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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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
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VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 74-1828067
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE VALERO PLACE
SAN ANTONIO, TEXAS 78212
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (210) 370-2000
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Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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COMMON STOCK, $.01 PAR VALUE NEW YORK STOCK EXCHANGE
PREFERRED SHARE PURCHASE RIGHTS NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value on February 1, 1999, of the registrant's
Common Stock, $.01 par value ("Common Stock"), held by nonaffiliates of the
registrant, based on the average of the high and low prices as quoted in the New
York Stock Exchange Composite Transactions listing for that date, was
approximately $1.0 billion. As of February 1, 1999, 56,070,215 shares of the
registrant's Common Stock were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Company intends to file with the Securities and Exchange Commission
(the "Commission") in March 1999 a definitive Proxy Statement (the "1999 Proxy
Statement") for the Company's Annual Meeting of Stockholders scheduled for April
29, 1999, at which directors of the Company will be elected. Portions of the
1999 Proxy Statement are incorporated by reference in Part III of this Form 10-K
and shall be deemed to be a part hereof.
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CROSS-REFERENCE SHEET
The following table indicates the headings in the 1999 Proxy Statement
where the information required in Part III of Form 10-K may be found.
<TABLE>
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FORM 10-K ITEM NO. AND CAPTION HEADING IN 1999 PROXY STATEMENT
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10. "Directors and Executive Officers of the
Registrant".............................................. "Proposal No. 1 - Election of Directors," and
"Information Concerning Nominees and Other
Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance"
11. "Executive Compensation".................................... "Executive Compensation," "Stock Option Grants and
Related Information," "Report of the Compensation
Committee of the Board of Directors on Executive
Compensation," "Retirement Benefits,"
"Arrangements with Certain Officers and Directors"
and "Performance Graph"
12. "Security Ownership of Certain Beneficial
Owners and Management"................................... "Beneficial Ownership of Valero Securities"
13. "Certain Relationships and Related
Transactions"............................................ "Transactions with Management and Others"
</TABLE>
Copies of all documents incorporated by reference, other than exhibits
to such documents, will be provided without charge to each person who receives a
copy of this Form 10-K upon written request to Jay D. Browning, Corporate
Secretary, Valero Energy Corporation, P.O. Box 500, San Antonio, Texas
78292-0500.
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CONTENTS
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PAGE
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Cross Reference Sheet..................................................................... ii
PART I
Item 1. Business ................................................................................ 1
Restructuring.......................................................................... 1
Basis Acquisition...................................................................... 2
1998 Developments......................................................................... 2
Acquisition of Mobil's Paulsboro, New Jersey Refinery.................................. 2
Refining and Marketing.................................................................... 3
Corpus Christi Refinery................................................................ 3
Texas City Refinery.................................................................... 4
Paulsboro Refinery..................................................................... 5
Houston Refinery....................................................................... 5
Krotz Springs Refinery................................................................. 6
Marketing.............................................................................. 6
Feedstock Supply....................................................................... 7
Selected Operating Results................................................................ 8
Factors Affecting Operating Results....................................................... 8
Competition............................................................................... 10
Environmental Matters..................................................................... 10
Executive Officers of the Registrant...................................................... 12
Employees................................................................................. 13
Item 2. Properties................................................................................ 13
Item 3. Legal Proceedings......................................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders....................................... 15
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..................... 16
Item 6. Selected Financial Data................................................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................. 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................ 36
Item 8. Financial Statements...................................................................... 39
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................................... 75
PART III
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................... 75
</TABLE>
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The following 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 are discussed in "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the heading
"Forward-Looking Statements" and in the Company's other filings with the
Securities and Exchange Commission. 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.
PART I
ITEM 1. BUSINESS
Valero Energy Corporation is one of the United States' largest
independent petroleum refiners and marketers, and the largest on the Gulf Coast.
With the May 1, 1997 acquisition of Basis Petroleum, Inc. and the September 16,
1998 acquisition of Mobil Oil Corporation's Paulsboro, New Jersey refinery, the
Company currently owns and operates five refineries in Texas, Louisiana and New
Jersey with a combined throughput capacity of approximately 735,000 barrels per
day ("BPD"). The Company principally produces premium, environmentally clean
products such as reformulated gasoline, low-sulfur diesel and oxygenates. The
Company also produces a substantial slate of middle distillates, jet fuel and
petrochemicals. The Company markets its products in 31 states and selected
export markets.
Unless otherwise required by the context, the term "Valero" as used
herein refers to Valero Energy Corporation, and the term "Company" refers to
Valero and its consolidated subsidiaries. Valero's principal executive offices
are located at One Valero Place, San Antonio, Texas, 78212 and its telephone
number is (210) 370-2000.
Restructuring
Valero was incorporated in Delaware in 1981 under the name Valero
Refining and Marketing Company and became a publicly held corporation on July
31, 1997. 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 by distributing all of the
common stock of Valero (the "Distribution"). Immediately after the Distribution,
Energy, with its remaining natural gas related services business, merged (the
"Merger") with a wholly owned subsidiary of PG&E Corporation ("PG&E"). The
Distribution and the Merger are collectively referred to as the "Restructuring."
Upon completion of the Restructuring, Valero's name was changed from Valero
Refining and Marketing Company to Valero Energy Corporation and its common stock
was listed for trading on the New York Stock Exchange under the symbol "VLO."
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Basis Acquisition
Effective May 1, 1997, Energy acquired all of the outstanding common
stock of Basis Petroleum, Inc. ("Basis"), a wholly owned subsidiary of Salomon
Inc ("Salomon"). The primary assets acquired with Basis included three
refineries located in Texas City, Texas (the "Texas City Refinery"), Houston,
Texas (the "Houston Refinery") and Krotz Springs, Louisiana (the "Krotz Springs
Refinery") (collectively, the "Basis Refineries") and an extensive wholesale
marketing business. At the time of their acquisition, these refineries had a
combined total throughput capacity in excess of 300,000 BPD. Prior to the
Restructuring, Energy transferred the stock of Basis to Valero. 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.
For financial and statistical information regarding the Company's
operations, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations." For a discussion of cash flows provided by and used in
the Company's operations, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
1998 DEVELOPMENTS
Acquisition of Mobil's Paulsboro, New Jersey Refinery
On September 16, 1998, Valero Refining Company-New Jersey ("VRC-NJ"), a
wholly owned subsidiary of Valero, purchased substantially all of the assets
related to Mobil Oil Corporation's ("Mobil") 155,000 BPD refinery in Paulsboro,
New Jersey (the "Paulsboro Refinery") and assumed certain of its liabilities.
The purchase price was $228 million plus approximately $107 million representing
the value of inventories and certain other items acquired in the transaction.
The purchase price was paid in cash from borrowings under the Company's
committed bank credit facility. In addition, 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 are limited to $20 million in any year and $50
million in the aggregate.
As part of the acquisition, the Company and Mobil signed long-term
agreements for the Paulsboro Refinery to supply Mobil's adjacent lube oil
blending and packaging facility with fuels and lubricant basestocks and for
Mobil to provide high-quality crude feedstocks to the Paulsboro Refinery. In
addition, the Company and Mobil signed long-term agreements for the Paulsboro
Refinery to supply portions of Mobil's marketing operations with light products
at market-related prices.
The acquisition of the Paulsboro Refinery increased the Company's total
throughput capacity by approximately 25%, improved the Company's geographic
diversity by providing better access to Northeast markets and diversified the
Company's product mix through the Paulsboro Refinery's production of high-margin
products such as lubricants and asphalt.
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REFINING AND MARKETING
The Company owns and operates five refineries having a combined total
throughput capacity of approximately 735,000 BPD. The following table lists the
location of each of the Company's refineries and each refinery's feedstock
throughput capacity.
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REFINERY FEEDSTOCK THROUGHPUT CAPACITY IN BPD
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Corpus Christi, Texas 205,000
Texas City, Texas 180,000
Paulsboro, New Jersey 155,000
Houston, Texas 115,000
Krotz Springs, Louisiana 80,000
</TABLE>
The diversity of the Company's refineries allows it to process a wide
slate of feedstocks including medium sour crude oils and heavy sweet crudes,
both of which can typically be purchased at a discount to West Texas
Intermediate, a benchmark crude oil. The primary feedstocks for the Company's
Gulf Coast refineries are medium sour crude oil, heavy and light sweet crude oil
and high-sulfur atmospheric residual fuel oil ("resid"). Since 1997, the
aggregate throughput capacity of the Gulf Coast refineries has been increased to
approximately 580,000 BPD from roughly 480,000 BPD immediately after the
acquisition of the Basis Refineries, principally through (i) upgrading and
reconfiguration improvements undertaken by the Company at the Basis Refineries,
(ii) efforts to optimize feedstock selection in order to capitalize on the
reconfiguration of the Basis Refineries, and (iii) modifications to the
hydrodesulfurization unit at the Corpus Christi Refinery. The Company has the
ability to capitalize on the diverse feedstock capabilities of its Gulf Coast
refineries by transferring up to 35,000 BPD of intermediate feedstocks such as
deasphalted oil ("DAO") and atmospheric tower bottoms ("ATB") from the Texas
City Refinery to the Houston and/or Corpus Christi Refineries which are able to
more effectively produce light products from DAO and ATBs. During 1998, the
Company's refineries operated at approximately 94% of capacity, exclusive of
scheduled turnarounds.
