<PAGE> 1
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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 SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
--------------------- ---------------------
Commission file number 1-13175
---------
VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 74-1828067
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Valero Place
San Antonio, Texas
(Address of principal executive offices)
78212
(Zip Code)
(210) 370-2000
(Registrant's telephone number, including area code)
---------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
---------
Indicated below is the number of shares outstanding of the registrant's
only class of common stock, as of November 1, 1999.
<TABLE>
<CAPTION>
Number of
Shares
Title of Class Outstanding
-------------- -----------
<S> <C>
Common Stock, $.01 Par Value 55,754,482
</TABLE>
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<PAGE> 2
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 1999 and December 31, 1998........... 3
Consolidated Statements of Income - For the Three Months Ended and
Nine Months Ended September 30, 1999 and 1998.................................. 4
Consolidated Statements of Cash Flows - For the Nine Months Ended
September 30, 1999 and 1998.................................................... 5
Notes to Consolidated Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................ 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................. 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................... 29
Item 6. Exhibits and Reports on Form 8-K............................................ 29
SIGNATURE.............................................................................. 30
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
September 30,
1999 December 31,
(Unaudited) 1998
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments ............................ $ 7,819 $ 11,199
Receivables, less allowance for doubtful accounts of
$1,782 (1999) and $1,150 (1998) .............................. 352,226 283,456
Inventories .................................................... 418,745 316,405
Current deferred income tax assets ............................. 63,750 4,851
Prepaid expenses and other ..................................... 19,643 23,799
------------ ------------
862,183 639,710
------------ ------------
PROPERTY, PLANT AND EQUIPMENT - including
construction in progress of $127,030 (1999)
and $179,136 (1998), at cost ................................... 2,662,398 2,572,190
Less: Accumulated depreciation .............................. 678,624 612,847
------------ ------------
1,983,774 1,959,343
------------ ------------
DEFERRED CHARGES AND OTHER ASSETS ................................ 153,118 126,611
------------ ------------
$ 2,999,075 $ 2,725,664
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt ................................................ $ 12,000 $ 160,000
Accounts payable ............................................... 610,842 283,183
Accrued expenses ............................................... 79,202 54,561
------------ ------------
702,044 497,744
------------ ------------
LONG-TERM DEBT ................................................... 845,788 822,335
------------ ------------
DEFERRED INCOME TAXES ............................................ 261,274 210,389
------------ ------------
DEFERRED CREDITS AND OTHER LIABILITIES ........................... 113,677 109,909
------------ ------------
COMMON STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 150,000,000 shares authorized;
issued 56,316,914 (1999) and 56,314,798 (1998) shares ........ 563 563
Additional paid-in capital ..................................... 1,095,539 1,112,726
Accumulated deficit ............................................ (19,807) (17,618)
Treasury stock, 147 (1999) and 378,130 (1998) shares, at cost .. (3) (10,384)
------------ ------------
1,076,292 1,085,287
------------ ------------
$ 2,999,075 $ 2,725,664
============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE> 4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
OPERATING REVENUES ............................................ $ 2,161,938 $ 1,338,649 $ 5,323,491 $ 4,149,112
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales and operating expenses ........................ 2,074,784 1,288,064 5,170,784 3,926,793
Write-down of inventories to market value ................... -- -- -- 37,673
Selling and administrative expenses ......................... 16,395 16,753 49,123 52,668
Depreciation expense ........................................ 23,321 20,106 68,359 56,345
------------ ------------ ------------ ------------
Total ..................................................... 2,114,500 1,324,923 5,288,266 4,073,479
------------ ------------ ------------ ------------
OPERATING INCOME .............................................. 47,438 13,726 35,225 75,633
OTHER INCOME (EXPENSE), NET ................................... 2,496 (420) 3,483 17
INTEREST AND DEBT EXPENSE:
Incurred .................................................... (16,292) (8,742) (46,593) (24,610)
Capitalized ................................................. 1,170 1,547 4,496 3,426
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES ............................. 34,812 6,111 (3,389) 54,466
INCOME TAX EXPENSE (BENEFIT) .................................. 12,200 1,800 (1,200) 16,100
------------ ------------ ------------ ------------
NET INCOME (LOSS) ............................................. $ 22,612 $ 4,311 $ (2,189) $ 38,366
============ ============ ============ ============
EARNINGS (LOSS) PER SHARE OF COMMON STOCK ..................... $ .40 $ .08 $ (.04) $ .68
Weighted average common shares outstanding (in thousands) ... 56,266 56,096 56,161 56,149
EARNINGS (LOSS) PER SHARE OF COMMON STOCK -
ASSUMING DILUTION ........................................... $ .40 $ .08 $ (.04) $ .67
Weighted average common shares outstanding -
assuming dilution (in thousands) .......................... 56,953 56,651 56,161 57,121
DIVIDENDS PER SHARE OF COMMON STOCK ........................... $ .08 $ .08 $ .24 $ .24
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE> 5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ........................................ $ (2,189) $ 38,366
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation expense ................................. 68,359 56,345
Amortization of deferred charges and other, net ...... 37,843 31,176
Write-down of inventories to market value ............ -- 37,673
Changes in current assets and current liabilities .... 167,208 98,111
Deferred income tax expense (benefit) ................ (8,100) 8,400
Changes in deferred items and other, net ............. 2,057 (1,979)
------------ ------------
Net cash provided by operating activities .......... 265,178 268,092
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ..................................... (76,717) (113,473)
Deferred turnaround and catalyst costs ................... (58,626) (41,316)
Purchase of Paulsboro Refinery ........................... -- (330,798)
Earn-out payment in connection with Basis acquisition .... -- (10,325)
Other, net ............................................... 487 857
------------ ------------
Net cash used in investing activities .................. (134,856) (495,055)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term debt, net ......................... (148,000) (15,000)
Long-term borrowings ..................................... 722,794 403,656
Long-term debt reduction ................................. (701,000) (137,000)
Common stock dividends ................................... (13,479) (13,486)
Issuance of common stock ................................. 6,638 3,490
Purchase of treasury stock ............................... (655) (16,436)
------------ ------------
Net cash provided by (used in) financing activities .... (133,702) 225,224
------------ ------------
NET DECREASE IN CASH AND TEMPORARY
CASH INVESTMENTS ......................................... (3,380) (1,739)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD ...................................... 11,199 9,935
------------ ------------
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD ............................................ $ 7,819 $ 8,196
============ ============
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE> 6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements included herein have been
prepared by Valero Energy Corporation ("Valero") and subsidiaries (collectively
referred to as the "Company"), without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC"). 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 for the periods presented. 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.
2. ACQUISITION OF PAULSBORO REFINERY
On September 16, 1998, the Company and Mobil Oil Corporation ("Mobil")
entered into an asset sale and purchase agreement for the acquisition by the
Company of substantially all of the assets and the assumption of certain
liabilities related to Mobil's 155,000 barrel-per-day ("BPD") refinery in
Paulsboro, New Jersey ("Paulsboro Refinery"). The acquisition was accounted for
using the purchase method of accounting and the purchase price was allocated to
the assets acquired and liabilities assumed based on estimated fair values as
determined by an independent appraisal. Pursuant to the purchase method of
accounting, the accompanying Consolidated Statements of Income for the three
months ended and nine months ended September 30, 1998 include the results of
operations of the Paulsboro Refinery for the period September 17 through
September 30, 1998.
