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 September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 333-27015
VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 74-1828067
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7990 West IH 10
San Antonio, Texas
(Address of principal executive offices)
78230
(Zip Code)
(210) 370-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes X No
Indicated below is the number of shares outstanding of the registrant's only
class of common stock, as of November 1, 1997.
Number of
Shares
Title of Class Outstanding
Common Stock, $.01 Par Value 56,120,558
<PAGE>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
Page
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets - September 30, 1997 and December 31,
1996 . .........................................................
Consolidated Statements of Income - For the Three Months Ended and
Nine Months Ended September 30, 1997 and 1996. . . . . . . . . . .
Consolidated Statements of Cash Flows - For the Nine Months Ended
September 30, 1997 and 1996. . . . . . . . . . . . . . . . . . . .
Notes to Consolidated Financial Statements . . . . . . . . . . . . .
Management's Discussion and Analysis of Financial Condition and
Results of Operations. . . . . . . . . . . . . . . . . . . . . .
PART II. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . .
SIGNATURE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
<PAGE>
<TABLE>
PART I - FINANCIAL INFORMATION
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
<CAPTION>
September 30, December 31,
1997 1996
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and temporary cash investments. . . . . $ 21,930 $ 10
Receivables, less allowance for doubtful
accounts of $1,200 (1997) and $975 (1996). 352,420 162,457
Inventories. . . . . . . . . . . . . . . . . 347,277 159,871
Current deferred income tax assets . . . . . 14,797 17,587
Prepaid expenses and other . . . . . . . . . 10,471 11,924
746,895 351,849
PROPERTY, PLANT AND EQUIPMENT - including
construction in progress of $54,984 (1997)
and $21,786 (1996), at cost. . . . . . . . . 2,083,151 1,712,334
Less: Accumulated depreciation. . . . . . 524,831 480,124
1,558,320 1,232,210
INVESTMENT IN AND ADVANCES TO JOINT VENTURES . 32,443 29,192
NET ASSETS OF DISCONTINUED OPERATIONS. . . . . - 280,515
DEFERRED CHARGES AND OTHER ASSETS. . . . . . . 81,043 91,865
$2,418,701 $1,985,631
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
PART I - FINANCIAL INFORMATION
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
(Unaudited)
<CAPTION>
September 30, December 31,
1997 1996
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
CURRENT LIABILITIES:
Short-term debt. . . . . . . . . . . . . . . $ 175,000 $ 57,728
Current maturities of long-term debt . . . . - 26,037
Accounts payable . . . . . . . . . . . . . . 432,540 191,555
Other accrued expenses . . . . . . . . . . . 53,639 25,264
661,179 300,584
LONG-TERM DEBT, less current maturities. . . . 323,500 353,307
DEFERRED INCOME TAXES. . . . . . . . . . . . . 242,755 224,548
DEFERRED CREDITS AND OTHER LIABILITIES . . . . 40,567 30,217
REDEEMABLE PREFERRED STOCK, SERIES A, issued
1,150,000 shares, outstanding -0- (1997)
and 11,500 (1996) shares . . . . . . . . . . - 1,150
COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY:
Preferred stock, $.01 (1997) and $1 (1996)
par value - 20,000,000 shares authorized
including redeemable preferred shares:
$3.125 Convertible Preferred Stock,
issued and outstanding -0- (1997)
and 3,450,000 (1996) shares. . . . . . - 3,450
Common stock, $.01 (1997) and $1 (1996) par
value - 150,000,000 shares authorized;
issued 56,116,917 (1997)and
44,185,513 (1996) shares . . . . . . . . . 561 44,186
Additional paid-in capital . . . . . . . . . 1,110,540 540,133
Unearned Valero Employees' Stock Ownership
Plan Compensation. . . . . . . . . . . . . - (8,783)
Retained earnings. . . . . . . . . . . . . . 39,750 496,839
Treasury stock, 4,631 (1997) and -0- (1996)
common shares, at cost . . . . . . . . . . (151) -
1,150,700 1,075,825
$2,418,701 $1,985,631
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Thousands of Dollars, Except Per Share Amounts)
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
OPERATING REVENUES . . . . . . . . . . . . . . .$ 1,975,665 $ 678,059 $ 4,160,091 $ 1,927,590
COSTS AND EXPENSES:
Cost of sales and operating expenses . . . . . 1,846,626 634,632 3,887,135 1,793,652
Selling and administrative expenses. . . . . . 17,502 6,678 36,962 23,333
Depreciation expense . . . . . . . . . . . . . 17,430 13,689 47,674 40,906
Total. . . . . . . . . . . . . . . . . . . . 1,881,558 654,999 3,971,771 1,857,891
OPERATING INCOME . . . . . . . . . . . . . . . . 94,107 23,060 188,320 69,699
EQUITY IN EARNINGS OF JOINT VENTURES . . . . . . 1,189 1,350 3,251 2,171
OTHER INCOME, NET. . . . . . . . . . . . . . . . 272 249 1,224 2,694
INTEREST AND DEBT EXPENSE:
Incurred . . . . . . . . . . . . . . . . . . . (12,601) (10,003) (37,178) (30,900)
Capitalized. . . . . . . . . . . . . . . . . . 408 1,089 1,274 2,004
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES. . . . . . . . . . . . . . 83,375 15,745 156,891 45,668
INCOME TAX EXPENSE . . . . . . . . . . . . . . . 31,382 9,115 57,489 17,911
INCOME FROM CONTINUING OPERATIONS. . . . . . . . 51,993 6,630 99,402 27,757
INCOME (LOSS) FROM DISCONTINUED OPERATIONS,
NET OF INCOME TAX EXPENSE (BENEFIT) OF
$(1,082), $(1,415), $(8,889) AND $10,889,
RESPECTIVELY. . . . . . . . . . . . . . . . . (432) 6,516 (15,672) 26,144
NET INCOME . . . . . . . . . . . . . . . . . . . 51,561 13,146 83,730 53,901
Less: Preferred stock dividend
requirements and redemption
premium . . . . . . . . . . . . . . . . . . - 2,844 4,592 8,526
NET INCOME APPLICABLE TO COMMON STOCK. . . . . . $ 51,561 $ 10,302 $ 79,138 $ 45,375
EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Continuing operations. . . . . . . . . . . . . $ .93 $ .15 $ 1.98 $ .63
Discontinued operations. . . . . . . . . . . . (.01) .08 (.40) .40
Total. . . . . . . . . . . . . . . . . . . . $ .92 $ .23 $ 1.58 $ 1.03
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (in thousands) . . . . . . . . . . 55,950 43,984 50,175 43,878
DIVIDENDS PER SHARE OF COMMON STOCK. . . . . . . $ .08 $ .13 $ .34 $ .39
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands of Dollars)
(Unaudited)
<CAPTION>
Nine Months Ended
September 30,
1997 1996
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations. . . . . . . . . . . . . . $ 99,402 $ 27,757
Adjustments to reconcile income from continuing
operations to net cash provided by continuing
operations:
Depreciation expense . . . . . . . . . . . . . . . . . 47,674 40,906
Amortization of deferred charges and other, net. . . . 22,540 23,733
Changes in current assets and current liabilities. . . 50,500 17,671
Deferred income tax expense. . . . . . . . . . . . . . 20,927 9,763
Equity in earnings of joint ventures . . . . . . . . . (3,251) (2,171)
Changes in deferred items and other, net . . . . . . . (7,927) (10,030)
Net cash provided by continuing operations . . . . . 229,865 107,629
Net cash provided by discontinued operations . . . . 24,752 75,613
Net cash provided by operating activities. . . . . 254,617 183,242
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures:
Continuing operations. . . . . . . . . . . . . . . . . . (40,586) (41,973)
Discontinued operations. . . . . . . . . . . . . . . . . (52,674) (48,141)
Deferred turnaround and catalyst costs . . . . . . . . . . (4,466) (23,952)
Acquisition of Basis Petroleum, Inc. . . . . . . . . . . . (362,060) -
Investment in and advances to joint ventures, net. . . . . - 1,792
Dispositions of property, plant and equipment. . . . . . . 28 92
Other, net . . . . . . . . . . . . . . . . . . . . . . . . (5) (1,162)
Net cash used in investing activities. . . . . . . . . . (459,763) (113,344)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in short-term debt, net . . . . . . . . . . . . . 208,088 44,888
Long-term borrowings . . . . . . . . . . . . . . . . . . . 1,300,068 28,500
Long-term debt reduction . . . . . . . . . . . . . . . . . (1,092,668) (122,754)
Special spin-off dividend, including intercompany
note settlement. . . . . . . . . . . . . . . . . . . . . (214,653) -
Common stock dividends . . . . . . . . . . . . . . . . . . (16,541) (17,114)
Preferred stock dividends. . . . . . . . . . . . . . . . . (5,419) (8,526)
Issuance of common stock . . . . . . . . . . . . . . . . . 58,794 8,017
Purchase of treasury stock . . . . . . . . . . . . . . . . (9,264) (2,895)
Redemption of preferred stock. . . . . . . . . . . . . . . (1,339) -
Net cash provided by (used in)
financing activities. . . . . . . . . . . . . . . . . . 227,066 (69,884)
NET INCREASE IN CASH AND TEMPORARY
CASH INVESTMENTS . . . . . . . . . . . . . . . . . . . . . 21,920 14
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD. . . . . . . . . . . . . . . . . . . . 10 13
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD. . . . . . . . . . . . . . . . . . . . . . . $ 21,930 $ 27
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<PAGE>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Restructuring
In the discussion below and Notes that follow, "Energy" refers to
Valero Energy Corporation and its consolidated subsidiaries, both
individually and collectively, for periods prior to the restructuring, and to
the natural gas related services business of Energy for periods subsequent to
the restructuring. The "Company" refers to the former Valero Refining and
Marketing Company ("VRMC"), which was renamed Valero Energy Corporation
("VEC") on the date of the restructuring, and its consolidated subsidiaries.
