described herein shall be secondary to those provided
under such other plan during such applicable period of eligibility. For
purposes of determining eligibility (but not the time of commencement of
benefits) of the Executive for retiree benefits pursuant to such plans,
practices, programs and policies, the Executive shall be considered to have
remained employed (for purposes of both age and service credit) until three
years after the Date of Termination and to have retired on the last day of
such period;
(3) during the 12-month period following the Date of Termination, the
Company shall, at its sole expense as incurred, provide the Executive with
outplacement services the scope and provider of which shall be selected by
the Executive in the Executive's sole discretion, provided that, the cost
of such outplacement shall not exceed $25,000 (as adjusted for inflation
based on the Consumer Price Index or another nationally recognized
published inflation index); and
(4) to the extent not theretofore paid or provided, the Company shall
timely pay or provide to the Executive any other amounts or benefits
required to be paid or provided or that the Executive is eligible to
receive under any plan, program, policy or practice or contract or
agreement of the Company and the Affiliated Companies, including, without
limitation, the Employment Agreement between the Company and the Executive,
dated as of March 25th, 1999, as amended from time to time (the "Employment
Agreement") (such other amounts and benefits, the "Other Benefits").
(b) Death. If the Executive's employment is terminated by reason of the
Executive's death during the Employment Period, the Company shall provide the
Executive's estate or beneficiaries with the Accrued Obligations and the timely
payment or delivery of the Other Benefits, and shall have no other severance
obligations under this Agreement. The Accrued Obligations shall be paid to the
Executive's estate or beneficiary, as applicable, in a lump sum in cash within
30 days of the Date of Termination. With respect to the provision of the Other
Benefits, the term "Other Benefits" as utilized in this Section 5(b) shall
include, without limitation, and the Executive's estate and/or beneficiaries
shall be entitled to receive, benefits at least equal to the most favorable
benefits provided by the Company and the Affiliated Companies to the estates and
beneficiaries of peer executives of the Company and the Affiliated Companies
under such plans, programs, practices and policies relating to death benefits,
if any, as in effect with respect to other peer executives and their
beneficiaries at any time during the 120-day period immediately preceding the
Effective Date or, if more favorable to the Executive's estate and/or the
Executive's beneficiaries, as in effect on the date of the Executive's death
with respect to other peer executives of the Company and the Affiliated
Companies and their beneficiaries.
9
(c) Disability. If the Executive's employment is terminated by reason of
the Executive's Disability during the Employment Period, the Company shall
provide the Executive with the Accrued Obligations and the timely payment or
delivery of the Other Benefits, and shall have no other severance obligations
under this Agreement. The Accrued Obligations shall be paid to the Executive in
a lump sum in cash within 30 days of the Date of Termination. With respect to
the provision of the Other Benefits, the term "Other Benefits" as utilized in
this Section 5(c) shall include, and the Executive shall be entitled after the
Disability Effective Date to receive, disability and other benefits at least
equal to the most favorable of those generally provided by the Company and the
Affiliated Companies to disabled executives and/or their families in accordance
with such plans, programs, practices and policies relating to disability, if
any, as in effect generally with respect to other peer executives and their
families at any time during the 120-day period immediately preceding the
Effective Date or, if more favorable to the Executive and/or the Executive's
family, as in effect at any time thereafter generally with respect to other peer
executives of the Company and the Affiliated Companies and their families.
(d) Cause; Other Than for Good Reason. If the Executive's employment is
terminated for Cause during the Employment Period, the Company shall provide to
the Executive (1) the Executive's Annual Base Salary through the Date of
Termination, (2) any accrued vacation pay, and (3) the Other Benefits, in each
case, to the extent theretofore unpaid, and shall have no other severance
obligations under this Agreement. If the Executive voluntarily terminates
employment during the Employment Period, excluding a termination for Good
Reason, the Company shall provide to the Executive the Accrued Obligations and
the timely payment or delivery of the Other Benefits, and shall have no other
severance obligations under this Agreement. In such case, all the Accrued
Obligations shall be paid to the Executive in a lump sum in cash within 30 days
of the Date of Termination.
Section 6. Non-exclusivity of Rights. Nothing in this Agreement shall
prevent or limit the Executive's continuing or future participation in any plan,
program, policy or practice provided by the Company or the Affiliated Companies
and for which the Executive may qualify, nor, subject to Section 11(f) and the
proviso of the last sentence of this Section 6, shall anything herein limit or
otherwise affect such rights as the Executive may have under any other contract
or agreement with the Company or the Affiliated Companies, including, without
limitation, the Employment Agreement. Amounts that are vested benefits or that
the Executive is otherwise entitled to receive under any plan, policy, practice
or program of or any other contract or agreement, including, without limitation,
the Employment Agreement, with the Company or the Affiliated Companies at or
subsequent to the Date of Termination shall be payable in accordance with such
plan, policy, practice or program or contract or agreement, except as explicitly
modified by this Agreement. Notwithstanding the foregoing, if the Executive
receives payments and benefits pursuant to Section 5(a) of this Agreement, the
Executive shall not be entitled to any severance pay or benefits under any
severance plan, program or policy of the Company and the Affiliated Companies,
unless otherwise specifically provided therein by a specific reference to this
Agreement. Notwithstanding the foregoing or anything to the contrary contained
herein, if the Executive is entitled to receive a payment, benefit or right
under the Employment Agreement that is in addition to those provided under this
Agreement, nothing contained in this Agreement shall prohibit him from receiving
such payment, benefit or right, and, if the Executive is entitled to receive a
payment, benefit or right pursuant to both this Agreement and the Employment
Agreement, the Executive shall be entitled to the more favorable of any such
10
payment, benefit or right, whether based on a provision of this Agreement or the
Employment Agreement or a combination of the provisions under such agreements;
provided, however, that in no event shall the Executive be entitled to duplicate
payments, rights or benefits.
Section 7. Full Settlement. The Company's obligation to make the payments
provided for in this Agreement and otherwise to perform its obligations
hereunder shall not be affected by any set-off, counterclaim, recoupment,
defense, or other claim, right or action that the Company may have against the
Executive or others. In no event shall the Executive be obligated to seek other
employment or take any other action by way of mitigation of the amounts payable
to the Executive under any of the provisions of this Agreement, and such amounts
shall not be reduced whether or not the Executive obtains other employment. The
Company agrees to pay as incurred, to the full extent permitted by law, all
legal fees and expenses that the Executive may reasonably incur as a result of
any contest (regardless of the outcome thereof) by the Company, the Executive or
others of the validity or enforceability of, or liability under, any provision
of this Agreement or any guarantee of performance thereof (including as a result
of any contest by the Executive about the amount of any payment pursuant to this
Agreement), plus, in each case, interest on any delayed payment at the
applicable federal rate provided for in Section 7872(f)(2)(A) of the Internal
Revenue Code of 1986, as amended (the "Code").
Section 8. Certain Additional Payments by the Company.
(a) Anything in this Agreement to the contrary notwithstanding, in the
event it shall be determined that any payment or distribution by the Company or
its Affiliated Companies to or for the benefit of the Executive (whether paid or
payable or distributed or distributable pursuant to the terms of this Agreement
or otherwise, but determined without regard to any additional payments required
under this Section 8) (a "Payment") would be subject to the excise tax imposed
by Section 4999 of the Code or any interest or penalties are incurred by the
Executive with respect to such excise tax (such excise tax, together with any
such interest and penalties, collectively the "Excise Tax"), then the Executive
shall be entitled to receive an additional payment (the "Gross-Up Payment") in
an amount such that, after payment by the Executive of all taxes (including any
interest or penalties imposed with respect to such taxes), including, without
limitation, any income taxes (and any interest and penalties imposed with
respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive
retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon
the Payments.
