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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
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 1-16417
VALERO L.P.
(Exact name of registrant as specified in its charter)
Delaware 74-2956831
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Valero Place
San Antonio, Texas
(Address of principal executive offices)
78212
(Zip Code)
Telephone number: (210) 370-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No ____
The number of common units outstanding as of August 11, 2003 was 13,442,072.
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VALERO L.P. AND SUBSIDIARIES
FORM 10-Q
JUNE 30, 2003
TABLE OF CONTENTS
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002........ 3
Consolidated Statements of Income for the Three and Six Months Ended
June 30, 2003 and 2002..................................................... 4
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2003 and 2002..................................................... 5
Notes to Consolidated Financial Statements................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 33
Item 4. Controls and Procedures....................................................... 33
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds..................................... 33
Item 6. Exhibits and Reports on Form 8-K.............................................. 33
Signatures.................................................................... 35
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
VALERO L.P. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands)
June 30, December 31,
2003 2002
---- ----
Assets
Current assets:
Cash and cash equivalents.................................... $ 12,027 $ 33,533
Receivable from Valero Energy................................ 16,088 8,482
Accounts receivable.......................................... 2,812 1,502
Other current assets......................................... 1,576 177
------- -------
Total current assets........................................ 32,503 43,694
------- -------
Property, plant and equipment................................. 861,439 486,939
Less accumulated depreciation and amortization................ (149,192) (137,663)
------- -------
Property, plant and equipment, net........................... 712,247 349,276
Goodwill...................................................... 4,715 4,715
Investment in Skelly-Belvieu Pipeline Company................. 15,794 16,090
Other noncurrent assets, net.................................. 10,682 1,733
------- -------
Total assets................................................ $ 775,941 $ 415,508
======= =======
Liabilities and Partners' Equity
Current liabilities:
Current portion of long-term debt............................ $ 449 $ 747
Accounts payable and accrued liabilities..................... 14,855 8,133
Payable to Valero Energy..................................... 6,666 -
Taxes other than income taxes................................ 3,528 3,797
------- -------
Total current liabilities................................... 25,498 12,677
Long-term debt, less current portion.......................... 364,782 108,911
Other long-term liabilities................................... 25 25
Commitments and contingencies (see Note 5)
Partners' equity:
Common units................................................. 260,306 170,655
Subordinated units........................................... 116,875 117,042
General partner's equity..................................... 8,455 6,198
------- -------
Total partners' equity...................................... 385,636 293,895
------- -------
Total liabilities and partners' equity...................... $ 775,941 $ 415,508
======= =======
See accompanying notes to consolidated financial statements.
3
VALERO L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited, in thousands, except unit and per unit data)
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues..................................................... $ 47,542 $ 30,030 $ 79,358 $ 56,054
------ ------ ------ ------
Costs and expenses:
Operating expenses.......................................... 16,335 9,565 27,996 18,749
General and administrative expenses......................... 1,670 1,698 3,514 3,487
Depreciation and amortization expense....................... 7,269 3,876 11,552 8,231
------ ------ ------ ------
Total costs and expenses................................... 25,274 15,139 43,062 30,467
------ ------ ------ ------
Operating income............................................. 22,268 14,891 36,296 25,587
Equity income from Skelly-Belvieu
Pipeline Company.......................................... 600 844 1,331 1,522
Interest expense, net....................................... (4,736) (796) (7,113) (1,352)
------ ------ ------ ------
Income before income tax expense............................. 18,132 14,939 30,514 25,757
Income tax expense.......................................... - - - 395
------ ------ ------ ------
Net income................................................... $ 18,132 $ 14,939 $ 30,514 $ 25,362
====== ====== ====== ======
Allocation of net income:
Net income.................................................. $ 18,132 $ 14,939 $ 30,514 $ 25,362
Less net income applicable to the Wichita
Falls Business for the month ended
January 31, 2002........................................... - - - (650)
------ ------ ------ ------
Net income applicable to the general and limited
partners' interests........................................ 18,132 14,939 30,514 24,712
General partner's interest in net income..................... (1,066) (299) (1,690) (494)
------ ------ ------ ------
Limited partners' interest in net income..................... $ 17,066 $ 14,640 $ 28,824 $ 24,218
====== ====== ====== ======
Net income per unit applicable to limited partners........... $ 0.79 $ 0.76 $ 1.40 $ 1.26
==== ==== ==== ====
Weighted average number of units outstanding................. 21,702,990 19,253,894 20,635,667 19,247,789
========== =========== ========== ==========
Cash distributions per unit applicable to limited partners... $ 0.75 $ 0.70 $ 1.45 $ 1.35
==== ==== ==== ====
See accompanying notes to consolidated financial statements.
4
VALERO L.P. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
Six Months Ended June 30,
------------------------
2003 2002
---- ----
Cash Flows from Operating Activities:
Net income ....................................................... $ 30,514 $ 25,362
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization expense............................ 11,552 8,231
Equity income from Skelly-Belvieu Pipeline Company............... (1,331) (1,522)
Distributions of equity income from Skelly-Belvieu
Pipeline Company................................................ 1,331 1,622
Provision for deferred income taxes.............................. - 54
Changes in operating assets and liabilities:
Increase in receivable from Valero Energy....................... (7,606) (519)
(Increase) decrease in accounts receivable...................... (1,310) 185
Increase in other current assets................................ (1,399) (291)
Increase in accounts payable and accrued liabilities............ 6,722 525
Increase in payable to Valero Energy............................ 6,666 -
(Decrease) increase in taxes other than income taxes............ (269) 1,311
Other, net....................................................... 2,272 267
-------- -------
Net cash provided by operating activities....................... 47,142 35,225
-------- -------
Cash Flows from Investing Activities:
Reliability capital expenditures.................................. (2,638) (1,530)
Expansion capital expenditures.................................... (5,187) (1,230)
Acquisitions...................................................... (366,675) (75,000)
Distributions in excess of equity income from
Skelly-Belvieu Pipeline Company................................. 296 -
-------- -------
Net cash used in investing activities.......................... (374,204) (77,760)
-------- -------
Cash Flows from Financing Activities:
Proceeds from 6.05% senior note private placement, net of discount
and issuance costs............................................... 247,328 -
Proceeds from other long-term debt borrowings..................... 25,000 75,000
Repayment of long-term debt....................................... (25,298) (46)
Distributions to unitholders and general partner.................. (30,088) (24,646)
Distributions to Valero Energy and affiliates..................... - (512)
General partner contributions, net of redemption.................. 1,892 -
Proceeds from sale of common units to the public, net of
issuance costs................................................... 220,787 -
Redemption of common units held by UDS Logistics, LLC............. (134,065) -
-------- -------
Net cash provided by financing activities...................... 305,556 49,796
-------- -------
Net (decrease) increase in cash and cash equivalents.............. (21,506) 7,261
Cash and cash equivalents as of the beginning of the period....... 33,533 7,796
-------- -------
Cash and cash equivalents as of the end of the period............. $ 12,027 $ 15,057
======== =======
Non-Cash Activities - Adjustment related to the transfer of the
Wichita Falls Business to Valero L.P. by Valero Energy:
Property, plant and equipment................................. $ - $ 64,160
Accrued liabilities and taxes other than income taxes......... - (382)
Deferred income tax liabilities............................... - (13,147)
Net Valero Energy investment.................................. - (50,631)
See accompanying notes to consolidated financial statements.
5
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Three and Six Months Ended June 30, 2003 and 2002
(unaudited)
NOTE 1: Organization, Basis of Presentation, Revenue Changes and New Accounting
Pronouncements
Organization
Valero L.P. is a Delaware limited partnership and through its wholly owned
subsidiary, Valero Logistics Operations, L.P. (Valero Logistics), owns and
operates crude oil and refined product pipeline and terminalling assets that
serve Valero Energy Corporation's (Valero Energy) McKee, Three Rivers, Corpus
Christi East and Corpus Christi West refineries located in Texas and the Ardmore
refinery located in Oklahoma. Valero Logistics also owns and operates the crude
oil storage tanks that serve Valero Energy's Corpus Christi West and Texas City
refineries located in Texas, and the Benicia refinery located in California. The
pipeline, terminalling and storage tank assets provide for the transportation of
crude oil and other feedstocks to the refineries and the transportation of
refined products from the refineries to terminals or third-party pipelines for
further distribution. Revenues of Valero L.P. and its subsidiaries are earned
primarily from providing these services to Valero Energy (see Note 6).
As used in this report, the term Partnership may refer, depending on the
context, to Valero L.P., Valero Logistics, or both of them taken as a whole.
Riverwalk Logistics, L.P., a wholly owned subsidiary of Valero Energy, is the 2%
general partner of Valero L.P. Valero Energy, through various affiliates, is
also a limited partner in Valero L.P., resulting in a combined ownership of
48.2% as of June 30, 2003 (see Note 8 and 9). The remaining 51.8% limited
partnership interest is held by public unitholders.
Valero Energy is an independent refining and marketing company. Its operations
consist of 14 refineries with a total throughput capacity of 2.1 million barrels
per day and an extensive network of company-operated and dealer-operated
convenience stores. Valero Energy's refining operations rely on various
logistics assets (pipelines, terminals, marine dock facilities, bulk storage
facilities, refinery delivery racks and rail car loading equipment) that support
its refining and retail operations, including the logistics assets owned and
operated by the Partnership. Valero Energy markets the refined products produced
at the McKee, Three Rivers, Ardmore, Corpus Christi East, Corpus Christi West,
Texas City and Benicia refineries primarily in Texas, Oklahoma, Colorado, New
Mexico, Arizona, California and several other mid-continent states through a
network of company-operated and dealer-operated convenience stores, as well as
through other wholesale and spot market sales and exchange agreements.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with United States generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they
do not include all of the information and notes required by United States
generally accepted accounting principles (GAAP) for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Certain previously reported amounts have been reclassified to conform
to the 2003 presentation.
Operating results for the six months ended June 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003. The balance sheet as of December 31, 2002 has been derived from the
audited consolidated financial statements as of that date and does not include
the balances of the Telfer asphalt terminal acquired in January 2003 or the
South Texas Pipelines and Terminals or the Crude Oil Storage Tanks acquired in
March 2003 as discussed in Note 3. These consolidated financial statements
should be read along with the audited consolidated financial statements and
notes thereto included in Valero L.P.'s Annual Report on Form 10-K for the year
ended December 31, 2002.
6
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenue Changes
Effective January 1, 2003, the Partnership began purchasing the additives that
are blended with refined products at the various refined product terminals and
increased its blending fee correspondingly. As a result, the fee charged to
blend additives into refined products was increased from $0.04 per barrel to
$0.12 per barrel.
In conjunction with the acquisitions discussed in Note 3, the Partnership began
charging a filtering fee for jet fuel terminalled at the Hobby Airport terminal,
and began charging a throughput fee for each barrel of crude oil and
intermediate feedstocks received by the Corpus Christi West refinery, the Texas
City refinery and the Benicia refinery representing the type of feedstock stored
in the crude oil storage tank assets that were acquired from Valero Energy.
New Accounting Pronouncements
FASB Interpretation No. 46
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46).