On July 31, 1997, pursuant to an agreement and plan of distribution
between Energy and VRMC (the "Distribution Agreement"), Energy spun off VRMC
to Energy's stockholders by distributing all of VRMC's $.01 par value common
stock on a share for share basis to holders of record of Energy common stock
at the close of business on such date (the "Distribution"). Immediately
after the Distribution, Energy merged its natural gas related services
business with a wholly owned subsidiary of PG&E Corporation ("PG&E")(the
"Merger"). The completion of the Distribution and the Merger (collectively
referred to as the "Restructuring") finalizes the restructuring of Energy
previously announced in January 1997. The Distribution and the Merger
were approved by Energy's stockholders at Energy's annual meeting of
stockholders held on June 18, 1997 and, in the opinion of Energy's outside
counsel, were tax-free transactions. Regulatory approval of the Merger was
received from the Federal Energy Regulatory Commission (the "FERC") on
July 16, 1997. Upon completion of the Restructuring, VRMC was renamed
Valero Energy Corporation and is listed on the New York Stock Exchange
under the symbol "VLO."
Immediately prior to the Distribution, the Company paid to Energy a
$210 million dividend pursuant to the Distribution Agreement. In addition,
the Company paid to Energy approximately $5 million in settlement of the
intercompany note balance between the Company and Energy arising from
certain transactions during the period from January 1 through July 31, 1997.
In connection with the Merger, PG&E issued approximately 31 million
shares of its common stock in exchange for the outstanding $1 par value
common shares of Energy, and assumed $785.7 million of Energy's debt.
Each Energy stockholder received .554 of a share of PG&E common stock
(trading on the New York Stock Exchange under the symbol "PCG") for each
Energy share owned. This fractional share amount was based on the average
price of PG&E common stock during a prescribed period preceding the closing
of the transaction and the number of Energy shares issued and outstanding
at the time of the closing.
Prior to the Restructuring, Energy, the Company, and PG&E entered into
a tax sharing agreement ("Tax Sharing Agreement"), which sets forth each
party's rights and obligations with respect to payments and refunds, if any,
of federal, state, local or other taxes for periods before the Restructuring.
In general, under the Tax Sharing Agreement, Energy and the Company are each
responsible for its allocable share of the federal, state and other taxes
incurred by the combined operations of Energy and the Company prior to the
Distribution. Furthermore, the Company is responsible for substantially all
tax liability resulting from the failure of the Distribution or the Merger
to qualify as a tax-free transaction, except that Energy will be responsible
for any such tax liability attributable to certain actions taken by Energy
and/or PG&E.
2. Basis of Presentation
The consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (the "Commission").
However, all adjustments have been made to the accompanying financial
statements which are, in the opinion of the Company's management, necessary
for a fair presentation of the Company's results of operations for the
periods covered. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented herein not
misleading.
Prior to the Restructuring, VRMC was a wholly owned subsidiary of
Energy. For financial reporting purposes under the federal securities
laws, VRMC (now VEC) is a "successor registrant" to Energy. As a result,
the historical financial information included herein for periods prior to
the Restructuring is the historical financial information of Energy,
adjusted to reflect Energy's natural gas related services business as
discontinued operations. These consolidated financial statements should
be read in conjunction with the unaudited pro forma condensed combined
financial statements and the notes thereto of VRMC and the consolidated
financial statements and the notes thereto of Energy included in VRMC's
Form S-1 registration statement filed with the Commission on May 13, 1997
("Form S-1").
3. Discontinued Operations
Prior to the Restructuring, Energy's historical practice was to
utilize a centralized cash management system and to incur certain
indebtedness for its consolidated group at the parent company level
rather than at the operating subsidiary level. Therefore, the accompanying
consolidated financial statements reflect, for periods prior to the
Restructuring, the allocation of a portion of the borrowings under Energy's
various bank credit facilities, as well as a portion of other corporate
debt of Energy, to the discontinued natural gas related services business
based upon the ratio of such business' net assets, excluding the amounts
of intercompany notes receivable or payable, to Energy's consolidated net
assets. Interest expense related to corporate debt was also allocated to
the discontinued natural gas related services business for periods prior
to the Restructuring based on the same net asset ratio. Total interest
expense allocated to discontinued operations in the accompanying
Consolidated Statements of Income, including a portion of interest on
corporate debt allocated pursuant to the methodology described above
plus interest specifically attributed to discontinued operations,
was $4.7 million and $32.7 million for the one month and seven months
ended July 31, 1997, respectively, and $14.1 million and $43.7 million
for the three months and nine months ended September 30, 1996, respectively.
Revenues of the discontinued natural gas related services business
were $283.5 million and $1.7 billion for the one month and seven months
ended July 31, 1997, respectively, and $504.4 million and $1.6 billion
for the three months and nine months ended September 30, 1996, respectively.
These amounts are not included in operating revenues as reported in the
accompanying Consolidated Statements of Income.
4. Acquisition of Basis Petroleum, Inc.
Effective May 1, 1997, Energy acquired the outstanding common stock
of Basis Petroleum, Inc. ("Basis"), a wholly owned subsidiary of Salomon
Inc ("Salomon"). Prior to the Restructuring, Energy transferred the stock
of Basis to VRMC. As a result, Basis was a part of the Company at the time
it was spun off to Energy's stockholders pursuant to the Restructuring.
The primary assets of Basis included three refineries in the U.S. Gulf
Coast region with total throughput capacity in excess of 300,000 barrels
per day ("BPD") and an extensive wholesale marketing business. The three
refineries were comprised of a 160,000 BPD facility in Texas City, Texas;
an 85,000 BPD facility in Houston, Texas; and a 65,000 BPD facility in
Krotz Springs, Louisiana. With the acquisition, the Company owns and
operates four refineries with total throughput capacity of about 500,000 BPD.
The acquisition was accounted for using the purchase method of accounting.
Therefore, the accompanying consolidated statements of income of the
Company include the results of the operations acquired in connection with
the purchase of Basis for the months of May through September 1997.