Corpus Christi Refinery
The Corpus Christi Refinery is situated on 254 acres along the Corpus
Christi Ship Channel. The Corpus Christi Refinery specializes in processing
primarily heavy crude oil and resid into premium products, such as reformulated
gasoline ("RFG"). The Corpus Christi Refinery can produce approximately 120,000
BPD of gasoline and gasoline-related products, 38,000 BPD of middle distillates
and 35,000 BPD of other products such as chemicals, asphalt and propane. The
Corpus Christi Refinery can produce all of its gasoline as RFG and all of its
diesel fuel as low-sulfur diesel. The Corpus Christi Refinery has substantial
flexibility to vary its mix of gasoline products to meet changing market
conditions.
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The Corpus Christi Refinery's primary operating units include an 81,000
BPD heavy oil cracker ("HOC"), an 82,000 BPD hydrodesulfurization unit ("HDS"),
a 36,000 BPD hydrocracker and a 36,000 BPD reformer complex. It also operates
certain units which produce oxygenates(1) such as MTBE (methyl tertiary butyl
ether) and TAME (tertiary amyl methyl ether). The MTBE facility can produce
approximately 17,700 BPD of MTBE from butane and methanol feedstocks and the
MTBE/TAME unit converts light olefin streams produced by the refinery's HOC into
MTBE and TAME. These two units enable the Corpus Christi Refinery to produce
approximately 23,000 BPD of oxygenates, which are blended into the Company's own
gasoline production or sold separately. Substantially all of the methanol
feedstocks required for the production of oxygenates at the Corpus Christi
Refinery can normally be provided by a methanol plant in Clear Lake, Texas owned
by a joint venture between a Valero subsidiary and Hoechst Celanese Chemical
Group, Inc. (the "Clear Lake Methanol Plant"). In January 1997, a mixed xylene
fractionation facility, which recovers the mixed xylene stream from the Corpus
Christi Refinery's reformate stream, was placed into service at the refinery.
The fractionated xylene is sold into the petrochemical feedstock market for use
in the production of paraxylene when market conditions are favorable. These
units and related facilities diversify the Corpus Christi Refinery's operations,
giving this refinery the flexibility to pursue potentially higher-margin product
markets.
The Company completed a scheduled turnaround of certain of the Corpus
Christi Refinery's major refining units in the first quarter of 1998.
Modifications made during the 1998 turnaround increased throughput capacity by
10,000 to 15,000 BPD, depending upon the type of feedstocks utilized. In
addition, the HDS unit was modified during 1998 and early 1999 to allow for the
processing of up to 50,000 BPD of high sulfur crude oil, thereby increasing the
Corpus Christi Refinery's feedstock flexibility. The Corpus Christi Refinery
experienced two significant unscheduled shutdowns of its HOC during the first
and third quarters. Both shutdowns related to expander reliability issues which
were resolved during the first quarter 1999 turnaround. To date in 1999,
maintenance turnarounds have been completed for the HOC (during which its
capacity was increased by 4,000 BPD), the HDS unit, the hydrocracker, the
reformer unit, and certain other units. Except for the maintenance turnaround
completed in the first quarter of 1999 and a catalyst change in the HDS unit
likely to occur in the second quarter of 1999, no other turnarounds are
scheduled during 1999 at the Corpus Christi Refinery.
Texas City Refinery
The Texas City Refinery is capable of refining lower-value, medium sour
crudes into a slate of gasolines, low- sulfur diesels and distillates, including
home heating oil, kerosene and jet fuel. The Texas City Refinery typically
produces approximately 55,000 BPD of gasoline and 55,000 BPD of distillates. The
Texas City Refinery can provide approximately 35,000 BPD of intermediate
feedstocks such as DAO and ATBs to the Corpus Christi Refinery and/or the
Houston Refinery. The Texas City Refinery typically receives its feedstocks and
ships product by tanker via deep water docking facilities along the Texas City
Ship Channel, and also has access to the Colonial, Explorer and TEPPCO pipelines
for distribution of its products.
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(1) "Oxygenates" are liquid hydrocarbon compounds containing oxygen.
Gasoline that contains oxygenates usually has lower carbon monoxide emissions
than conventional gasoline. MTBE is an oxygen-rich, high-octane gasoline
blendstock produced by reacting methanol and isobutylene, and is used to
manufacture oxygenated and reformulated gasolines. TAME, like MTBE, is an
oxygen-rich, high-octane gasoline blendstock.
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The Texas City Refinery's primary operating units include a 160,000 BPD
crude distillation complex and a 52,000 BPD fluid catalytic cracking unit ("FCC
Unit"). During the latter part of 1996, a 78,000 BPD Residfiner (which improves
the cracking characteristics of the feedstocks for the FCC Unit), and a 40,000
BPD Residual Oil Supercritical Extraction unit ("ROSE") (which recovers DAO from
the vacuum tower bottoms for feed to the FCC Unit) were placed in service at the
Texas City Refinery. These units significantly enhanced this refinery's
feedstock flexibility and product diversity.
During 1998, the Texas City Refinery experienced unscheduled downtime
at its Residfiner, primarily due to an unreliable supply of hydrogen from a
third-party supplier. In late 1998, the Company entered into an agreement with
other third-party suppliers for back-up supplies of a portion of the Texas City
Refinery's hydrogen needs. The Company expects to enter into additional
agreements in 1999 that will improve the reliability of hydrogen supplied to the
Texas City Refinery. A scheduled turnaround was completed on the Residfiner in
April 1998 and a catalyst change for this unit is also anticipated in 1999.
Except for the Residfiner catalyst change, no other significant turnarounds are
planned for 1999.
Paulsboro Refinery
The Paulsboro Refinery processes primarily medium sour and heavy sour
crudes into a wide slate of gasoline and distillates, including home heating
oil, lubricants and asphalt. The Paulsboro Refinery typically produces 65,000
BPD of gasoline and 55,000 BPD of distillates, along with 12,000 BPD of
lubricant basestocks. Major units at the Paulsboro Refinery include a 105,000
BPD lubricants crude unit, a 50,000 BPD fuels crude unit, a 48,000 BPD FCC Unit,
a 25,500 BPD delayed coking unit and a 12,000 BPD lubricants plant. Feedstocks
and refined products are typically transported via the Company's facilities
along the Delaware River or through the refinery's access to the Colonial
pipeline, which allows products to be sold into the New York Harbor market.
Pursuant to a crude oil supply contract entered into between Mobil and
the Company at the time of the acquisition, Mobil agreed to provide the
Paulsboro Refinery with approximately 100,000 BPD of lubricant-quality, medium
sour feedstocks under a ten-year contract, subject to extension under certain
circumstances. Substantially all of the Paulsboro Refinery's light products are
purchased by Mobil at market-related prices for its retail distribution network.
In addition, Mobil and the Company signed a long-term agreement for the
Paulsboro Refinery to supply Mobil with fuels and lubricant basestocks to its
adjacent lubricants blending and packaging facility.
During the fourth quarter of 1998, the turnaround of the coker unit was
completed. The Paulsboro Refinery also experienced unscheduled processing rate
reductions and unit downtime in the fourth quarter. No significant turnarounds
are scheduled for 1999.
Houston Refinery
The Houston Refinery is capable of processing heavy sweet or medium
sour crude oil and can produce approximately 54,000 BPD of gasoline and 37,000
BPD of distillates. It operates an 85,000 BPD crude distillation complex and a
61,000 BPD FCC Unit. The refinery typically receives its feedstocks via tanker
at deep water docking facilities along the Houston Ship Channel. This facility
also has access to major product pipelines, including the Colonial, Explorer and
TEPPCO pipelines.
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The Houston Refinery experienced three unplanned shutdowns of its FCC
Unit during the second and fourth quarters of 1998. During these shutdowns,
certain reliability improvements were made to the regenerator, the power train
and emission control devices. No significant turnarounds at the Houston Refinery
are currently planned for 1999.
Krotz Springs Refinery
The Krotz Springs Refinery processes primarily local, light Louisiana
sweet crude oil and can produce approximately 34,000 BPD of gasoline and 38,000
BPD of distillates. The refinery is geographically located to benefit from
access to upriver markets on the Mississippi River and it has docking facilities
along the Atchafalaya River sufficiently deep to allow barge and light ship
access. The facility is also connected to the Colonial pipeline for product
transportation to the Southeast and Northeast. This refinery was built during
the 1979-1982 time period making it, like the Corpus Christi Refinery, a
relatively new facility compared to other Gulf Coast refineries. Primary units
include an 80,000 BPD crude distillation complex, a 31,000 BPD FCC Unit and a
12,000 BPD reformer complex. This refinery also benefits from recently added
MTBE/polymerization and isomerization units.
In December 1998, the Krotz Springs Refinery's principal operating
units were down for a major maintenance turnaround. As a result of modifications
to the FCC Unit, its capacity was increased to 31,000 BPD and its light products
conversion capacity was increased by 3%. A turnaround of the reformer complex is
currently anticipated in the latter part of 1999.