FIN 46 requires the consolidation of a variable interest entity (VIE) in which
an enterprise absorbs a majority of the entity's expected losses, receives a
majority of the entity's expected residual returns, or both, as a result of
ownership, contractual or other financial interest in the entity. Prior to the
issuance of FIN 46, an entity was generally consolidated by an enterprise when
the enterprise had a controlling financial interest through ownership of a
majority voting interest in the entity.
FIN 46 was immediately applicable to VIE's created after January 31, 2003, and
to VIE's in which an enterprise obtained an interest after that date. However,
for VIE's created before February 1, 2003, FIN 46 first became applicable as of
the first fiscal year or interim period beginning after June 15, 2003. The
Partnership holds a variable interest in a VIE that was created prior to
February 1, 2003, but it has not obtained any new variable interests during the
six months ended June 30, 2003. As such, FIN 46 first applied to the Partnership
effective July 1, 2003.
As of June 30, 2003, the Partnership participates in a joint venture
(Skelly-Belvieu Pipeline Company, LLC) with ConocoPhillips, and the
Partnership's share of this joint venture is 50%. The joint venture owns and
operates a refined products pipeline that is only used by each venture partner.
The joint venture was created by a contribution of capital from each partner in
the form of cash and/or property equal to its proportional share in the venture.
In addition, each venture partner shares in all profits and losses equal to its
proportional share in the venture, and there are no limits on the exposure to
losses or on the ability to share in returns. The Partnership provides
management services to the joint venture for which it receives an administrative
fee. The Partnership does not control this joint venture, and it records its
proportional share of the venture's operating results using the equity method.
Under FIN 46, the Partnership's joint venture interest and its other contractual
relationships with the joint venture represent variable interests in the joint
venture; however, the Partnership is not the primary beneficiary of the joint
venture. As a result, the Partnership will not consolidate the joint venture,
but will continue to account for its joint venture interest under the equity
method.
FASB Statement No. 143
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes standards for accounting for
an obligation associated with the retirement of a tangible long-lived asset. An
asset retirement obligation should be recognized in the financial statements in
the period in which it meets the definition of a liability as defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements." The amount of the
liability would initially be measured at fair value. Subsequent to initial
measurement, an entity would recognize changes in the amount of the liability
resulting from (a) the passage of time and (b) revisions to either the timing or
amount of estimated cash flows. Statement No. 143 also establishes standards for
accounting for the cost associated with an asset retirement obligation. It
requires that, upon initial recognition of a liability for an asset retirement
obligation, an entity capitalize that cost by recognizing an increase in the
carrying amount of the related long-lived asset. The capitalized asset
retirement cost would then be allocated to expense using a systematic and
rational method.
7
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Partnership adopted the provisions of Statement No. 143 effective January 1,
2003 and has determined that it is obligated by contractual or regulatory
requirements to remove assets or perform other remediation upon retirement of
certain of its assets. Determination of the amounts to be recognized upon
adoption is based upon numerous estimates and assumptions, including expected
settlement dates, future retirement costs, future inflation rates and the
credit-adjusted risk-free interest rate. However, the fair value of the asset
retirement obligation cannot be reasonably estimated as of June 30, 2003,
because the settlement dates are indeterminate. The Partnership will record an
asset retirement obligation in the periods in which it can reasonably determine
the settlement dates. Accordingly, the adoption of Statement No. 143 did not
have an impact on the Partnership's financial position or results of operations.
NOTE 2: Equity and Debt Offerings, Redemption of Common Units and Related
Transactions
In conjunction with the Partnership's acquisition from Valero Energy of the
South Texas Pipelines and Terminals and the Crude Oil Storage Tanks discussed in
Note 3, the Partnership entered into the following transactions:
Common Unit Offering
On March 18, 2003, Valero L.P. consummated a public offering of common units,
selling 5,750,000 common units to the public at $36.75 per unit, before
underwriters' discount of $1.56 per unit. Net proceeds were $202.3 million, or
$35.19 per unit, before offering expenses of $2.0 million. In order to maintain
a 2% general partner interest, Riverwalk Logistics, L.P. contributed $4.3
million to Valero L.P. The net proceeds of the common unit offering and the
general partner contribution were primarily used to fund the acquisition of the
Crude Oil Storage Tanks.
On April 16, 2003, Valero L.P. closed on the exercise of a portion of the
underwriters' over-allotment option, by selling 581,000 common units at $35.19
per unit. Net proceeds from this sale were $20.4 million and Riverwalk
Logistics, L.P. contributed $0.5 million to maintain its 2% general partner
interest. The common unit proceeds and general partner contribution were used to
pay down the outstanding balance on the revolving credit facility.
Private Placement of 6.05% Senior Notes and Revolving Credit Facility
Also on March 18, 2003, concurrent with the closing of the common unit offering,
Valero Logistics issued, in a private placement, $250.0 million of 6.05% senior
notes, due March 2013, at a price of 99.719% before consideration of debt
issuance costs of $2.0 million. In addition, Valero Logistics borrowed $25.0
million under its amended $175.0 million revolving credit facility. The net
proceeds from the 6.05% senior notes and borrowings under the revolving credit
facility were used to redeem common units held by an affiliate of Valero Energy,
redeem a related portion of the general partner interest and partially fund the
acquisition of the South Texas Pipelines and Terminals.
Redemption of Common Units and Amendment to Partnership Agreement
On March 18, 2003, subsequent to the common unit offering and private placement
of 6.05% senior notes discussed above, Valero L.P. redeemed from UDS Logistics,
LLC, a wholly owned subsidiary of Valero Energy, 3,809,750 common units at a
total cost of $134.1 million, or $35.19 per common unit. In order to maintain a
2% general partner interest, Valero L.P. redeemed a portion of Riverwalk
Logistics, L.P.'s general partner interest at a total cost of $2.9 million. In
addition to the redemption transaction, Valero L.P. amended its partnership
agreement to reduce the vote required to remove the general partner from 66 2/3%
to 58% of its outstanding units and to exclude from participating in such a vote
the common and subordinated units held by affiliates of the general partner.
8
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summary
The net proceeds from the common unit offering (including the over-allotment
option exercise), the private placement of 6.05% senior notes and the borrowings
under the revolving credit facility were used to redeem common units held by UDS
Logistics, LLC and acquire the South Texas Pipelines and Terminals and the Crude
Oil Storage Tanks discussed in Note 3. A summary of the proceeds received and
use of proceeds is as follows (in thousands):
Proceeds received:
Sale of common units to the public.............. $ 202,342
Private placement of 6.05% senior notes......... 249,298
Borrowings under the revolving credit facility.. 25,000
Exercise of a portion of the underwriters'
over-allotment option........................ 20,445
General partner contributions................... 4,749
-------
Total proceeds............................... 501,834
-------
Use of proceeds:
South Texas Pipelines and Terminals............. 150,000
Crude Oil Storage Tanks......................... 200,000
Redemption of common units...................... 134,065
Repayment of a portion of the borrowings
under the revolving credit facility.......... 20,000
Redemption of general partner interest.......... 2,857
Professional fees and other costs of equity
issuance..................................... 2,000
Debt issuance costs............................. 1,970
-------
Total use of proceeds........................ 510,892
-------
Net cash on hand paid out......................... $ (9,058)
=======
Both the South Texas Pipelines and Terminals and the Crude Oil Storage Tanks
acquisitions were approved by the conflicts committee of the board of directors
of Valero GP, LLC, the general partner of Riverwalk Logistics, L.P., based in
part on an opinion from its independent financial advisor that the consideration
paid by the Partnership was fair, from a financial point of view, to the
Partnership and its public unitholders.
NOTE 3: Acquisitions
Telfer Asphalt Terminal
On January 7, 2003, the Partnership completed its acquisition of Telfer Oil
Company's (Telfer) California asphalt terminal for $15.1 million. The asphalt
terminal includes two storage tanks with a combined storage capacity of 350,000
barrels, six 5,000-barrel polymer modified asphalt tanks, a truck rack, rail
facilities and various other tanks and equipment. In conjunction with the Telfer
acquisition, the Partnership entered into a six-year Terminal Storage and
Throughput Agreement with Valero Energy (see Note 6). A portion of the purchase
price represented payment to the principal owner of Telfer for a non-compete
agreement and for the lease of certain facilities adjacent to the terminal
operations.
South Texas Pipelines and Terminals
On March 18, 2003, Valero Energy contributed a South Texas pipeline system to
the Partnership for $150.0 million. The South Texas pipeline system is comprised
of the Houston pipeline system, the Valley pipeline system and the San Antonio
pipeline system (together referred to as the South Texas Pipelines and
Terminals) as follows:
o The Houston pipeline system is a 204-mile refined product pipeline
originating in Corpus Christi, Texas and ending in Pasadena, Texas at
the Houston ship channel. The pipeline has the capacity to transport
105,000 barrels per day of refined products produced at Valero
Energy's Corpus Christi East and Corpus Christ West refineries and
third party refineries located in Corpus Christi. The pipeline system
9
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
includes four refined product terminals (Hobby Airport, Placedo,
Houston asphalt and Almeda, which is currently idle) with a combined
storage capacity of 310,900 barrels of refined products and 75,000
barrels of asphalt.
o The Valley pipeline system is a 130-mile refined product pipeline
originating in Corpus Christi and ending in Edinburg, Texas. The
pipeline has the capacity to transport 27,100 barrels per day of
refined products. Currently, the pipeline transports refined products
produced at Valero Energy's Corpus Christi East and Corpus Christi
West refineries. The pipeline system includes a refined product
terminal in Edinburg with a storage capacity of 184,600 barrels.
o The San Antonio pipeline system is comprised of two segments: the
north segment, which runs from Pettus, Texas to San Antonio, Texas and
the south segment which runs from Pettus to Corpus Christi. The north
segment is 74 miles long and has a capacity of 24,000 barrels per day.
The south segment is 60 miles long and has a capacity of 15,000
barrels per day and ends at Valero Energy's Corpus Christi East
refinery. The pipeline system includes a refined product terminal in
east San Antonio with a storage capacity of 148,200 barrels.
In conjunction with the South Texas Pipelines and Terminals acquisition, the
Partnership entered into several agreements with Valero Energy (see Note 6).
Pro Forma Financial Information
The following unaudited pro forma financial information assumes that the South
Texas Pipelines and Terminals acquisition was funded with $111.0 million of net
proceeds from the issuance of the 6.05% senior notes, $25.0 million of
borrowings under the revolving credit facility, $6.7 million of net proceeds
from the issuance of 185,422 common units and the related general partner
interest capital contribution and $7.3 million of available cash. The unaudited
pro forma financial information for the six months ended June 30, 2003 and 2002,
assumes that each of these transactions occurred on January 1, 2003 and 2002,
respectively.
Six Months Ended
June 30,
--------
2003 2002
---- ----
(in thousands)
Revenues................................ $85,202 $ 69,570
Operating income........................ 38,286 28,093
Net income.............................. 30,850 24,113
Net income per unit applicable to
limited partners...................... 1.41 1.18
Crude Oil Storage Tanks
On March 18, 2003, Valero Energy contributed 58 crude oil storage tanks and
related assets (the Crude Oil Storage Tanks) to the Partnership for $200.0
million. The Crude Oil Storage Tanks consist of certain tank shells,
foundations, tank valves, tank gauges, pressure equipment, temperature
equipment, corrosion protection, leak detection, tank lighting and related
equipment located at the following Valero Energy refineries:
o Corpus Christi West refinery, which has a total capacity to process
225,000 barrels per day of crude oil and other feedstocks;
o Texas City refinery, which has a total capacity to process 243,000
barrels per day of crude oil and other feedstocks; and
o Benicia refinery, which has a total capacity to process 180,000
barrels per day of crude oil and other feedstocks.