(b) Subject to the provisions of Section 8(c), all determinations required
to be made under this Section 8, including whether and when a Gross-Up Payment
is required, the amount of such Gross-Up Payment and the assumptions to be
utilized in arriving at such determination, shall be made by Ernst & Young, LLP,
or such other nationally recognized certified public accounting firm as may be
designated by the Executive, subject to the Company's approval which will not be
unreasonably withheld (the "Accounting Firm"). The Accounting Firm shall provide
detailed supporting calculations both to the Company and the Executive within 15
business days of the receipt of notice from the Executive that there has been a
Payment or such earlier time as is requested by the Company. In the event that
the Accounting Firm is serving as accountant or auditor for the individual,
entity or group effecting the Change of Control, the Executive, subject to the
Company's approval which will not be unreasonably withheld, may appoint another
nationally recognized accounting firm to make the determinations required
11
hereunder (which accounting firm shall then be referred to as the Accounting
Firm hereunder). All fees and expenses of the Accounting Firm shall be borne
solely by the Company. Any Gross-Up Payment, as determined pursuant to this
Section 8, shall be paid by the Company to the Executive within 5 days of the
receipt of the Accounting Firm's determination. Any determination by the
Accounting Firm shall be binding upon the Company and the Executive. As a result
of the uncertainty in the application of Section 4999 of the Code at the time of
the initial determination by the Accounting Firm hereunder, it is possible that
Gross-Up Payments that will not have been made by the Company should have been
made (the "Underpayment"), consistent with the calculations required to be made
hereunder. In the event the Company exhausts its remedies pursuant to Section
8(c) and the Executive thereafter is required to make a payment of any Excise
Tax, the Accounting Firm shall determine the amount of the Underpayment that has
occurred and any such Underpayment shall be promptly paid by the Company to or
for the benefit of the Executive.
(c) The Executive shall notify the Company in writing of any claim by the
Internal Revenue Service that, if successful, would require the payment by the
Company of the Gross-Up Payment. Such notification shall be given as soon as
practicable, but no later than 10 business days after the Executive is informed
in writing of such claim. The Executive shall apprise the Company of the nature
of such claim and the date on which such claim is requested to be paid. The
Executive shall not pay such claim prior to the expiration of the 30-day period
following the date on which the Executive gives such notice to the Company (or
such shorter period ending on the date that any payment of taxes with respect to
such claim is due). If the Company notifies the Executive in writing prior to
the expiration of such period that the Company desires to contest such claim,
the Executive shall:
(1) give the Company any information reasonably requested by the
Company relating to such claim,
(2) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such
claim by an attorney reasonably selected by the Company,
(3) cooperate with the Company in good faith in order effectively to
contest such claim, and
(4) permit the Company to participate in any proceedings relating to
such claim;
provided, however, that the Company shall bear and pay directly all costs
and expenses (including additional interest and penalties) incurred in
connection with such contest, and shall indemnify and hold the Executive
harmless, on an after-tax basis, for any Excise Tax or income tax (including
interest and penalties) imposed as a result of such representation and payment
of costs and expenses. Without limitation on the foregoing provisions of this
Section 8(c), the Company shall control all proceedings taken in connection with
such contest, and, at its sole discretion, may pursue or forgo any and all
administrative appeals, proceedings, hearings and conferences with the
applicable taxing authority in respect of such claim and may, at its sole
12
discretion, either pay the tax claimed to the appropriate taxing authority on
behalf of the Executive and direct the Executive to sue for a refund or contest
the claim in any permissible manner, and the Executive agrees to prosecute such
contest to a determination before any administrative tribunal, in a court of
initial jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however, that, if the Company pays such claim and directs
the Executive to sue for a refund, the Company shall indemnify and hold the
Executive harmless, on an after-tax basis, from any Excise Tax or income tax
(including interest or penalties) imposed with respect to such payment or with
respect to any imputed income in connection with such payment; and provided,
further, that any extension of the statute of limitations relating to payment of
taxes for the taxable year of the Executive with respect to which such contested
amount is claimed to be due is limited solely to such contested amount.
Furthermore, the Company's control of the contest shall be limited to issues
with respect to which the Gross-Up Payment would be payable hereunder, and the
Executive shall be entitled to settle or contest, as the case may be, any other
issue raised by the Internal Revenue Service or any other taxing authority.
(d) If, after the receipt by the Executive of a Gross-Up Payment or payment
by the Company of an amount on the Executive's behalf pursuant to Section 8(c),
the Executive becomes entitled to receive any refund with respect to the Excise
Tax to which such Gross-Up Payment relates or with respect to such claim, the
Executive shall (subject to the Company's complying with the requirements of
Section 8(c), if applicable) promptly pay to the Company the amount of such
refund (together with any interest paid or credited thereon after taxes
applicable thereto). If, after payment by the Company of an amount on the
Executive's behalf pursuant to Section 8(c), a determination is made that the
Executive shall not be entitled to any refund with respect to such claim and the
Company does not notify the Executive in writing of its intent to contest such
denial of refund prior to the expiration of 30 days after such determination,
then the amount of such payment shall offset, to the extent thereof, the amount
of Gross-Up Payment required to be paid.
(e) Notwithstanding any other provision of this Section 8, the Company may,
in its sole discretion, withhold and pay to the Internal Revenue Service or any
other applicable taxing authority, for the benefit of the Executive, all or any
portion of any Gross-Up Payment, and the Executive hereby consents to such
withholding.
Section 9. Confidential Information. The Executive shall hold in a
fiduciary capacity for the benefit of the Company all secret or confidential
information, knowledge or data relating to the Company or the Affiliated
Companies, and their respective businesses, which information, knowledge or data
shall have been obtained by the Executive during the Executive's employment by
the Company or the Affiliated Companies and which information, knowledge or data
shall not be or become public knowledge (other than by acts by the Executive or
representatives of the Executive in violation of this Agreement). After
termination of the Executive's employment with the Company, the Executive shall
not, without the prior written consent of the Company or as may otherwise be
required by law or legal process, communicate or divulge any such information,
knowledge or data to anyone other than the Company and those persons designated
by the Company. In no event shall an asserted violation of the provisions of
this Section 9 constitute a basis for deferring or withholding any amounts
otherwise payable to the Executive under this Agreement.
13
Section 10. Successors. (a) This Agreement is personal to the Executive,
and, without the prior written consent of the Company, shall not be assignable
by the Executive other than by will or the laws of descent and distribution.
This Agreement shall inure to the benefit of and be enforceable by the
Executive's legal representatives.
(b) This Agreement shall inure to the benefit of and be binding upon the
Company and its successors and assigns. Except as provided in Section 10(c),
without the prior written consent of the Executive, this Agreement shall not be
assignable by the Company.
(c) The Company will require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of the
business and/or assets of the Company to assume expressly and agree to perform
this Agreement in the same manner and to the same extent that the Company would
be required to perform it if no such succession had taken place. "Company" means
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid that assumes and agrees to perform this Agreement by
operation of law or otherwise.
Section 11. Miscellaneous. (a) This Agreement shall be governed by and
construed in accordance with the laws of the State of Delaware, without
reference to principles of conflict of laws. The captions of this Agreement are
not part of the provisions hereof and shall have no force or effect. This
Agreement may not be amended or modified other than by a written agreement
executed by the parties hereto or their respective successors and legal
representatives.
(b) All notices and other communications hereunder shall be in writing and
shall be given by hand delivery to the other party or by registered or certified
mail, return receipt requested, postage prepaid, addressed as follows:
if to the Executive: At the most recent address on file in the
Company's records
if to the Company: Valero Energy Corporation
One Valero Place
San Antonio, Texas 78212
Attention: Corporate Secretary
or to such other address as either party shall have furnished to the other in
writing in accordance herewith. Notice and communications shall be effective
when actually received by the addressee.
(c) The invalidity or unenforceability of any provision of this Agreement
shall not affect the validity or enforceability of any other provision of this
Agreement.
(d) The Company may withhold from any amounts payable under this Agreement
such United States federal, state or local or foreign taxes as shall be required
to be withheld pursuant to any applicable law or regulation.
(e) The Executive's or the Company's failure to insist upon strict
compliance with any provision of this Agreement or the failure to assert any
right the Executive or the Company may have hereunder, including, without
limitation, the right of the Executive to terminate employment for Good Reason
14
pursuant to Sections 4(c)(1) through 4(c)(5), shall not be deemed to be a waiver
of such provision or right or any other provision or right of this Agreement.
(f) The Executive and the Company acknowledge that, except as may otherwise
be provided under any other written agreement between the Executive and the
Company, the employment of the Executive by the Company is "at will" and,
subject to Section 1(a), prior to the Effective Date, the Executive's employment
may be terminated by either the Executive or the Company at any time prior to
the Effective Date, in which case the Executive shall have no further rights
under this Agreement. From and after the date hereof, this Agreement shall
supersede the Executive Severance Agreement between the Company and the
Executive, dated December 15, 1982.