Energy acquired the stock of Basis for $476 million. The purchase
price was paid, in part, with 3,429,796 shares of Energy common stock having
a fair market value of $114 million, with the remainder paid in cash from
borrowings under Energy's bank credit facilities (see Note 8). In
addition, Salomon is entitled to receive payments in any of the next 10
years if certain average refining margins during any of such years improve
above a specified level. Any payments under this earn-out arrangement,
which will be determined as of May 1 of each year beginning in 1998, are
limited to $35 million in any year and $200 million in the aggregate and
will be accounted for by the Company as an additional cost of the acquisition
and depreciated over the remaining lives of the assets to which the
additional cost is allocated.
The following unaudited pro forma financial information of the Company
assumes that the acquisition of Basis occurred at the beginning of each period
presented. Such pro forma information is not necessarily indicative of the
results of future operations. (Dollars in thousands, except per share amounts.)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1997 1996
<S> <C> <C>
Operating revenues. . . . . . . . . . . . . . . . . . $ 5,980,547 $ 7,104,243
Operating income (loss) . . . . . . . . . . . . . . . 127,133 (4,393)
Income (loss) from continuing operations. . . . . . . 60,902 (24,061)
Income (loss) from discontinued operations. . . . . . (15,672) 26,143
Net income. . . . . . . . . . . . . . . . . . . . . . 45,230 2,082
Earnings (loss) per share of common stock:
Continuing operations . . . . . . . . . . . . . . . 1.12 (.55)
Discontinued operations . . . . . . . . . . . . . . (.43) .40
Net income (loss) per share of common stock . . . . . .69 (.15)
</TABLE>
5. Inventories
Refinery feedstocks and refined products and blendstocks are carried
at the lower of cost or market, with the cost of feedstocks purchased for
processing and produced products determined primarily under the last-in,
first-out ("LIFO") method of inventory pricing and the cost of feedstocks
and products purchased for resale determined primarily under the weighted
average cost method. The excess of the replacement cost of the Company's
LIFO inventories over their LIFO values was approximately $61 million
at September 30, 1997. Materials and supplies are carried principally
at weighted average cost not in excess of market. In September 1997,
the Company entered into a petroleum products purchase agreement whereby
the Company reduced its inventory investment and working capital requirements
through the sale to a third party of various crude oil, residual fuel oil,
distillate and gasoline inventories totaling $150 million. Pursuant to
such agreement, the Company has an option through August 2002 to purchase
all or a portion of petroleum product volumes equivalent to that sold.
The Company pays a quarterly reservation fee of approximately $2.6 million
for such option. Inventories as of September 30, 1997 and December 31,
1996 were as follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
<S> <C> <C>
Refinery feedstocks . . . . . . . . . . $ 103,183 $ 42,744
Refined products and blendstocks. . . . 184,612 99,398
Materials and supplies. . . . . . . . . 59,482 17,729
$ 347,277 $ 159,871
</TABLE>
6. Statements of Cash Flows
In order to determine net cash provided by continuing operations,
income from continuing operations has been adjusted by, among other things,
changes in current assets and current liabilities, excluding changes in
cash and temporary cash investments, current deferred income tax assets,
short-term debt and current maturities of long-term debt. The changes in
the Company's current assets and current liabilities, excluding the items
noted above, are shown in the following table as an (increase)/decrease
in current assets and an increase/(decrease) in current liabilities.
The Company's temporary cash investments are highly liquid, low-risk
debt instruments which have a maturity of three months or less when
acquired. (Dollars in thousands.)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1996
<S> <C> <C>
Receivables, net. . . . . . . . . . . . . . . $ 50,182 $ 23,429
Inventories . . . . . . . . . . . . . . . . . 59,085 (52,012)
Prepaid expenses and other. . . . . . . . . . 3,091 1,495
Accounts payable. . . . . . . . . . . . . . . (57,708) 44,744
Other accrued expenses. . . . . . . . . . . . (4,150) 15
Total. . . . . . . . . . . . . . . . . . . $ 50,500 $ 17,671
</TABLE>
Noncash investing and financing activities for the nine months ended
September 30, 1997 included the issuance of Energy common stock to Salomon
as partial consideration for the acquisition of the stock of Basis discussed
in Note 4, and various adjustments to debt and equity, including the
assumption of certain debt by PG&E that was previously allocated to the
Company, resulting from the Merger discussed in Note 1.
Cash interest and income taxes paid, including amounts related to
discontinued operations for periods up to and including July 31, 1997,
were as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1997 1996
<S> <C> <C>
Interest (net of amount capitalized). . . . . $60,055 $90,898
Income taxes. . . . . . . . . . . . . . . . . 5,601 10,746
</TABLE>
7. Industrial Revenue Bonds
On April 16, 1997, the Industrial Development Corporation of the Port
of Corpus Christi issued and sold, for the benefit of the Company,
$98.5 million of tax-exempt Revenue Refunding Bonds (the "Refunding Bonds"),
with credit enhancement provided through a letter of credit issued by
the Bank of Montreal (see Note 8). The Refunding Bonds were issued in four
series with due dates ranging from 2009 to 2027. The Refunding Bonds bear
interest at floating rates determined weekly, with the Company having the
right to convert such rates to a daily, weekly or commercial paper rate,
or to a fixed rate. Interest rates on the Refunding Bonds were initially
set at rates ranging from 3.85% to 3.95%. The Refunding Bonds were issued
to refund the Company's $98.5 million principal amount of tax-exempt
bonds which were issued in 1987 and were guaranteed by Energy. In
connection with the refinancing, both the Energy guarantee, as well as a
deed of trust and security agreement covering the Company's refinery in
Corpus Christi, Texas, were released.
On May 15, 1997, the Gulf Coast Industrial Development Authority issued
and sold, for the benefit of the Company, $25 million of new Waste Disposal
Revenue Bonds (the "Revenue Bonds") which mature on December 1, 2031. Other
terms and conditions of these bonds are similar to those of the Refunding
Bonds described above.
8. Bank Credit Facility
Effective May 1, 1997, Energy replaced its existing unsecured
$300 million revolving bank credit and letter of credit facility with a
new five-year, unsecured $835 million revolving bank credit and letter of
credit facility. The new credit facility has been used to finance a
portion of the acquisition cost of Basis as discussed above in Note 4
and to fund a $210 million dividend paid by the Company to Energy
immediately prior to the Distribution as discussed above in Note 1.
The facility also provides continuing credit enhancement for the Company's
Refunding Bonds and Revenue Bonds as discussed above in Note 7, and can
be used to provide financing for other general corporate purposes.
Energy was the borrower under the facility until the completion of the
Restructuring on July 31, 1997, at which time all obligations of Energy
under the facility were assumed by the Company.
The facility amount reduces by $150 million at the end of each of
the third and fourth years. Availability under the facility is also
reduced by the proceeds from debt issuances and certain asset sales,
and by 75% of the proceeds from certain equity issuances. The credit
facility includes certain restrictive covenants including a minimum
fixed charge coverage ratio of 1.8 to 1.0, a maximum debt to
capitalization ratio of 45%, a minimum net worth test, and certain
restrictions on, among other things, long-term leases and subsidiary debt.
Borrowings under the credit facility bear interest at either LIBOR
plus a margin, a base rate, or a money market rate. In addition, various
fees and expenses are required to be paid in connection with the credit
facility, including a facility fee, a letter of credit issuance fee and
a fee based on letters of credit outstanding. The interest rate and fees
under the credit facility are subject to adjustment based upon the credit
ratings assigned to the Company's long-term debt. In September 1997,
the Company received a corporate credit rating of BBB- from
Standard & Poor's. As a result, interest rate margins and fees under the
credit facility were immediately reduced and the credit facility's prior
limitations on the Company's ability to make certain dividend payments or
repurchases of common stock were eliminated. The Company is currently in
the process of amending the bank credit facility to further enhance
the Company's financial flexibility.
9. Redemption of Preferred Stock
On March 30, 1997, Energy redeemed the remaining 11,500 outstanding
shares of its Cumulative Preferred Stock, $8.50 Series A ("Series A
Preferred Stock"). The redemption price was $104 per share, plus dividends
accrued to the redemption date of $.685 per share.
In April 1997, Energy called all of its outstanding $3.125
convertible preferred stock ("Convertible Preferred Stock") for redemption
on June 2, 1997. The total redemption price for the Convertible Preferred
Stock was $52.1966 per share (representing a per-share redemption price of
$52.188, plus accrued dividends in the amount of $.0086 per share for the
one-day period from June 1, 1997 to the June 2, 1997 redemption date).