10
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Historically, the Crude Oil Storage Tanks were operated as part of Valero
Energy's refining operations and, as a result, no separate fee was charged
related to these assets and, accordingly, no revenues were recorded by Valero
Energy. The Crude Oil Storage Tanks were not accounted for separately by Valero
Energy and were not operated as an autonomous business unit. As a result, the
purchase of the Crude Oil Storage Tanks represented an asset acquisition and,
therefore, no pro forma impact of this transaction has been included above. In
conjunction with the Crude Oil Storage Tanks acquisition, the Partnership
entered into several agreements with Valero Energy (see Note 6).
Shell Pipeline Interest
On May 1, 2003, the Partnership acquired Shell Pipeline Company, LP's (Shell)
28% interest in the Amarillo to Abernathy refined product pipeline and Shell's
46% interest in the Abernathy to Lubbock refined product pipeline for $1.6
million. After this acquisition, the Partnership owns a 67% interest and
ConocoPhillips owns the remaining 33% interest in the Amarillo to Abernathy
refined product pipeline and ConocoPhillips owns the remaining 54% interest in
the Abernathy to Lubbock refined product pipeline.
Purchase Price Allocations
The Telfer, South Texas Pipelines and Terminals, Crude Oil Storage Tanks and
Shell pipeline interest acquisitions were accounted for using the purchase
method. The purchase price for each acquisition has been 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 Partnership, pending completion of final purchase price
allocations.
South Texas Crude Oil Shell
Pipelines and Storage Pipeline
Telfer Terminals Tanks Interest
------ --------- ----- --------
(in thousands)
Property, plant and equipment........ $ 14,807 $ 150,000 $ 200,000 $ 1,600
Intangible assets.................... 250 - - -
NOTE 4: Long-term Debt
Long-term debt consisted of the following:
June 30, December 31,
2003 2002
---- ----
(in thousands)
6.05% senior notes due 2013.............................. $ 253,816 $ -
6.875% senior notes due 2012............................. 101,755 99,700
8.0% Port Authority of Corpus Christi note payable....... 9,660 9,958
Revolving credit facility................................ - -
------- -------
Total debt.............................................. 365,231 109,658
Less current portion..................................... (449) (747)
------- -------
Long-term debt, less current portion.................... $ 364,782 $ 108,911
======= =======
Interest payments totaled $4.2 million and $1.3 million for the six months ended
June 30, 2003 and 2002, respectively.
Valero L.P. has no operations and its only asset is its investment in Valero
Logistics, which owns and operates the Partnership's pipelines, terminals and
crude oil storage tank assets. Valero L.P. has fully and unconditionally
11
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
guaranteed the senior notes issued by Valero Logistics and any obligations under
Valero Logistics' revolving credit facility.
6.05% Senior Notes
On March 18, 2003, Valero Logistics completed the sale of $250.0 million of
6.05% senior notes due March 15, 2013, issued in a private placement, for total
proceeds of $249.3 million, before debt issuance costs. Debt issuance costs of
$2.0 million are being amortized over the life of the senior notes using the
effective interest method. The 6.05% senior notes do not have sinking fund
requirements. Interest on the 6.05% senior notes is payable semiannually in
arrears on March 15 and September 15 of each year beginning September 15, 2003.
The 6.05% senior notes rank equally with all other existing senior unsecured
indebtedness of Valero Logistics, including indebtedness under the revolving
credit facility and the 6.875% senior notes due July 15, 2012. The 6.05% senior
notes contain restrictions on Valero Logistics' ability to incur secured
indebtedness unless the same security is also provided for the benefit of
holders of the 6.05% senior notes. In addition, the 6.05% senior notes limit
Valero Logistics' ability to incur indebtedness secured by certain liens and to
engage in certain sale-leaseback transactions. The 6.05% senior notes are
irrevocably and unconditionally guaranteed on a senior unsecured basis by Valero
L.P. The guarantee by Valero L.P. ranks equally with all of its existing
unsecured and unsubordinated indebtedness and is required to rank equally with
any future unsecured and unsubordinated indebtedness. At the option of Valero
Logistics, the 6.05% senior notes may be redeemed in whole or in part at any
time at a redemption price, which includes a make-whole premium, plus accrued
and unpaid interest to the redemption date.
The 6.05% senior notes issued on March 18, 2003 were not registered under the
Securities Act of 1933 or any other securities laws and consequently the 6.05%
senior notes were originally subject to transfer and resale restrictions. The
6.05% senior notes included registration rights which provided that Valero
Logistics would use its best efforts to file, within 90 days of issuance, a
registration statement for the exchange of the 6.05% senior notes for new notes
of the same series that generally would be freely transferable, and to
consummate the exchange offer within 210 days. In July of 2003, Valero Logistics
closed on the exchange of the outstanding $250.0 million 6.05% senior notes that
were not registered under the Securities Act of 1933 for $250.0 million of 6.05%
senior notes that have been registered under the Securities Act of 1933.
Accordingly, the new senior notes are freely transferable.
The 6.05% senior notes also include a change-in-control provision, which
requires that an investment grade entity own and control the general partner of
Valero L.P. and Valero Logistics. Otherwise, Valero Logistics must offer to
purchase the 6.05% senior notes at a price equal to 100% of their outstanding
principal balance plus accrued interest through the date of purchase.
$175.0 Million Revolving Credit Facility
On March 6, 2003, Valero Logistics entered into an amended revolving credit
facility with the various banks included in the existing revolving credit
facility and with a group of new banks to increase the revolving credit facility
to $175.0 million. In addition, the amount that may be borrowed to fund
distributions to unitholders was increased from $25.0 million to $40.0 million.
In addition to increasing the amount that may be borrowed under the revolving
credit facility, the "Total Debt to EBITDA Ratio" as defined in the revolving
credit facility was changed such that the ratio may not exceed 4.0 to 1.0 (as
opposed to 3.0 to 1.0 in the original facility), and Valero L.P. is now
guaranteeing the revolving credit facility. This guarantee by Valero L.P. ranks
equally with all of its existing unsecured senior obligations and is required to
rank equally with any future unsecured senior obligations.
Interest Rate Swaps
During the six months ended June 30, 2003, Valero Logistics entered into
interest rate swap agreements to manage its exposure to changes in interest
rates. The interest rate swap agreements have an aggregate notional amount of
$167.5 million, of which $60.0 million is tied to the maturity of the 6.875%
senior notes and $107.5 million is tied to the maturity of the 6.05% senior
notes. Under the terms of the interest rate swap agreements, the Partnership
will receive a fixed rate (6.875% and 6.05% for the $60.0 million and $107.5
million of interest rate swap agreements, respectively) and will pay a variable
rate based on LIBOR plus a percentage that varies with each agreement. As of
12
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003, the weighted average effective interest rate for the interest
rate swaps was 2.9%. The Partnership accounts for the interest rate swaps as
fair value hedges, with changes in the fair value of each swap and the related
debt instrument recorded as an adjustment to interest expense in the
consolidated statement of income. As of June 30, 2003, the aggregate estimated
fair value of the interest rate swaps was $6.5 million.
NOTE 5: Commitments and Contingencies
Environmental, Health and Safety
The Partnership's operations are subject to extensive federal, state and local
environmental and safety laws and regulations. Although the Partnership believes
its operations are in substantial compliance with applicable environmental and
safety laws and regulations, risks of additional costs and liabilities are
inherent in pipeline, terminalling and storage operations, and there can be no
assurance that significant costs and liabilities will not be incurred. Moreover,
it is possible that other developments, such as increasingly stringent
environmental and safety laws, regulations and enforcement policies thereunder,
and claims for damages to property or persons resulting from the operations,
could result in substantial costs and liabilities. Accordingly, the Partnership
has adopted policies, practices and procedures in the areas of pollution
control, pipeline integrity, operator qualifications, public relations, product
safety, occupational health and the handling, storage, use and disposal of
hazardous materials that are designed to prevent material environmental or other
damage, and to limit the financial liability which could result from such
events. However, some risk of environmental or other damage is inherent in
pipeline, terminalling and storage operations, as it is with other entities
engaged in similar businesses. Although environmental and safety costs may have
a significant impact on results of operations for any single period, the
Partnership believes that such costs will not have a material adverse effect on
its financial position.
In connection with the South Texas Pipelines and Terminals acquisition discussed
in Note 3, Valero Energy has agreed to indemnify the Partnership from
environmental liabilities that are known as of March 18, 2003 or are discovered
within 10 years after March 18, 2003 related to:
o the South Texas Pipelines and Terminals that arose as a result of
events occurring or conditions existing prior to March 18, 2003; and
o any real or personal property on which the South Texas Pipelines and
Terminals are located that arose prior to March 18, 2003.
In connection with the Crude Oil Storage Tanks acquisition, Valero Energy has
agreed to indemnify the Partnership from environmental liabilities related to:
o the Crude Oil Storage Tanks that arose as a result of events occurring
or conditions existing prior to March 18, 2003;
o any real or personal property on which the Crude Oil Storage Tanks are
located that arose prior to March 18, 2003; and
o any actions taken by Valero Energy before, on or after March 18, 2003,
in connection with the ownership, use or operation of the Corpus
Christi West refinery, the Texas City refinery and the Benicia
refinery or the property on which the Crude Oil Storage Tanks are
located, or any accident or occurrence in connection therewith.
Legal
The Partnership is involved in various lawsuits, claims and regulatory
proceedings incidental to its business. In the opinion of management, the
outcome of such matters will not have a material adverse effect on the
Partnership's financial position or results of operations.
13
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6: Related Party Transactions
The Partnership has related party transactions with Valero Energy for pipeline
tariff, terminalling fee and crude oil storage tank fee revenues, certain
employee costs, insurance costs, operating expenses, administrative costs and
rent expense. The receivable from Valero Energy as of December 31, 2002 and
through March 18, 2003 represented the net amount due for these related party
transactions and the net cash collected under Valero Energy's centralized cash
management program on the Partnership's behalf. Beginning March 19, 2003, the
receivable from Valero Energy represents amounts due for pipeline tariff,
terminalling fee and crude oil storage tank fee revenues and the payable to
Valero Energy represents amounts due for employee costs, insurance costs,
operating expenses, administrative costs and rent expense.
The following table summarizes transactions with Valero Energy:
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
(in thousands)
Revenues................................. $ 47,493 $ 29,892 $ 79,259 $ 55,802
Operating expenses....................... 6,127 3,377 10,195 6,784
General and administrative expenses...... 1,409 1,631 2,968 2,931
Telfer Terminal Storage and Throughput Agreement
On January 7, 2003, the Partnership and Valero Energy entered into a five-year
Terminal Storage and Throughput Agreement pursuant to which Valero Energy agreed
to (a) lease the asphalt storage tanks and related equipment for a monthly fee
of $0.60 per barrel of storage capacity, (b) move asphalt through the terminal
during the term of the agreement for a fee of $1.25 per barrel of throughput
with a guaranteed minimum annual throughput of 280,000 barrels, and (c)
reimburse the Partnership for certain costs, including utilities.