Marketing
The Company's product slate is presently comprised of approximately 90%
premium products such as gasoline and related components, distillates,
lubricants and chemicals. The Company sells refined products under spot and term
contracts to bulk and truck rack customers at over 180 locations in 31 states
throughout the United States and selected export markets in Latin America.
Primarily as a result of the Basis acquisition on May 1, 1997 and the Paulsboro
Refinery acquisition, total product sales volumes increased from approximately
630,000 BPD during 1997 to approximately 1,000,000 BPD during the fourth quarter
of 1998. Sales volumes include amounts produced at the Company's refineries and
amounts purchased from third parties and resold in connection with the Company's
marketing activities. Substantially all of the light products from the Paulsboro
Refinery are sold to Mobil at market-related prices pursuant to long-term
agreements. Currently, the Company markets approximately 150,000 BPD of gasoline
and distillates through truck rack facilities. The principal purchasers of the
Company's products from truck racks have been wholesalers and jobbers in the
Northeast, Southeast, Midwest and Gulf Coast. Other sales are made to large oil
companies and gasoline distributors and transported by pipeline, barges and
tankers. With its access to the Gulf of Mexico and the Atlantic Ocean, the
Company's refineries are able to ship refined products throughout the world.
Interconnects with common-carrier pipelines give the Company the flexibility to
sell products in most major geographic regions of the United States. No single
purchaser of the Company's products accounted for more than 10% of total sales
during 1998.
Approximately 70,000 BPD of the Company's RFG production is under
contract to supply gasoline marketers in Texas and the Northeast with RFG at
market-related prices. The Company also sells RFG into the spot market. When
market conditions are favorable, the Company can supply CARB Phase II gasoline
to West Coast markets under the California Air Resources Board's gasoline
program. The Company expects demand for RFG to continue to improve as a result
of increased demand in areas currently designated as non-attainment and more
cities across the United
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States "opting in" to the federal RFG program. For further discussion, see
"Factors Affecting Operating Results" and "Outlook" under "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Feedstock Supply
The Company's refinery acquisitions and capital improvements since 1997
have expanded and diversified the slate of feedstocks which the Company can
process. Prior to these acquisitions, the Company's primary feedstock was resid
processed at the Corpus Christi Refinery, representing 50-70% of total
feedstocks. Approximately 60% of the Company's feedstock slate is now comprised
of medium sour crude oil and heavy sweet crude oil, while high-sulfur resid
purchases comprise less than 5% of total feedstocks. The remaining feedstocks
are primarily intermediates, light sweet crude oil, methanol and butane.
The Company has term feedstock contracts totaling approximately 380,000
BPD, or approximately 55% of its total feedstock requirements. The Company's
long-term supply arrangement with Mobil comprises approximately 100,000 BPD of
this amount. The remainder of its feedstock requirements are purchased on the
spot market. The term agreements include contracts to purchase feedstocks from
various foreign national oil companies, including certain Middle Eastern
suppliers, and various domestic integrated oil companies.
In connection with the Restructuring, the Company entered into several
contracts with its former affiliates, including a 10-year term contract under
which a former affiliate is to supply approximately 50% of the butane required
to operate the MTBE facilities at Corpus Christi and natural gasoline for
blending. The Company obtains approximately 80% of its total methanol
requirements for all of its refineries through its 50% joint venture interest in
the Clear Lake Methanol Plant.
The Company owns feedstock and refined product storage facilities and
leases feedstock and refined product storage facilities in various locations.
The Company believes its storage facilities are generally adequate for its
refining and marketing operations.
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SELECTED OPERATING RESULTS
The following table sets forth certain consolidated operating results
for the last three fiscal years (volumes are stated in thousand barrels per day
or Mbpd). Amounts for 1998 include the results of operations of the Paulsboro
Refinery after September 16, 1998. Amounts for 1997 include the results of
operations of the Basis Refineries from May 1, 1997. Average throughput margin
per barrel is computed by subtracting total direct product cost of sales from
product sales revenues and dividing the result by throughput volumes.
<TABLE>
<CAPTION>
Year Ended December 31,
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1998 1997 1996
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<S> <C> <C> <C>
Refinery Throughput Volumes (Mbpd) 579(2) 417(3) 170
Sales Volumes (Mbpd) 894(2) 630(3) 291
Average Throughput Margin per Barrel $ 3.53 $ 4.35 $ 5.29
Average Operating Cost per Barrel:
Cash (fixed and variable) $ 2.06 $ 2.00 $ 1.95
Depreciation and Amortization .57 .61 1.34
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Total Operating Cost per Barrel $ 2.63 $ 2.61 $ 3.29
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</TABLE>
For additional information regarding the Company's operating results
for the three years ended December 31, 1998, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
FACTORS AFFECTING OPERATING RESULTS
The Company's earnings and cash flow from operations are primarily
affected by the relationship between refined product prices and the prices for
crude oil and other feedstocks. The cost to acquire feedstocks and the price for
which refined products are ultimately sold depends on numerous factors beyond
the Company's control, including the global, national and regional supply and
demand for crude oil, gasoline, diesel, heating oil and other refined products
which in turn are dependent upon, among other things, weather, the availability
of imports, the economies and production levels of foreign suppliers, the
marketing of competitive fuels, political affairs and the extent of governmental
regulation.
Feedstock and refined product prices are affected by other factors,
such as product pipeline capacity, local market conditions and the operating
levels of competing refineries. Crude oil costs and the price of refined
products have historically been subject to wide fluctuation. Installation of
additional refinery crude distillation and upgrading facilities, price
volatility, international political and economic developments and other factors
beyond the control of the Company are likely to continue to play an important
role in refining industry economics. The Company is aware, for example, of
additional capacity of up to 200,000 BPD from a refinery in Good Hope, Louisiana
which may become
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(2) For the fourth quarter of 1998 following the acquisition of the
Paulsboro Refinery, refinery throughput volumes and sales volumes were 680 Mbpd
and 999 Mbpd, respectively.
(3) For the eight months following the acquisition of Basis, refinery
throughput volumes and sales volumes were 573 Mbpd and 780 Mbpd, respectively.
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operational in 1999. These factors can impact, among other things, the level of
inventories in the market resulting in price volatility and margin compression.
Moreover, the industry typically experiences seasonal fluctuations in demand for
refined products, such as for gasoline during the summer driving season and for
home heating oil during the winter in the Northeast. The recent warmer than
normal winters in the Northeast have resulted in reduced demand, unusually high
inventories and lower prices for heating oil.
A large portion of the Company's feedstock supplies are secured under
term contracts. There is no assurance of renewal of such contracts upon their
expiration or that economically equivalent substitute supply contracts can be
secured. The Company's feedstock supplies from international producers are
loaded aboard chartered vessels and are subject to the usual maritime hazards.
If the Company's foreign sources of crude oil or access to the marine system for
delivering crude oil were curtailed, the Company's operations could be adversely
affected. In addition, the loss of, or an adverse change in the terms of,
certain of its feedstock supply agreements or the loss of sources or means of
delivery of its feedstock supplies, could adversely affect the Company's
operating results. The volatility of prices and quantities of feedstocks that
may be purchased on the spot market or pursuant to term contracts could also
have a material adverse effect on operating results.
Because the Company manufactures a significant portion of its gasoline
as RFG and can produce approximately 26,000 BPD of oxygenates, certain federal
and state clean-fuel programs significantly affect the operations of the Company
and the markets in which it sells its refined products. In the future, the
Company cannot control or with certainty predict the effect of such clean-fuel
programs on the cost to manufacture, demand for or supply of refined products.
Presently, the EPA's oxygenated fuel program under the Clean Air Act requires
that areas designated "nonattainment" for carbon monoxide use gasoline that
contains a prescribed amount of clean burning oxygenates during certain winter
months. Additionally, the EPA's RFG program under the Clean Air Act requires
year-round usage of RFG in areas designated "extreme" or "severe" nonattainment
for ozone. In addition to these nonattainment areas, approximately 44 of the 87
areas that were designated as "serious," "moderate" or "marginal" nonattainment
for ozone also "opted in" to the RFG program to decrease their emissions of
hydrocarbons and toxic pollutants. In 1998, St. Louis and Kansas City, Missouri
"opted-in" to the federal RFG program. Phase II of the federal RFG program is
expected to become effective in 2000, further restricting the acceptable levels
of nitrous oxides, volatile organic compounds and toxics in gasoline. In order
to meet the new restrictions, refiners will necessarily need to reduce the
sulfur and aromatics content of gasoline and reduce its vapor pressure.
MTBE margins are affected by the price of MTBE and its feedstocks,
methanol and butane, as well as the demand for RFG, oxygenated gasoline and
premium gasoline. The worldwide movement to reduce lead in gasoline is expected
to increase worldwide demand for oxygenates to replace the octane provided by
lead-based compounds. The general growth in gasoline demand as well as
additional "opt-ins" by certain areas into the EPA clean fuels programs should
continue to increase the demand for MTBE. However, initiatives have been
presented in California and Maine which would restrict or potentially ban the
use of MTBE as a gasoline component. If MTBE were to be restricted or banned,
the Company believes that its major MTBE-producing facilities could be modified
to produce other gasoline blendstocks or other petrochemicals.