Pursuant to the asset sale and purchase agreement, Mobil is entitled to
receive payments in any of the five years following the acquisition if certain
average refining margins during any of such years exceed a specified level. Any
payments under this earn-out arrangement, which are determined in September of
each year beginning in 1999, are limited to $20 million in any year and $50
million in the aggregate. No earn-out amount was due for the year ended
September 16, 1999.
In connection with the acquisition of the Paulsboro Refinery, Mobil
agreed to indemnify the Company for certain environmental matters and conditions
existing on or prior to the acquisition and the Company agreed to assume Mobil's
environmental liabilities, with certain limited exceptions (including
"superfund" liability for off-site waste disposal). Mobil's indemnities and the
periods of indemnification include (i) third party environmental claims for a
period of five years, (ii) governmental fines and/or penalties for a period of
five years, (iii) required remediation of known environmental conditions for a
period of five years, subject to a cumulative deductible, (iv) required
remediation of unknown environmental conditions for a period of
6
<PAGE> 7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
seven years, subject to a sharing arrangement with a cap on the Company's
obligation and subject to a cumulative deductible, and (v) certain capital
expenditures required by a governmental entity for a three-year period, to the
extent required to cure a breach of certain representations of Mobil concerning
compliance with environmental laws, subject to a specified deductible. The
Company's assumed liabilities include remediation obligations to the New Jersey
Department of Environmental Protection. These remediation obligations relate
primarily to clean-up costs associated with groundwater contamination, landfill
closure and post-closure monitoring costs, and tank farm spill prevention costs.
The Company has recorded approximately $20 million in Accrued Expenses and
Deferred Credits and Other Liabilities representing its best estimate of costs
to be borne by the Company related to these remediation obligations. The
majority of such costs are expected to be incurred in relatively level amounts
over the next 19 years.
The following unaudited pro forma financial information of the Company
for the nine months ended September 30, 1998 assumes that the acquisition of the
Paulsboro Refinery occurred at the beginning of such period. Such pro forma
information is not necessarily indicative of the results of future operations.
(Dollars in thousands, except per share amounts.)
<TABLE>
<S> <C>
Operating revenues.................................. $4,856,556
Operating income.................................... 112,409
Net income.......................................... 52,153
Earnings per common share........................... .93
Earnings per common share - assuming dilution....... .91
</TABLE>
3. ACCOUNTS RECEIVABLE
In September 1999, the Company entered into an agreement with a
financial institution to sell on a revolving basis up to $100 million of an
undivided percentage ownership interest in a designated pool of accounts
receivable (the "Receivables Purchase Agreement"). As of September 30, 1999,
accounts receivable were reduced by $100 million for receivables sold under this
program. Proceeds from such sales were used to reduce indebtedness under the
Company's bank credit facilities.
4. 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 under the last-in, first-out
("LIFO") method of inventory pricing, and the cost of feedstocks and products
purchased for resale determined under the weighted average cost method. During
the first quarter of 1999, LIFO inventory quantities were reduced causing prior
year LIFO costs, which were lower than current year replacement costs,
7
<PAGE> 8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
to be charged to cost of sales. This LIFO liquidation resulted in a decrease in
cost of sales of $10.5 million and a decrease in the net loss of $6.8 million,
or $.12 per share, for the first nine months of 1999. At September 30, 1999, the
replacement cost of the Company's LIFO inventories exceeded their LIFO carrying
values by approximately $175 million. Materials and supplies are carried
principally at weighted average cost not in excess of market. Inventories as of
September 30, 1999 and December 31, 1998 were as follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Refinery feedstocks .................... $ 96,361 $ 80,036
Refined products and blendstocks ....... 261,783 174,125
Materials and supplies ................. 60,601 62,244
------------ ------------
$ 418,745 $ 316,405
============ ============
</TABLE>
5. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net
income (loss) has been adjusted by, among other things, changes in current
assets and current liabilities. The changes in the Company's current assets and
current liabilities are shown in the following table as an (increase)/decrease
in current assets and an increase/(decrease) in current liabilities (in
thousands). These amounts exclude (i) a $37.7 million noncash write-down of
inventory to market value in the first quarter of 1998 and (ii) the current
assets and current liabilities of the Paulsboro Refinery as of its acquisition
date in 1998, which are reflected separately in the Statement of Cash Flows.
Also excluded from the following table are changes in cash and temporary cash
investments, current deferred income tax assets and short-term debt.
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Receivables, net ....................... $ (68,770) $ 95,093
Inventories ............................ (103,412) (18,775)
Prepaid expenses and other ............. 4,156 4,949
Accounts payable ....................... 320,484 (13,406)
Accrued expenses ....................... 14,750 30,250
------------ ------------
Total ............................... $ 167,208 $ 98,111
============ ============
</TABLE>
8
<PAGE> 9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Cash flows related to interest and income taxes were as follows (in thousands):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Interest paid (net of amount capitalized) ... $ 36,086 $ 15,405
Income tax refunds received ................. 7,505 9,389
Income taxes paid ........................... 581 9,950
</TABLE>
Noncash investing activities for the nine months ended September 30,
1999 and 1998 included various adjustments to property, plant and equipment and
certain current assets and current liabilities resulting from the completion of
independent appraisals performed in connection with the September 1998
acquisition of the Paulsboro Refinery and the May 1997 acquisition of Basis
Petroleum, Inc. ("Basis"), respectively, and the allocation of the respective
purchase prices to the assets acquired and liabilities assumed.
6. LONG-TERM DEBT
In March 1999, the Company completed a public offering of $300 million
principal amount of 7 3/8% notes which are due on March 15, 2006. The notes were
issued under the Company's $600 million universal shelf registration statement
which was previously declared effective by the SEC on June 30, 1998. Net
proceeds from the financing of approximately $297.5 million were used to pay
down borrowings under the Company's revolving bank credit facility.
Also in March 1999, the Company refinanced $25 million of its Series
1998 taxable, variable rate Waste Disposal Revenue Bonds with tax-exempt bonds.
These Series 1999 tax-exempt bonds have a fixed interest rate of 5.7% and mature
on April 1, 2032.
7. EARNINGS PER SHARE
The computation of basic and diluted per-share amounts, as required by
the Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 128, is as follows (dollars and shares in
thousands, except per share amounts):
9
<PAGE> 10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
Three Months Ended September 30,
---------------------------------------------------------------------------
1999 1998
----------------------------------- ----------------------------------
Per- Per-
Net Share Net Share
Income Shares Amt. Income Shares Amt.
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Net income ........................ $ 22,612 $ 4,311
======== ========
BASIC EARNINGS PER SHARE:
Net income available to
common stockholders ............. $ 22,612 56,266 $ .40 $ 4,311 56,096 $ .08
======== ========
EFFECT OF DILUTIVE SECURITIES:
Stock options ..................... -- 370 -- 444
Performance awards ................ -- 317 -- 111
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE:
Net income available to
common stockholders
plus assumed conversions ........ $ 22,612 56,953 $ .40 $ 4,311 56,651 $ .08
======== ======== ======== ======== ======== ========
<CAPTION>
Nine Months Ended September 30,
---------------------------------------------------------------------------
1999 1998
----------------------------------- ----------------------------------
Per- Per-
Net Share Net Share
(Loss) Shares Amt. Income Shares Amt.