South Texas Pipelines and Terminals Agreements
In conjunction with the acquisition of the South Texas Pipelines and Terminals,
Valero Energy and the Partnership entered into the following agreements:
o Throughput Commitment Agreement pursuant to which Valero Energy
agreed, for an initial period of seven years, to (i) transport in the
Houston and Valley pipeline systems an aggregate of 40% of the Corpus
Christi East and Corpus Christi West refineries gasoline and
distillate production but only if the combined throughput on these
pipelines is less than 110,000 barrels per day, (ii) transport in the
Pettus to San Antonio refined product pipeline 25% of the Three Rivers
refinery gasoline and distillate production and in the Pettus to
Corpus Christi refined product pipeline 90% of the Three Rivers
refinery raffinate production, (iii) use the Houston asphalt terminal
for an aggregate of 7% of the asphalt production of the Corpus Christi
East and Corpus Christi West refineries, (iv) use the Edinburg refined
product terminal for an aggregate of 7% of the gasoline and distillate
production of the Corpus Christi East and Corpus Christi West
refineries, but only if the throughput at this terminal is less than
20,000 barrels per day; and (v) use the San Antonio terminal for 75%
of the throughput in the Pettus to San Antonio refined product
pipeline. In the event Valero Energy does not transport in the
pipelines or use the terminals to handle the minimum volume
requirements and if its obligation has not been suspended under the
terms of the agreement, it will be required to make a cash payment
determined by multiplying the shortfall in volume by the applicable
weighted average tariff rate or terminal fee. Also, Valero Energy
agreed to allow the Partnership to increase its tariff to compensate
for any revenue shortfall in the event the Partnership has to curtail
throughput in the Corpus Christi to Edinburg refined product pipeline
as a result of repair and replacement activities.
o Terminalling Agreements pursuant to which Valero Energy agreed, during
the initial period of five years, to pay a terminalling fee for each
14
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
barrel of refined product stored or handled by or on behalf of Valero
Energy at the terminals included in the South Texas Pipelines and
Terminals, including an additive fee for gasoline additives blended at
the terminals. At the Hobby Airport terminal, Valero Energy will also
pay a filtering fee for each barrel of jet fuel stored or handled at
the terminal.
Additionally, Valero Energy has indicated to the Partnership that the segment of
the Corpus Christi to Edinburg refined product pipeline that runs approximately
60 miles south from Corpus Christi to Seeligson Station will require repair and,
in some places, replacement. Valero Energy has agreed to indemnify the
Partnership for any costs the Partnership incurs to repair and replace this
segment in excess of $1.5 million.
Crude Oil Storage Tanks Agreements
In conjunction with the acquisition of the Crude Oil Storage Tanks, Valero
Energy and the Partnership entered into the following agreements:
o Handling and Throughput Agreement pursuant to which Valero Energy
agreed to pay the Partnership a fee, for an initial period of ten
years, for 100% of crude oil delivered to each of the Corpus Christi
West refinery, the Texas City refinery or the Benicia refinery and to
use the Partnership for handling all deliveries to these refineries.
The throughput fees under the agreement are adjustable annually,
generally based on 75% of the regional consumer price index applicable
to the location of each refinery.
o Services and Secondment Agreements pursuant to which Valero Energy
agreed to second to the Partnership personnel who will provide
operating and routine maintenance services with respect to the Crude
Oil Storage Tanks. The annual reimbursement for services is an
aggregate $3.5 million for the initial year and is subject to
adjustment based on actual expenses incurred and increases in the
regional consumer price index. The initial term of the Services and
Secondment Agreements is ten years with a Partnership option to extend
for an additional five years.
o Lease and Access Agreements pursuant to which Valero Energy will lease
to the Partnership the real property on which the Crude Oil Storage
Tanks are located for an aggregate of $0.7 million per year. The
initial term of each lease will be 25 years, subject to automatic
renewal for successive one-year periods thereafter. The Partnership
may terminate any of these leases upon 30 days notice after the
initial term or at the end of a renewal period. In addition, the
Partnership may terminate any of these leases upon 180 days notice
prior to the expiration of the current term if the Partnership ceases
to operate the Crude Oil Storage Tanks or ceases business operations.
NOTE 7: Employee Benefit Expenses
The Partnership, which has no employees, relies on employees of Valero Energy
and its affiliates to provide the necessary services to operate the
Partnership's assets. Effective January 1, 2003, most of the employees providing
services to the Partnership became employees of Valero GP, LLC, a wholly owned
subsidiary of Valero Energy. The Valero GP, LLC employees are included in the
various employee benefit plans of Valero Energy and its affiliates. These plans
include qualified, non-contributory defined benefit retirement plans, defined
contribution 401(k) plans, employee and retiree medical, dental and life
insurance plans, long-term incentive plans (i.e., unit options and bonuses) and
other such benefits.
The Partnership's share of allocated Valero Energy employee benefit plan
expenses was $0.8 million and $0.4 million for the three months ended June 30,
2003 and 2002, respectively, and $1.3 million and $0.7 million for the six
months ended June 30, 2003 and 2002, respectively. These employee benefit plan
expenses are included in operating expenses with the related payroll costs.
Long-Term Incentive Plan
The Board of Directors of Valero GP, LLC previously adopted the 2000 Long-Term
Incentive Plan (the LTIP) under which Valero GP, LLC may award up to 250,000
common units to certain key employees of Valero Energy's affiliates providing
services to Valero L.P. and to directors and officers of Valero GP, LLC. Awards
15
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
under the LTIP can include awards such as unit options, restricted common units,
distribution equivalent rights (DERs) and contractual rights to receive common
units.
On January 24, 2003, under the LTIP, Valero GP, LLC granted 30,000 contractual
rights to receive common units and DERs to its officers and directors, excluding
the outside directors. In conjunction with the grant of contractual rights to
receive common units under the LTIP, Valero GP, LLC purchased 30,000 newly
issued Valero L.P. common units from Valero L.P. for total consideration of $1.1
million. In addition, in March of 2003, Valero GP, LLC settled the previous
purchase of 55,250 common units with the payment of $2.3 million.
In January of 2003, one-third of the previously issued 55,250 contractual rights
vested and Valero GP, LLC distributed actual Valero L.P. common units to the
officers and directors. Certain of the officers and directors settled their tax
withholding on the vested common units by delivering 6,491 common units to
Valero GP, LLC. As of June 30, 2003, Valero GP, LLC owns 73,319 common units of
Valero L.P.
The Partnership's share of the LTIP expenses was $0.1 million and $0.3 million
for the three months ended June 30, 2003 and 2002, respectively, and $0.4
million and $0.3 million for the six months ended June 30, 2003 and 2002,
respectively. These LTIP expenses are included in general and administrative
expenses.
In June of 2003, the Board of Directors of Valero GP, LLC adopted the 2003
Employee Unit Incentive Plan (the UIP) under which Valero GP, LLC may award up
to 500,000 common units to any employee of Valero GP, LLC or its affiliates,
excluding officers and directors of Valero GP, LLC and its affiliates. Awards
under the UIP can include unit options, unit appreciation rights, restricted
units, performance awards, unit compensation and other unit based awards.
NOTE 8: Partners' Equity
Outstanding Equity
Prior to the redemption of common units and the common unit offering in March
2003 and the exercise of a portion of the underwriters' over-allotment option in
April 2003, Valero Energy, through various affiliates, owned 73.6% of Valero
L.P.'s outstanding partners' equity. After giving effect to the redemption of
common units, the common unit offering and the over-allotment option exercise,
outstanding partners' equity of Valero L.P. as of June 30, 2003 includes
12,205,822 common units (614,572 of which are held by UDS Logistics, LLC and
73,319 of which are held by Valero GP, LLC), 9,599,322 subordinated units held
by UDS Logistics, LLC and a 2% general partner interest held by Riverwalk
Logistics, L.P. As a result, Valero Energy now owns 48.2% of Valero L.P.,
including the 2% general partner interest (see Note 9).
Net Income per Unit Applicable to Limited Partners
The computation of net income per unit applicable to limited partners is based
on the weighted-average number of common and subordinated units outstanding
during the period. Net income per unit applicable to limited partners is
computed by dividing net income applicable to limited partners, after deducting
the general partner's 2% interest and incentive distributions, by the
weighted-average number of limited partnership units outstanding. Basic and
diluted net income per unit applicable to limited partners is the same because
the Partnership has no potentially dilutive securities outstanding. The
Partnership generated sufficient net income such that the amount of net income
allocated to common units was equal to the amount allocated to the subordinated
units.
16
VALERO L.P. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash Distributions
The Partnership makes quarterly distributions of 100% of its available cash,
generally defined as cash receipts less cash disbursements and cash reserves
established by the general partner in its sole discretion. These quarterly
distributions are declared and paid within 45 days subsequent to each
quarter-end. The following table reflects the allocation of total cash
distributions to the general and limited partners applicable to the period in
which the distributions are earned:
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
(in thousands, except per unit data)
General partner interest........................ $ 348 $ 282 $ 667 $ 539
General partner incentive distribution.......... 718 339 1,102 425
---- ------ ------ ------
Total general partner distribution............. 1,066 621 1,769 964
Limited partners' distributions................. 16,354 13,478 31,618 25,993
------ ------ ------ ------
Total cash distributions....................... $ 17,420 $ 14,099 $ 33,387 $ 26,957
====== ====== ====== ======
Cash distributions per unit applicable to
limited partners............................... $ 0.75 $ 0.70 $ 1.45 $ 1.35
====== ====== ====== ======
NOTE 9: Subsequent Events
Distributions
On July 28, 2003, the Partnership declared a quarterly distribution of $0.75 per
unit payable on August 14, 2003 to unitholders of record on August 5, 2003.