Because the Company's refineries are generally more complex than many
conventional refineries and are designed principally to process heavy and/or
sour crude oils, including resid, its operating costs per barrel are generally
higher than those of most conventional refiners. But because the Company's
primary feedstocks usually sell at discounts to benchmark crude oil, it has been
generally able to recover its higher operating costs and generate higher
9
<PAGE> 13
margins than many conventional refiners that use lighter crude oil as their
principal feedstock. Moreover, through recent acquisitions, improvements in
technology and modifications to its operating units, the Company has improved
its flexibility to process different types of feedstocks, including heavy crude
oils. The Company expects its primary feedstocks to continue to sell at a
discount to benchmark crude oil, but is unable to predict future relationships
between the supply of and demand for its feedstocks.
In April 1995, six major oil refiners filed a lawsuit against Unocal
Corporation ("Unocal") in Los Angeles, California seeking a determination that
Unocal's claimed patent on certain gasoline compositions was invalid and
unenforceable. The Company was not a party to this litigation. Unocal's claimed
patent covers a substantial portion of the reformulated gasoline compositions
required by the CARB Phase II regulations that went into effect in March 1996.
In 1997, a federal court jury upheld the validity of Unocal's patent and awarded
Unocal royalty damages based on infringement of the patent. The case is on
appeal, but no decision has been reached. If the Company were required to pay a
royalty on the compositions claimed by Unocal's patents, such amounts could
affect the operating results of the Company and alter the blending economics for
compositions not covered by the patent. The Company is unable to predict the
validity or effect of any claimed Unocal patent.
COMPETITION
Many of the Company's competitors in the petroleum industry are fully
integrated companies engaged, on a national and/or international basis, in many
segments of the petroleum business, including exploration, production,
transportation, refining and marketing on scales much larger than the Company's.
Such competitors may have greater flexibility in responding to or absorbing
market changes occurring in one or more of such segments. All of the Company's
crude oil and feedstock supplies are purchased from third party sources, while
some competitors have proprietary sources of crude oil available for their own
refineries.
The refining industry is highly competitive with respect to both
feedstock supply and marketing. The Company competes with numerous other
companies for available supplies of feedstocks and for outlets for its refined
products. The Company does not produce any of its crude oil feedstocks or own
retail outlets for its refined products. Many of the Company's competitors,
however, obtain a significant portion of their feedstocks from company-owned
production and are able to dispose of refined products at their own retail
outlets. Competitors that have their own production or retail outlets (and
brand-name recognition) are at times able to offset losses from refining
operations with profits from producing or retailing operations, and may be
better positioned to withstand periods of depressed refining margins or
feedstock shortages.
The Company expects a continuation of the trend of industry
restructuring and consolidation through mergers, acquisitions, divestitures,
joint ventures and similar transactions, making for a more competitive business
environment while providing the Company with opportunities to expand its
operations. As refining margins merit, the Company expects to continue making
capital improvements to increase the throughput capacity of its refinery
facilities and increase their operational flexibility.
ENVIRONMENTAL MATTERS
The Company's operations are subject to environmental regulation by
federal, state and local authorities, including but not limited to, the EPA, the
Texas Natural Resource Conservation Commission, the New Jersey
10
<PAGE> 14
Department of Environmental Protection ("NJDEP") and the Louisiana Department of
Environmental Quality. The regulatory requirements relate primarily to discharge
of materials into the environment, waste management and pollution prevention
measures. Several of the more significant federal laws applicable to the
Company's operations include the Clean Air Act, the Clean Water Act, the
Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA")
and the Solid Waste Disposal Act, as amended by the Resource Conservation and
Recovery Act ("RCRA"). The Clean Air Act establishes stringent criteria for
regulating conventional air pollutants as well as toxic pollutants at operating
facilities in addition to requiring refiners to market cleaner-burning gasoline
in specific regions of the country to reduce ozone forming pollutants and toxic
emissions.
During the second quarter of 1999, the Refinery MACT II (Maximum
Available Control Technology) standards under the Clean Air Act are anticipated
to be published in final form and contain a three year compliance schedule for
installing required pollution control technology. These rules will require
refiners to control toxic emissions from FCC Units, sulfur recovery units and
reformers. Once the final rules are published, the Company will determine what,
if any capital improvements will be required at the Company's refineries. Based
on the proposed rules, it appears that significant expenditures will not be
required.
CERCLA and RCRA, and related state law, subject the Company to the
potential obligation to remove or mitigate the environmental impact of the
disposal or release of certain pollutants at the Company's facilities and at
formerly owned sites. Under CERCLA, the Company is subject to potential joint
and several liability for the costs of remediation at "superfund" sites at which
it has been identified as a "potentially responsible party" (a "PRP"). Pursuant
to the terms of the Basis acquisition, Salomon agreed to indemnify the Company
from third party claims, including "superfund" liability associated with any
pre-closing activities with respect to the Basis Refineries, subject to certain
terms, conditions and limitations. See Note 3 of Notes to Consolidated Financial
Statements for information regarding the settlement of certain contingent
environmental obligations for which Salomon was responsible in connection with
the Company's acquisition of Basis. As of December 31, 1998, the Company has not
been designated as a PRP under CERCLA for any sites or costs not covered by
Salomon's indemnity.
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 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 NJDEP.
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. As of December 31, 1998, the Company has
accrued approximately $20 million 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
20 years. See Note 3 of Notes to Consolidated Financial Statements.
11
<PAGE> 15
The Company is leading an industry initiative in the State of Texas to
voluntarily permit its "grandfathered" emissions sources by participating in the
Governor's Clean Air Responsibility Enterprise program at the Houston Refinery
and by utilizing a flexible permitting process for the Texas City Refinery. The
flexible permit is a new permitting concept in Texas that allows companies that
have committed to install advanced pollution control technology greater
operational flexibility, including increased throughput capacities, as long as a
facility-wide emissions cap is not exceeded. The Corpus Christi Refinery does
not have any "grandfathered" emissions sources and has also applied for a
flexible permit.
As part of the Company's efforts to permit all of its "grandfathered"
emissions sources and achieve operational flexibility and increased production
capability, the Company plans to install a flue gas scrubber on the FCC Unit at
the Texas City Refinery and install additional emission control devices at the
Houston Refinery. In addition, the water treatment plant at the Corpus Christi
Refinery is being upgraded. The Company anticipates spending approximately $50
million in connection with these efforts over the next several years.
In 1998, capital expenditures for the Company attributable to
compliance with environmental regulations were approximately $16 million and are
currently estimated to be $10 million for 1999. These amounts are exclusive of
any amounts related to constructed facilities for which the portion of
expenditures relating to compliance with environmental regulations is not
determinable. The estimated amount of 1999 environmental expenditures includes
amounts for pollution abatement, water well monitoring and nitrogen oxide
emission controls, among other things, at the Company's refining locations, but
excludes any amounts related to the efforts referred to in the preceding
paragraph.
Governmental regulations are complex and subject to different
interpretations. Therefore, future action and regulatory initiatives could
result in changes to expected operating permits, additional remedial actions or
increased capital expenditures and operating costs that cannot be assessed with
certainty at this time. There are no material governmental fines or corrective
action requirements associated with the Company's operations and the Company
believes its operations are in substantial compliance with current and
applicable environmental laws and regulations.
EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
NAME AGE POSITIONS HELD WITH VALERO OFFICER SINCE
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
William E. Greehey 62 Chairman of the Board, President and 1982
Chief Executive Officer
Gregory C. King 38 Vice President and General Counsel 1997
John D. Gibbons 45 Chief Financial Officer, Vice President-Finance 1997
Keith D. Booke 40 Vice President-Administration and Human 1997
Resources
S. Eugene Edwards 42 Vice President 1998
John F. Hohnholt 46 Vice President 1998
- ----------------------------------------------------------------------------------------------------------
</TABLE>
MR. GREEHEY served as Chief Executive Officer and a director of Energy
from 1979, and as Chairman of the Board of Energy from 1983. He retired from his
position as Chief Executive Officer in June 1996 but, upon request of the Board,
resumed this position in November 1996. Mr. Greehey also served as Chairman of
the Board and Chief
12
<PAGE> 16
Executive Officer of Valero prior to the Restructuring when Valero was a wholly
owned subsidiary of Energy. Mr. Greehey is also a director of Santa Fe Energy
Resources, Inc.
MR. KING was elected Vice President and General Counsel of Valero in
1997. He joined Energy in 1993 as Associate General Counsel and prior to that
was a partner in the Houston law firm of Bracewell and Patterson.
MR. GIBBONS was elected Chief Financial Officer of the Company in 1998.
Previously, he was elected Vice President - Finance and Treasurer of Valero in
1997, and was elected Treasurer of Energy in 1992. He joined Energy in 1981 and
held various other positions with Energy prior to the Restructuring.
MR. BOOKE was elected Vice President-Administration and Human Resources
of the Company in 1998. Prior to that he served as Vice President-Administration
of the Company since 1997 and Vice President-Investor Relations of Energy since
1994. He joined Energy in 1983 and held various other positions with Energy
prior to the Restructuring.
MR. EDWARDS was elected Vice President of the Company in January 1998
and functions as head of the Marketing, Supply and Logistics department. Mr.