The Convertible Preferred Stock was convertible into Energy common stock
at a conversion price of $27.03 per share (equivalent to a conversion rate
of approximately 1.85 shares of common stock for each share of Convertible
Preferred Stock). Prior to the redemption, substantially all of the
outstanding shares of Convertible Preferred Stock were converted into
shares of Energy common stock.
10. Employee Benefit Plans
In connection with effecting the Restructuring discussed in Note 1,
on April 11, 1997, Energy's Board of Directors approved the termination of
Energy's leveraged employee stock ownership plan ("VESOP"), in which
Company employees were participants, and subsequently directed the VESOP
trustee to sell a sufficient amount of Energy common stock held in the
VESOP suspense account to repay the outstanding amount of notes issued
in connection with the VESOP ("VESOP Notes") and allocate the remaining
stock in the suspense account to the accounts of the VESOP participants.
The VESOP Notes were repaid in full in May 1997, after which 226,198
remaining shares of Energy common stock were allocated to all VESOP
participants.
11. Litigation and Contingencies
Litigation Relating to Operations of Basis Prior to Acquisition
Basis was named as a party to numerous claims and legal proceedings
which arose prior to its acquisition by the Company. Pursuant to the stock
purchase agreement between Energy, the Company, Salomon, and Basis,
Salomon assumed the defense of all known suits, actions, claims and
investigations pending at the time of the acquisition and all obligations,
liabilities and expenses related to or arising therefrom. In addition,
Salomon will assume all obligations, liabilities and expenses related
to or resulting from all private third-party suits, actions and claims
which arise out of a state of facts existing on or prior to the time
of the acquisition, but which were not pending at such time, subject to
certain terms, conditions and limitations. In certain pending matters,
the plaintiffs are seeking damages and requesting injunctive relief which,
if granted, could potentially result in the operations acquired in
connection with the purchase of Basis being adversely affected through
required reductions in emissions or discharges, required additions and
improvements to refinery controls or other equipment, or required
reductions in permit limits or refinery throughput. Although Energy and
the Company have conducted a due diligence investigation of Basis, there
can be no assurance that other material matters, not identified or fully
investigated in due diligence, will not be subsequently identified.
Litigation Relating to Discontinued Operations
Energy and certain of its natural gas related subsidiaries, as well
as the Company, have been sued by Teco Pipeline Company ("Teco") regarding
the operation of the 340-mile West Texas pipeline in which a subsidiary of
Energy holds a 50% undivided interest. In 1985, a subsidiary of Energy
sold a 50% undivided interest in the pipeline and entered into a joint
venture through an ownership agreement and an operating agreement, each
dated February 28, 1985, with the purchaser of the interest. In 1988,
Teco succeeded to that purchaser's 50% interest. A subsidiary of Energy
has at all times been the operator of the pipeline. Notwithstanding the
written ownership and operating agreements, the plaintiff alleges that a
separate, unwritten partnership agreement exists, and that the defendants
have exercised improper dominion over such alleged partnership's affairs.
The plaintiff also alleges that the defendants acted in bad faith by
negatively affecting the economics of the joint venture in order to provide
financial advantages to facilities or entities owned by the defendants
and by allegedly usurping for the defendants' own benefit certain
opportunities available to the joint venture. The plaintiff asserts
causes of action for breach of fiduciary duty, fraud, tortious
interference with business relationships, professional malpractice and
other claims, and seeks unquantified actual and punitive damages. Energy's
motion to compel arbitration was denied, but Energy has filed an appeal.
Energy has also filed a counterclaim alleging that the plaintiff breached
its own obligations to the joint venture and jeopardized the economic and
operational viability of the pipeline by its actions. Energy is seeking
unquantified actual and punitive damages. Although PG&E previously
acquired Teco and now ultimately owns both Teco and Energy after the
Restructuring, PG&E's Teco acquisition agreement purports to assign the
benefit or detriment of this lawsuit to the former shareholders of Teco.
Pursuant to the Distribution Agreement by which the Company was spun off
to Energy's stockholders in connection with the Restructuring, the Company
has agreed to indemnify and hold harmless Energy with respect to this
lawsuit to the extent of 50% of the amount of any final judgment or
settlement amount not in excess of $30 million, and 100% of that part of
any final judgment or settlement amount in excess of $30 million.
General
The Company is also a party to additional claims and legal
proceedings arising in the ordinary course of business. The Company
believes it is unlikely that the final outcome of any of the claims or
proceedings to which the Company is a party would have a material adverse
effect on the Company's financial statements; however, due to the inherent
uncertainty of litigation, the range of possible loss, if any, cannot be
estimated with a reasonable degree of precision and there can be no
assurance that the resolution of any particular claim or proceeding would
not have an adverse effect on the Company's results of operations for the
interim period in which such resolution occurred.
12. Accounting Policies for Derivatives
The Company enters into over-the-counter price swaps, options and
futures contracts with third parties to hedge refinery feedstock purchases
and refined product inventories in order to reduce the impact of adverse
price changes on these inventories before the conversion of the feedstock
to finished products and ultimate sale. Hedges of inventories are
accounted for under the deferral method with gains and losses included
in the carrying amounts of inventories and ultimately recognized in cost
of sales as those inventories are sold.
The Company also hedges anticipated transactions. Over-the-counter
price swaps, options and futures contracts with third parties are used to
hedge refining operating margins for periods up to two years by locking
in components of the margins, including the resid discount, the
conventional crack spread and the premium product differentials. Hedges
of anticipated transactions are also accounted for under the deferral
method with gains and losses on these transactions recognized
in cost of sales when the hedged transaction occurs.
The above noted contracts are designated at inception as a hedge
where there is a direct relationship to the price risk associated with
the Company's inventories, future purchases and sales of commodities
used in the Company's operations, or components of the Company's refining
operating margins. If such direct relationship ceases to exist, the
related contract is designated "for trading purposes" and accounted for
as described below.
Gains and losses on early terminations of financial instrument
contracts designated as hedges are deferred and included in cost of
sales in the measurement of the hedged transaction. When an
anticipated transaction being hedged is no longer likely to occur,
the related derivative contract is accounted for similar to a contract
entered into for trading purposes.
The Company also enters into price swaps, over-the-counter and
exchange-traded options, and futures contracts with third parties for
trading purposes using its fundamental and technical analysis of market
conditions to earn additional revenues. Contracts entered into for trading
purposes are accounted for under the fair value method. Changes in the
fair value of these contracts are recognized as gains or losses in cost
of sales currently and are recorded in the Consolidated Balance Sheets
in "Prepaid expenses and other" and "Accounts payable" at fair value at
the reporting date. The Company determines the fair value of its
exchange-traded contracts based on the settlement prices for open
contracts, which are established by the exchange on which the
instruments are traded. The fair value of the Company's over-the-counter
contracts is determined based on market-related indexes or by obtaining
quotes from brokers.
The Company's derivative contracts and their related gains and
losses are reported in the Consolidated Balance Sheets and Consolidated
Statements of Income as discussed above, depending on whether they are
designated as a hedge or for trading purposes. In the Consolidated
Statements of Cash Flows, recognized gains and losses on derivative
contracts are included in net income while deferred gains and losses
are included in changes in current assets and current liabilities.
13. Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," both of which become
effective for the Company's financial statements beginning in 1998.
The FASB had previously issued in March 1997 SFAS No. 128, "Earnings
per Share," and SFAS No. 129, "Disclosure of Information about
Capital Structure," both of which become effective for the Company's
financial statements beginning with the period ending December 31, 1997.
Based on information currently available to the Company, the adoption of
these statements will not have a material effect on the Company's
consolidated financial statements.