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) ................. $ (2,189) $ 38,366
======== ========
BASIC EARNINGS PER SHARE:
Net income (loss) available to
common stockholders ............. $ (2,189) 56,161 $ (.04) $ 38,366 56,149 $ .68
======== ========
EFFECT OF DILUTIVE SECURITIES:
Stock options ..................... -- -- -- 862
Performance awards ................ -- -- -- 110
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE:
Net income (loss) available to
common stockholders
plus assumed conversions ........ $ (2,189) 56,161 $ (.04) $ 38,366 57,121 $ .67
======== ======== ======== ======== ======== ========
</TABLE>
10
<PAGE> 11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Because the Company reported a net loss for the nine months ended
September 30, 1999, various stock options and performance awards which were
granted to employees in connection with the Company's stock compensation plans
and were outstanding during such period were not included in the computation of
diluted earnings per share because the effect would have been antidilutive. At
September 30, 1999, options to purchase approximately 6.4 million common shares
and performance awards totaling approximately 317,000 common shares were
outstanding.
8. NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." This SOP
provides guidance for determining when to capitalize or expense costs incurred
to develop or obtain internal-use software. This statement became effective for
the Company's financial statements beginning January 1, 1999, with its
requirements applied to costs incurred on or after such date. The adoption of
this SOP did not have a material effect on the Company's consolidated financial
statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in a derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting. As issued, this statement was to
become effective for the Company's financial statements beginning January 1,
2000. However, in June 1999, the FASB issued SFAS No. 137 which delayed for one
year the effective date of SFAS No. 133. As a result, SFAS No. 133 will become
effective for the Company's financial statements beginning January 1, 2001 and
is not allowed to be applied retroactively to financial statements of prior
periods. At such effective date, SFAS No. 133 must be applied to (i) all
freestanding derivative instruments and (ii) all embedded derivative instruments
required by the statement to be separated from their host contracts (or, at the
Company's election, only those derivatives embedded in hybrid instruments
issued, acquired or substantively modified on or after January 1, 1998 or
January 1, 1999). The Company is currently evaluating the impact on its
financial statements of adopting this statement. Adoption of this statement
could result in increased volatility in the Company's earnings and other
comprehensive income.
9. LITIGATION AND CONTINGENCIES
Prior to July 31, 1997, Valero was a wholly owned subsidiary of Valero
Energy Corporation ("Energy"). Energy was engaged in both the refining and
marketing business and the natural gas related
11
<PAGE> 12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
services business. On July 31, 1997, Energy spun off Valero to Energy's
stockholders and merged its remaining natural gas related services business with
a wholly owned subsidiary of PG&E Corporation ("PG&E") (the "Restructuring").
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 by
the trial court, but Energy appealed, and in August 1999, the court of appeals
ruled in Energy's favor and compelled arbitration of the entire dispute.
Although the plaintiff is seeking further appellate review of this decision, the
trial court has since vacated its original denial and has now compelled
arbitration. 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 owns both Teco and Energy, 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 agreement by which the Company was spun off to Energy's
stockholders in connection with the Restructuring, the Company has agreed to
indemnify 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.
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.
10. SUBSEQUENT EVENTS
On October 21, 1999, the Company's Board of Directors declared a
regular quarterly cash dividend of $.08 per common share payable December 7,
1999, to holders of record at the close of business on November 9, 1999.
12
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
THIRD QUARTER 1999 COMPARED TO THIRD QUARTER 1998
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended September 30,
------------------------------------------------------------
Change
----------------------------
1999 1998(1) Amount %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Operating revenues ......................................... $ 2,161,938 $ 1,338,649 $ 823,289 62 %
Cost of sales .............................................. (1,941,511) (1,173,717) (767,794) (65)
Operating costs:
Cash (fixed and variable) .............................. (120,061) (103,104) (16,957) (16)
Depreciation and amortization .......................... (35,311) (30,591) (4,720) (15)
Selling and administrative expenses (including related
depreciation expense) .................................. (17,617) (17,511) (106) (1)
------------ ------------ ------------
Total operating income ............................. $ 47,438 $ 13,726 $ 33,712 246
============ ============ ============
Other income (expense), net ................................ $ 2,496 $ (420) $ 2,916 694
Interest and debt expense, net ............................. $ (15,122) $ (7,195) $ (7,927) (110)
Income tax expense ......................................... $ (12,200) $ (1,800) $ (10,400) (578)
Net income ................................................. $ 22,612 $ 4,311 $ 18,301 425
Earnings per share of common stock - assuming
dilution ............................................... $ .40 $ .08 $ .32 400
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") ............................ $ 86,547 $ 45,213 $ 41,334 91
Ratio of EBITDA to interest incurred ....................... 5.3x 5.2x .1x 2
</TABLE>
- ------------------------------------------------------
(1)Includes the operations of the Paulsboro Refinery commencing
September 17, 1998.
13
<PAGE> 14
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
Three Months Ended September 30,
------------------------------------------------------------
Change
----------------------------
1999 1998(1) Amount %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales volumes (Mbbls per day) .............................. 967 884 83 9 %
Throughput volumes (Mbbls per day) (2) ..................... 714 559 155 28
Average throughput margin per barrel ....................... $ 3.36 $ 3.20 $ .16 5
Operating costs per barrel:
Cash (fixed and variable) .............................. $ 1.83 $ 2.00 $ (.17) (9)
Depreciation and amortization .......................... .54 .60 (.06) (10)
------------ ------------ ------------
Total operating costs per barrel ................... $ 2.37 $ 2.60 $ (.23) (9)
============ ============ ============
Charges:
Crude oils:
Sour ............................................... 50% 38% 12% 32
Heavy sweet ........................................ 12 21 (9) (43)
Light sweet ........................................ 8 11 (3) (27)
------------ ------------ ------------
Total crude oils ............................... 70 70 -- --
High-sulfur residual fuel oil ("resid") ................ 3 8 (5) (63)
Low-sulfur resid ....................................... 6 2 4 200
Other feedstocks and blendstocks ....................... 21 20 1 5
------------ ------------ ------------
Total charges ...................................... 100% 100% --% --
============ ============ ============
Yields:
Gasolines and blendstocks .............................. 50% 52% (2)% (4)
Distillates ............................................ 29 28 1 4
Petrochemicals ......................................... 5 4 1 25
Lubes and asphalts ..................................... 3 2 1 50
Other products ......................................... 13 14 (1) (7)
------------ ------------ ------------
Total yields ....................................... 100% 100% --% --
============ ============ ============
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (U.S. GULF COAST)
(DOLLARS PER BARREL)
<TABLE>
<CAPTION>
Three Months Ended September 30,
------------------------------------------------------------
Change
----------------------------
1999 1998 Amount %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Feedstocks:
West Texas Intermediate ("WTI") crude oil .............. $ 21.75 $ 14.16 $ 7.59 54%
WTI less sour crude oil (Arab medium) (3) .............. $ 3.10 $ 3.22 $ (.12) (4)
WTI less heavy sweet crude oil (Cabinda) (3) ........... $ 1.04 $ 1.52 $ (.48) (32)
WTI less high-sulfur resid (Singapore) (3) ............. $ 1.80 $ 1.72 $ .08 5
Products:
Conventional 87 gasoline less WTI ...................... $ 3.65 $ 2.58 $ 1.07 41
No. 2 fuel oil less WTI ................................ $ .57 $ 1.00 $ (.43) (43)
Propylene less WTI ..................................... $ 1.82 $ 1.68 $ .14 8
</TABLE>
- -------------------------------------------------
(1) Includes the operations of the Paulsboro Refinery commencing September 17,
1998.