Edwards joined Energy in 1982 and held various positions within Energy's
refining operations, planning and economics, business development and marketing
departments prior to the Restructuring.
MR. HOHNHOLT was elected Vice President of the Company in January 1998
and functions as the head of the Refining Operations and Planning department.
Prior to that he was General Manager of the Corpus Christi Refinery. Mr.
Hohnholt joined Energy in 1982 and held various positions within Energy's
refining operations department prior to the Restructuring.
EMPLOYEES
As of January 31, 1999, the Company had approximately 2,500 employees.
ITEM 2. PROPERTIES
The Company's properties include its five refineries described above
and related facilities located in the States of Texas, Louisiana and New Jersey.
See "Refining and Marketing" for additional information regarding properties of
the Company. The Company believes that its facilities are generally adequate for
their respective operations and that its facilities are maintained in a good
state of repair. The Company is the lessee under a number of cancelable and
non-cancelable leases for certain real properties, including office facilities
and various facilities and equipment used to store, transport and produce
refinery feedstocks and/or refined products. See Note 13 of Notes to
Consolidated Financial Statements.
13
<PAGE> 17
ITEM 3. LEGAL PROCEEDINGS
Environmental Proceedings related to Paulsboro Acquisition
In connection with the acquisition of the Paulsboro Refinery from
Mobil, VRC-NJ assumed certain environmental liabilities associated with the
refinery, including obligations under the NJDEP Administrative Consent Orders
(dated September 10, 1979, September 29, 1980, May 10, 1991, and August 27,
1998, related to ongoing site remediation), and the NJDEP Administrative Order
and Notice of Civil Administrative Penalty Assessment (Log #A960262 dated
September 27, 1996, related to particulate emissions from the Paulsboro Refinery
fluid catalytic cracking unit.) These proceedings potentially involve the
imposition of monetary sanctions in excess of $100,000, although the Company is
not currently aware of the existence of, or of any governmental determination to
impose, any such sanctions. Pursuant to the terms of the purchase agreement,
Mobil agreed to indemnify the Company for a period of five years from the
closing of the acquisition for any governmental environmental fines or penalties
assessed against the Company that relate to events that occurred prior to
September 17, 1998. The Company believes that the foregoing proceedings are not
of material importance to the business or financial condition of the Company.
On November 25, 1998, the TNRCC initiated an enforcement action against
the Corpus Christi Refinery alleging violations of state and federal air
regulations and proposed an Agreed Order settlement of $226,050. The TNRCC
alleged that nitrous oxide emission monitors were not installed in two utility
boiler stacks and certain recordkeeping deficiencies. The Company has challenged
the allegations and on February 18, 1999 the TNRCC issued a revised Agreed Order
for $111,000 in penalties. The Company expects a final settlement to occur
during 1999.
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 Corporation ("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 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
14
<PAGE> 18
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of 1998.
15
<PAGE> 19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed under the symbol "VLO" on the New
York Stock Exchange, which is the principal trading market for this security. As
of February 1, 1999, there were approximately 5,800 holders of record and an
estimated 14,600 additional beneficial owners of the Company's Common Stock. The
Company's Common Stock began trading on the New York Stock Exchange on August 1,
1997 (the business day immediately following the Restructuring).
The following table sets forth the range of the high and low sales
prices of the Common Stock as quoted in The Wall Street Journal New York Stock
Exchange-Composite Transactions listing, and the amount of per-share dividends
for each quarter in the preceding two years. The information for 1997 reflects
amounts (i) for the Company after the Restructuring and (ii) for Energy prior to
the Restructuring.
<TABLE>
<CAPTION>
SALES PRICES
OF THE
COMMON STOCK DIVIDENDS
--------------------- PER
QUARTER ENDED HIGH LOW COMMON SHARE
-------- -------- ------------
<S> <C> <C> <C>
1998:
March 31 ........................... $36 1/2 $27 9/16 $ .08
June 30 ............................ 36 31 5/16 .08
September 30 ....................... 33 13/16 17 5/8 .08
December 31 ........................ 26 1/16 17 3/4 .08
1997:
March 31 ........................... $36 3/8 $28 5/8 $ .13
June 30 ............................ 38 1/2 34 1/4 .13
September 30 (through 7/31/97) ..... 43 36 1/4 --
September 30 (after 7/31/97) ....... 35 1/8 28 3/4 .08
December 31 ........................ 34 26 15/16 .08
</TABLE>
The Company's Board of Directors declared a quarterly dividend of $.08
per share of Common Stock at its January 21, 1999 meeting. Dividends are
considered quarterly by the Company's Board of Directors and may be paid only
when approved by the Board.
16
<PAGE> 20
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below for the year ended December
31, 1998 is derived from the Company's Consolidated Financial Statements
contained elsewhere herein. The selected financial data for the years ended
prior to December 31, 1998 is derived from the selected financial data contained
in the Company's Annual Report on Form 10-K for the year ended December 31,
1997.
The following summaries are in thousands of dollars except for per
share amounts:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------
1998(1) 1997(2) 1996 1995 1994
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES ............................... $ 5,539,346 $ 5,756,220 $ 2,757,853 $ 1,772,638 $ 1,090,497
OPERATING INCOME (LOSS) .......................... $ (51,198) $ 211,034 $ 89,748 $ 123,755 $ 63,611
INCOME (LOSS) FROM
CONTINUING OPERATIONS .......................... $ (47,291) $ 111,768 $ 22,472 $ 58,242 $ 18,511
INCOME (LOSS) FROM DISCONTINUED
OPERATIONS, NET OF INCOME TAXES (3) ............ $ -- $ (15,672) $ 50,229 $ 1,596 $ (1,229)
NET INCOME (LOSS) ................................ $ (47,291) $ 96,096 $ 72,701 $ 59,838 $ 17,282
Less: Preferred stock dividend requirements
and redemption premium ................ -- 4,592 11,327 11,818 9,490
----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) APPLICABLE TO
COMMON STOCK ................................... $ (47,291) $ 91,504 $ 61,374 $ 48,020 $ 7,792
=========== =========== =========== =========== ===========
EARNINGS (LOSS) PER SHARE OF
COMMON STOCK:
Continuing operations ........................ $ (.84) $ 2.16 $ .51 $ 1.33 $ .43
Discontinued operations ...................... -- (.39) .89 (.23) (.25)
----------- ----------- ----------- ----------- -----------
Total ...................................... $ (.84) $ 1.77 $ 1.40 $ 1.10 $ .18
=========== =========== =========== =========== ===========
EARNINGS (LOSS) PER SHARE OF
COMMON STOCK - ASSUMING DILUTION:
Continuing operations ........................ $ (.84) $ 2.03 $ .44 $ 1.16 $ .38
Discontinued operations ...................... -- (.29) .98 .01 (.05)
----------- ----------- ----------- ----------- -----------
Total ...................................... $ (.84) $ 1.74 $ 1.42 $ 1.17 $ .33
=========== =========== =========== =========== ===========
TOTAL ASSETS ..................................... $ 2,725,664 $ 2,493,043 $ 1,985,631 $ 1,904,655 $ 1,869,198
LONG-TERM OBLIGATIONS AND
REDEEMABLE PREFERRED STOCK ..................... $ 822,335 $ 430,183 $ 354,457 $ 461,521 $ 449,717
DIVIDENDS PER SHARE OF COMMON
STOCK .......................................... $ .32 $ .42 $ .52 $ .52 $ .52
</TABLE>
- ---------------------
(1) Includes the operations of the Paulsboro Refinery commencing September 17,
1998.
(2) Includes the operations of the Texas City, Houston and Krotz Springs
refineries commencing May 1, 1997.
(3) Reflects the results of Energy's natural gas related services business for
periods prior to the Restructuring.
See Notes to Consolidated Financial Statements.
17
<PAGE> 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following review of the results of operations and financial
condition of the Company should be read in conjunction with Item 1. Business and
Item 8. Financial Statements included elsewhere herein. In the discussions that
follow, all "per share" amounts are on a diluted basis.
SEGMENT INFORMATION
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131, which
superceded SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise," establishes new standards for reporting information about operating
segments in annual and interim financial statements, requiring that public
business enterprises report financial and descriptive information about its
reportable segments based on a management approach. SFAS No. 131 also
establishes standards for related disclosures about products and services,
geographic areas and major customers. This statement became effective for the
Company's financial statements beginning with the current year ended December
31, 1998. Interim period information is not required until the second year of
application (i.e., 1999). As discussed further in Note 10 of Notes to
Consolidated Financial Statements, the Company has determined that it continues
to have one reportable segment, which is the refining and wholesale marketing of
premium, environmentally clean products. The following discussion of the
Company's results of operations and financial condition is consistent with this
determination.
RESTRUCTURING
As described in Item 1. Business - Restructuring and in Note 1 of Notes
to Consolidated Financial Statements under Principles of Consolidation and Basis
of Presentation, on July 31, 1997, Energy spun off the Company to Energy's
stockholders and merged its remaining natural gas related services business with
PG&E (collectively referred to as the "Restructuring"). As a result of the
Restructuring, the Company became a "successor registrant" to Energy for
financial reporting purposes under the federal securities laws. Accordingly, the
following Management's Discussion and Analysis of Financial Condition and
Results of Operations, and the consolidated financial statements included
elsewhere herein, reflect Energy's natural gas related services business as
discontinued operations of the Company.