<PAGE>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following are the Company's financial and operating highlights
for the three months ended and nine months ended September 30, 1997
and 1996. The amounts in the following table are in thousands of dollars,
unless otherwise noted:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 (1) 1996 1997 (1) 1996
<S> <C> <C> <C> <C>
Operating revenues . . . . . . . . . . . . . . $1,975,665 $ 678,059 $4,160,091 $1,927,590
Operating income . . . . . . . . . . . . . . . 94,107 23,060 188,320 69,699
Equity in earnings of joint ventures . . . . . 1,189 1,350 3,251 2,171
Other income, net. . . . . . . . . . . . . . . 272 249 1,224 2,694
Interest and debt expense, net . . . . . . . . 12,193 8,914 35,904 28,896
Income from continuing operations. . . . . . . 51,993 6,630 99,402 27,757
Income (loss) from discontinued
operations, net of income taxes. . . . . . . (432) 6,516 (15,672) 26,144
Net income . . . . . . . . . . . . . . . . . . 51,561 13,146 83,730 53,901
Net income applicable to common stock. . . . . 51,561 10,302 79,138 45,375
Earnings (loss) per share of common stock:
Continuing operations. . . . . . . . . . . . $ .93 $ .15 $ 1.98 $ .63
Discontinued operations. . . . . . . . . . . (.01) .08 (.40) .40
Total. . . . . . . . . . . . . . . . . . . $ .92 $ .23 $ 1.58 $ 1.03
Operating statistics:
Corpus Christi refinery:
Throughput volumes (Mbbls per day) . . . . 189 165 177 167
Operating cost per barrel. . . . . . . . . $ 3.16 $ 3.21 $ 3.43 $ 3.32
Texas City/Houston/Krotz Springs refineries:
Throughput volumes (Mbbls per day) (2) . . 318 N/A 312 N/A
Operating cost per barrel (2). . . . . . . $ 2.14 N/A $ 2.21 N/A
Sales volumes (Mbbls per day). . . . . . . . 774 282 578 281
Average throughput margin per barrel . . . . $ 4.91 $ 5.22 $ 5.18 $ 5.40
<FN>
(1)Includes the operations of the Texas City, Houston and Krotz Springs
refineries commencing May 1, 1997.
(2)Year-to-date amounts are for the five months ended September 30, 1997.
</TABLE>
General
The Company reported income from continuing operations of $52 million,
or $.93 per share, for the third quarter of 1997 compared to $6.7 million,
or $.15 per share, for the same period in 1996. For the first nine months
of 1997, income from continuing operations was $99.4 million, or $1.98 per
share, compared to $27.8 million, or $.63 per share, for the first nine
months of 1996. Results from discontinued operations were losses of
$.5 million, or $.01 per share, and $15.7 million, or $.40 per share, for
the one month and seven months ended July 31, 1997, respectively, and income
of $6.4 million, or $.08 per share, and $26.1 million, or $.40 per share,
for the three months and nine months ended September 30, 1996, respectively.
In determining earnings per share for the third quarter of 1996 and the
1996 and 1997 year-to-date periods, dividends on Energy's Convertible
Preferred Stock, which was redeemed on June 2, 1997 as described in Note 9
of Notes to Consolidated Financial Statements, were deducted from income
from discontinued operations as the Convertible Preferred Stock was issued
to fund the repurchase of the publicly held units of Valero Natural Gas
Partners, L.P. in 1994.
The May 1, 1997 acquisition of Basis added significantly to the
Company's third quarter and year-to-date results. Income from continuing
operations and related earnings per share increased during the quarter
and year-to-date periods due primarily to significant increases in operating
income, partially offset by increases in interest and income tax expense.
Third Quarter 1997 Compared to Third Quarter 1996
Operating revenues increased $1.3 billion, or 191%, to $2 billion
during the third quarter of 1997 compared to the same period in 1996 due
to a 174% increase in average daily sales volumes resulting primarily from
additional volumes attributable to the May 1, 1997 acquisition of Basis.
Also contributing to the increase in revenues was the effect of the sale
of $150 million of certain inventories pursuant to a petroleum products
purchase agreement as discussed in Note 5 of Notes to Consolidated
Financial Statements.
Operating income increased $71 million, from $23.1 million during
the third quarter of 1996 to $94.1 million during the third quarter of 1997.
The increase in operating income was due primarily to an approximate
$55 million contribution from the operations related to the Texas City,
Houston and Krotz Springs refineries which were acquired on May 1, 1997,
and to an approximate $31 million increase in total throughput margins
for the Company's previously existing refining operations in Corpus Christi
and related marketing operations. Partially offsetting these increases in
operating income were an approximate $7 million increase in operating
expenses relating to the Company's previously existing refining operations
and an approximate $8 million increase in administrative expenses resulting
primarily from higher employee-related costs, including the effect of
additional personnel resulting from the acquisition of Basis in May 1997.
Total throughput margins for the Company's previously existing refining
and marketing operations increased during the third quarter of 1997
compared to the same period in 1996 due to a substantial improvement
in the price differential between conventional gasoline and crude oil,
higher oxygenate margins resulting primarily from an increase in sales
prices of oxygenates, such as MTBE, and higher premiums on sales of
reformulated gasoline and petrochemical feedstocks, including a benefit
from the sale of mixed xylenes produced from the xylene fractionation
unit that was placed in service at the Corpus Christi refinery in January
1997. Total throughput margins for previously existing operations were
also higher in the third quarter of 1997 as total margins for the 1996
period were reduced by the effect of certain scheduled maintenance
turnarounds described below. The increases resulting from these factors
were partially offset by lower discounts on purchases of residual oil
("resid") feedstocks due to continued high demand for resid in the Far
East and a decrease in crude oil prices, and by decreased results from
price risk management activities. Operating expenses relating to the
Company's previously existing refining operations increased, although
operating expenses per barrel decreased, due primarily to costs
associated with the xylene fractionation unit and higher variable costs
resulting from a 15% increase in throughput volumes at the Company's
Corpus Christi refinery. Corpus Christi throughput volumes were higher
during the third quarter of 1997 compared to the third quarter of 1996 due
to the effects of scheduled maintenance turnarounds completed during the
third quarter of 1996 on the hydrodesulfurization ("HDS") and MTBE units,
and to a new processing arrangement entered into in 1997 with a local
Corpus Christi refiner.
Net interest and debt expense increased $3.3 million to $12.2 million
during the third quarter of 1997 compared to the same period in 1996 due
primarily to an increase in bank borrowings related to the acquisition of
Basis and to the special pre-Distribution dividend paid to Energy described
in Note 1 of Notes to Consolidated Financial Statements. The increase in
interest and debt expense resulting from these factors was partially offset
by a decrease in allocated interest expense related to corporate debt
resulting from the Restructuring on July 31, 1997. Income tax expense
increased $22.3 million to $31.4 million during the third quarter of 1997
compared to the same period in 1996 due primarily to higher pre-tax income
from continuing operations.
Year-to-Date 1997 Compared to Year-To-Date 1996
For the first nine months of 1997, operating revenues increased
$2.2 billion, or 116%, to $4.2 billion compared to the first nine months
of 1996 due to a 106% increase in average daily sales volumes resulting
primarily from additional volumes attributable to the Basis acquisition and
to a lesser extent from increased wholesale marketing activities relating
to the Company's previously existing refining and marketing operations.
Operating revenues also increased due to the effect of the sale of
$150 million of inventories pursuant to a petroleum products purchase
agreement as noted above in the quarter-to-quarter comparison.
Operating income increased $118.6 million, or 170%, to $188.3 million
during the first nine months of 1997 compared to the same period in 1996
due to an approximate $78 million contribution from the operations related
to the Texas City, Houston and Krotz Springs refineries, and to an
approximate $64 million increase in total throughput margins, partially
offset by an approximate $13 million increase in operating expenses,
relating to the Company's previously existing refining and marketing
operations. Also impacting the change in operating income was an
approximate $10 million increase in administrative expenses resulting
primarily from higher employee-related costs, including the effect of the
Basis acquisition as noted above. Total throughput margins for previously
existing refining and marketing operations increased due primarily to
increased price differentials between conventional gasoline and crude oil,
higher premiums on sales of petrochemical feedstocks including premiums
on sales of mixed xylenes in 1997, and the effect of less unit downtime in
the 1997 period. The increases resulting from these factors were partially
offset by lower oxygenate margins and resid discounts and decreased results
from price risk management activities. Operating expenses relating to
the Company's previously existing refining operations increased due to the
factors noted above in the quarter-to-quarter comparison and to higher
maintenance costs resulting primarily from certain unit repairs required
in the 1997 second quarter.