Common Unit Offering
On August 11, 2003, Valero L.P. closed on a public offering of common units,
selling 1,236,250 common units, which includes 161,250 common units related to
the over-allotment option, to the public at $41.15 per unit, before
underwriter's discount of $1.85 per unit. Net proceeds were $48.6 million, or
$39.30 per unit, before offering expenses of $0.3 million. In order to maintain
its 2% general partner interest, Riverwalk Logistics, L.P. contributed $1.0
million to Valero L.P. As a result of this common unit offering, Valero Energy
now owns 45.8% of Valero L.P., including the 2% general partner interest.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Cautionary Statement Regarding Forward-Looking Information
This report includes forward-looking statements regarding future events and the
future financial performance of the Partnership. All forward-looking statements
are based on the Partnership's beliefs as well as assumptions made by and
information currently available to the Partnership. Words such as "believes",
"expects", "intends", "forecasts", "projects" and similar expressions, identify
forward-looking statements within the meaning of the Securities Litigation
Reform Act of 1995. These statements reflect the Partnership's current views
with respect to future events and are subject to various risks, uncertainties
and assumptions including:
o Any reduction in the quantities of crude oil and refined products
transported in the Partnership's pipelines and handled at the
Partnership's terminals and storage tanks;
o Any significant decrease in the demand for refined products in the
markets served by the Partnership's pipelines;
o Any material decline in production by any of Valero Energy's McKee,
Three Rivers, Corpus Christi East, Corpus Christi West, Texas City,
Benicia or Ardmore refineries;
o Any downward pressure on market prices caused by new competing refined
product pipelines that could cause Valero Energy to decrease the
volumes transported in the Partnership's pipelines;
o Any challenges to the Partnership's tariff rates or changes in the
FERC's ratemaking methodology;
o Any material decrease in the supply of or material increase in the
price of crude oil available for transport through the Partnership's
pipelines and storage tanks;
o Inability to expand the Partnership's business and acquire new assets
as well as to attract third party shippers;
o Conflicts of interest with Valero Energy;
o Any inability to borrow additional funds;
o Any substantial costs related to environmental and safety risks,
including increased costs of compliance;
o Any change in the credit rating assigned to Valero Logistics'
indebtedness;
o Any change in the credit rating assigned to Valero Energy's
indebtedness;
o Any reductions in space allocated to the Partnership in
interconnecting third party pipelines;
o Any material increase in the price of natural gas;
o Terrorist attacks, threats of war or terrorist attacks or political or
other disruptions that limit crude oil production, and
o The Partnership's former use of Arthur Andersen LLP as its independent
auditor.
If one or more of these risks or uncertainties materialize, or if the underlying
assumptions prove incorrect, actual results may vary materially from those
described in the forward-looking statement. Readers are cautioned not to place
undue reliance on this forward-looking information, which is as of the date of
this Form 10-Q, and the Partnership undertakes no obligation to update publicly
or revise any forward-looking information, whether as a result of new
information, future events or otherwise.
18
Introduction
The following discussion and analysis of the Partnership's results of operations
and financial condition should be read in conjunction with Part I - Financial
Information, Item 1. Financial Statements.
Significant Developments in 2003
On January 7, 2003, the Partnership acquired an asphalt terminal located in
Pittsburg, California from Telfer for $15.1 million in cash. The statement of
income for the six months ended June 30, 2003 includes the results of operations
of the Telfer asphalt terminal from January 7, 2003 through June 30, 2003.
On March 18, 2003, Valero L.P. consummated a public offering of common units
resulting in net proceeds of $204.6 million (including the general partner
contribution), Valero Logistics issued the 6.05% senior notes in a private
placement resulting in net proceeds of $247.3 million and Valero Logistics
borrowed $25.0 million under its revolving credit facility. A portion of the net
proceeds from the 6.05% senior notes were used to redeem 3,809,750 common units
owned by UDS Logistics, LLC and a prorata portion of general partner interest
for $136.9 million. The remainder of the net proceeds from the 6.05% senior
notes, along with the net proceeds from the common unit offering, cash on hand
and borrowings under the revolving credit facility were used to pay $350 million
related to the contribution by Valero Energy to Valero Logistics of the South
Texas Pipelines and Terminals and the Crude Oil Storage Tanks. The statement of
income for the six months ended June 30, 2003 includes the results of operations
of the South Texas Pipelines and Terminals and the Crude Oil Storage Tanks from
March 19, 2003 through June 30, 2003, and includes the impact of the debt and
equity financings related to the above acquisitions and redemption. On April 16,
2003, Valero L.P. closed on the exercise of a portion of the underwriters'
over-allotment option, by selling 581,000 common units for net proceeds of $20.9
million (including the general partner contribution), which proceeds were used
to pay down a portion of the outstanding borrowings under the revolving credit
facility.
On May 1, 2003, the Partnership acquired Shell's 28% interest in the Amarillo to
Abernathy refined product pipeline and Shell's 46% interest in the Abernathy to
Lubbock refined product pipeline for $1.6 million. The statement of income for
the three and six months ended June 30, 2003, includes the results of operations
of the additional Shell pipeline interest from May 1, 2003 through June 30,
2003.
Seasonality
The operating results of the Partnership are affected by factors affecting the
business of Valero Energy, including refinery utilization rates, the demand for
refined products and industry refining capacity.
The throughput of crude oil that the Partnership transports is directly affected
by the level of, and refiner demand for, crude oil in markets served directly by
the Partnership's crude oil pipelines and crude oil storage tanks. Crude oil
inventories tend to increase due to overproduction of crude oil by producing
companies and countries, planned maintenance turnaround activity by refiners and
unplanned outages at refineries.
The throughput of the refined products that the Partnership transports is
directly affected by the level of, and user demand for, refined products in the
markets served directly or indirectly by the Partnership's refined product
pipelines and terminals. Demand for gasoline in most markets peaks during the
summer driving season, which extends from May through September, and declines
during the fall and winter months. Demand for gasoline in the Arizona market,
however, generally is higher in the winter months than summer months due to
greater tourist activity and second home usage in the winter months.
19
Results of Operations
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
The results of operations for the three months ended June 30, 2003 presented in
the following table are derived from the consolidated statement of income for
Valero L.P. and subsidiaries for the three months ended June 30, 2003, which
includes the results of operations of the South Texas Pipelines and Terminals,
the Crude Oil Storage Tanks and Telfer for the full quarter and the results of
operations of the Shell pipeline interest from May 1, 2003 through June 30,
2003. The results of operations for the three months ended June 30, 2002
presented in the following table are derived from the consolidated statement of
income for Valero L.P. and subsidiaries for the three months ended June 30,
2002.
Financial Data:
Three Months Ended June 30,
---------------------------
2003 2002
---- ----
Statement of Income Data: (in thousands)
Revenues........................................................ $ 47,542 $ 30,030
------ ------
Costs and expenses:
Operating expenses............................................. 16,335 9,565
General and administrative expenses............................ 1,670 1,698
Depreciation and amortization expense.......................... 7,269 3,876
------- ------
Total costs and expenses.................................... 25,274 15,139
------ ------
Operating income................................................ 22,268 14,891
Equity income from Skelly-Belvieu Pipeline Company............. 600 844
Interest expense, net.......................................... (4,736) (796)
------ ------
Net income...................................................... 18,132 14,939
Less net income applicable to general partner.................. (1,066) (299)
------ ------
Net income applicable to the limited partners' interest......... $ 17,066 $ 14,640
====== ======
Net income per unit applicable to limited partners.............. $ 0.79 $ 0.76
====== ======
Weighted average number of limited partnership units
outstanding.................................................... 21,702,990 19,253,894
========== ==========
Earnings before interest, taxes and depreciation and
amortization (EBITDA) (a)...................................... $ 30,137 $ 19,611
====== ======
Distributable cash flow (a)..................................... $ 24,234 $ 18,081
====== ======
June 30, June 30,
Balance Sheet Data: 2003 2002
---- ----
Long-term debt, including current portion (1)................... $ 365,231 $ 101,076
Partners' equity (2)............................................ 385,636 291,932
Debt-to-capitalization ratio (1) / ((1)+(2)).................... 48.6% 25.7%
20
(a) The following is a reconciliation of income before income tax expense
to EBITDA and distributable cash flow.
Three Months Ended June 30,
--------------------------
2003 2002
---- ----
(in thousands)
Income before income tax expense.................... $ 18,132 $ 14,939
Plus interest expense, net......................... 4,736 796
Plus depreciation and amortization expense......... 7,269 3,876
------ ------
EBITDA.............................................. 30,137 19,611
Less equity income from Skelly-Belvieu Pipeline
Company........................................... (600) (844)
Less interest expense, net......................... (4,736) (796)
Less reliability capital expenditures.............. (1,446) (741)
Plus distributions from Skelly-Belvieu Pipeline
Company........................................... 879 851
------ ------
Distributable cash flow............................. $ 24,234 $ 18,081
====== ======
For a discussion regarding the Partnership's rationale for utilizing the
non-GAAP measures of EBITDA and distributable cash flow, please see Valero
L.P.'s Annual Report on Form 10-K for the year ended December 31, 2002.
Operating Data:
The following table reflects total throughput, on a barrels per day basis, for
the Partnership's crude oil pipelines, refined product pipelines, refined
product terminals and crude oil storage tanks for the three months ended June
30, 2003 and 2002.
Three Months Ended June 30,
---------------------------
2003 2002 % Change
---- ---- --------
(barrels per day)
Crude oil pipeline throughput........... 348,390 360,558 (3)%
======= =======
Refined product pipeline throughput..... 396,639 303,654 31%
======= =======
Refined product terminal throughput..... 233,881 179,915 30%
======= =======
Crude oil storage tank throughput....... 475,280 N/A N/A
=======
Net income for the three months ended June 30, 2003 was $18.1 million as
compared to $14.9 million for the three months ended June 30, 2002. The increase
of $3.2 million was primarily attributable to the additional net income
generated from the acquisition of the South Texas Pipelines and Terminals and
the Crude Oil Storage Tanks on March 18, 2003 and the Telfer asphalt terminal on
January 7, 2003. The increase in net income resulting from these acquisitions
was partially offset by the impact of lower throughput barrels in the Ardmore
crude oil pipelines resulting from a major refinery turnaround, and lower
throughput barrels in the McKee to Colorado Springs to Denver refined product
pipeline resulting from Valero Energy's Denver refinery maximizing production
and lower jet fuel sales by Valero Energy in Denver.
21
Revenues for the three months ended June 30, 2003 were $47.5 million as compared
to $30.0 million for the three months ended June 30, 2002, an increase of 58% or
$17.5 million. The following discusses significant revenue increases and
decreases:
o revenues for the Crude Oil Storage Tanks acquired on March 18, 2003
totaled $8.6 million for the three months ended June 30, 2003;
o revenues for the South Texas Terminals for the three months ended June
30, 2003 totaled $1.9 million based on throughput of 50,398 barrels
per day and revenues for the Telfer asphalt terminal for the three
months ended June 30, 2003 were $1.1 million based on throughput of
938 barrels per day. Revenues for the other refined product terminals,
excluding the South Texas Terminals and the Telfer asphalt terminal,
increased $0.6 million primarily due to an increase in the additive
blending fee from $0.04 per barrel to $0.12 per barrel effective
January 1, 2003 and a 1% increase in throughput barrels;
o revenues for the refined product pipelines increased $3.9 million and
throughput increased 31% primarily due to revenues from the
acquisition of the South Texas Pipelines on March 18, 2003. Revenues
for the South Texas Pipelines were $5.8 million and throughput totaled
109,759 barrels per day during the second quarter of 2003. Partially
offsetting the increased revenues related to the South Texas Pipelines
was a $2.1 million decrease in revenues related to the McKee to
Colorado Springs to Denver pipeline resulting from Valero Energy
maximizing production at its Denver refinery and lower jet fuel sales
by Valero Energy in Denver, resulting in lower throughput in this
pipeline; and
o revenues for the crude oil pipelines increased $1.4 million even
though total throughput decreased 3% primarily due to increased
revenues for the Wichita Falls to McKee and the Corpus Christi to
Three Rivers crude oil pipelines due to a combined 16% increase in
throughput barrels, which was partially offset by a decrease in
revenues for the Ardmore crude oil pipelines due to a combined 20%
decrease in throughput barrels. During the second quarter of 2003,
Valero Energy supplied its McKee refinery with greater quantities of
heavy sour crude oil, which was transported from the Texas Gulf Coast,
instead of crude oil transported through the Clawson to Dixon to McKee
crude oil pipelines. Also during the second quarter of 2003, Valero
Energy's Ardmore refinery was shut down for a major refinery
turnaround for most of April, resulting in a decrease in the Ringgold
to Wasson to Ardmore crude oil pipelines.