FORWARD-LOOKING STATEMENTS
The following 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;
18
<PAGE> 22
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 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.
19
<PAGE> 23
RESULTS OF OPERATIONS
1998 COMPARED TO 1997
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------
Change
---------------------------
1998 (1) 1997 (2) Amount %
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Operating revenues ......................................... $ 5,539,346 $ 5,756,220 $ (216,874) (4)%
Cost of sales .............................................. (4,792,665) (5,092,150) 299,485 6
Operating costs:
Cash (fixed and variable) .............................. (435,542) (304,683) (130,859) (43)
Depreciation and amortization .......................... (119,524) (92,317) (27,207) (29)
Selling and administrative expenses (including related
depreciation expense) .................................. (71,884) (56,036) (15,848) (28)
----------- ----------- -----------
Operating income, before inventory write-down .............. 119,731 211,034 (91,303) (43)
Write-down of inventories to market value .................. (170,929) -- (170,929) --
----------- ----------- -----------
Total operating income (loss)........................... $ (51,198) $ 211,034 $ (262,232) (124)
=========== =========== ===========
Other income, net .......................................... $ 586 $ 6,978 $ (6,392) (92)
Interest and debt expense, net ............................. $ (32,479) $ (42,455) $ 9,976 23
Income tax (expense) benefit ............................... $ 35,800 $ (63,789) $ 99,589 156
Income (loss) from continuing operations ................... $ (47,291) $ 111,768 $ (159,059) (142)
Loss from discontinued operations, net of
income tax benefit (3) ................................. $ -- $ (15,672) $ 15,672 100
Net income (loss) .......................................... $ (47,291) $ 96,096 $ (143,387) (149)
Net income (loss) applicable to common stock ............... $ (47,291) $ 91,504 $ (138,795) (152)
Earnings (loss) per share of common stock
assuming dilution:
Continuing operations............................... $ (.84) $ 2.03 $ (2.87) (141)
Discontinued operations............................. -- (.29) .29 100
----------- ----------- -----------
Total........................................... $ (.84) $ 1.74 $ (2.58) (148)
=========== =========== ===========
Earnings before interest, taxes, depreciation
and amortization ("EBITDA")............................. $ 244,523(4) $ 313,025 $ (68,502) (22)
Ratio of EBITDA to interest incurred (5).................... 6.5x 7.1x (.6)x (8)
</TABLE>
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------
Change
--------------------------
1998 (1) 1997 (2) Amount %
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales volumes (Mbbls per day) .................... 894 630 264 42%
Throughput volumes (Mbbls per day) ............... 579 (6) 417 (7) 162 39
Average throughput margin per barrel ............. $ 3.53 (8) $ 4.35 $ (.82) (19)
Operating costs per barrel:
Cash (fixed and variable) .................... $ 2.06 $ 2.00 $ .06 3
Depreciation and amortization ................ .57 .61 (.04) (7)
----------- ----------- -----------
Total operating costs per barrel ......... $ 2.63 $ 2.61 $ .02 1
=========== =========== ===========
</TABLE>
20
<PAGE> 24
OPERATING HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------
Change
--------------------------
1998 (1) 1997 (2) Amount %
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Charges:
Crude oils:
Sour ..................................... 36% 25% 11% 44%
Heavy sweet .............................. 20 21 (1) (5)
Light sweet .............................. 11 11 -- --
----------- ----------- -----------
Total crude oils ..................... 67 57 10 18
Residual fuel oil ("resid") .................. 11 18 (7) (39)
Other feedstocks and blendstocks ............. 22 25 (3) (12)
----------- ----------- -----------
Total charges ............................ 100% 100% -- % --
=========== =========== ===========
Yields:
Gasoline and blending components ............. 48% 48% -- % --
Distillates .................................. 28 25 3 12
Petrochemicals ............................... 4 6 (2) (33)
Natural gas liquids ("NGLs") and naphtha ..... 6 6 -- --
Lubes and asphalts ........................... 2 -- 2 --
Other products ............................... 12 15 (3) (20)
----------- ----------- -----------
Total yields ............................. 100% 100% -- % --
=========== =========== ===========
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (U.S. GULF COAST)
(DOLLARS PER BARREL)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
Change
------------------------
1998 1997 Amount %
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Feedstocks:
West Texas Intermediate ("WTI") crude oil ................... $ 14.41 $ 20.61 $ (6.20) (30)%
WTI less sour crude oil (Arab medium) (9) ................... $ 3.37 $ 3.05 $ .32 10
WTI less heavy sweet crude oil (Cabinda plus freight) (9) ... $ 1.40 $ 1.08 $ .32 30
WTI less resid (Singapore plus freight) (9) ................. $ 1.57 $ 2.61 $ (1.04) (40)
Products:
Unleaded 87 gasoline less WTI ............................... $ 2.98 $ 3.97 $ (.99) (25)
No. 2 fuel oil less WTI ..................................... $ 1.45 $ 1.96 $ (.51) (26)
Propylene less WTI .......................................... $ 2.23 $ 8.14 $ (5.91) (73)
</TABLE>
(1) Includes the operations of the Paulsboro Refinery commencing September 17,
1998.
(2) Includes the operations of the Texas City, Houston and Krotz Springs
refineries commencing May 1, 1997.
(3) Reflects the results of Energy's natural gas related services business for
periods prior to the Restructuring.
(4) Excludes the $170.9 million pre-tax write-down of inventories to market
value.
(5) Interest incurred for 1997 includes $18,164 of interest on corporate debt
that was allocated to continuing operations (see Note 2 of Notes to
Consolidated Financial Statements).
(6) Includes 46 Mbbls per day related to the Paulsboro Refinery.
(7) Includes 238 Mbbls per day related to the Texas City, Houston and Krotz
Springs refineries.
(8) Excludes an $.81 per barrel reduction resulting from pre-tax write-downs of
inventories to market value of $37.7 million in the first quarter and
$133.2 million in the fourth quarter.
(9) Excludes $.25 to $.50 per barrel for other delivery related costs.
21
<PAGE> 25
GENERAL
The Company reported a net loss of $47.3 million, or $.84 per share,
for the year ended December 31, 1998 compared to income from continuing
operations of $111.8 million, or $2.03 per share, for the year ended December
31, 1997. For the fourth quarter of 1998, the Company reported a net loss of
$85.7 million, or $1.53 per share, compared to net income of $12.4 million, or
$.22 per share, for the fourth quarter of 1997. The fourth quarter 1998 results
were reduced by a $133.2 million ($86.6 million after-tax, or $1.55 per share)
non-cash 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 quarter. Coupled with a $37.7 million non-cash inventory write-down
in the first quarter of 1998, full year 1998 results were reduced by non-cash
inventory write-downs totaling $170.9 million ($111.1 million after-tax, or
$1.98 per share).
Excluding the effects of the inventory write-downs, fourth quarter 1998
net income ($.9 million, or $.02 per share), and total year 1998 net income
($63.8 million, or $1.14 per share) were still well below 1997 levels due to
extremely weak refining industry fundamentals that lasted throughout most of
1998 and are continuing into 1999. Partially offsetting the effects of such
depressed industry conditions were full year contributions in 1998 from the
operations related to the Texas City, Houston and Krotz Springs refineries
acquired on May 1, 1997 and the contribution from the Paulsboro Refinery
commencing September 17, 1998. Results from discontinued operations in 1997 were
a loss of $15.7 million, or $.29 per share, for the seven months prior to the
July 31, 1997 Restructuring. In determining earnings per share for the year
ended December 31, 1997, dividends on Energy's preferred stock were deducted
from income from discontinued operations as such preferred stock was issued in
connection with Energy's natural gas related services business.
OPERATING REVENUES
Operating revenues decreased $216.9 million, or 4%, to $5.5 billion
during 1998 compared to 1997 due to a 32% decrease in the average sales price
per barrel partially offset by a 42% increase in average daily sales volumes.
The significant decrease in sales prices was attributable to an oversupply of
crude oil due to lower worldwide energy demand, particularly in Asia. These
excess crude oil supplies, combined with high refinery utilization rates and
below average demand for heating oil due to mild winter weather, resulted in a
build-up of refined product inventories, particularly distillates, and severely
depressed refined product prices. The increase in sales volumes was due
primarily to additional volumes attributable to the acquisition of the Texas
City, Houston and Krotz Springs refineries, the acquisition of the Paulsboro
Refinery, and an increase in related marketing activities.
OPERATING INCOME (LOSS)
Operating income decreased $262.2 million during 1998 compared to 1997
due in large part to the $170.9 million in inventory write-downs noted above.
Excluding the effect of the inventory write-downs, operating income decreased
$91.3 million, or 43%, to $119.7 million during 1998 compared to 1997. This
decrease was due to an approximate $158 million increase in operating costs and
higher selling and administrative expenses of approximately $16 million (both
including related depreciation expense), partially offset by an approximate $83
million increase in total throughput margins.