IN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand
and, pursuant to the authorization from the Board, the Company has caused these
presents to be executed in its name on its behalf, all as of the day and year
first above written.
EXECUTIVE
/s/ William E. Greehey
-------------------------------------
William E. Greehey
VALERO ENERGY CORPORATION
By: /s/ Keith D. Booke
-------------------------------------
Name: Keith D. Booke
Title: Executive Vice President and
Chief Administrative Officer
15
EXHIBIT 10.9
Change of Control
Severance AGREEMENT
AGREEMENT, dated as of the 19th day of March, 2003 (this "Agreement"), by
and between Valero Energy Corporation, a Delaware corporation (the "Company"),
and Gregory C. King (the "Executive").
WHEREAS, the Board of Directors of the Company (the "Board"), has
determined that it is in the best interests of the Company and its stockholders
to assure that the Company will have the continued dedication of the Executive,
notwithstanding the possibility, threat or occurrence of a Change of Control (as
defined herein). The Board believes it is imperative to diminish the inevitable
distraction of the Executive by virtue of the personal uncertainties and risks
created by a pending or threatened Change of Control and to encourage the
Executive's full attention and dedication to the current Company in the event of
any threatened or pending Change of Control, and to provide the Executive with
compensation and benefits arrangements upon a Change of Control that ensure that
the compensation and benefits expectations of the Executive will be satisfied
and that are competitive with those of other corporations. Therefore, in order
to accomplish these objectives, the Board has caused the Company to enter into
this Agreement.
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
Section 1. Certain Definitions. (a) "Effective Date" means the first date
during the Change of Control Period (as defined herein) on which a Change of
Control occurs. Notwithstanding anything in this Agreement to the contrary, if a
Change of Control occurs and if the Executive's employment with the Company is
terminated prior to the date on which the Change of Control occurs, and if it is
reasonably demonstrated by the Executive that such termination of employment (1)
was at the request of a third party that has taken steps reasonably calculated
to effect a Change of Control or (2) otherwise arose in connection with or
anticipation of a Change of Control, then "Effective Date" means the date
immediately prior to the date of such termination of employment.
(b) "Change of Control Period" means the period commencing on the date
hereof and ending on the third anniversary of the date hereof; provided,
however, that, commencing on the date one year after the date hereof, and on
each annual anniversary of such date (such date and each annual anniversary
thereof, the "Renewal Date"), unless previously terminated, the Change of
Control Period shall be automatically extended so as to terminate three years
from such Renewal Date, unless, at least 60 days prior to the Renewal Date, the
Company shall give notice to the Executive that the Change of Control Period
shall not be so extended.
(c) "Affiliated Company" means any company controlled by, controlling or
under common control with the Company.
(d) "Change of Control" means:
(1) The acquisition by any individual, entity or group (within the meaning
of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as
1
amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the
meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of
either (A) the then-outstanding shares of common stock of the Company (the
"Outstanding Company Common Stock") or (B) the combined voting power of the
then-outstanding voting securities of the Company entitled to vote generally in
the election of directors (the "Outstanding Company Voting Securities");
provided, however, that, for purposes of this Section 1(d)(1), the following
acquisitions of Outstanding Company Common Stock or of Outstanding Company
Voting Securities shall not constitute a Change of Control: (i) any acquisition
directly from the Company, (ii) any acquisition by the Company, (iii) any
acquisition by any employee benefit plan (or related trust) sponsored or
maintained by the Company or any Affiliated Company or (iv) any acquisition by
any corporation pursuant to a transaction that complies with Sections
1(d)(3)(A), 1(d)(3)(B) and 1(d)(3)(C);
(2) Individuals who, as of the date hereof, constitute the Board (the
"Incumbent Board") cease for any reason to constitute at least a majority of the
Board; provided, however, that any individual becoming a director subsequent to
the date hereof whose election, or nomination for election by the Company's
stockholders, was approved by a vote of at least a majority of the directors
then comprising the Incumbent Board shall be considered as though such
individual were a member of the Incumbent Board, but excluding, for this
purpose, any such individual whose initial assumption of office occurs as a
result of an actual or threatened election contest with respect to the election
or removal of directors or other actual or threatened solicitation of proxies or
consents by or on behalf of a Person other than the Board;
(3) Consummation of a reorganization, merger, statutory share exchange or
consolidation or similar corporate transaction involving the Company or any of
its subsidiaries, a sale or other disposition of all or substantially all of the
assets of the Company (each, a "Business Combination"), in each case unless,
following such Business Combination, (A) all or substantially all of the
individuals and entities that were the beneficial owners of the Outstanding
Company Common Stock and the Outstanding Company Voting Securities immediately
prior to such Business Combination beneficially own, directly or indirectly,
more than 50% of the then-outstanding shares of common stock and the combined
voting power of the then-outstanding voting securities entitled to vote
generally in the election of directors, as the case may be, of the corporation
resulting from such Business Combination (including, without limitation, a
corporation that, as a result of such transaction, owns the Company or all or
substantially all of the Company's assets either directly or through one or more
subsidiaries) in substantially the same proportions as their ownership
immediately prior to such Business Combination of the Outstanding Company Common
Stock and the Outstanding Company Voting Securities, as the case may be, (B) no
Person (excluding any corporation resulting from such Business Combination or
any employee benefit plan (or related trust) of the Company or such corporation
resulting from such Business Combination) beneficially owns, directly or
indirectly, 20% or more of, respectively, the then-outstanding shares of common
stock of the corporation resulting from such Business Combination or the
combined voting power of the then-outstanding voting securities of such
corporation, except to the extent that such ownership existed prior to the
Business Combination, and (C) at least a majority of the members of the board of
directors of the corporation resulting from such Business Combination were
members of the Incumbent Board at the time of the execution of the initial
agreement or of the action of the Board providing for such Business Combination;
or
2
(4) Approval by the stockholders of the Company of a complete liquidation
or dissolution of the Company.
Section 2. Employment Period. The Company hereby agrees to continue the
Executive in its employ, subject to the terms and conditions of this Agreement,
for the period commencing on the Effective Date and ending on the third
anniversary of the Effective Date (the "Employment Period"). The Employment
Period shall terminate upon the Executive's termination of employment for any
reason.
Section 3. Terms of Employment. (a) Position and Duties. (1) During the
Employment Period, (A) the Executive's position (including status, offices,
titles and reporting requirements), authority, duties and responsibilities shall
be at least commensurate in all material respects with the most significant of
those held, exercised and assigned at any time during the 120-day period
immediately preceding the Effective Date and (B) the Executive's services shall
be performed at the office where the Executive was employed immediately
preceding the Effective Date or at any other location less than 35 miles from
such office.
(2) During the Employment Period, and excluding any periods of vacation and
sick leave to which the Executive is entitled, the Executive agrees to devote
reasonable attention and time during normal business hours to the business and
affairs of the Company and, to the extent necessary to discharge the
responsibilities assigned to the Executive hereunder, to use the Executive's
reasonable best efforts to perform faithfully and efficiently such
responsibilities. During the Employment Period, it shall not be a violation of
this Agreement for the Executive to (A) serve on corporate, civic or charitable
boards or committees, (B) deliver lectures, fulfill speaking engagements or
teach at educational institutions and (C) manage personal investments, so long
as such activities do not significantly interfere with the performance of the
Executive's responsibilities as an employee of the Company in accordance with
this Agreement. It is expressly understood and agreed that, to the extent that
any such activities have been conducted by the Executive prior to the Effective
Date, the continued conduct of such activities (or the conduct of activities
similar in nature and scope thereto) subsequent to the Effective Date shall not
thereafter be deemed to interfere with the performance of the Executive's
responsibilities to the Company.