Operating expenses increased $6.8 million for the three months ended June 30,
2003 as compared to the three months ended June 30, 2002 primarily due to the
following items:
o the acquisition of the South Texas Pipelines and Terminals increased
operating expenses by $3.5 million;
o the acquisition of the Crude Oil Storage Tanks increased operating
expenses by $1.4 million;
o the acquisitions of the Telfer asphalt terminal and crude hydrogen
pipeline increased operating expenses by $0.6 million;
o power costs, excluding the impact of acquisitions, increased $0.6
million due primarily to higher natural gas prices; and
o employee benefit expenses increased $0.4 million as a result of higher
accruals for incentive compensation due to higher net income and
increases in medical and pension costs.
22
General and administrative expenses were as follows:
Three Months Ended June 30,
---------------------------
2003 2002
---- ----
(in thousands)
Services agreement............................... $ 1,300 $ 1,300
Third party expenses............................. 482 557
Reimbursement from partners on jointly owned
pipelines....................................... (112) (159)
----- -----
General and administrative expenses............ $ 1,670 $ 1,698
===== =====
General and administrative expenses decreased 2% for the three months ended June
30, 2003 as compared to the three months ended June 30, 2002 due to lower third
party legal and accounting expenses, partially offset by lower reimbursements
from partners on jointly owned pipelines as a result of the Partnership's
purchase of Shell's interest in the Amarillo to Abernathy and the Abernathy to
Lubbock refined product pipelines.
Depreciation and amortization expense increased 88% during the three months
ended June 30, 2003 as compared to the three months ended June 30, 2002 due to
the additional depreciation recognized for the South Texas Pipelines and
Terminals, the Crude Oil Storage Tanks and the Telfer asphalt terminal.
Equity income from Skelly-Belvieu Pipeline Company for the three months ended
June 30, 2003 decreased 29% as compared to the three months ended June 30, 2002
due to a 16% decrease in throughput barrels in the Skellytown to Mont Belvieu
refined product pipeline. The decrease in throughput is due to both Valero
Energy and ConocoPhillips utilizing greater quantities of natural gas to run
their North Texas refining operations instead of selling the natural gas to
third parties in Mont Belvieu.
Interest expense for the three months ended June 30, 2003 was $4.7 million, net
of interest income and capitalized interest of $0.1 million, as compared to $0.8
million of interest expense, net of interest income and capitalized interest of
$0.1 million, for the three months ended June 30, 2002. Interest expense was
higher in 2003 due to interest expense related to the $100.0 million of 6.875%
senior notes issued in July of 2002 and the $250.0 million of 6.05% senior notes
issued in March of 2003. The 2003 borrowings were used to fund the common unit
redemption and a portion of the South Texas Pipelines and Terminals acquisition,
all of which closed in March 2003. The 2002 borrowings were used to repay
borrowings under the variable-rate revolving credit facility. Partially
offsetting the higher interest expense in 2003 from the above factors is the
effect of interest rate swaps entered into during the first quarter and early
April of 2003. The Partnership entered into $167.5 million (notional amount) of
interest rate swaps, which effectively convert $167.5 million of fixed-rate debt
to variable-rate debt, reducing the effective interest rate on such debt by
approximately 300 basis points based on current rates.
Net income applicable to the general partner for the three months ended June 30,
2003 includes the effect of $0.7 million of incentive distributions.
23
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
The results of operations for the six months ended June 30, 2003 presented in
the following table are derived from the consolidated statement of income for
Valero L.P. and subsidiaries for the six months ended June 30, 2003, which
includes the results of operations of the South Texas Pipelines and Terminals
and the Crude Oil Storage Tanks for the period from March 19, 2003 through June
30, 2003, the Telfer asphalt terminal from January 7, 2003 through June 30, 2003
and the Shell pipeline interest from May 1, 2003 through June 30, 2003. The
results of operations for the six months ended June 30, 2002 presented in the
following table are derived from the consolidated statement of income for Valero
L.P. and subsidiaries for the six months ended June 30, 2002, which includes the
Wichita Falls Business for the month ended January 31, 2002 prior to its actual
acquisition on February 1, 2002.
Financial Data:
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
Statement of Income Data: (in thousands)
Revenues.................................................... $ 79,358 $ 56,054
------ ------
Costs and expenses:
Operating expenses......................................... 27,996 18,749
General and administrative expenses........................ 3,514 3,487
Depreciation and amortization expense...................... 11,552 8,231
------ ------
Total costs and expenses.................................. 43,062 30,467
------ ------
Operating income............................................ 36,296 25,587
Equity income from Skelly-Belvieu Pipeline Company......... 1,331 1,522
Interest expense, net...................................... (7,113) (1,352)
------ ------
Income before income tax expense............................ 30,514 25,757
Income tax expense......................................... - 395
------ ------
Net income.................................................. 30,514 25,362
Less net income applicable to general partner.............. (1,690) (494)
Less net income related to the Wichita Falls Business
for the month ended January 31, 2002...................... - (650)
------ ------
Net income applicable to the limited partners' interest..... $ 28,824 $ 24,218
====== ======
Net income per unit applicable to limited partners.......... $ 1.40 $ 1.26
====== ======
Weighted average number of limited partnership units
outstanding................................................ 20,635,667 19,247,789
========== ==========
EBITDA (a).................................................. $ 49,179 $ 35,340
====== ======
Distributable cash flow (a)................................. $ 39,724 $ 32,558
====== ======
June 30, December 31,
Balance Sheet Data: 2003 2002
---- ----
Long-term debt, including current portion (1)............... $ 365,231 $ 109,658
Partners' equity (2)........................................ 385,636 293,895
Debt-to-capitalization ratio (1) / ((1)+(2))................ 48.6% 27.2%
24
(a) The following is a reconciliation of income before income tax expense to
EBITDA and distributable cash flow.
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
(in thousands)
Income before income tax expense.................. $ 30,514 $ 25,757
Plus interest expense, net....................... 7,113 1,352
Plus depreciation and amortization expense....... 11,552 8,231
------ ------
EBITDA............................................ 49,179 35,340
Less equity income from Skelly-Belvieu Pipeline
Company........................................ (1,331) (1,522)
Less interest expense, net....................... (7,113) (1,352)
Less reliability capital expenditures............ (2,638) (1,530)
Plus distributions from Skelly-Belvieu Pipeline
Company........................................ 1,627 1,622
------ ------
Distributable cash flow........................... $ 39,724 $ 32,558
====== ======
For a discussion regarding the Partnership's rationale for utilizing the
non-GAAP measures of EBITDA and distributable cash flow, please see Valero
L.P.'s Annual Report on Form 10-K for the year ended December 31, 2002.
Operating Data:
The following table reflects total throughput, on a barrels per day basis, for
the Partnership's crude oil pipelines, refined product pipelines, refined
product terminals and crude oil storage tanks for the six months ended June 30,
2003 and 2002. On March 18, 2003, the Partnership acquired the South Texas
Pipelines and Terminals and the Crude Oil Storage Tanks from Valero Energy. The
throughput related to these newly acquired assets included in the table below is
calculated based on throughput for the period from March 19, 2003 through June
30, 2003 divided by the 181 days in the six months ended June 30, 2003.
Six Months Ended June 30,
-------------------------
2003 2002 % Change
---- ---- --------
(barrels per day)
Crude oil pipeline throughput............. 340,619 336,605 1%
======= =======
Refined product pipeline throughput....... 347,000 283,375 22%
======= =======
Refined product terminal throughput....... 205,495 177,877 16%
======= =======
Crude oil storage tank throughput......... 277,468 N/A N/A
=======
Net income for the six months ended June 30, 2003 was $30.5 million as compared
to $25.4 million for the six months ended June 30, 2002. The increase of $5.1
million was primarily attributable to the additional net income generated from
the acquisitions of the South Texas Pipelines and Terminals, the Crude Oil
Storage Tanks and the Telfer asphalt terminal. Net income generated by the
acquired assets during the six months ended June 30, 2003 totaled $6.6 million.
25
Revenues for the six months ended June 30, 2003 were $79.4 million as compared
to $56.1 million for the six months ended June 30, 2002, an increase of 42% or
$23.3 million. The following discusses significant revenue increases and
decreases:
o revenues for the Crude Oil Storage Tanks from March 19, 2003 through
June 30, 2003 totaled $10.0 million;
o revenues for the refined product pipelines increased $5.2 million and
throughput increased 22% primarily due to revenues from the
acquisition of the South Texas Pipelines on March 18, 2003. Revenues
for the South Texas Pipelines were $6.9 million and throughput totaled
63,798 barrels per day from March 19, 2003 through June 30, 2003.
Partially offsetting the increased revenues related to the South Texas
Pipelines was a $2.7 million decrease in revenues related to the McKee
to Colorado Springs to Denver pipeline resulting from Valero Energy
maximizing production at its Denver refinery and lower jet fuel sales
by Valero Energy in Denver, resulting in lower throughput in this
pipeline;
o revenues for the South Texas Terminals for the period from March 19,
2003 through June 30, 2003 totaled $2.1 million based on throughput of
29,233 barrels per day and revenues for the Telfer asphalt terminal
for the six months ended June 30, 2003 were $2.1 million based on
throughput of 1,584 barrels per day. Revenues for the other refined
product terminals, excluding the South Texas Terminals and the Telfer
asphalt terminal, increased $0.8 million primarily due to an increase
in the additive blending fee from $0.04 per barrel to $0.12 per barrel
effective January 1, 2003, partially offset by a 2% decrease in
throughput barrels; and
o revenues for the crude oil pipelines increased $3.1 million primarily
due to increased revenues for the Wichita Falls to McKee and the
Corpus Christi to Three Rivers crude oil pipelines due to a combined
16% increase in throughput barrels and the crude hydrogen pipeline
which was acquired in May of 2002. Revenues and throughput for the
Partnership's other crude oil pipelines for the first six months of
2003 were comparable to the first six months of 2002 as the impact of
the economic-based refinery production cuts made by Valero Energy in
the first quarter of 2003, coupled with the Ardmore refinery
turnaround in March and April of 2003, offset the economic-based
refinery production cuts initiated by Valero Energy in the first six
months of 2002;.
Operating expenses increased $9.2 million for the six months ended June 30, 2003
as compared to the six months ended June 30, 2002 primarily due to the following
items:
o the acquisition of the South Texas Pipelines and Terminals increased
operating expenses by $4.2 million;
o the acquisition of the Crude Oil Storage Tanks increased operating
expenses by $1.6 million;
o maintenance expenses, excluding the impact of acquisitions, increased
$1.5 million due primarily to the increased number of pipeline and
terminal integrity inspections performed during the first six months
of 2003 as compared to 2002 and increased chemical expenses related to
drag reducing agents and gasoline additives;
o the acquisitions of the Telfer asphalt terminal and crude hydrogen
pipeline increased operating expenses by $1.1 million; and
o employee benefit expenses increased $0.5 million as a result of higher
accruals for incentive compensation due to higher net income and
increases in medical and pension costs.