(2) Includes 170 Mbbls per day and 23 Mbbls per day for the 1999 and 1998
periods, respectively, related to the Paulsboro Refinery.
(3) Excludes $.25 to $.50 per barrel for other delivery-related costs into the
Company's refineries.
14
<PAGE> 15
The Company reported net income for the third quarter of 1999 of $22.6
million, or $.40 per share, compared to net income of $4.3 million, or $.08 per
share, for the third quarter of 1998. The increase in third quarter results was
due primarily to strong gasoline fundamentals in the 1999 period and continued
reductions in cash operating costs (excluding the effect of the Paulsboro
Refinery which was acquired in September 1998) resulting from the Company's
comprehensive cost reduction efforts. Partially offsetting the increases in
income resulting from these factors were lower distillate margins and increases
in interest and income tax expense.
Operating revenues increased $823.3 million, or 62%, to $2.2 billion
during the third quarter of 1999 compared to the same period in 1998 due to a
$7.87, or 48%, increase in the average sales price per barrel and a 9% increase
in average daily sales volumes. The increase in sales volumes was due primarily
to a full quarter of operations during 1999 for the Paulsboro Refinery,
partially offset by a decrease in barrels purchased for resale. The increase in
sales prices was attributable primarily to significantly higher crude oil prices
resulting from the continuation of OPEC production cuts announced in March 1999,
and to lower refined product inventories, particularly for gasoline. Demand
growth for gasoline increased approximately 2% for the quarter, while gasoline
production showed only a moderate increase. As a result, gasoline inventories
fell approximately 13 million barrels to finish below both 1998 and historical
levels.
Operating income increased $33.7 million to $47.4 million during the
third quarter of 1999 compared to the third quarter of 1998 due primarily to an
approximate $55 million increase in total throughput margins and an approximate
$8 million decrease in operating costs for all refineries exclusive of the
Paulsboro Refinery. Partially offsetting these increases in operating income was
an approximate $30 million increase in operating costs attributable to a full
quarter of operations in 1999 for the Paulsboro Refinery.
The increase in total throughput margins noted above was attributable
to (i) higher margins for gasolines and blendstocks resulting primarily from the
factors noted above in the discussion of operating revenues, (ii) a full
quarter's contribution in 1999 from the Paulsboro Refinery and (iii) an increase
in premiums for xylene and other petrochemical feedstocks resulting from
improved Asian demand. Partially offsetting the increases in total throughput
margins resulting from these factors were lower distillate margins resulting
mainly from continued higher than historical inventory levels, and an
approximate $14 million decrease in results from price risk management
activities resulting primarily from losses on hedging activities incurred in the
third quarter of 1999.
The above-noted decrease in operating costs for all refineries
exclusive of the Paulsboro Refinery was due to a $9 million decrease in cash
operating expenses resulting mainly from lower maintenance, fuel, catalyst and
chemical costs, partially offset by a $1 million increase in depreciation
expense and amortization of deferred turnaround and catalyst costs.
Net interest and debt expense increased $7.9 million to $15.1 million
during the third quarter of 1999 compared to the same period in 1998 due
primarily to the full-quarter effect of interest on borrowings related to the
acquisition of the Paulsboro Refinery and an increase in average interest rates.
Income tax expense increased $10.4 million to $12.2 million during the
third quarter of 1999 compared to the same period in 1998 due primarily to an
increase in pre-tax income.
15
<PAGE> 16
YEAR-TO-DATE 1999 COMPARED TO YEAR-TO-DATE 1998
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------------------------------------
Change
----------------------------
1999 1998(1) Amount %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Operating revenues ......................................... $ 5,323,491 $ 4,149,112 $ 1,174,379 28 %
Cost of sales .............................................. (4,777,359) (3,595,819) (1,181,540) (33)
Operating costs:
Cash (fixed and variable) .............................. (354,601) (302,686) (51,915) (17)
Depreciation and amortization .......................... (104,176) (83,034) (21,142) (25)
Selling and administrative expenses (including related
depreciation expense) .................................. (52,130) (54,267) 2,137 4
------------ ------------ ------------
Operating income, before inventory write-down .............. 35,225 113,306 (78,081) (69)
Write-down of inventories to market value .................. -- (37,673) 37,673 100
------------ ------------ ------------
Total operating income ................................. $ 35,225 $ 75,633 $ (40,408) (53)
============ ============ ============
Other income, net .......................................... $ 3,483 $ 17 $ 3,466 --(2)
Interest and debt expense, net ............................. $ (42,097) $ (21,184) $ (20,913) (99)
Income tax (expense) benefit ............................... $ 1,200 $ (16,100) $ 17,300 107
Net income (loss) .......................................... $ (2,189) $ 38,366 $ (40,555) (106)
Earnings (loss) per share of common stock - assuming
dilution ............................................... $ (.04) $ .67 $ (.71) (106)
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") ............................ $ 146,787 $ 199,270(3) $ (52,483) (26)
Ratio of EBITDA to interest incurred ....................... 3.2x 8.1x (4.9)x (60)
</TABLE>
- ------------------------------------------------------------
(1) Includes the operations of the Paulsboro Refinery commencing September 17,
1998.
(2) Variance exceeds 1,000%.
(3) Excludes the $37.7 million pre-tax write-down of inventories to market
value.
16
<PAGE> 17
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------------------------------------
Change
----------------------------
1999 1998 (1) Amount %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales volumes (Mbbls per day) .............................. 1,018 858 160 19%
Throughput volumes (Mbbls per day) (2) ..................... 709 546 163 30
Average throughput margin per barrel ....................... $ 2.82 $ 3.71(3) $ (.89) (24)
Operating costs per barrel:
Cash (fixed and variable) .............................. $ 1.83 $ 2.03 $ (.20) (10)
Depreciation and amortization .......................... .54 .56 (.02) (4)
------------ ------------ ------------
Total operating costs per barrel ................... $ 2.37 $ 2.59 $ (.22) (8)
============ ============ ============
Charges:
Crude oils:
Sour ............................................... 48% 34% 14% 41
Heavy sweet ........................................ 13 21 (8) (38)
Light sweet ........................................ 9 13 (4) (31)
------------ ------------ ------------
Total crude oils ............................... 70 68 2 3
High-sulfur resid ...................................... 3 10 (7) (70)
Low-sulfur resid ....................................... 6 2 4 200
Other feedstocks and blendstocks ....................... 21 20 1 5
------------ ------------ ------------
Total charges ...................................... 100% 100% --% --
============ ============ ============
Yields:
Gasolines and blendstocks .............................. 51% 53% (2)% (4)
Distillates ............................................ 30 28 2 7
Petrochemicals ......................................... 4 4 -- --
Lubes and asphalts ..................................... 3 1 2 200
Other products ......................................... 12 14 (2) (14)
------------ ------------ ------------
Total yields ....................................... 100% 100% --% --
============ ============ ============
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (U.S. GULF COAST)
(DOLLARS PER BARREL)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------------------------------------
Change
----------------------------
1999 1998 Amount %
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Feedstocks:
WTI crude oil .......................................... $ 17.48 $ 14.92 $ 2.56 17%
WTI less sour crude oil (Arab medium) (4) .............. $ 3.00 $ 3.46 $ (.46) (13)
WTI less heavy sweet crude oil (Cabinda) (4) ........... $ 1.10 $ 1.37 $ (.27) (20)
WTI less high-sulfur resid (Singapore) (4) ............. $ 1.72 $ 2.30 $ (.58) (25)
Products:
Conventional 87 gasoline less WTI ...................... $ 2.72 $ 3.38 $ (.66) (20)
No. 2 fuel oil less WTI ................................ $ .09 $ 1.51 $ (1.42) (94)
Propylene less WTI ..................................... $ (.13) $ 2.35 $ (2.48) (106)
</TABLE>
- --------------------------------------------------------
(1) Includes the operations of the Paulsboro Refinery commencing
September 17, 1998.