(b) Compensation. (1) Base Salary. During the Employment Period, the
Executive shall receive an annual base salary (the "Annual Base Salary") at an
annual rate at least equal to 12 times the highest monthly base salary paid or
payable, including any base salary that has been earned but deferred, to the
Executive by the Company and the Affiliated Companies in respect of the 12-month
period immediately preceding the month in which the Effective Date occurs. The
Annual Base Salary shall be paid at such intervals as the Company pays executive
salaries generally. During the Employment Period, the Annual Base Salary shall
be reviewed at least annually, beginning no more than 12 months after the last
salary increase awarded to the Executive prior to the Effective Date. Any
increase in the Annual Base Salary shall not serve to limit or reduce any other
obligation to the Executive under this Agreement. The Annual Base Salary shall
not be reduced after any such increase and the term "Annual Base Salary" shall
refer to the Annual Base Salary as so increased.
3
(2) Annual Bonus. In addition to the Annual Base Salary, the Executive
shall be awarded, for each fiscal year ending during the Employment Period, an
annual bonus (the "Annual Bonus") in cash at least equal to the Executive's
highest bonus earned under the Company's annual incentive bonus plans, or any
comparable bonus under any predecessor or successor plan or plans, for the last
three full fiscal years prior to the Effective Date (or for such lesser number
of full fiscal years prior to the Effective Date for which the Executive was
eligible to earn such a bonus, and annualized in the case of any bonus earned
for a partial fiscal year) (the "Recent Annual Bonus"). (If the Executive has
not been eligible to earn such a bonus for any period prior to the Effective
Date, the "Recent Annual Bonus" shall mean the Executive's target annual bonus
for the year in which the Effective Date occurs.) Each such Annual Bonus shall
be paid no later than the end of the third month of the fiscal year next
following the fiscal year for which the Annual Bonus is awarded, unless the
Executive shall elect to defer the receipt of such Annual Bonus.
(3) Incentive, Savings and Retirement Plans. During the Employment Period,
the Executive shall be entitled to participate in all incentive, savings and
retirement plans, practices, policies, and programs applicable generally to
other peer executives of the Company and the Affiliated Companies, but in no
event shall such plans, practices, policies and programs provide the Executive
with incentive opportunities (measured with respect to both regular and special
incentive opportunities, to the extent, if any, that such distinction is
applicable), savings opportunities and retirement benefit opportunities, in each
case, less favorable, in the aggregate, than the most favorable of those
provided by the Company and the Affiliated Companies for the Executive under
such plans, practices, policies and programs as in effect at any time during the
120-day period immediately preceding the Effective Date or, if more favorable to
the Executive, those provided generally at any time after the Effective Date to
other peer executives of the Company and the Affiliated Companies.
(4) Welfare Benefit Plans. During the Employment Period, the Executive
and/or the Executive's family, as the case may be, shall be eligible for
participation in and shall receive all benefits under welfare benefit plans,
practices, policies and programs provided by the Company and the Affiliated
Companies (including, without limitation, medical, prescription, dental, vision,
disability, employee life, group life, accidental death and travel accident
insurance plans and programs) to the extent applicable generally to other peer
executives of the Company and the Affiliated Companies, but in no event shall
such plans, practices, policies and programs provide the Executive with benefits
that are less favorable, in the aggregate, than the most favorable of such
plans, practices, policies and programs in effect for the Executive at any time
during the 120-day period immediately preceding the Effective Date or, if more
favorable to the Executive, those provided generally at any time after the
Effective Date to other peer executives of the Company and the Affiliated
Companies.
(5) Expenses. During the Employment Period, the Executive shall be entitled
to receive prompt reimbursement for all reasonable expenses incurred by the
Executive in accordance with the most favorable policies, practices and
procedures of the Company and the Affiliated Companies in effect for the
Executive at any time during the 120-day period immediately preceding the
Effective Date or, if more favorable to the Executive, as in effect generally at
any time thereafter with respect to other peer executives of the Company and the
Affiliated Companies.
4
(6) Fringe Benefits. During the Employment Period, the Executive shall be
entitled to fringe benefits, including, without limitation, tax and financial
planning services, payment of club dues, and, if applicable, use of an
automobile and payment of related expenses, in accordance with the most
favorable plans, practices, programs and policies of the Company and the
Affiliated Companies in effect for the Executive at any time during the 120-day
period immediately preceding the Effective Date or, if more favorable to the
Executive, as in effect generally at any time thereafter with respect to other
peer executives of the Company and the Affiliated Companies.
(7) Office and Support Staff. During the Employment Period, the Executive
shall be entitled to an office or offices of a size and with furnishings and
other appointments, and to exclusive personal secretarial and other assistance,
at least equal to the most favorable of the foregoing provided to the Executive
by the Company and the Affiliated Companies at any time during the 120-day
period immediately preceding the Effective Date or, if more favorable to the
Executive, as provided generally at any time thereafter with respect to other
peer executives of the Company and the Affiliated Companies.
(8) Vacation. During the Employment Period, the Executive shall be entitled
to paid vacation in accordance with the most favorable plans, policies, programs
and practices of the Company and the Affiliated Companies as in effect for the
Executive at any time during the 120-day period immediately preceding the
Effective Date or, if more favorable to the Executive, as in effect generally at
any time thereafter with respect to other peer executives of the Company and the
Affiliated Companies.
(9) Immediate Vesting of Outstanding Equity Incentive Awards.
Notwithstanding any provision in the Company's stock incentive plans or the
award agreements thereunder, effective immediately upon the occurrence of a
Change of Control, (A) all stock options (incentive or non-qualified)
outstanding as of the date of such Change of Control, which are not then
exercisable and vested, shall become fully exercisable and vested to the full
extent of the original grant and, following the Executive's termination of
employment for any reason, shall remain exercisable for the shorter of (x) five
years from the Executive's date of termination of employment and (y) the
remainder of the original option term; (B) all restrictions and deferral
limitations applicable to any restricted stock awards outstanding as of the date
of such Change of Control shall lapse, and such restricted stock awards shall
become free of all restrictions and become fully vested and transferable to the
full extent of the original grant; and (C) all performance share awards
outstanding as of the date of such Change of Control for any outstanding
performance periods shall fully vest and be earned and payable in full based on
the deemed achievement of performance at 200% of target level for the entire
performance period.
Section 4. Termination of Employment. (a) Death or Disability. The
Executive's employment shall terminate automatically if the Executive dies
during the Employment Period. If the Company determines in good faith that the
Executive has a Disability (as defined herein) that has occurred during the
Employment Period (pursuant to the definition of "Disability"), it may give to
the Executive written notice in accordance with Section 11(b) of its intention
to terminate the Executive's employment. In such event, the Executive's
employment with the Company shall terminate effective on the 30th day after
receipt of such notice by the Executive (the "Disability Effective Date"),
provided that, within the 30 days after such receipt, the Executive shall not
5
have returned to full-time performance of the Executive's duties. "Disability"
means the absence of the Executive from the Executive's duties with the Company
on a full-time basis for 180 consecutive business days as a result of incapacity
due to mental or physical illness that is determined to be total and permanent
by a physician selected by the Company or its insurers and acceptable to the
Executive or the Executive's legal representative.
(b) Cause. The Company may terminate the Executive's employment during the
Employment Period for Cause. "Cause" means:
(1) the willful and continued failure of the Executive to perform
substantially the Executive's duties (as contemplated by Section
3(a)(1)(A)) with the Company or any Affiliated Company (other than any such
failure resulting from incapacity due to physical or mental illness or
following the Executive's delivery of a Notice of Termination for Good
Reason), after a written demand for substantial performance is delivered to
the Executive by the Board or the Chief Executive Officer of the Company
that specifically identifies the manner in which the Board or the Chief
Executive Officer of the Company believes that the Executive has not
substantially performed the Executive's duties, or
(2) the willful engaging by the Executive in illegal conduct or gross
misconduct that is materially and demonstrably injurious to the Company.
For purposes of this Section 4(b), no act, or failure to act, on the part
of the Executive shall be considered "willful" unless it is done, or omitted to
be done, by the Executive in bad faith or without reasonable belief that the
Executive's action or omission was in the best interests of the Company. Any
act, or failure to act, based upon authority given pursuant to a resolution duly
adopted by the Board or upon the instructions of the Chief Executive Officer of
the Company or a senior officer of the Company or based upon the advice of
counsel for the Company shall be conclusively presumed to be done, or omitted to
be done, by the Executive in good faith and in the best interests of the
Company. The cessation of employment of the Executive shall not be deemed to be
for Cause unless and until there shall have been delivered to the Executive a
copy of a resolution duly adopted by the affirmative vote of not less than
three-quarters of the entire membership of the Board at a meeting of the Board
called and held for such purpose (after reasonable notice is provided to the
Executive and the Executive is given an opportunity, together with counsel for
the Executive, to be heard before the Board), finding that, in the good faith
opinion of the Board, the Executive is guilty of the conduct described in
Section 4(b)(1) or 4(b)(2), and specifying the particulars thereof in detail.