26
General and administrative expenses were as follows:
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
(in thousands)
Services agreement................................... $ 2,600 $ 2,600
Third party expenses................................. 1,188 1,162
General and administrative expenses related to the
Wichita Falls Business for the month ended
January 31, 2002.................................... - 40
Reimbursement from partners on jointly owned
pipelines........................................... (274) (315)
----- -----
General and administrative expenses................. $ 3,514 $ 3,487
===== =====
General and administrative expenses increased 1% for the six months ended June
30, 2003 as compared to the six months ended June 30, 2002 due primarily to an
increase in general and administrative costs from third parties and lower
reimbursements from partners on jointly owned pipelines as a result of the
Partnership's purchase of Shell's interest in the Amarillo to Abernathy and the
Abernathy to Lubbock refined product pipelines.
Depreciation and amortization expense increased by 40% during the six months
ended June 30, 2003 as compared to the six months ended June 30, 2002 due
primarily to the acquisitions of the South Texas Pipelines and Terminals, the
Crude Oil Storage Tanks and the Telfer asphalt terminal.
Equity income from Skelly-Belvieu Pipeline Company for the six months ended June
30, 2003 decreased 13% as compared to the six months ended June 30, 2002 due to
a 6% decrease in throughput barrels in the Skellytown to Mont Belvieu refined
product pipeline. The decrease in throughput is due to both Valero Energy and
ConocoPhillips utilizing greater quantities of natural gas to run their North
Texas refining operations instead of selling the natural gas to third parties in
Mont Belvieu.
Interest expense for the six months ended June 30, 2003 was $7.1 million, net of
interest income and capitalized interest of $0.2 million, as compared to $1.4
million of interest expense, net of interest income and capitalized interest of
$0.2 million, for the six months ended June 30, 2002. Interest expense was
higher in 2003 due to interest expense related to the $100.0 million of 6.875%
senior notes issued in July of 2002 and the $250.0 million of 6.05% senior notes
issued in March of 2003. Partially offsetting the higher interest expense in
2003 from the above factors is the effect of interest rate swaps entered into
during the six months ended June 30, 2003. The Partnership entered into $167.5
million (notional amount) of interest rate swaps, which effectively convert
$167.5 million of fixed-rate debt to variable-rate debt, reducing the effective
interest rate on such debt by approximately 300 basis points based on current
rates.
Income tax expense for the six months ended June 30, 2002 represents income tax
expense incurred by the Wichita Falls Business during the month ended January
31, 2002, prior to the transfer of the Wichita Falls Business to the
Partnership.
Net income for the six months ended June 30, 2002 includes $0.7 million of net
income related to the Wichita Falls Business for the month ended January 31,
2002, which was allocated entirely to the general partner. Net income applicable
to the general partner for the six months ended June 30, 2003 includes the
effect of $1.1 million of incentive distributions.
27
Financial Outlook
Throughput volumes thus far in the third quarter of 2003 are similar to the
throughput volumes handled by the Partnership in the second quarter of 2003,
which included a full quarter of operations of the South Texas Pipelines and
Terminals and the Crude Oil Storage Tanks. Due to the favorable refined product
fundamentals Valero Energy is experiencing throughout its refining system, and
the expected return to service of certain processing facilities at Valero
Energy's Benicia and Texas City refineries, the Partnership anticipates its
throughput volumes will trend at or above current levels for the remainder of
the third quarter of 2003. Net income per unit for the third quarter of 2003
will be impacted by the 1,236,250 increase in common units outstanding resulting
from the August 2003 common unit offering.
Liquidity and Capital Resources
The Partnership's primary cash requirements, in addition to normal operating
expenses, are for capital expenditures (both reliability and expansion),
business and asset acquisitions, distributions to partners and debt service. The
Partnership expects to fund its short-term needs for such items as reliability
capital expenditures and quarterly distributions to the partners from operating
cash flows. Capital expenditures for long-term needs resulting from future
expansion projects and acquisitions are expected to be funded by a variety of
sources including cash flows from operating activities, borrowings under the
revolving credit facility and the issuance of additional common units, debt
securities and other capital market transactions.
Amended Revolving Credit Facility
On March 6, 2003, Valero Logistics amended its revolving credit facility,
increasing its credit limit to $175.0 million. On March 18, 2003, Valero
Logistics borrowed $25.0 million under the revolving credit facility to
partially fund the purchase of the South Texas Pipelines and Terminals from
Valero Energy, which borrowings were repaid during the three months ended June
30, 2003 primarily with the proceeds from the underwriters' exercise of the
over-allotment option. The revolving credit facility expires on January 15,
2006. At Valero Logistics' option, borrowings under the revolving credit
facility bear interest based on either an alternative base rate or LIBOR. Valero
Logistics also incurs a facility fee on the aggregate commitments of lenders
under the revolving credit facility, whether used or unused. Borrowings under
the revolving credit facility may be used for working capital and general
partnership purposes; however, borrowings to fund distributions to unitholders
are limited to $40.0 million. All borrowings designated as borrowings subject to
the $40.0 million sublimit must be reduced to zero for a period of at least 15
consecutive days during each fiscal year. The revolving credit facility also
allows Valero Logistics to issue letters of credit for an aggregate of $75.0
million.
The amended revolving credit facility requires that Valero Logistics maintain
certain financial ratios and includes other restrictive covenants, including a
prohibition on distributions by Valero Logistics to Valero L.P. if any default,
as defined in the revolving credit facility, exists or would result from the
distribution. Valero L.P. has guaranteed the obligations under the revolving
credit facility.
6.05% Senior Notes
On March 18, 2003, Valero Logistics issued, in a private placement, $250.0
million of 6.05% senior notes, due March 15, 2013, for proceeds of $247.3
million, net of discount of $0.7 million and debt issuance costs of $2.0
million. The net proceeds were used to redeem 3,809,750 common units held by an
affiliate of Valero Energy ($134.1 million), redeem a related portion of the
general partner interest ($2.9 million) and partially fund the South Texas
Pipelines and Terminals acquisition. The 6.05% senior notes are redeemable and
do not have sinking fund requirements. Interest on the 6.05% senior notes is
payable semiannually in arrears on March 15 and September 15 of each year
beginning September 15, 2003. Valero L.P. has guaranteed the 6.05% senior notes.
The 6.05% senior notes were not registered under the Securities Act of 1933 or
any other securities laws and consequently the 6.05% senior notes were subject
to transfer and resale restrictions. In July 2003, Valero Logistics closed on
the exchange of the outstanding $250.0 million 6.05% senior notes that were not
registered under the Securities Act of 1933 for $250.0 million of 6.05% senior
notes that have been registered under the Securities Act of 1933. Accordingly,
the new senior notes are freely transferable.
28
6.875% Senior Notes
The $100.0 million of 6.875% senior notes are due July 15, 2012 with interest
payable on January 15 and July 15 of each year. The 6.875% senior notes are
redeemable, do not have sinking fund requirements and rank equally with all
other existing senior unsecured indebtedness of Valero Logistics, including
indebtedness under the revolving credit facility. Valero L.P. has guaranteed the
6.875% senior notes.
Common Unit Offerings
On March 18, 2003, Valero L.P. closed on a public offering of 5,750,000 common
units at a price of $36.75 per unit, before underwriters' discount of $1.56 per
unit, for net proceeds of $202.3 million before offering expenses of $2.0
million. In order to maintain its 2% general partner interest, Riverwalk
Logistics, L.P. made a $4.3 million general partner contribution. The
Partnership used the net proceeds of the common unit offering and the general
partner contribution primarily to fund the acquisition of the Crude Oil Storage
Tanks. On April 16, 2003, Valero L.P. closed on the exercise of a portion of the
underwriters' over-allotment option, by selling 581,000 common units at $35.19
per unit, net of underwriters' discount. Net proceeds from this sale of $20.4
million, combined with a $0.4 million contribution from Riverwalk Logistics,
L.P. to maintain its 2% general partner interest, were used to pay down the
outstanding balance due under the revolving credit facility.
On August 11, 2003, Valero L.P. closed on a public offering of 1,236,250 common
units, which includes 161,250 common units related to the over-allotment option,
at a price of $41.15 per unit, before underwriter's discount of $1.85 per unit,
for net proceeds of $48.6 million before offering expenses of $0.3 million. In
order to maintain its 2% general partner interest, Riverwalk Logistics, L.P.
made a $1.0 million general partner contribution. As a result of this common
unit offering, Valero Energy's ownership of Valero L.P. has been reduced to
45.8%, including the 2% general partner interest.
Shelf Registration Statement
On June 6, 2002, Valero L.P. and Valero Logistics filed a $500.0 million
universal shelf registration statement with the Securities and Exchange
Commission covering the issuance of an unspecified amount of common units or
debt securities or a combination thereof. Valero L.P. may, in one or more
offerings, offer and sell common units representing limited partner interests in
Valero L.P. Valero Logistics may, in one or more offerings, offer and sell its
debt securities, which will be fully and unconditionally guaranteed by Valero
L.P. As a result of the July 2002 6.875% senior note offering by Valero
Logistics, the March 2003 common unit offering (including the over-allotment
option) by Valero L.P. and the August 2003 common unit offering (including the
over-allotment option) by Valero L.P., the remaining balance available under the
universal shelf registration statement is $116.5 million.
Interest Rate Swaps
During the six months ended June 30, 2003, Valero Logistics entered into
interest rate swap agreements to manage its exposure to changes in interest
rates. The interest rate swap agreements have an aggregate notional amount of
$167.5 million, of which $60.0 million is tied to the maturity of the 6.875%
senior notes and $107.5 million is tied to the maturity of the 6.05% senior
notes. Under the terms of the interest rate swap agreements, the Partnership
will receive the fixed rate (6.875% and 6.05%, respectively) and will pay a
variable rate based on LIBOR plus a percentage that varies with each agreement.
The Partnership accounts for the interest rate swaps as fair value hedges, with
changes in the fair value of each swap and the related debt instrument recorded
as an adjustment to interest expense in the consolidated statement of income.
Distributions
Valero L.P.'s partnership agreement, as amended, sets forth the calculation to
be used to determine the amount and priority of cash distributions that the
common unitholders, subordinated unitholders and the general partner will
receive. During the subordination period, the holders of Valero L.P.'s common
units are entitled to receive each quarter a minimum quarterly distribution of
$0.60 per unit ($2.40 annualized) prior to any distribution of available cash to
holders of Valero L.P.'s subordinated units. The subordination period is defined
generally as the period that will end on the first day of any quarter beginning
after March 31, 2006 if (1) Valero L.P. has distributed at least the minimum
quarterly distribution on all outstanding units with respect to each of the
immediately preceding three consecutive, non-overlapping four-quarter periods
and (2) Valero L.P.'s adjusted operating surplus, as defined in the partnership
29
agreement, during such periods equals or exceeds the amount that would have been
sufficient to enable Valero L.P. to distribute the minimum quarterly
distribution on all outstanding units on a fully diluted basis and the related
distribution on the 2% general partner interest during those periods. If the
subordination period ends, the rights of the holders of subordinated units will
no longer be subordinated to the rights of the holders of common units and the
subordinated units may be converted into common units, on a one-for-one basis.