22
<PAGE> 26
Total throughput margins increased due primarily to four additional
months of operations in 1998 versus 1997 related to the Texas City, Houston and
Krotz Springs refineries, and the inclusion of the Paulsboro Refinery commencing
with its acquisition. Although total throughput margins increased, the average
throughput margin per barrel declined $.82, or 19%, due in large part to the
fact that the newly-acquired refineries normally realize a lower per-barrel
margin (but also lower per-barrel operating costs) than that realized by the
Corpus Christi Refinery. Also contributing to an increase in total throughput
margins was a significant improvement in feedstock discounts relative to WTI due
to improved sweet and sour crude differentials and enhanced feedstock processing
flexibility, particularly at the Corpus Christi Refinery, partially offset by
lower discounts on resid. However, this feedstock benefit was more than offset
by (i) lower gasoline and distillate margins resulting primarily from the
factors noted above under "Operating Revenues," and (ii) significantly lower
petrochemical margins and other factors as discussed below. The net negative
effect on throughput margins resulting from the changes in gasoline and
distillate margins and feedstock discounts was somewhat offset by a benefit from
hedging activities related to such products and feedstocks under the Company's
price risk management program. In 1998, the Company's hedging activities
resulted in a benefit to total throughput margins of approximately $17 million,
while in 1997, the effect of hedging activities on throughput margins was
slightly negative. See Item 7A. Quantitative and Qualitative Disclosures About
Market Risk, Note 1 of Notes to Consolidated Financial Statements under "Price
Risk Management Activities," and Note 6 of Notes to Consolidated Financial
Statements for additional information. The decline in petrochemical margins
noted above which substantially reduced total throughput margins resulted from
depressed demand for petrochemical feedstocks due to the Asian economic crisis.
Total throughput margins were also reduced by lower margins from the Clear Lake
Methanol Plant.
With regard to operating costs, approximately $38 million ($33 million
cash cost and $5 million depreciation and amortization), or 24%, of the total
operating cost increase was attributable to the Paulsboro Refinery acquired in
September 1998, while $92 million, or 58%, of the increase was attributable to
the four additional months of operations during the 1998 period for the Texas
City, Houston and Krotz Springs refineries. The remainder of the increase in
operating costs was attributable to an increase in amortization of deferred
turnaround and catalyst costs for the Texas City, Houston and Corpus Christi
refineries resulting from various turnarounds and catalyst change-outs as
described in Item 1. Business - Refining and Marketing, an increase in cash
costs for injected catalyst at those same refineries resulting from the use of
lower-cost/reduced-quality feedstocks, higher catalyst costs at the Corpus
Christi Refinery resulting primarily from shorter than expected catalyst life,
and higher salary costs. Selling and administrative expenses increased due
primarily to the three and one-half months of operations for the Paulsboro
Refinery and to the four additional months of operations for the Texas City,
Houston and Krotz Springs refineries during 1998.
OTHER INCOME
Other income, net, decreased by $6.4 million to $.6 million during 1998
compared to 1997 due primarily to lower results from the Company's 20% equity
interest in the Javelina off-gas processing plant in Corpus Christi (see Note 1
of Notes to Consolidated Financial Statements under "Deferred Charges and Other
Assets") due primarily to lower petrochemical and other product prices,
partially offset by lower natural gas feedstock costs.
23
<PAGE> 27
NET INTEREST AND DEBT EXPENSE
Net interest and debt expense decreased $10 million, or 23%, to $32.5
million during 1998 compared to 1997 due primarily to the inclusion in the 1997
period of allocated interest expense related to corporate debt that was
subsequently assumed by PG&E pursuant to the Restructuring on July 31, 1997 and
to a reduction in average interest rates. The decrease in net interest and debt
expense resulting from these factors was partially offset by an increase in bank
borrowings due primarily to the acquisition of the Paulsboro Refinery. See Note
3 of Notes to Consolidated Financial Statements.
INCOME TAX EXPENSE (BENEFIT)
Income taxes decreased from a $63.8 million expense in 1997 to a $35.8
million benefit in 1998 due primarily to the significant decrease in pre-tax
results from continuing operations and, to a lesser extent, to the recognition
in 1998 of $5.8 million related to a research and experimentation tax credit.
See Note 11 of Notes to Consolidated Financial Statements.
DISCONTINUED OPERATIONS
The loss from discontinued operations in 1997 of $15.7 million (net of
an income tax benefit of $8.9 million), or $.29 per share, reflected the net
loss of Energy's natural gas related services business for the seven months
ended July 31, 1997, prior to consummation of the Restructuring. See Note 2 of
Notes to Consolidated Financial Statements.
24
<PAGE> 28
1997 COMPARED TO 1996
FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
Change
--------------------------
1997 (1) 1996 (2) Amount %
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Operating revenues .............................................. $ 5,756,220 $ 2,757,853 $ 2,998,367 109%
Cost of sales ................................................... (5,092,150) (2,429,220) (2,662,930) (110)
Operating costs:
Cash (fixed and variable) ................................... (304,683) (121,516) (183,167) (151)
Depreciation and amortization ............................... (92,317) (83,211) (9,106) (11)
Selling and administrative expenses (including related
depreciation expense) ....................................... (56,036) (34,158) (21,878) (64)
----------- ----------- -----------
Operating income ........................................ $ 211,034 $ 89,748 $ 121,286 135
=========== =========== ===========
Loss on investment in Proesa joint venture ...................... $ -- $ (19,549) $ 19,549 100
Other income, net ............................................... $ 6,978 $ 7,418 $ (440) (6)
Interest and debt expense, net .................................. $ (42,455) $ (38,534) $ (3,921) (10)
Income tax expense .............................................. $ (63,789) $ (16,611) $ (47,178) (284)
Income from continuing operations ............................... $ 111,768 $ 22,472 $ 89,296 397
Income (loss) from discontinued operations, net of
income taxes (3) ............................................ $ (15,672) $ 50,229 $ (65,901) (131)
Net income ...................................................... $ 96,096 $ 72,701 $ 23,395 32
Net income applicable to common stock ........................... $ 91,504 $ 61,374 $ 30,130 49
Earnings (loss) per share of common stock-assuming dilution:
Continuing operations ................................... $ 2.03 $ .44 $ 1.59 361
Discontinued operations ................................. (.29) .98 (1.27) (130)
----------- ----------- -----------
Total ............................................... $ 1.74 $ 1.42 $ .32 23
=========== =========== ===========
Earnings before interest, taxes, depreciation
and amortization ("EBITDA") ................................. $ 313,025 $ 164,958 $ 148,067 90
Ratio of EBITDA to interest incurred (4) ........................ 7.1x 4.0x 3.1x 78
</TABLE>
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
Change
--------------------------
1997 (1) 1996 (2) Amount %
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales volumes (Mbbls per day) ................................... 630 291 339 116%
Throughput volumes (Mbbls per day) .............................. 417(5) 170 247 145
Average throughput margin per barrel ............................ $ 4.35 $ 5.29 $ (.94) (18)
Operating costs per barrel:
Cash (fixed and variable) ................................... $ 2.00 $ 1.95 $ .05 3
Depreciation and amortization ............................... .61 1.34 (.73) (54)
----------- ----------- -----------
Total operating costs per barrel ........................ $ 2.61 $ 3.29 $ (.68) (21)
=========== =========== ===========
</TABLE>
25
<PAGE> 29
OPERATING HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
Change
----------------------------
1997 (1) 1996 (2) Amount %
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Charges:
Crude oils:
Sour .......................................... 25% 7% 18% 257%
Heavy sweet ................................... 21 17 4 24
Light sweet ................................... 11 -- 11 --
----------- ----------- -----------
Total crude oils .......................... 57 24 33 138
Residual fuel oil ("resid") ....................... 18 48 (30) (63)
Other feedstocks and blendstocks .................. 25 28 (3) (11)
----------- ----------- -----------
Total charges ................................. 100% 100% -- % --
=========== =========== ===========
Yields:
Gasoline and blending components .................. 48% 74% (26)% (35)
Distillates ....................................... 25 15 10 67
Petrochemicals .................................... 6 8 (2) (25)
Natural gas liquids ("NGLs") and naphtha .......... 6 -- 6 --
Other products .................................... 15 3 12 400
----------- ----------- -----------
Total yields .................................. 100% 100% -- % --
=========== =========== ===========
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (U.S. GULF COAST)
(DOLLARS PER BARREL)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------
Change
-------------------
1997 1996 Amount %
-------- -------- ------- -------
<S> <C> <C> <C> <C>
Feedstocks:
West Texas Intermediate ("WTI") crude oil ................... $ 20.61 $ 22.14 $ (1.53) (7)%
WTI less sour crude oil (Arab medium) (6) ................... $ 3.05 $ 2.49 $ .56 22
WTI less heavy sweet crude oil (Cabinda plus freight) (6) ... $ 1.08 $ .70 $ .38 54
WTI less resid (Singapore plus freight) (6) ................. $ 2.61 $ 3.35 $ (.74) (22)
Products:
Unleaded 87 gasoline less WTI ............................... $ 3.97 $ 2.79 $ 1.18 42
No. 2 fuel oil less WTI ..................................... $ 1.96 $ 2.30 $ (.34) (15)
Propylene less WTI .......................................... $ 8.14 $ 1.56 $ 6.58 422
</TABLE>
(1) Includes the operations of the Texas City, Houston and Krotz Springs
refineries commencing May 1, 1997.