(c) Good Reason. The Executive's employment may be terminated by the
Executive for Good Reason or by the Executive voluntarily without Good Reason.
"Good Reason" means:
(1) the assignment to the Executive of any duties inconsistent in any
respect with the Executive's position (including status, offices, titles
and reporting requirements), authority, duties or responsibilities as
contemplated by Section 3(a)(1)(A), or any other action by the Company that
results in a diminution in such position, authority, duties or
responsibilities, excluding for this purpose an isolated, insubstantial and
inadvertent action not taken in bad faith and that is remedied by the
Company promptly after receipt of notice thereof given by the Executive;
6
(2) any failure by the Company to comply with any of the provisions of
Section 3(b), other than an isolated, insubstantial and inadvertent failure
not occurring in bad faith and that is remedied by the Company promptly
after receipt of notice thereof given by the Executive;
(3) the Company's requiring the Executive (i) to be based at any
office or location other than as provided in Section 3(a)(1)(B), (ii) to be
based at a location other than the principal executive offices of the
Company if the Executive was employed at such location immediately
preceding the Effective Date, or (iii) to travel on Company business to a
substantially greater extent than required immediately prior to the
Effective Date;
(4) any purported termination by the Company of the Executive's
employment otherwise than as expressly permitted by this Agreement; or
(5) any failure by the Company to comply with and satisfy Section
10(c).
For purposes of this Section 4(c), any good faith determination of Good
Reason made by the Executive shall be conclusive. The Executive's mental or
physical incapacity following the occurrence of an event described above in
clauses (1) through (5) shall not affect the Executive's ability to terminate
employment for Good Reason.
(d) Notice of Termination. Any termination by the Company for Cause, or by
the Executive for Good Reason, shall be communicated by Notice of Termination to
the other party hereto given in accordance with Section 11(b). "Notice of
Termination" means a written notice that (1) indicates the specific termination
provision in this Agreement relied upon, (2) to the extent applicable, sets
forth in reasonable detail the facts and circumstances claimed to provide a
basis for termination of the Executive's employment under the provision so
indicated, and (3) if the Date of Termination (as defined herein) is other than
the date of receipt of such notice, specifies the Date of Termination (which
Date of Termination shall be not more than 30 days after the giving of such
notice). The failure by the Executive or the Company to set forth in the Notice
of Termination any fact or circumstance that contributes to a showing of Good
Reason or Cause shall not waive any right of the Executive or the Company,
respectively, hereunder or preclude the Executive or the Company, respectively,
from asserting such fact or circumstance in enforcing the Executive's or the
Company's respective rights hereunder.
(e) Date of Termination. "Date of Termination" means (1) if the Executive's
employment is terminated by the Company for Cause, or by the Executive for Good
Reason, the date of receipt of the Notice of Termination or any later date
specified in the Notice of Termination, as the case may be, (2) if the
Executive's employment is terminated by the Company other than for Cause or
Disability, the Date of Termination shall be the date on which the Company
notifies the Executive of such termination, and (3) if the Executive's
employment is terminated by reason of death or Disability, the Date of
Termination shall be the date of death of the Executive or the Disability
Effective Date, as the case may be.
Section 5. Obligations of the Company upon Termination. (a) Good Reason;
Other Than for Cause, Death or Disability. If, during the Employment Period, the
7
Company terminates the Executive's employment other than for Cause or Disability
or the Executive terminates employment for Good Reason:
(1) the Company shall pay to the Executive, in a lump sum in cash
within 30 days after the Date of Termination, the aggregate of the
following amounts:
(A) the sum of (i) the Executive's Annual Base Salary through the
Date of Termination, (ii) the product of (x) the Recent Annual Bonus
and (y) a fraction, the numerator of which is the number of days in
the current fiscal year through the Date of Termination and the
denominator of which is 365, and (iii) any accrued vacation pay, in
each case, to the extent not theretofore paid (the sum of the amounts
described in subclauses (i), (ii) and (iii), the "Accrued
Obligations");
(B) the amount equal to the product of (i) two and (ii) the sum
of (x) the Executive's Annual Base Salary and (y) the Recent Annual
Bonus;
(C) an amount equal to the excess of (i) the actuarial equivalent
of the benefit under the Company's qualified defined benefit
retirement plan (the "Retirement Plan") (utilizing actuarial
assumptions no less favorable to the Executive than those in effect
under the Retirement Plan immediately prior to the Effective Date) and
any excess or supplemental retirement plan in which the Executive
participates (collectively, the "SERP") that the Executive would
receive if the Executive's employment continued for two years after
the Date of Termination, assuming for this purpose that (x) the
Executive's age and service credit increase during the two-year
period, (y) all accrued benefits are fully vested and (z) the
Executive's compensation in each of the two years is that required by
Sections 3(b)(1) and 3(b)(2), over (ii) the actuarial equivalent of
the Executive's actual benefit (paid or payable), if any, under the
Retirement Plan and the SERP as of the Date of Termination; and
(D) an amount equal to the sum of the Company matching or other
Company contributions under the Company's qualified defined
contribution plans and any excess or supplemental defined contribution
plans in which the Executive participates that the Executive would
receive if the Executive's employment continued for two years after
the Date of Termination, assuming for this purpose that (x) the
Executive's benefits under such plans are fully vested, (y) the
Executive's compensation in each of the two years is that required by
Sections 3(b)(1) and 3(b)(2) and (z) to the extent that the Company
contributions are determined based on the contributions or deferrals
of the Executive, that the Executive's contribution or deferral
elections, as appropriate, are those in effect immediately prior the
Date of Termination; and
(2) for two years after the Executive's Date of Termination, or
such longer period as may be provided by the terms of the appropriate
plan, program, practice or policy, the Company shall continue benefits
to the Executive and/or the Executive's family at least equal to those
that would have been provided to them in accordance with the plans,
8
programs, practices and policies described in Section 3(b)(4) if the
Executive's employment had not been terminated or, if more favorable
to the Executive, as in effect generally at any time thereafter with
respect to other peer executives of the Company and the Affiliated
Companies and their families, provided, however, that, if the
Executive becomes reemployed with another employer and is eligible to
receive such benefits under another employer provided plan, the
medical and other welfare benefits described herein shall be secondary
to those provided under such other plan during such applicable period
of eligibility. For purposes of determining eligibility (but not the
time of commencement of benefits) of the Executive for retiree
benefits pursuant to such plans, practices, programs and policies, the
Executive shall be considered to have remained employed (for purposes
of both age and service credit) until two years after the Date of
Termination and to have retired on the last day of such period;
(3) during the 12-month period following the Date of Termination,
the Company shall, at its sole expense as incurred, provide the
Executive with outplacement services the scope and provider of which
shall be selected by the Executive in the Executive's sole discretion,
provided that, the cost of such outplacement shall not exceed $25,000
(as adjusted for inflation based on the Consumer Price Index or
another nationally recognized published inflation index); and
(4) to the extent not theretofore paid or provided, the Company
shall timely pay or provide to the Executive any other amounts or
benefits required to be paid or provided or that the Executive is
eligible to receive under any plan, program, policy or practice or
contract or agreement of the Company and the Affiliated Companies
(such other amounts and benefits, the "Other Benefits").
(b) Death. If the Executive's employment is terminated by reason of
the Executive's death during the Employment Period, the Company shall
provide the Executive's estate or beneficiaries with the Accrued
Obligations and the timely payment or delivery of the Other Benefits, and
shall have no other severance obligations under this Agreement. The Accrued
Obligations shall be paid to the Executive's estate or beneficiary, as
applicable, in a lump sum in cash within 30 days of the Date of
Termination. With respect to the provision of the Other Benefits, the term
"Other Benefits" as utilized in this Section 5(b) shall include, without
limitation, and the Executive's estate and/or beneficiaries shall be
entitled to receive, benefits at least equal to the most favorable benefits
provided by the Company and the Affiliated Companies to the estates and
beneficiaries of peer executives of the Company and the Affiliated
Companies under such plans, programs, practices and policies relating to
death benefits, if any, as in effect with respect to other peer executives
and their beneficiaries at any time during the 120-day period immediately
preceding the Effective Date or, if more favorable to the Executive's
estate and/or the Executive's beneficiaries, as in effect on the date of
the Executive's death with respect to other peer executives of the Company
and the Affiliated Companies and their beneficiaries.