(2) Includes 173 Mbbls per day and 8 Mbbls per day for the 1999 and 1998
periods, respectively, related to the Paulsboro Refinery.
(3) Excludes a $.25 per barrel reduction resulting from the effect of the $37.7
million pre-tax write-down of inventories to market value.
(4) Excludes $.25 to $.50 per barrel for other delivery-related costs into the
Company's refineries.
17
<PAGE> 18
The Company reported a net loss for the first nine months of 1999 of
$2.2 million, or $.04 per share, compared to net income of $38.4 million, or
$.67 per share, for the first nine months of 1998. The results for the 1998
period were reduced by a $37.7 million ($23.9 million after-tax) write-down in
the carrying amount of the Company's refinery inventories resulting from a
significant decline in feedstock and refined product prices during the 1998
first quarter. Excluding the effect of the 1998 inventory write-down, results
for the first nine months of 1999 were significantly below 1998 levels for the
same period due primarily to extremely weak refining industry fundamentals
during the first half of 1999, the effect of significant downtime at the
Company's Corpus Christi refinery in early 1999 due to a major maintenance
turnaround and expansion of the heavy oil cracker and related units, and
increased interest expense. Partially offsetting the decreases in income
resulting from these factors were improvements in industry conditions in the
third quarter of 1999, a significant reduction in cash operating costs
(excluding the effect of the Paulsboro Refinery which was acquired in September
1998) and reduced selling and administrative expenses resulting from the
Company's comprehensive cost reduction efforts, lower income tax expense, and a
benefit to income related to a permanent reduction in LIFO inventories during
the first quarter of 1999 (see Note 4 of Notes to Consolidated Financial
Statements).
Operating revenues increased $1.2 billion, or 28%, to $5.3 billion
during the first nine months of 1999 compared to the same period in 1998 due to
a 19% increase in average daily sales volumes and a $1.47, or 8%, increase in
the average sales price per barrel. The increase in sales volumes was due
primarily to additional volumes attributable to the September 1998 acquisition
of the Paulsboro Refinery, while the increase in sales prices was due primarily
to higher crude oil prices attributable to OPEC production cuts announced in
March 1999 and lower refined product inventories in the third quarter.
Excluding the effect of the $37.7 million inventory write-down in the
first nine months of 1998 described above, operating income decreased $78.1
million, or 69%, to $35.2 million during the first nine months of 1999 compared
to the same period in 1998. This decrease in operating income was due primarily
to an approximate $96 million increase in operating costs attributable to a full
nine months of operations in 1999 for the Paulsboro Refinery, an approximate $10
million increase in depreciation expense and amortization of deferred turnaround
and catalyst costs for all refineries exclusive of the Paulsboro Refinery, and
an approximate $7 million decrease in total throughput margins. Partially
offsetting these decreases was an approximate $33 million reduction in cash
operating costs for all refineries exclusive of the Paulsboro Refinery resulting
mainly from lower costs related to maintenance, fuel, catalyst and chemicals,
and an approximate $2 million decrease in selling and administrative expenses
(including related depreciation expense) due mainly to Company-wide cost
reduction initiatives.
The decrease in total throughput margins noted above was attributable
to (i) significantly lower distillate and gasoline margins resulting from both
depressed refined product prices during the first two quarters of 1999 and
higher crude oil prices resulting from the OPEC production cuts discussed above,
(ii) a decrease in feedstock discounts relative to WTI, and (iii) lower
propylene margins. The negative effect on throughput margins resulting from
these factors was offset to a large extent by an increase in the contribution
from the Paulsboro Refinery resulting from a full nine months of operations in
1999, and a $10.5 million benefit resulting from the liquidation of LIFO
inventories in the 1999 period.
18
<PAGE> 19
Net interest and debt expense increased $20.9 million, or 99%, to $42.1
million during the first nine months of 1999 compared to the same period in 1998
due to an increase in borrowings resulting primarily from the acquisition of the
Paulsboro Refinery in September 1998, and to a lesser extent, to an increase in
average interest rates.
Income taxes decreased $17.3 million, from a $16.1 million expense
during the first nine months of 1998 to a $1.2 million benefit during the same
period in 1999, due primarily to a decrease in pre-tax income.
OUTLOOK
Thus far in the fourth quarter of 1999, gasoline margins have narrowed
from third quarter levels due to normal seasonal patterns, but are in excess of
fourth quarter 1998 margins. Heating oil margins have improved from 1999 third
quarter levels and are approaching fourth quarter 1998 margins as inventories
are below 1998 levels. However, heating oil inventories are still above, and
heating oil margins are still below, historical averages. On the cost side,
strong crude oil prices resulting from production cuts continue to impact
refining margins. Although market fundamentals have improved since earlier in
the year, earnings for the fourth quarter of 1999 will be dependent, to a large
extent, on the return of normal winter heating demand and a corresponding
reduction in distillate inventories. The Company expects to continue to
recognize significant benefits from its cost-cutting initiatives begun earlier
in 1999.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $265.2 million during the
first nine months of 1999, a decrease of only $2.9 million compared to the same
period in 1998 despite the significant decline in income between the two
periods. Net cash provided by operating activities benefitted during the first
nine months of both 1999 and 1998 from a substantial decrease in the amount of
cash utilized for working capital purposes, as detailed in Note 5 of Notes to
Consolidated Financial Statements. In the first nine months of 1999, cash
utilized for working capital purposes decreased $167.2 million. During the
period, accounts receivable, accounts payable and inventories increased due to a
significant increase in commodity prices from December 31, 1998 to September 30,
1999. Combined with concerted efforts by the Company during such period to
collect accounts receivable, and the sale of receivables in September 1999
described in Note 3 of Notes to Consolidated Financial Statements, both of which
helped reduce the increase in receivables resulting from higher commodity
prices, the Company realized a net decrease in cash utilized for working capital
purposes. The decrease in the amount of cash utilized for working capital
purposes for the 1998 period was due primarily to an approximate $82 million net
reduction in accounts receivable and accounts payable resulting from decreases
in commodity prices from December 31, 1997 to September 30, 1998, as well as a
$30 million increase in accrued expenses resulting from a statutorily mandated
delay in the payment of motor fuel taxes that were subsequently paid in the 1998
fourth quarter. During the first nine months of 1999, cash provided by (i)
operating activities, (ii) proceeds from the issuance of the 7 3/8% notes
described in Note 6 of Notes to Consolidated Financial Statements (approximately
$298 million), (iii) issuances of common stock related to the Company's benefit
plans, and (iv) existing cash balances were utilized to reduce bank borrowings,
fund capital expenditures and deferred turnaround and catalyst costs, and pay
common stock dividends.