The general partner is entitled to incentive distributions if the amount Valero
L.P. distributes with respect to any quarter exceeds $0.60 per unit.
The following table reflects the allocation of the total cash distributions to
the general and limited partners applicable to the period in which the
distributions are earned:
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
(in thousands, except per unit data)
General partner interest............................ $ 667 $ 539
General partner incentive distribution.............. 1,102 425
------ ------
Total general partner distribution................. 1,769 964
Limited partners' distributions..................... 31,618 25,993
------ ------
Total cash distributions........................... $ 33,387 $ 26,957
====== ======
Cash distributions per unit applicable to limited
partners........................................... $ 1.45 $ 1.35
====== ======
In May 2003, Valero L.P. paid a quarterly cash distribution of $0.70 per unit
for the first quarter of 2003. On July 28, 2003, Valero L.P. declared a
quarterly cash distribution of $0.75 per unit for the second quarter of 2003,
which is payable on August 14, 2003 to holders of record on August 5, 2003. The
1,236,250 common units issued in the August 2003 common unit offering are not
eligible to receive a distribution related to the second quarter of 2003.
Capital Requirements
The petroleum pipeline and storage industry is capital-intensive, requiring
significant investments to maintain, upgrade or enhance existing operations and
to comply with environmental and safety regulations. The Partnership's capital
expenditures consist primarily of:
o reliability capital expenditures (formerly referred to as maintenance
capital expenditures), such as those required to maintain equipment
reliability and safety and to address environmental and safety
regulations; and
o expansion capital expenditures, such as those to expand and upgrade
pipeline capacity and to construct new pipelines, terminals and
storage tanks. In addition, expansion capital expenditures may include
acquisitions of pipeline, terminal or storage tank assets.
During the six months ended June 30, 2003, the Partnership incurred reliability
capital expenditures of $2.6 million primarily related to tank and pipeline pump
station upgrades at numerous locations. Expansion capital expenditures of $5.2
million during the six months ended June 30, 2003 were related to modifications
of the Albuquerque refined product terminal, the addition of new pumps on the
Wichita Falls to McKee crude oil pipeline and initial construction of the Nuevo
Laredo pipeline and propane terminal.
For the remainder of 2003, the Partnership expects to incur approximately $17
million of capital expenditures including approximately $5 million for
reliability capital expenditures and approximately $12 million for expansion
capital expenditures, including a refined product pipeline from Laredo, Texas to
Nuevo Laredo, Mexico and a propane terminal in Nuevo Laredo. The Partnership
expects to fund its capital expenditures from cash provided by operations and to
the extent necessary, from proceeds of borrowings under the revolving credit
facility or debt and equity offerings.
30
Acquisitions during the six months of 2003 include the January 7, 2003 purchase
of an asphalt terminal from Telfer for $15.1 million, the March 18, 2003
purchases of the South Texas Pipelines and Terminals and the Crude Oil Storage
Tanks from Valero Energy for a total of $350.0 million and the May 1, 2003
purchase of Shell's interest in the Amarillo to Abernathy and the Abernathy to
Lubbock refined product pipelines for $1.6 million. Acquisitions during the
first six months of 2002 represent the February 1, 2002 purchase, under a
purchase option included in the Omnibus Agreement, of the Wichita Falls crude
oil pipeline and storage facilities from Valero Energy for $64.0 million, which
was funded with proceeds under the revolving credit facility.
The Partnership believes it has sufficient funds from operations, and to the
extent necessary, from public and private capital markets and bank markets, to
fund its ongoing operating requirements. The Partnership 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 assurance regarding the
availability of any future financings or whether such financings can be made
available on terms acceptable to the Partnership.
Environmental, Health and Safety
The Partnership is subject to extensive federal, state and local environmental
and safety laws and regulations, including those relating to the discharge of
materials into the environment, waste management, pollution prevention measures,
pipeline integrity and operator qualifications. Because environmental and safety
laws and regulations are becoming more complex and stringent and new
environmental and safety laws and regulations are continuously being enacted or
proposed, the level of future expenditures required for environmental, health
and safety matters is expected to increase.
Valero Energy has agreed to indemnify the Partnership, for a period of
approximately 10 years, for pre-acquisition environmental damage related to
assets transferred or otherwise acquired by the Partnership from Valero Energy.
These indemnifications do not include liabilities that result from a change in
environmental law subsequent to acquisition. As an operator or owner of the
assets, the Partnership could be held liable for pre-acquisition environmental
damage should Valero Energy be unable to fulfill its obligation. However, the
Partnership believes that such a situation is remote given Valero Energy's
financial condition. As of June 30, 2003, the Partnership is not aware of any
material environmental liabilities that were not covered by the environmental
indemnifications.
31
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The principal market risk (i.e., the risk of loss arising from adverse changes
in market rates and prices) to which the Partnership is exposed is interest rate
risk on its debt. The Partnership manages its debt considering various financing
alternatives available in the market and manages its exposure to changing
interest rates principally through the use of a combination of fixed and
variable-rate debt. In addition, the Partnership utilizes interest rate swap
agreements to manage a portion of the exposure to changing interest rates by
converting certain fixed-rate debt to variable-rate debt.
Borrowings under the revolving credit facility expose the Partnership to
increases in the benchmark interest rate underlying its variable-rate revolving
credit facility. As of June 30, 2003, the Partnership's fixed-rate debt
consisted of the 6.05% senior notes, the 6.875% senior notes and the 8.0% Port
of Corpus Christi Authority note payable.
The following table provides information about the Partnership's long-term debt
and interest rate derivative instruments, all of which are sensitive to changes
in interest rates. For long-term debt, principal cash flows and related
weighted-average interest rates by expected maturity dates are presented. For
interest rate swaps, the table presents notional amounts and weighted-average
interest rates by expected (contractual) maturity dates. Weighted-average
variable rates are based on implied forward interest rates in the yield curve at
the reporting date.
June 30, 2003
---------------------------------------------------------------------------------------------
Expected Maturity Dates
--------------------------------------------------------------------------
There- Fair
2003 2004 2005 2006 2007 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
(in thousands, except interest rates)
Long-term Debt:
Fixed rate.................. $ 449 $ 485 $ 524 $ 566 $ 611 $ 357,025 $ 359,660 $ 384,403
Average interest rate..... 8.0% 8.0% 8.0% 8.0% 8.0% 6.3% 6.3%
Variable rate............... $ - $ - $ - $ - $ - $ - $ - $ -
Average interest rate..... - - - - - - -
Interest Rate Swaps
Fixed to Variable:
Notional amount............ $ - $ - $ - $ - $ - $ 167,500 $ 167,500 $ 6,536
Average pay rate.......... 2.9% 3.4% 4.4% 5.2% 6.1% 6.8% 5.8%
Average receive rate...... 6.3% 6.3% 6.3% 6.3% 6.3% 6.4% 6.4%
December 31, 2002
------------------------------------------------------------------------------------------
Expected Maturity Dates
-----------------------------------------------------------------------
There- Fair
2003 2004 2005 2006 2007 after Total Value
---- ---- ---- ---- ---- ----- ----- -----
(in thousands, except interest rates)
Long-term Debt:
Fixed rate................... $ 747 $ 485 $ 524 $ 566 $ 611 $ 107,025 $ 109,958 $ 109,922
Average interest rate...... 8.0% 8.0% 8.0% 8.0% 8.0% 6.9 % 7.0%
Variable rate................ $ - $ - $ - $ - $ - $ - $ - $ -
Average interest rate...... - - - - - - -
Prior to 2003, the Partnership did not engage in interest rate hedging
transactions.
32
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
The principal executive officer and principal financial officer of Valero
GP, LLC have evaluated Valero L.P.'s disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of
the end of the period covered by this Quarterly Report on Form 10-Q. Based
on that evaluation, these officers concluded that the design and operation
of Valero L.P.'s disclosure controls and procedures are effective in
ensuring that information required to be disclosed by Valero L.P. in the
reports that it files or submits under the Securities Exchange Act of 1934
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 control over financial reporting.
Therehave been no significant changes in Valero L.P.'s internal control
over financial reporting (as defined in Rule 13a-15(f) under the Securities
Exchange Act of 1934) that occurred during Valero L.P.'s last fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, Valero L.P.'s internal control over financial reporting.
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On July 10, 2003, Valero Logistics closed on the exchange of the outstanding
$250.0 million 6.05% senior notes that were not registered under the Securities
Act of 1933 for $250.0 million of 6.05% senior notes that have been registered
under the Securities Act of 1933. Accordingly, the new 6.05% senior notes are
freely transferable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 12.1 Statement of Computation of Ratio of Earnings to Fixed
Charges
Exhibit 31.1 Rule 13a-14(a) Certifications (under Section 302 of the
Sarbanes-Oxley Act of 2002)
Exhibit 32.1 Section 1350 Certifications (as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002)
(b) Reports on Form 8-K
(i) On April 2, 2003, Valero L.P. filed a Current Report on Form 8-K dated
March 18, 2003 reporting Item 2 (Acquisition or Disposition of Assets) in
connection with Valero L.P.'s acquisition of (a) 58 crude oil storage tanks with
an aggregate storage capacity of approximately 11.0 million barrels for $200.0
million and (b) the Valero South Texas Pipelines and Terminals Business
consisting of three pipeline systems with an aggregate throughput capacity of
171,100 barrels per day for $150.0 million. Filed in Item 7 (Financial
Statements and Exhibits) of the Form 8-K were (1) audited financial statements
for the Valero South Texas Pipeline and Terminal Business as of and for the year
ended December 31, 2002, and (2) pro forma financial statements for Valero L.P.
and subsidiaries as of and for the year ended December 31, 2002 that give effect
to the acquisition of the Valero South Texas Pipeline and Terminal Business.
33
(ii) On April 21, 2003, Valero L.P. furnished pursuant to Regulation FD a
Current Report on Form 8-K dated April 21, 2003 reporting Item 12 (under Item 9
for EDGAR System purposes) and furnishing a copy of Valero L.P.'s press release
relating to its earnings announcement for the first quarter of 2003. Financial
statements were not filed with this report.
(iii) On June 12, 2003, Valero L.P. furnished pursuant to Regulation FD a
Current Report on Form 8-K dated June 12, 2003 reporting Item 9 and furnishing a
copy of a slide presentation made by Valero L.P.'s management to analysts and
investors in June 2003 at the Lehman Brothers Fixed Income Conference in
Houston, Texas. Financial statements were not filed with this report.
34
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 L.P.
(Registrant)
By: Riverwalk Logistics, L.P., its general partner
By: Valero GP, LLC, its general partner
By: /s/ Curtis V. Anastasio
-------------------------------
(Curtis V. Anastasio)
President and Chief Executive Officer
August 13, 2003
By: /s/ Steven A. Blank
-------------------------------
(Steven A. Blank)
Senior Vice President and Chief Financial Officer
August 13, 2003
By: /s/ Clayton E. Killinger
-------------------------------
(Clayton E. Killinger)
Vice President and Controller
August 13, 2003
35