(c) Disability. If the Executive's employment is terminated by reason
of the Executive's Disability during the Employment Period, the Company
shall provide the Executive with the Accrued Obligations and the timely
payment or delivery of the Other Benefits, and shall have no other
severance obligations under this Agreement. The Accrued Obligations shall
9
be paid to the Executive in a lump sum in cash within 30 days of the Date
of Termination. With respect to the provision of the Other Benefits, the
term "Other Benefits" as utilized in this Section 5(c) shall include, and
the Executive shall be entitled after the Disability Effective Date to
receive, disability and other benefits at least equal to the most favorable
of those generally provided by the Company and the Affiliated Companies to
disabled executives and/or their families in accordance with such plans,
programs, practices and policies relating to disability, if any, as in
effect generally with respect to other peer executives and their families
at any time during the 120-day period immediately preceding the Effective
Date or, if more favorable to the Executive and/or the Executive's family,
as in effect at any time thereafter generally with respect to other peer
executives of the Company and the Affiliated Companies and their families.
(d) Cause; Other Than for Good Reason. If the Executive's employment
is terminated for Cause during the Employment Period, the Company shall
provide to the Executive (1) the Executive's Annual Base Salary through the
Date of Termination, (2) any accrued vacation pay, and (3) the Other
Benefits, in each case, to the extent theretofore unpaid, and shall have no
other severance obligations under this Agreement. If the Executive
voluntarily terminates employment during the Employment Period, excluding a
termination for Good Reason, the Company shall provide to the Executive the
Accrued Obligations and the timely payment or delivery of the Other
Benefits, and shall have no other severance obligations under this
Agreement. In such case, all the Accrued Obligations shall be paid to the
Executive in a lump sum in cash within 30 days of the Date of Termination.
Section 6. Non-exclusivity of Rights. Nothing in this Agreement shall
prevent or limit the Executive's continuing or future participation in any
plan, program, policy or practice provided by the Company or the Affiliated
Companies and for which the Executive may qualify, nor, subject to Section
11(f), shall anything herein limit or otherwise affect such rights as the
Executive may have under any other contract or agreement with the Company
or the Affiliated Companies. Amounts that are vested benefits or that the
Executive is otherwise entitled to receive under any plan, policy, practice
or program of or any other contract or agreement with the Company or the
Affiliated Companies at or subsequent to the Date of Termination shall be
payable in accordance with such plan, policy, practice or program or
contract or agreement, except as explicitly modified by this Agreement.
Notwithstanding the foregoing, if the Executive receives payments and
benefits pursuant to Section 5(a) of this Agreement, the Executive shall
not be entitled to any severance pay or benefits under any severance plan,
program or policy of the Company and the Affiliated Companies, unless
otherwise specifically provided therein by a specific reference to this
Agreement.
Section 7. Full Settlement. The Company's obligation to make the
payments provided for in this Agreement and otherwise to perform its
obligations hereunder shall not be affected by any set-off, counterclaim,
recoupment, defense, or other claim, right or action that the Company may
have against the Executive or others. In no event shall the Executive be
obligated to seek other employment or take any other action by way of
mitigation of the amounts payable to the Executive under any of the
provisions of this Agreement, and such amounts shall not be reduced whether
or not the Executive obtains other employment. The Company agrees to pay as
incurred, to the full extent permitted by law, all legal fees and expenses
that the Executive may reasonably incur as a result of any contest
(regardless of the outcome thereof) by the Company, the Executive or others
10
of the validity or enforceability of, or liability under, any provision of
this Agreement or any guarantee of performance thereof (including as a
result of any contest by the Executive about the amount of any payment
pursuant to this Agreement), plus, in each case, interest on any delayed
payment at the applicable federal rate provided for in Section
7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the
"Code").
Section 8. Certain Additional Payments by the Company.
(a) Anything in this Agreement to the contrary notwithstanding, in the
event it shall be determined that any payment or distribution by the
Company or its Affiliated Companies to or for the benefit of the Executive
(whether paid or payable or distributed or distributable pursuant to the
terms of this Agreement or otherwise, but determined without regard to any
additional payments required under this Section 8) (a "Payment") would be
subject to the excise tax imposed by Section 4999 of the Code or any
interest or penalties are incurred by the Executive with respect to such
excise tax (such excise tax, together with any such interest and penalties,
collectively the "Excise Tax"), then the Executive shall be entitled to
receive an additional payment (the "Gross-Up Payment") in an amount such
that, after payment by the Executive of all taxes (including any interest
or penalties imposed with respect to such taxes), including, without
limitation, any income taxes (and any interest and penalties imposed with
respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the
Executive retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments.
(b) Subject to the provisions of Section 8(c), all determinations
required to be made under this Section 8, including whether and when a
Gross-Up Payment is required, the amount of such Gross-Up Payment and the
assumptions to be utilized in arriving at such determination, shall be made
by Ernst & Young, LLP, or such other nationally recognized certified public
accounting firm as may be designated by the Executive, subject to the
Company's approval which will not be unreasonably withheld (the "Accounting
Firm"). The Accounting Firm shall provide detailed supporting calculations
both to the Company and the Executive within 15 business days of the
receipt of notice from the Executive that there has been a Payment or such
earlier time as is requested by the Company. In the event that the
Accounting Firm is serving as accountant or auditor for the individual,
entity or group effecting the Change of Control, the Executive, subject to
the Company's approval which will not be unreasonably withheld, may appoint
another nationally recognized accounting firm to make the determinations
required hereunder (which accounting firm shall then be referred to as the
Accounting Firm hereunder). All fees and expenses of the Accounting Firm
shall be borne solely by the Company. Any Gross-Up Payment, as determined
pursuant to this Section 8, shall be paid by the Company to the Executive
within 5 days of the receipt of the Accounting Firm's determination. Any
determination by the Accounting Firm shall be binding upon the Company and
the Executive. As a result of the uncertainty in the application of Section
4999 of the Code at the time of the initial determination by the Accounting
Firm hereunder, it is possible that Gross-Up Payments that will not have
been made by the Company should have been made (the "Underpayment"),
consistent with the calculations required to be made hereunder. In the
event the Company exhausts its remedies pursuant to Section 8(c) and the
Executive thereafter is required to make a payment of any Excise Tax, the
Accounting Firm shall determine the amount of the Underpayment that has
occurred and any such Underpayment shall be promptly paid by the Company to
or for the benefit of the Executive.
11
(c) The Executive shall notify the Company in writing of any claim by
the Internal Revenue Service that, if successful, would require the payment
by the Company of the Gross-Up Payment. Such notification shall be given as
soon as practicable, but no later than 10 business days after the Executive
is informed in writing of such claim. The Executive shall apprise the
Company of the nature of such claim and the date on which such claim is
requested to be paid. The Executive shall not pay such claim prior to the
expiration of the 30-day period following the date on which the Executive
gives such notice to the Company (or such shorter period ending on the date
that any payment of taxes with respect to such claim is due). If the
Company notifies the Executive in writing prior to the expiration of such
period that the Company desires to contest such claim, the Executive shall:
(1) give the Company any information reasonably requested by the
Company relating to such claim,
(2) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such
claim by an attorney reasonably selected by the Company,
(3) cooperate with the Company in good faith in order effectively to
contest such claim, and
(4) permit the Company to participate in any proceedings relating to
such claim;
provided, however, that the Company shall bear and pay directly all costs
and expenses (including additional interest and penalties) incurred in
connection with such contest, and shall indemnify and hold the Executive
harmless, on an after-tax basis, for any Excise Tax or income tax (including
interest and penalties) imposed as a result of such representation and payment
of costs and expenses. Without limitation on the foregoing provisions of this
Section 8(c), the Company shall control all proceedings taken in connection with
such contest, and, at its sole discretion, may pursue or forgo any and all
administrative appeals, proceedings, hearings and conferences with the
applicable taxing authority in respect of such claim and may, at its sole
discretion, either pay the tax claimed to the appropriate taxing authority on
behalf of the Executive and direct the Executive to sue for a refund or contest
the claim in any permissible manner, and the Executive agrees to prosecute such
contest to a determination before any administrative tribunal, in a court of
initial jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however, that, if the Company pays such claim and directs
the Executive to sue for a refund, the Company shall indemnify and hold the
Executive harmless, on an after-tax basis, from any Excise Tax or income tax
(including interest or penalties) imposed with respect to such payment or with
respect to any imputed income in connection with such payment; and provided,
further, that any extension of the statute of limitations relating to payment of
taxes for the taxable year of the Executive with respect to which such contested
amount is claimed to be due is limited solely to such contested amount.