19
<PAGE> 20
The Company currently maintains an unsecured $835 million revolving
bank credit and letter of credit facility that matures in November 2002 and is
available for general corporate purposes including working capital needs and
letters of credit. Borrowings under this facility bear interest at either LIBOR
plus a margin, a base rate or a money market rate. The Company is also charged
various fees and expenses in connection with this facility, including a facility
fee and various letter of credit fees. The interest rate and fees under the
credit facility are subject to adjustment based upon the credit ratings assigned
to the Company's long-term debt. The credit facility includes certain
restrictive covenants including a coverage ratio, a capitalization ratio, and a
minimum net worth test. As of September 30, 1999, outstanding borrowings and
letters of credit under this committed bank credit and letter of credit facility
totaled approximately $225 million. The Company also has uncommitted short-term
bank credit facilities under which amounts up to $125 million may be borrowed,
along with uncommitted bank letter of credit facilities totaling $285 million.
As of September 30, 1999, $12 million was outstanding under the short-term bank
credit facilities, and letters of credit totaling approximately $48 million were
outstanding under the uncommitted letter of credit facilities. As of September
30, 1999, the Company's debt to capitalization ratio was 44.4%.
During the first nine months of 1999, the Company reduced its exposure
to increases in interest rates and increased its financial flexibility by (i)
issuing $300 million of seven-year 7 3/8% notes under its $600 million shelf
registration statement and using the net proceeds to reduce variable rate bank
borrowings and (ii) refinancing $25 million of its taxable, variable rate
industrial revenue bonds with tax-exempt 5.7% fixed rate bonds. See Note 6 of
Notes to Consolidated Financial Statements.
As described in Note 2 of Notes to Consolidated Financial Statements,
Mobil is entitled to receive payments from the Company in any of the five years
following the Company's September 1998 acquisition of the Paulsboro Refinery if
certain average refining margins during any of such years exceed a specified
level. Based on margin levels since the acquisition date, no earn-out payment
was due to Mobil for the year ended September 16, 1999.
During the first nine months of 1999, the Company expended
approximately $135 million for capital investments, including capital
expenditures of $77 million and deferred turnaround and catalyst costs of $58
million. The deferred turnaround and catalyst costs related primarily to (i) a
major maintenance turnaround of the heavy oil cracker and related units at the
Corpus Christi refinery in the first quarter, (ii) a catalyst change for the
Corpus Christi hydrodesulfurization unit in the second quarter, and (iii) a
turnaround and catalyst change of the Texas City Residfiner also in the second
quarter. For total year 1999, the Company currently expects to incur
approximately $175 million for capital investments, including approximately $105
million for capital expenditures and approximately $70 million for deferred
turnaround and catalyst costs. The capital expenditure estimate includes
approximately $13 million for computer system projects and approximately $7
million for projects related to environmental control and protection.
During the fourth quarter of 1999, the Company has repurchased shares
of common stock at a cost of approximately $13 million pursuant to a stock
repurchase program approved by the Company's Board of Directors in the third
quarter of 1998. Such shares will be used primarily to meet requirements under
the Company's employee benefit plans during the coming twelve months.
20
<PAGE> 21
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 or offerings under its universal shelf registration statement that
may occur from time to time, the Company has no other specific financing plans.
NEW ACCOUNTING PRONOUNCEMENTS
As discussed in Note 8 of Notes to Consolidated Financial Statements,
various new financial accounting pronouncements have been issued by the AICPA
and FASB which either became effective for the Company's financial statements
beginning in 1999 or become effective in 2001. Except for SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," for which the
impact has not yet been determined, the adoption of these statements has not had
a material effect on the Company's consolidated financial statements.
YEAR 2000 READINESS DISCLOSURE
BACKGROUND
The transition to January 1, 2000 poses problems for almost all users
of information technology ("IT"). These potential problems result from the fact
that many computer programs created in the past were programmed to identify
calendar dates with only the last two digits of the year. As a result, such
programs are unable to distinguish between the year 1900 and the year 2000,
potentially resulting in miscalculations, malfunctions or failures of such
programs. In addition to its potential effect on computer systems, the century
date change may also result in malfunctions or failures of non-IT equipment
which contain embedded systems with date-sensitive functions. These potential
consequences are generally referred to as the "Year 2000" problem.
STATE OF READINESS
In 1996, in order to improve business processes, reduce costs,
integrate business information, improve access to such information, and provide
flexibility for ongoing business changes, the Company began the implementation
of new client/server based systems which will run substantially all of the
Company's principal business software applications. These new systems have been
represented as Year 2000 compliant by their respective manufacturers and were
substantially implemented by the end of 1998.
In order to verify the Year 2000 compliance of the above noted systems,
and address the Year 2000 problem with respect to other IT systems and non-IT
embedded systems, the Company has developed a compliance plan with respect to
those systems and services that are deemed to be critical to the Company's
operations and safety of its employees. This plan is divided into the following
sections, which represent major business areas that are potentially affected by
the Year 2000 problem: Business Systems (includes IT hardware, software and
network systems serving the Company's corporate, refining, marketing and supply
areas);
21
<PAGE> 22
Plant Facilities (includes non-IT embedded systems such as process control
systems and the physical equipment and facilities at the Company's refineries);
and Office Facilities/Aviation (includes telephone, security and environmental
systems and office equipment at the Company's office facilities and
aviation-related equipment and software). Implementation of the Company's Year
2000 compliance plan is led by a Management Oversight Committee, which includes
members of executive management, and Year 2000 coordinators for each of the
business areas described above. The compliance plan is monitored weekly by the
business area coordinators and progress reported monthly to the Management
Oversight Committee. The compliance plan includes the following phases:
o Form internal Year 2000 organizations, both at the corporate and refinery
level, to pursue relevant action plans.
o Inventory affected systems and services for all business areas and
prioritize the importance of each particular system to the Company and its
operations as either high, medium, or low priority.
o Assess the compliance of inventoried items by contacting the vendor or
manufacturer to determine whether the system is Year 2000 compliant.
o Develop action plans to remediate (fix, replace, or discard) each of the
non-compliant high and medium priority items (those items believed by the
Company to have a risk involving the safety of individuals, significant
damage to equipment, the environment, or communications, or a significant
loss of revenues).
o Remediate the non-compliant high and medium priority items by implementing
the plans developed above.
o Validate Year 2000 compliance by testing, wherever possible, all high and
medium priority items.
o Develop contingency plans for (i) the most critical high-priority items,
even if validated as compliant, and (ii) all high and medium priority items
that cannot be tested.