Net interest and debt expense increased $7 million to $35.9 million
during the first nine months of 1997 compared to the same period in 1996
due primarily to the factors noted above in the quarter-to-quarter
comparison. Income tax expense increased $39.6 million to $57.5 million
during the same periods due primarily to higher pre-tax income from
continuing operations.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by continuing operations increased $122.2 million
to $229.9 million during the first nine months of 1997 compared to the
same period in 1996 due primarily to the increase in income from continuing
operations described above under "Results of Operations," and, to a lesser
extent, to the changes in current assets and current liabilities detailed
in Note 6 of Notes to Consolidated Financial Statements. Included in the
changes in current assets and current liabilities was a $59.1 million
decrease in inventories in the first nine months of 1997 which was
primarily attributable to a $150 million reduction in the Company's
inventory investment pursuant to the petroleum products purchase agreement
entered into in September 1997 and described in Note 5, partially offset
by higher feedstock inventory levels attributable to the operation of the
Texas City, Houston and Krotz Springs refineries. During the first nine
months of 1997, cash provided by operating activities, including proceeds
from the sale of inventories pursuant to the petroleum products purchase
agreement, along with net proceeds from bank borrowings, proceeds from
the issuance of the Revenue Bonds as described in Note 7, and issuances
of common stock related to Energy's benefit plans totaled approximately
$729 million. These funds were utilized to acquire Basis, fund capital
expenditures and deferred turnaround and catalyst costs, pay common and
preferred stock dividends, pay a special dividend to Energy and settle
the intercompany note balance with Energy pursuant to the Distribution
Agreement as described in Note 1, purchase treasury stock, and redeem
the remaining outstanding shares of Energy's Series A Preferred Stock
and Convertible Preferred Stock as described in Note 9.
As described in Note 8 of Notes to Consolidated Financial Statements,
effective May 1, 1997, the financial flexibility and liquidity of the
Company was significantly increased through the replacement of Energy's
existing $300 million revolving bank credit and letter of credit facility
with a new $835 million revolving bank credit and letter of credit facility.
Such facility was assumed by the Company upon completion of the Restructuring
on July 31, 1997 at which time total availability increased to the full
$835 million. As of September 30, 1997, approximately $327 million was
outstanding under this committed facility with approximately $508 million
available for additional borrowings and letters of credit. The Company
also has numerous uncommitted short-term bank credit facilities, along with
several uncommitted letter of credit facilities. As of September 30, 1997,
$175 million was outstanding under the short-term bank credit facilities,
and approximately $57 million was outstanding under the uncommitted letter
of credit facilities with approximately $223 million available for
additional letters of credit. The Company was in compliance with all
covenants contained in its various debt facilities as of September 30, 1997.
As described in Note 8 of Notes to Consolidated Financial Statements,
in September 1997, the Company received a corporate credit rating of BBB-
from Standard and Poor's. This rating resulted in an immediate reduction
in interest rate margins and fees associated with the Company's $835 million
bank credit facility and allowed the Company to eliminate the prior
restrictive covenant under such facility which limited the Company's
ability to make certain dividend payments and repurchases of common stock.
The Company is currently in the process of amending the bank credit facility
to further enhance the Company's financial flexibility.
As described in Note 4 of Notes to Consolidated Financial Statements,
Energy acquired the outstanding common stock of Basis on May 1, 1997 for
approximately $362 million in cash, funded with borrowings under Energy's
bank credit facilities, and Energy common stock which had a fair market
value of $114 million on the date of issuance. Although Basis incurred
significant operating losses during 1995 and 1996, the Texas City, Houston
and Krotz Springs refining and marketing operations were able to contribute
approximately $78 million to the Company's operating income for the months
of May through September 1997, as described above under "Results of
Operations." The achievement of such results was due to, among other
things, recently completed refinery upgrading projects, a reduction in
depreciation and amortization expense due to the acquisition cost of
Basis being less than its net book value, and a reduction in operating
and overhead costs through various operational and personnel-related
changes implemented by the Company. The Company believes that the
operations related to the Texas City, Houston and Krotz Springs
refineries will continue to benefit the Company's consolidated cash
flow and earnings throughout the remainder of 1997.
During the first nine months of 1997, the Company expended, exclusive
of the Basis acquisition, approximately $98 million for capital investments,
primarily capital expenditures, $45 million of which related to continuing
refining and marketing operations while $53 million related to the
discontinued natural gas related services operations. For total year 1997,
the Company currently expects to incur approximately $120 million for
capital expenditures and deferred turnaround and catalyst costs related to
its continuing refining and marketing operations, $45 million of which
relates to the Texas City, Houston and Krotz Springs refineries for the
months of May through December.
As described in Note 7 of Notes to Consolidated Financial Statements,
the Company refinanced its outstanding $98.5 million principal amount of
industrial revenue bonds in April 1997 at substantially lower interest
rates. Based on the floating rates in effect as of September 30, 1997,
the Company expects the reduction in interest expense resulting from
such refinancing to be in excess of $5 million per year.
The Company believes it has sufficient funds from operations, and to
the extent necessary, from the public and private capital markets and
bank markets, to fund its ongoing operating requirements. The Company
expects that to the extent necessary, it can raise additional funds from
time to time through equity or debt financings; however, except for
borrowings under bank credit agreements, the Company has no specific
financing plans as of the date hereof to increase the amount of debt
outstanding. From time to time, the Company will consider the debt
market to fix the interest rate on a portion of its outstanding variable
rate debt. This could either be done synthetically through interest rate
swaps or caps, or by issuing new fixed rate debt and using the proceeds to
pay down existing variable rate debt.
As discussed in Note 13 of Notes to Consolidated Financial Statements,
the FASB has issued various new statements of financial accounting standards
in 1997 which require adoption at various times in the future. Based on
information currently available to the Company, the future adoption of these
statements is not expected to have a material effect on the Company's
consolidated financial statements.
The foregoing discussion contains certain estimates, predictions,
projections and other "forward-looking statements" (within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) that involve various risks and
uncertainties. While these forward-looking statements, and any assumptions
upon which they are based, are made in good faith and reflect the Company's
current judgment regarding the direction of its business, actual results
will almost always vary, sometimes materially, from any estimates,
predictions, projections, assumptions, or other future performance
suggested herein. Some important factors (but not necessarily all factors)
that could affect the Company's sales volumes, growth strategies, future
profitability and operating results, or that otherwise could cause actual
results to differ materially from those expressed in any forward-looking
statement include the following: renewal or satisfactory replacement of
the Company's resid feedstock arrangements as well as market, political
or other forces generally affecting the pricing and availability of resid
and other refinery feedstocks and refined products; accidents or other
unscheduled shutdowns affecting the Company's, its suppliers' or its
customers' pipelines, plants, machinery or equipment; excess industry
capacity; competition from products and services offered by other energy
enterprises; changes in the cost or availability of third-party vessels,
pipelines and other means of transporting feedstocks and products; ability
to implement the cost reductions and operational changes related to, and
realize the various assumptions and efficiencies projected for, the
operation of the Texas City, Houston and Krotz Springs refineries; state
and federal environmental, economic, safety and other policies and
regulations, any changes therein, and any legal or regulatory delays
or other factors beyond the Company's control; execution of planned
capital projects; weather conditions affecting the Company's operations
or the areas in which the Company's products are marketed; rulings,
judgments, or settlements in litigation or other legal matters, including
unexpected environmental remediation costs in excess of any reserves; the
introduction or enactment of legislation; and changes in the credit ratings
assigned to the Company's debt securities and trade credit. Certain of
these risk factors are more fully discussed in the Company's Form S-1.
The Company undertakes no obligation to publicly release the result of
any revisions to any such forward-looking statements that may be made to
reflect events or circumstances after the date hereof or to reflect
the occurrence of unanticipated events.