Furthermore, the Company's control of the contest shall be limited to issues
with respect to which the Gross-Up Payment would be payable hereunder, and the
Executive shall be entitled to settle or contest, as the case may be, any other
issue raised by the Internal Revenue Service or any other taxing authority.
12
(d) If, after the receipt by the Executive of a Gross-Up Payment or payment
by the Company of an amount on the Executive's behalf pursuant to Section 8(c),
the Executive becomes entitled to receive any refund with respect to the Excise
Tax to which such Gross-Up Payment relates or with respect to such claim, the
Executive shall (subject to the Company's complying with the requirements of
Section 8(c), if applicable) promptly pay to the Company the amount of such
refund (together with any interest paid or credited thereon after taxes
applicable thereto). If, after payment by the Company of an amount on the
Executive's behalf pursuant to Section 8(c), a determination is made that the
Executive shall not be entitled to any refund with respect to such claim and the
Company does not notify the Executive in writing of its intent to contest such
denial of refund prior to the expiration of 30 days after such determination,
then the amount of such payment shall offset, to the extent thereof, the amount
of Gross-Up Payment required to be paid.
(e) Notwithstanding any other provision of this Section 8, the Company may,
in its sole discretion, withhold and pay to the Internal Revenue Service or any
other applicable taxing authority, for the benefit of the Executive, all or any
portion of any Gross-Up Payment, and the Executive hereby consents to such
withholding.
Section 9. Confidential Information. The Executive shall hold in a
fiduciary capacity for the benefit of the Company all secret or confidential
information, knowledge or data relating to the Company or the Affiliated
Companies, and their respective businesses, which information, knowledge or data
shall have been obtained by the Executive during the Executive's employment by
the Company or the Affiliated Companies and which information, knowledge or data
shall not be or become public knowledge (other than by acts by the Executive or
representatives of the Executive in violation of this Agreement). After
termination of the Executive's employment with the Company, the Executive shall
not, without the prior written consent of the Company or as may otherwise be
required by law or legal process, communicate or divulge any such information,
knowledge or data to anyone other than the Company and those persons designated
by the Company. In no event shall an asserted violation of the provisions of
this Section 9 constitute a basis for deferring or withholding any amounts
otherwise payable to the Executive under this Agreement.
Section 10. Successors. (a) This Agreement is personal to the Executive,
and, without the prior written consent of the Company, shall not be assignable
by the Executive other than by will or the laws of descent and distribution.
This Agreement shall inure to the benefit of and be enforceable by the
Executive's legal representatives.
(b) This Agreement shall inure to the benefit of and be binding upon the
Company and its successors and assigns. Except as provided in Section 10(c),
without the prior written consent of the Executive, this Agreement shall not be
assignable by the Company.
(c) The Company will require any successor (whether direct or indirect, by
purchase, merger, consolidation or otherwise) to all or substantially all of the
business and/or assets of the Company to assume expressly and agree to perform
this Agreement in the same manner and to the same extent that the Company would
13
be required to perform it if no such succession had taken place. "Company" means
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid that assumes and agrees to perform this Agreement by
operation of law or otherwise.
Section 11. Miscellaneous. (a) This Agreement shall be governed by and
construed in accordance with the laws of the State of Delaware, without
reference to principles of conflict of laws. The captions of this Agreement are
not part of the provisions hereof and shall have no force or effect. This
Agreement may not be amended or modified other than by a written agreement
executed by the parties hereto or their respective successors and legal
representatives.
(b) All notices and other communications hereunder shall be in writing and
shall be given by hand delivery to the other party or by registered or certified
mail, return receipt requested, postage prepaid, addressed as follows:
if to the Executive: At the most recent address on file in the
Company's records
if to the Company: Valero Energy Corporation
One Valero Place
San Antonio, Texas 78212
Attention: Corporate Secretary
or to such other address as either party shall have furnished to the other in
writing in accordance herewith. Notice and communications shall be effective
when actually received by the addressee.
(c) The invalidity or unenforceability of any provision of this Agreement
shall not affect the validity or enforceability of any other provision of this
Agreement.
(d) The Company may withhold from any amounts payable under this Agreement
such United States federal, state or local or foreign taxes as shall be required
to be withheld pursuant to any applicable law or regulation.
(e) The Executive's or the Company's failure to insist upon strict
compliance with any provision of this Agreement or the failure to assert any
right the Executive or the Company may have hereunder, including, without
limitation, the right of the Executive to terminate employment for Good Reason
pursuant to Sections 4(c)(1) through 4(c)(5), shall not be deemed to be a waiver
of such provision or right or any other provision or right of this Agreement.
(f) The Executive and the Company acknowledge that, except as may otherwise
be provided under any other written agreement between the Executive and the
Company, the employment of the Executive by the Company is "at will" and,
subject to Section 1(a), prior to the Effective Date, the Executive's employment
may be terminated by either the Executive or the Company at any time prior to
the Effective Date, in which case the Executive shall have no further rights
under this Agreement. From and after the Effective Date, except as specifically
provided herein, this Agreement shall supersede any other agreement between the
parties with respect to the subject matter hereof.
14
IN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and,
pursuant to the authorization from the Board, the Company has caused these
presents to be executed in its name on its behalf, all as of the day and year
first above written.
/s/ Gregory C. King
------------------------------------------
Gregory C. King
VALERO ENERGY CORPORATION
By: /s/ Keith D. Booke
------------------------------------------
Name: Keith D. Booke
Title: Executive Vice President
Chief Administrative Officer
15
EXHIBIT 10.10
SCHEDULE OF CHANGE OF CONTROL AGREEMENTS
The following have executed Change of Control Agreements substantially in the
form of the agreement attached as Exhibit 10.9 to the Valero Energy Corporation
Form 10-K for the year ended December 31, 2002.
Gary L. Arthur, Jr.
Keith D. Booke
Mary Rose Brown
Michael S. Ciskowski
S. Eugene Edwards
John D. Gibbons
John F. Hohnholt
William R. Klesse
Richard J. Marcogliese
Exhibit 12.1
VALERO ENERGY CORPORATION AND SUBSIDIARIES
STATEMENTs OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Millions of Dollars, Except Ratios)
Year Ended December 31,
-----------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Earnings:
Income from continuing operations
before income tax expense,
minority interest in net income
of consolidated partnership,
distributions on preferred securities
of subsidiary trusts and income
from equity investees.................. $ 191.5 $ 913.0 $ 530.4 $ 17.9 $ (77.8)
Add:
Fixed charges.......................... 408.9 143.2 114.6 80.2 53.7
Amortization of capitalized interest... 5.7 5.3 5.1 5.2 4.9
Distributions from equity investees.... 4.8 2.8 9.2 4.0 0.5
Less:
Interest capitalized................... (16.2) (10.6) (7.4) (5.8) (5.3)
Distributions on preferred securities
of subsidiary trusts............. (30.0) (13.4) (6.8) - -
Minority interest in net income of
consolidated partnership............. (14.1) - - - -
------ ------- ----- ----- ----
Total earnings........................... $ 550.6 $ 1,040.3 $ 645.1 $ 101.5 $ (24.0)
===== ======= ===== ===== ====
Fixed charges:
Interest expense, net.................. $ 285.7 $ 88.5 $ 76.3 $ 55.4 $ 32.5
Interest capitalized................... 16.2 10.6 7.4 5.8 5.3
Rental expense interest factor (1)..... 77.0 30.7 24.1 19.0 15.9
Distributions on preferred securities
of subsidiary trusts................. 30.0 13.4 6.8 - -
------ ----- ----- ---- ----
Total fixed charges...................... $ 408.9 $ 143.2 $ 114.6 $ 80.2 $ 53.7
===== ===== ===== ==== ====
Ratio of earnings to fixed charges (2)... 1.3x 7.3x 5.6x 1.3x - (3)
=== === === === ==
(1) The interest portion of rental expense represents one-third of rents, which
is deemed representative of the interest portion of rental expense.