Currently, all of the above-noted phases in the Company's Year 2000
compliance plan have been substantially completed for each of its major business
areas. The Company is continuing to remediate and test the few remaining
inventoried items that are not yet compliant (less than 1% of all inventoried
items), and expects to complete such remediation and/or testing prior to
December 31, 1999. In addition to the remediation and testing of high and medium
priority items as noted in the compliance plan above, both the Business Systems
and Office Facilities/Aviation areas extended their remediation and testing
procedures to also include low priority items to ensure compliance for all
inventoried items. Remediation and testing of low priority items for the Plant
Facilities area was not performed as such items were determined to have minimal
risk to the Company. For a discussion of additional contingency planning to be
accomplished between now and the end of the year, see "Contingency Plans" below.
Completion of the Company's Year 2000 compliance plan has been, and
will continue to be, performed primarily by Company personnel. However, in
certain cases, outside contractors or consultants have been engaged to assist in
the Company's Year 2000 efforts and will continue to be used in the future.
Presently, no significant IT projects have been delayed due to the
implementation of the Company's Year 2000 compliance plan.
In addition to the major business areas described above, the Company's
External Service Providers (third-party relationships material to the Company's
operations, including (i) service providers for the
22
<PAGE> 23
Company's Business Systems, Plant Facilities and Office Facilities/Aviation
described above, (ii) "supply" relationships such as major suppliers of refinery
feedstocks, (iii) "marketing" relationships such as major customers and pricing
services, and (iv) "logistics" relationships such as pipelines, terminals,
ships, barges and storage facilities) could equally be affected by the Year 2000
problem, which in turn could have an impact on the Company's business. For that
reason, Year 2000 compliance of the External Service Providers which the Company
believes to be critical is also being assessed as part of the Company's Year
2000 compliance plan. Over 70 Year 2000 questionnaires were sent to External
Service Providers deemed to be critical. Additionally, over 200 questionnaires
were sent to External Service Providers classified as high priority. A risk
assessment has been completed for all critical and high priority External
Service Providers, and contingency plans have been developed for all critical
External Service Providers.
COSTS
The estimated total external costs to complete the Company's Year 2000
compliance plan are currently estimated to be approximately $3 million. The
Company does not separately track internal costs, principally consisting of
payroll and related costs for its information systems group and certain other
employees, incurred in connection with its Year 2000 compliance efforts. The
above amounts do not include costs associated with the implementation of the new
client/server based systems described under "State of Readiness."
RISKS
The current status of the Company's Year 2000 compliance plan and costs
of compliance noted above are the current best estimates of the Company's
management and are believed to be reasonably accurate. In the event
unanticipated problems are encountered in connection with the Company's Year
2000 efforts, the Company may need to devote more resources to such efforts and
additional costs may be incurred. If the Company does not satisfactorily
complete its Year 2000 compliance plan, including identifying and resolving
problems encountered by the Company's External Service Providers, potential
consequences could include, among other things, unit downtime at or damage to
the Company's refineries, delays in transporting refinery feedstocks and refined
products, impairment of relationships with significant suppliers or customers,
loss of accounting data or delays in processing such data, and loss of or delays
in internal and external communications. The occurrence of any or all of the
above could result in a material adverse effect on the Company's results of
operations, liquidity or financial condition. Although the Company currently
believes that it will satisfactorily complete its Year 2000 compliance plan as
described above prior to January 1, 2000, there can be no assurance that the
plan will be satisfactorily completed by such time or that the Year 2000 problem
will not adversely affect the Company and its business.
CONTINGENCY PLANS
During the third quarter of 1999, the Company substantially completed
the development of Year 2000 contingency plans for its Business Systems, Plant
Facilities and Office Facilities/Aviation business areas, as well as for various
key corporate departments and certain critical External Service Providers. These
plans consist of documenting established plans of action to be followed in the
event certain assumed Year 2000
23
<PAGE> 24
disruption scenarios occur during the period January 1-15, 2000 and are designed
to accomplish the following objectives: (i) continue critical Company business
operations; (ii) minimize the decisions and effort required to continue business
operations; (iii) minimize dependence on any one person to continue business
operations; (iv) minimize the risks to the Company in terms of diminished cash
flow, income, assets or customer relations; and (v) establish lines of
communication to be followed while the plans are in action.
Since the end of the quarter, the Company has, among other things,
communicated to all employees a detailed work schedule for the critical time
frame covering the last week of December 1999 through the first two weeks of
January 2000, and identified critical personnel that will be required to be
on-site during such period. The Company has also developed detailed procedures
for communicating to all of its employees the Company's Year 2000 status, and
the status of critical third parties, from the time the January 1, 2000 boundary
is crossed until at least two weeks later. From now until the end of the year,
the Company will be continually reviewing, refining and testing its work
schedules, communications and other contingency plans to ensure that all areas
of the Company are keenly aware of their responsibilities so that any potential
disruptions are minimized.
YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT
To the maximum extent permitted by applicable law, the above
information is being designated as a "Year 2000 Readiness Disclosure" pursuant
to the "Year 2000 Information and Readiness Disclosure Act" which was signed
into law on October 19, 1998.
FORWARD-LOOKING 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 feedstock arrangements as well as market, political or other forces
generally affecting the pricing and availability of 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; cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such projects; the
failure to avoid or correct a material Year 2000 problem, including internal
problems or problems encountered by third parties; state and federal
environmental, economic, safety and other policies and regulations, any changes
therein, and any legal or regulatory delays
24
<PAGE> 25
or other factors beyond the Company's control; weather conditions affecting the
Company's operations or the areas in which the Company's products are marketed;
rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any reserves;
the introduction or enactment of federal or state legislation which may
adversely affect the Company's business or operations; and changes in the credit
ratings assigned to the Company's debt securities and trade credit. All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by the foregoing. 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.
25
<PAGE> 26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COMMODITY PRICE RISK
The Company is exposed to market risks related to the volatility of
crude oil and refined product prices, as well as volatility in the price of
natural gas used in the Company's refining operations. In order to reduce the
risks of these price fluctuations, the Company uses derivative commodity
instruments to hedge certain refinery feedstock and refined product inventories
to reduce the impact of adverse price changes on these inventories before the
conversion of the feedstock to finished products and ultimate sale. The Company
also uses derivative commodity instruments to hedge the price risk of
anticipated transactions. Such transactions include anticipated feedstock,
product and natural gas purchases, and product sales. These instruments are used
to lock in purchase or sales prices or components of refining operating margins,
including feedstock discounts, crack spreads (i.e., the difference between the
price of crude oil and conventional gasoline or heating oil) and premium product
differentials. In addition, the Company uses derivative commodity instruments
for trading purposes using its fundamental and technical analysis of market
conditions to earn additional revenues. The types of instruments used in the
Company's hedging and trading activities described above include price swaps,
options, and futures contracts. The Company's positions in derivative commodity
instruments are monitored and managed on a daily basis by a risk control group
to ensure compliance with the Company's stated risk management policy which has
been approved by the Company's Board of Directors.
The following table provides information about the Company's derivative
commodity instruments, which mature in 1999, held to hedge refining inventories
as of September 30, 1999 (dollars in thousands, except amounts per barrel or per
million British thermal units ("MMBtu")). Volumes shown for swaps represent
notional volumes which are used to calculate amounts due under the agreements.