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Energy and certain of its natural gas related subsidiaries, as well
as the Company, have been sued by Teco Pipeline Company ("Teco") regarding
the operation of the 340-mile West Texas pipeline in which a subsidiary of
Energy holds a 50% undivided interest. In 1985, a subsidiary of Energy
sold a 50% undivided interest in the pipeline and entered into a joint
venture through an ownership agreement and an operating agreement, each
dated February 28, 1985, with the purchaser of the interest. In 1988,
Teco succeeded to that purchaser's 50% interest. A subsidiary of Energy
has at all times been the operator of the pipeline. Notwithstanding the
written ownership and operating agreements, the plaintiff alleges that a
separate, unwritten partnership agreement exists, and that the defendants
have exercised improper dominion over such alleged partnership's affairs.
The plaintiff also alleges that the defendants acted in bad faith by
negatively affecting the economics of the joint venture in order to provide
financial advantages to facilities or entities owned by the defendants and
by allegedly usurping for the defendants' own benefit certain opportunities
available to the joint venture. The plaintiff asserts causes of action
for breach of fiduciary duty, fraud, tortious interference with business
relationships, professional malpractice and other claims, and seeks
unquantified actual and punitive damages. Energy's motion to compel
arbitration was denied, but Energy has filed an appeal. Energy has also
filed a counterclaim alleging that the plaintiff breached its own
obligations to the joint venture and jeopardized the economic and
operational viability of the pipeline by its actions. Energy is seeking
unquantified actual and punitive damages. Although PG&E previously
acquired Teco and now ultimately owns both Teco and Energy after the
Restructuring, PG&E's Teco acquisition agreement purports to assign the
benefit or detriment of this lawsuit to the former shareholders of Teco.
Pursuant to the Distribution Agreement by which the Company was spun off
to Energy's stockholders in connection with the Restructuring, the Company
has agreed to indemnify and hold harmless Energy with respect to this
lawsuit to the extent of 50% of the amount of any final judgment or
settlement amount not in excess of $30 million, and 100% of that part of
any final judgment or settlement amount in excess of $30 million.
Item 2. Changes in Securities
Rights Agreement. In connection with the Distribution, the
Company's Board of Directors declared a dividend distribution of one
Preferred Share Purchase Right ("Right") for each outstanding share of the
Company's common stock, $.01 par value ("Common Stock") distributed to
Energy stockholders pursuant to the Distribution. Except as set forth
below, each Right entitles the registered holder to purchase from the
Company one one-hundredth of a share of the Company's Junior Participating
Preferred Stock, Series I, ("Junior Preferred Stock") at a price of
$100 per one one-hundredth of a share, subject to adjustment (the
"Purchase Price"). The description and terms of the Rights are set
forth in the Rights Agreement dated July 17, 1997 between the Company
and Harris Trust and Savings Bank (the "Rights Agreement").
Until the earlier to occur of (i) 10 days following a public
announcement that a person or group of affiliated or associated persons
(an "Acquiring Person") has acquired beneficial ownership of 15% or more
of the outstanding shares of the Company's Common Stock, (ii) 10 business
days (or such later date as may be determined by action of the Company's
Board of Directors) following the initiation of a tender offer or exchange
offer which would result in the beneficial ownership by an Acquiring
Person of 15% or more of such outstanding Common Stock (the earlier of
such dates being called the "Rights Separation Date"), or (iii)
the earlier redemption or expiration of the Rights, the Rights will be
transferred only with the Common Stock. The Rights are not exercisable
until the Rights Separation Date. As soon as practicable following the
Rights Separation Date, separate certificates evidencing the Rights (the
"Right Certificates") will be mailed to holders of record of Common Stock
as of the close of business on the Rights Separation Date and such
separate Right Certificates alone will evidence the Rights. The Rights
will expire on June 30, 2007 (the "Final Expiration Date"), unless the
Final Expiration Date is extended or unless the Rights are earlier
redeemed or exchanged by the Company, in each case, as described below.
Because of the nature of the Junior Preferred Stock's dividend,
liquidation and voting rights, the value of the one one-hundredth interest
in a share of Junior Preferred Stock purchasable upon exercise of each
Right should approximate the value of one share of Common Stock.
In the event that after the Rights Separation Date, the Company is
acquired in a merger or other business combination transaction, or if 50%
or more of its consolidated assets or earning power are sold, proper
provision will be made so that each holder of a Right will thereafter
have the right to receive, upon the exercise thereof at the then current
exercise price of the Right, that number of shares of common stock of the
acquiring company which at the time of such transaction will have a market
value of two times the exercise price of the Right. In the event that any
person or group of affiliated or associated persons becomes the beneficial
owner of 15% or more of the outstanding Common Stock, proper provision
shall be made so that each holder of a Right, other than Rights beneficially
owned by the Acquiring Person (which will thereafter be void), will
thereafter have the right to receive upon exercise that number of shares
of Common Stock having a market value of two times the exercise price of
the Right.
At any time after the acquisition by an Acquiring Person of beneficial
ownership of 15% or more of the outstanding Common Stock and prior to the
acquisition by such Acquiring Person of 50% or more of the outstanding
Common Stock, the Company's Board of Directors may exchange the Right
(other than Rights owned by such Acquiring Person which have become void),
at an exchange ratio of one share of Common Stock, or one one-hundredth of
a share of Junior Preferred Stock, per Right (subject to adjustment).
At any time prior to the acquisition by an Acquiring Person of
beneficial ownership of 15% or more of the outstanding Common Stock,
the Company's Board of Directors may redeem the Rights at a price of
$.01 per Right (the "Redemption Price"). The redemption of the Rights
may be made effective at such time, on such basis and with such conditions
as the Company's Board of Directors may establish. Immediately upon any
redemption of the Rights, the right to exercise the Rights will terminate
and the only right of the holders of Rights will be to receive the
Redemption Price.
Until a Right is exercised, the holder will have no rights as a
stockholder of the Company including, without limitation, the right to
vote or to receive dividends.
The Rights may have certain anti-takeover effects. The Rights will
cause substantial dilution to a person or group that attempts to acquire
the Company on terms not approved by the Company's Board of Directors,
except pursuant to an offer conditioned on a substantial number of Rights
being acquired. The Rights should not interfere with any merger or other
business combination approved by the Company's Board of Directors since
the Rights may be redeemed by the Company at the Redemption Price prior to
the time that a person or group has acquired beneficial ownership of 15%
or more of the Common Stock.
The foregoing summary of certain terms of the Rights is qualified in
its entirety by reference to the Rights Agreement and to the Certificate
of Designations, Rights and Preferences for the Junior Preferred Stock.
Credit Agreement. Effective May 1, 1997, Energy replaced its existing
unsecured $300 million revolving bank credit and letter of credit facility
with a new five-year, unsecured $835 million revolving bank credit and
letter of credit facility. The new credit facility has been used to
finance a portion of the acquisition cost of Basis (as discussed in the
Notes to Consolidated Financial Statements), to provide continuing credit
enhancement for the Company's Refunding Bonds and Revenue Bonds (also
discussed in the Notes to Consolidated Financial Statements) and to provide
financing for other general corporate purposes. Energy was the borrower
under the facility until the completion of the Restructuring on
July 31, 1997, at which time all obligations of Energy under the facility
were assumed by the Company.
The credit facility includes certain restrictive covenants including
a minimum fixed charge coverage ratio of 1.8 to 1.0, a maximum debt to
capitalization ratio of 45%, a minimum net worth test and certain
restrictions on, among other things, long-term leases and subsidiary debt.
In September 1997, the Company received a corporate credit rating of BBB-
from Standard & Poor's. As a result, interest rate margins and fees under
the credit facility were immediately reduced and the credit facility's
prior limitations on the Company's ability to make certain dividend
payments or repurchases of common stock were eliminated.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of stockholders (the "Meeting")
was held July 17, 1997. All of the issued and outstanding shares of
the Company's common stock (the "Company Common Stock") were voted by
Energy, then the sole stockholder of the Company, in favor of all
matters presented at the Meeting. William E. Greehey, Edward C. Benninger,
E. Baines Manning, Stan L. McLelland, George E. Kain and Wayne D. Smithers
were elected at the Meeting to serve as directors of the Company until
the time of the filing of an amendment and restatement of the Company's
Restated Certificate of Incorporation (the "Certificate") in connection
with the Distribution. New Bylaws for the Company were also adopted at
the Meeting. The amendment and restatement of the Certificate approved
at the Meeting, among other things, increased the authorized number of
shares of Company Common Stock from 3,000 shares to 150,000,000 shares;
changed the par value of the Company Common Stock from $1.00 par value
per share to $.01 par value per share; created an authorized class of
capital stock of the Company consisting of 20,000,000 shares designated
as Preferred Stock; classified the Board of Directors into three classes,
each having a three year term; and changed the name of the Company from
Valero Refining and Marketing Company to Valero Energy Corporation.