(2) Valero paid no dividends on preferred stock with respect to its continuing
operations during the periods indicated; therefore, the ratio of earnings
to combined fixed charges and preferred stock dividends is the same as the
ratio of earnings to fixed charges.
(3) For the year ended December 31, 1998, earnings were insufficient to cover
fixed charges by $77.7 million. This deficiency was due primarily to a
$170.9 million pre-tax charge to net income to write down the carrying
amount of Valero's inventories to market value. Excluding the effect of the
inventory write-down, the ratio of earnings to fixed charges would have
been 2.7x.
EXHIBIT 21.1
Valero Energy Corporation and Subsidiaries
Name of Entity State of Incorporation/Organization
- -------------- -----------------------------------
585043 ONTARIO LIMITED Ontario
AUTOTRONIC SYSTEMS, INC. Delaware
BAY AREA PETROCHEMICALS COMPANY, L.L.C. Delaware
BIG DIAMOND, INC. Texas
BIG DIAMOND NUMBER 1, INC. Texas
CANADIAN ULTRAMAR COMPANY Nova Scotia
COLONNADE ASSURANCE LIMITED Bermuda
COLONNADE VERMONT INSURANCE COMPANY Vermont
COLORADO REFINING COMPANY Colorado
CORPORATE CLAIMS MANAGEMENT, INC. Texas
COYOTE FUNDING, L.L.C. Delaware
DIAMOND OMEGA COMPANY, L.L.C. Delaware
DIAMOND SECURITY SYSTEMS, INC. Delaware
DIAMOND SHAMROCK ARIZONA, INC. Delaware
DIAMOND SHAMROCK BOLIVIANA, LTD. California
DIAMOND SHAMROCK LEASING, INC. Delaware
DIAMOND SHAMROCK REFINING AND MARKETING Delaware
COMPANY
DIAMOND SHAMROCK REFINING COMPANY, L.P. Delaware
DIAMOND SHAMROCK STATIONS, INC. Delaware
DIAMOND UNIT INVESTMENTS, L.L.C. Delaware
DSRM NATIONAL BANK N/A
EMERALD MARKETING, INC. Texas
EMERALD PIPE LINE CORPORATION Delaware
HUNTWAY REFINING COMPANY Delaware
INTEGRATED PRODUCT SYSTEMS, INC. Delaware
METRO OIL CO. Michigan
NATIONAL CONVENIENCE STORES INCORPORATED Delaware
NATIONAL MONEY ORDERS INCORPORATED Texas
OCEANIC TANKERS AGENCY LIMITED Quebec
PETRO/CHEM ENVIRONMENTAL SERVICES, INC. Delaware
RIVERWALK LOGISTICS, L.P. Delaware
ROBINSON OIL COMPANY (1987) LIMITED Nova Scotia
SCHEPPS FOOD STORES, INC. Texas
SHAMROCK VENTURES, LTD. Bermuda
SIGMOR BEVERAGE, INC. Texas
SIGMOR CORPORATION Delaware
SIGMOR NUMBER 5, INC. Texas
SIGMOR NUMBER 43, INC. Texas
SIGMOR NUMBER 79, INC. Texas
SIGMOR NUMBER 80, INC. Texas
SIGMOR NUMBER 103, INC. Texas
SIGMOR NUMBER 105, INC. Texas
SIGMOR NUMBER 119, INC. Texas
SIGMOR NUMBER 125, INC. Texas
SIGMOR NUMBER 140, INC. Texas
SIGMOR NUMBER 156, INC. Texas
SIGMOR NUMBER 170, INC. Texas
1
SIGMOR NUMBER 178, INC. Texas
SIGMOR NUMBER 181, INC. Texas
SIGMOR NUMBER 196, INC. Texas
SIGMOR NUMBER 206, INC. Texas
SIGMOR NUMBER 232, INC. Texas
SIGMOR NUMBER 238, INC. Texas
SIGMOR NUMBER 239, INC. Texas
SIGMOR NUMBER 259, INC. Texas
SIGMOR NUMBER 363, INC. Texas
SIGMOR NUMBER 422, INC. Texas
SIGMOR NUMBER 605, INC. Texas
SIGMOR NUMBER 606, INC. Texas
SIGMOR NUMBER 611, INC. Texas
SIGMOR NUMBER 613, INC. Texas
SKIPPER BEVERAGE COMPANY, INC. Texas
STOP 'N GO MARKETS OF TEXAS, INC. Texas
SUNSHINE BEVERAGE COMPANY Texas
TEXAS SUPER DUPER MARKETS, INC. Texas
THE SHAMROCK PIPE LINE CORPORATION Delaware
TOC-DS COMPANY Delaware
TPI PETROLEUM, INC. Michigan
TPI PIPELINE CORPORATION Michigan
UDS FUNDING I, L.P. Delaware
UDS LOGISTICS, LLC Delaware
UDS SERVICES, INC. Delaware
ULTRAMAR ACCEPTANCE INC. Canada
ULTRAMAR CREDIT CORPORATION Nova Scotia
ULTRAMAR D.S., INC. Texas
ULTRAMAR ENERGY INC. Delaware
ULTRAMAR INC. Nevada
ULTRAMAR LTEE / ULTRAMAR LTD. Canada
ULTRAMAR SERVICES INC. Canada
VALERO CANADA FINANCE, INC. Delaware
VALERO CANADA L.P. Newfoundland
VALERO CAPITAL CORPORATION Delaware
VALERO CORPORATE SERVICES COMPANY Delaware
VALERO CUSTOMS & TRADE SERVICES, INC. Delaware
VALERO ENERGY CORPORATION (parent) Delaware
VALERO FINANCE L.P. I Newfoundland
VALERO FINANCE L.P. II Newfoundland
VALERO FINANCE L.P. III Newfoundland
VALERO GP, INC. Delaware
VALERO GP, LLC Delaware
VALERO HOLDINGS, INC. Delaware
VALERO JAVELINA, INC. Delaware
VALERO JAVELINA, L.P. Delaware
VALERO LOGISTICS OPERATIONS, L.P. Delaware
*VALERO L.P. Delaware
VALERO MARKETING AND SUPPLY COMPANY Delaware
VALERO MTBE INVESTMENTS COMPANY Delaware
VALERO NATURAL GAS PIPELINE COMPANY Delaware
VALERO OMEGA COMPANY, L.L.C. Delaware
VALERO PIPELINE COMPANY Delaware
VALERO PRODUCING COMPANY Delaware
2
VALERO REFINING AND MARKETING COMPANY Delaware
VALERO REFINING COMPANY-CALIFORNIA Delaware
VALERO REFINING COMPANY-LOUISIANA Delaware
VALERO REFINING COMPANY-NEW JERSEY Delaware
VALERO REFINING-TEXAS, L.P. Texas
VALERO ULTRAMAR HOLDINGS, INC. Delaware
VALERO UNIT INVESTMENTS, L.L.C. Delaware
VALLEY SHAMROCK, INC. Texas
VMGA COMPANY Texas
XCEL PRODUCTS COMPANY, INC. Texas
* Valero owns about 49%.
3
EXHIBIT 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements, as
amended, on Form S-3 (Registration No. 333-84820) and Form S-8 (Registration
Nos. 333-31709, 333-31721, 333-31723, 333-31727, 333-81844 and 333-81858), of
our report dated March 19, 2003, with respect to the consolidated financial
statements of Valero Energy Corporation included in this Annual Report (Form
10-K) for the year ended December 31, 2002.
/s/ Ernst & Young LLP
San Antonio, Texas
March 19, 2003
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 Annual Report of Valero Energy Corporation (the
"Company") on Form 10-K for the year ended December 31, 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
March 20, 2003
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 Annual Report of Valero Energy Corporation (the
"Company") on Form 10-K for the year ended December 31, 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
March 20, 2003