<TABLE>
<CAPTION>
Fixed Price
------------------------------
Payor Receiver
------------ ------------
<S> <C> <C>
Swaps:
Notional volumes (Mbbls) ............................... 550 --
Weighted average pay price (per bbl) ................... $ .14 --
Weighted average receive price (per bbl) ............... $ .08 --
Fair value ............................................. $ (33) --
Futures:
Volumes (Mbbls) ........................................ 5,361 10,345
Weighted average price (per bbl) ....................... $ 24.62 $ 26.02
Contract amount ........................................ $ 132,007 $ 269,158
Fair value ............................................. $ 136,092 $ 276,337
Volumes (Billion Btus or "BBtus") ...................... -- 120
Weighted average price (per MMBtu) ..................... -- $ 2.58
Contract amount ........................................ -- $ 310
Fair value ............................................. -- $ 346
</TABLE>
26
<PAGE> 27
The following table provides information about the Company's derivative
commodity instruments held to hedge anticipated feedstock and product purchases,
product sales and refining margins as of September 30, 1999 and which mature in
1999 or 2000 (dollars in thousands, except amounts per barrel).
<TABLE>
<CAPTION>
Mature in 1999 Mature in 2000
--------------------- ---------------------
Fixed Price Fixed Price
--------------------- ---------------------
Payor Receiver Payor Receiver
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Futures:
Volumes (Mbbls) ......................... 11 20 23 11
Weighted average price (per bbl) ........ $ 22.15 $ 22.82 $ 22.07 $ 19.84
Contract amount ......................... $ 244 $ 457 $ 508 $ 218
Fair value .............................. $ 263 $ 458 $ 537 $ 231
</TABLE>
In addition to the above, as of September 30, 1999, the Company was the
fixed price payor under certain swap contracts held to hedge anticipated
purchases of refinery feedstocks and refined products that mature in 2002 with
notional volumes totaling approximately 7.5 million barrels, a weighted average
pay price of $20.11 per barrel, a weighted average receive price of $17.88 per
barrel, and a net unrecognized fair value of approximately $6 million.
The following table provides information about the Company's derivative
commodity instruments held or issued for trading purposes as of September 30,
1999 and which mature in 1999, 2000 or 2001 (dollars in thousands, except
amounts per barrel or per million British thermal units). Volumes shown for
swaps represent notional volumes which are used to calculate amounts due under
the agreements.
<TABLE>
<CAPTION>
Mature in 1999 Mature in 2000 Mature in 2001
------------------------ ----------------------- -----------------------
Fixed Price Fixed Price Fixed Price
------------------------ ----------------------- -----------------------
Payor Receiver Payor Receiver Payor Receiver
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Swaps:
Notional volumes (Mbbls) ........................ 13,775 15,300 14,025 16,775 -- 600
Weighted average pay price (per bbl) ............ $ 1.87 $ 1.77 $ 3.22 $ 2.17 -- $ 2.04
Weighted average receive price (per bbl)......... $ 1.84 $ 1.89 $ 3.42 $ 2.12 -- $ 2.18
Fair value ...................................... $ (396) $ 1,895 $ 2,808 $ (844) -- $ 82
Options:
Volumes (Mbbls) ................................. 1,450 1,900 -- -- -- --
Weighted average strike price (per bbl) ......... $ 12.30 $ 9.64 -- -- -- --
Contract amount ................................. $ 489 $ 297 -- -- -- --
Fair value ...................................... $ 4,222 $ 4,196 -- -- -- --
Futures:
Volumes (Mbbls) ................................. 25,322 25,870 9,806 9,258 -- --
Weighted average price (per bbl) ................ $ 20.85 $ 20.69 $ 17.00 $ 16.40 -- --
Contract amount ................................. $ 527,912 $ 535,277 $ 166,696 $ 151,845 -- --
Fair value ...................................... $ 628,546 $ 632,997 $ 201,927 $ 189,082 -- --
Volumes (BBtus) ................................. 1,100 1,100 -- -- -- --
Weighted average price (per MMBtu) .............. $ 2.70 $ 2.74 -- -- -- --
Contract amount ................................. $ 2,969 $ 3,011 -- -- -- --
Fair value ...................................... $ 3,175 $ 3,175 -- -- -- --
</TABLE>
27
<PAGE> 28
INTEREST RATE RISK
The Company's primary market risk exposure for changes in interest
rates relates to the Company's long-term debt obligations. The Company manages
its exposure to changing interest rates principally through the use of a
combination of fixed and floating rate debt and currently does not use
derivative financial instruments to manage such risk. See Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources for a discussion of various initiatives
undertaken by the Company in the first nine months of 1999 to reduce its
exposure to increases in interest rates and increase its financial flexibility.
28
<PAGE> 29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Prior to July 31, 1997, Valero was a wholly owned subsidiary of Valero
Energy Corporation ("Energy"). Energy was engaged in both the refining and
marketing business and the natural gas related services business. On July 31,
1997, Energy spun off Valero to Energy's stockholders and merged its remaining
natural gas related services business with a wholly owned subsidiary of PG&E
Corporation ("PG&E") (the "Restructuring"). 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 by the trial court, but Energy appealed,
and in August 1999, the court of appeals ruled in Energy's favor and compelled
arbitration of the entire dispute. Although the plaintiff is seeking further
appellate review of this decision, the trial court has since vacated its
original denial and has now compelled arbitration. 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 owns both Teco and
Energy, 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
agreement by which the Company was spun off to Energy's stockholders in
connection with the Restructuring, the Company has agreed to indemnify 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 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
*27.1 Financial Data Schedule (reporting financial information
as of and for the nine months ended September 30, 1999).
- --------------------------
* The Financial Data Schedule shall not be deemed "filed" for purposes of
Section 11 of the Securities Act of 1933 or Section 18 of the
Securities Exchange Act of 1934, and is included as an exhibit 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, 1999.
29
<PAGE> 30
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By: /s/ John D. Gibbons
-----------------------------------------------
John D. Gibbons
Chief Financial Officer, Vice President -
Finance
(Duly Authorized Officer and Principal
Financial and Accounting Officer)
Date: November 12, 1999
30
<PAGE> 31
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<S> <C>
*27.1 Financial Data Schedule (reporting financial information
as of and for the nine months ended September 30, 1999).
</TABLE>
- --------------------------
* The Financial Data Schedule shall not be deemed "filed" for purposes of
Section 11 of the Securities Act of 1933 or Section 18 of the
Securities Exchange Act of 1934, and is included as an exhibit 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.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1999 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 7,819
<SECURITIES> 0
<RECEIVABLES> 354,008
<ALLOWANCES> 1,782
<INVENTORY> 418,745
<CURRENT-ASSETS> 862,183
<PP&E> 2,662,398
<DEPRECIATION> 678,624
<TOTAL-ASSETS> 2,999,075
<CURRENT-LIABILITIES> 702,044
<BONDS> 845,788
0
0
<COMMON> 563
<OTHER-SE> 1,075,729
<TOTAL-LIABILITY-AND-EQUITY> 2,999,075
<SALES> 5,323,491
<TOTAL-REVENUES> 5,323,491
<CGS> 5,288,266
<TOTAL-COSTS> 5,288,266
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 42,097
<INCOME-PRETAX> (3,389)
<INCOME-TAX> (1,200)
<INCOME-CONTINUING> (2,189)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,189)
<EPS-BASIC> (.04)
<EPS-DILUTED> (.04)
</TABLE>