The sole stockholder also approved the removal of certain of the directors
elected at the Meeting upon effectiveness of the filing of the Certificate
and the simultaneous election of new directors so that after giving effect
to such actions, the Board of Directors would consist of eight directors
classified in the respective classes and serving for the respective
periods set forth below:
Class I - Directors to serve until 1998
Ruben Escobedo
Lowell H. Leberman
Class II - Directors to serve until 1999
Ronald K. Calgaard
William E. Greehey
Susan Kaufman Purcell
Class III - Directors to serve until 2000
Edward C. Benninger
James L. ("Rocky") Johnson
Robert G. Dettmer
Item 5. Other Information
Annual Stockholder's Meeting. The Company's 1998 Annual Meeting of
Stockholders will be held in San Antonio, Texas, on April 30, 1998. The
Company requests that any proposals of stockholders intended to be
submitted for inclusion in the proxy statement for such meeting pursuant to
Regulation 14A of the rules and regulations of the Securities and Exchange
Commission promulgated under the Securities Exchange Act of 1934, as
amended, be submitted to the Corporate Secretary of the Company not later
than November 28, 1997. Stockholders intending to propose business to be
considered by the stockholders of the Company are encouraged to review
the requirements of Regulation 14A and of the Company's By-laws before
submitting any such proposal.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
11.1 Computation of Earnings Per Share.
27.1* Financial Data Schedule (reporting financial
information as of and for the nine months ended
September 30, 1997).
27.2* Financial Data Schedule (reporting financial information
as of and for the nine months ended September 30, 1996).
__________
* The Financial Data Schedules shall not be deemed "filed"
for purposes of Section 11 of the Securities Act of 1933
or Section 18 of the Securities Exchange Act of 1934, and
are included as exhibits only to the electronic filing of
this Form 10-Q in accordance with Item 601(c) of
Regulation S-K and Section 401 of Regulation S-T.
(b) Reports on Form 8-K. The Company did not file any Current
Reports on Form 8-K during the quarter ended September 30, 1997.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By: /s/ Edward C. Benninger
Edward C. Benninger
President and Chief
Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Date: November 14, 1997
EXHIBIT 11.1
<TABLE>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(Thousands of Dollars, Except Per Share Amounts)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
COMPUTATION OF EARNINGS PER
SHARE ASSUMING NO DILUTION:
Income from continuing operations . . . . . . . . $ 51,993 $ 6,630 $ 99,402 $ 27,757
Income (loss) from discontinued operations,
net of income taxes. . . . . . . . . . . . . . $ (432) $ 6,516 $ (15,672) $ 26,144
Less: Preferred stock dividend requirements
and redemption premium . . . . . . . . . . . . - (2,844) (4,592) (8,526)
Income (loss) from discontinued operations
applicable to common stock . . . . . . . . . . $ (432) $ 3,672 $ (20,264) $ 17,618
Weighted average number of shares of
common stock outstanding . . . . . . . . . . . 55,949,765 43,983,599 50,175,077 43,877,733
Earnings (loss) per share assuming no dilution:
Continuing operations. . . . . . . . . . . . . $ .93 $ .15 $ 1.98 $ .63
Discontinued operations. . . . . . . . . . . . (.01) .08 (.40) .40
Total . . . . . . . . . . . . . . . . . . . $ .92 $ .23 $ 1.58 $ 1.03
COMPUTATION OF EARNINGS PER
SHARE ASSUMING FULL DILUTION:
Income from continuing operations assuming
full dilution. . . . . . . . . . . . . . . . . $ 51,993 $ 6,630 $ 99,402 $ 27,757
Income (loss) from discontinued operations,
net of income taxes. . . . . . . . . . . . . . $ (432) $ 6,516 $ (15,672) $ 26,144
Less: Preferred stock dividend requirements
and redemption premium . . . . . . . . . . . . - (2,844) (4,592) (8,526)
Add: Reduction of preferred stock dividends
applicable to the assumed conversion of
Convertible Preferred Stock at the
beginning of the period. . . . . . . . . . . . - 2,695 4,522 8,086
Income (loss) from discontinued operations
applicable to common stock assuming
full dilution . . . . . . . . . . . . . . . . $ (432) $ 6,367 $ (15,742) $ 25,704
Weighted average number of shares of
common stock outstanding . . . . . . . . . . . 55,949,765 43,983,599 50,175,077 43,877,733
Weighted average common stock
equivalents applicable to stock options. . . . 881,822 229,801 764,825 407,319
Weighted average shares issuable upon assumed
conversion of Convertible Preferred Stock
at the beginning of the period . . . . . . . . - 6,381,798 3,326,006 6,381,798
Weighted average shares used for
computation . . . . . . . . . . . . . . . . . . 56,831,587 50,595,198 54,265,908 50,666,850
Earnings (loss) per share assuming full
dilution:
Continuing operations. . . . . . . . . . . . . $ .92 $ .13 $ 1.83 $ .55
Discontinued operations. . . . . . . . . . . . (.01) .13 (.29) .51
Total . . . . . . . . . . . . . . . . . . . $ .91 (b) $ .26 (a) $ 1.54 (b) $ 1.06 (a)
<FN>
(a) This calculation is submitted in accordance with paragraph 601(b)(11) of Regulation S-K although
it is contrary to APB Opinion No. 15 because it produces an antidilutive result.
(b) This calculation is submitted in accordance with paragraph 601(b)(11) of Regulation S-K although
it is not required by APB Opinion No. 15 because it results in dilution of less than 3%.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1997 AND
THE CONSOLIDATED STATEMENT OF INCOME FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 21,930
<SECURITIES> 0
<RECEIVABLES> 353,620
<ALLOWANCES> 1,200
<INVENTORY> 347,277
<CURRENT-ASSETS> 746,895
<PP&E> 2,083,151
<DEPRECIATION> 524,831
<TOTAL-ASSETS> 2,418,701
<CURRENT-LIABILITIES> 661,179
<BONDS> 323,500
0
0
<COMMON> 561
<OTHER-SE> 1,150,139
<TOTAL-LIABILITY-AND-EQUITY> 2,418,701
<SALES> 4,160,091
<TOTAL-REVENUES> 4,160,091
<CGS> 3,971,771
<TOTAL-COSTS> 3,971,771
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 35,904
<INCOME-PRETAX> 156,891
<INCOME-TAX> 57,489
<INCOME-CONTINUING> 99,402
<DISCONTINUED> (15,672)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 83,730
<EPS-PRIMARY> 1.58
<EPS-DILUTED> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 27
<SECURITIES> 0
<RECEIVABLES> 106,274
<ALLOWANCES> 899
<INVENTORY> 153,794
<CURRENT-ASSETS> 289,741
<PP&E> 1,687,854
<DEPRECIATION> 463,106
<TOTAL-ASSETS> 1,946,344
<CURRENT-LIABILITIES> 248,978
<BONDS> 363,570
6,900
3,450
<COMMON> 44,024
<OTHER-SE> 1,024,448
<TOTAL-LIABILITY-AND-EQUITY> 1,946,344
<SALES> 1,927,590
<TOTAL-REVENUES> 1,927,590
<CGS> 1,857,891
<TOTAL-COSTS> 1,857,891
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 28,896
<INCOME-PRETAX> 45,668
<INCOME-TAX> 17,911
<INCOME-CONTINUING> 27,757
<DISCONTINUED> 26,144
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 53,901
<EPS-PRIMARY> 1.03
<EPS-DILUTED> 0
</TABLE>