(2) Continuing operations reflects only the operations related to the Corpus
Christi Refinery.
(3) Reflects the results of Energy's natural gas related services business for
periods prior to the Restructuring.
(4) Interest incurred includes $18,164 and $30,642 for 1997 and 1996,
respectively, of interest on corporate debt that was allocated to
continuing operations (see Note 2 of Notes to Consolidated Financial
Statements).
(5) Includes 238 Mbbls per day related to the Texas City, Houston and Krotz
Springs refineries.
(6) Excludes $.25 to $.50 per barrel for other delivery related costs.
26
<PAGE> 30
GENERAL
The Company reported income from continuing operations of $111.8
million, or $2.03 per share, for the year ended December 31, 1997 compared to
$22.5 million, or $.44 per share, for the year ended December 31, 1996. For the
fourth quarter of 1997, income from continuing operations was $12.4 million, or
$.22 per share, compared to a loss from continuing operations of $5.3 million,
or $.12 per share, for the fourth quarter of 1996. Results from discontinued
operations were a loss of $15.7 million, or $.29 per share, for the seven months
ended July 31, 1997, and income of $24.1 million, or $.49 per share, and $50.2
million, or $.98 per share, for the quarter and year ended December 31, 1996,
respectively. In determining earnings per share, dividends on Energy's preferred
stock were deducted from income from discontinued operations as such preferred
stock was issued in connection with Energy's natural gas related services
business.
The May 1, 1997 acquisition of the Texas City, Houston and Krotz
Springs refineries added significantly to the Company's 1997 results. Income
from continuing operations and related earnings per share increased
significantly during 1997 compared to 1996 due primarily to an increase in
operating income, partially offset by an increase in income tax expense. In
addition, fourth quarter and total year results for 1996 were negatively
impacted by a $19.5 million pre-tax loss resulting from the write-off of the
Company's investment in its joint venture project to design, construct and
operate a plant in Mexico to produce MTBE. This loss reduced results from
continuing operations for such periods by approximately $.25 per share.
OPERATING REVENUES
Operating revenues increased $3 billion, or 109%, to $5.8 billion
during 1997 compared to 1996 due to a 116% increase in average daily sales
volumes resulting primarily from additional throughput volumes attributable to
the May 1, 1997 acquisition of the Texas City, Houston and Krotz Springs
refineries. Also contributing, to a lesser extent, to the increase in sales
volumes was an increase in marketing activities and a 6% increase in throughput
volumes at the Corpus Christi Refinery resulting from, among other things,
various unit capacity expansions completed in late 1996 and 1997 and less unit
downtime experienced in 1997 compared to 1996.
OPERATING INCOME
Operating income increased $121.3 million, or 135%, to $211 million
during 1997 compared to 1996 due to an approximate $84 million contribution from
the operations related to the Texas City, Houston and Krotz Springs refineries,
and to an approximate $67 million increase in total throughput margins for the
operations related to the Corpus Christi Refinery. Partially offsetting these
increases in operating income were an approximate $15 million increase in
operating costs (including related depreciation expense) at the Corpus Christi
Refinery (explained below) and an approximate $15 million increase in selling
and administrative expenses (including related depreciation expense) resulting
primarily from higher employee-related costs, including the effect of additional
administrative personnel resulting from the acquisition of Basis in May 1997.
Total throughput margins for the operations related to the Corpus Christi
Refinery increased during 1997 compared to 1996 due to a substantial improvement
in the price differential between conventional gasoline and crude oil, higher
oxygenate margins resulting primarily from a decrease in methanol feedstock
costs as a result of lower production costs at the Clear Lake Methanol Plant,
and higher premiums on sales of reformulated gasoline and petrochemical
feedstocks, including a substantial benefit from the sale of mixed xylenes
produced from the xylene fractionation unit that was placed in service at the
27
<PAGE> 31
Corpus Christi Refinery in January 1997. Total throughput margins for the
operations related to the Corpus Christi Refinery were also higher in 1997 due
to less unit downtime compared to 1996. The increases resulting from these
factors were partially offset by lower discounts on purchases of resid
feedstocks during the last nine months of the year due to high demand for resid
in the Far East and a decrease in crude oil prices. The $15 million, or 7%,
increase in operating costs at the Corpus Christi Refinery was due primarily to
increases in maintenance and employee-related costs, incremental costs
associated with the xylene fractionation unit, and higher variable costs
resulting from the above noted increase in throughput volumes. However, due to
such increase in throughput volumes, operating costs per barrel at the Corpus
Christi Refinery increased only 2%.
In 1997 and 1996, the effect of hedging activities on refining
throughput margins was not significant. In 1996, the Company reduced its
operating costs by approximately $2.8 million as a result of hedges on refining
natural gas fuel requirements. The effect of such hedging activities on
operating costs in 1997 was not significant.
NET INTEREST AND DEBT EXPENSE
Net interest and debt expense increased $3.9 million, or 10%, to $42.5
million during 1997 compared to 1996 due primarily to interest on bank
borrowings related to (i) the acquisition of Basis and (ii) a special
pre-Distribution dividend paid to Energy of $210 million in connection with the
Restructuring. The increase in net interest and debt expense resulting from
these factors was partially offset by a $12.5 million decrease in interest
expense on corporate debt of Energy allocated to continuing operations (see Note
2 of Notes to Consolidated Financial Statements), and by a reduction in bank
borrowings resulting from cash provided by operations subsequent to the
Restructuring.
INCOME TAX EXPENSE
Income tax expense increased $47.2 million to $63.8 million during 1997
compared to 1996 due primarily to higher pre-tax income from continuing
operations.
DISCONTINUED OPERATIONS
The loss from discontinued operations in 1997 of $15.7 million (net of
an income tax benefit of $8.9 million), or $.29 per share, reflected the net
loss of Energy's natural gas related services business for the seven months
ended July 31, 1997, prior to consummation of the Restructuring. Income from
discontinued operations in 1996 of $50.2 million (net of income tax expense of
$24.4 million), or $.98 per share, reflected the net income of Energy's natural
gas related services business for all of such year. See Note 2 of Notes to
Consolidated Financial Statements for additional information.
28
<PAGE> 32
OUTLOOK
In the fourth quarter of 1998, refining margins fell to 15-year lows
due to several negative factors that simultaneously affected the industry. These
factors, which led to significant increases in refined product inventories and
put extreme downward pressure on refined product prices, included:
o Warm winter weather which reduced demand for distillates and
resulted in excess distillate inventories.
o Continuation of the Asian economic crisis which has significantly
reduced the growth in worldwide oil and light product demand,
including petrochemicals.
o Failure of the industry to curtail crude oil production rates,
which, combined with continued growth of non-OPEC production and
lower growth in worldwide energy demand, resulted in a worldwide
surplus of crude oil.
o High refinery utilization rates in the U.S., resulting from low
crude oil prices and strong gasoline demand, which, combined with
weak export markets, resulted in higher gasoline inventories.
These depressed margin conditions have continued into 1999 for gasoline
and heating oil. U.S. Gulf Coast margins on gasoline and heating oil in January
1999 averaged $1.29 and $.53, respectively, and continued to deteriorate in
February, averaging $.77 and $(.16), respectively, for the month through
February 23, which are substantially below historical levels. Combined with a
turnaround of the heavy oil cracker and related units at the Company's Corpus
Christi Refinery for approximately 35 days beginning January 8, the Company
currently expects to incur a significant net loss in the first quarter of 1999.
Although only marginal improvements in margins are expected in the
near-term, the Company estimates that margins will improve longer-term based on
several factors. These factors include:
o A healthy U.S. economy resulting in a projected 2% growth in
gasoline demand in 1999.
o An increase in demand for low-sulfur diesel and jet fuel.
o Expected ample supplies of sour crude oil at favorable discounts.
o Belief that margins for petrochemical feedstocks, essentially
trading at gasoline blend value, have reached a natural floor.
o Current high number of refinery turnarounds, which should help
reduce refined product inventory levels.
o Refinery production cuts by several independent refiners,
including the Company's cut-back of production at its Houston,
Corpus Christi and Krotz Springs refineries, and expected
slowdown in additions to industry refining capacity due to poor
margin conditions, both of which should also help reduce market
supplies.
o Signs of increased demand for crude oil in Asia.
Beyond 1999, the Company anticipates a moderate improvement in refining
margins due to tightening U.S. refining capacity. Increased demand for light
products is expected to outpace capacity additions due to slow growth in
capacity additions resulting from poor margins experienced in recent years. In
addition, changes in gasoline specifications as a result of Phase II RFG in the
year 2000 will reduce production capability in the industry. Excess conversion
capacity resulting from new conversion projects in the early to mid-1990's has
now been fully absorbed. Any such projects currently planned will not keep pace
with an expected increase in the supply of heavy crudes
29
<PAGE> 33
resulting from increased Middle East and Latin American production. As a result,
the spread between light and heavy crudes is expected to increase.
Domestic gasoline demand, which increased 2.5% in 1997, 2% in 1998, and
is up almost 4% thus far in 1999, is expected to continue to improve due to a
strong economy and the trend in recent years toward less fuel-efficient
vehicles. Demand for RFG is expected to continue to improve as a result of
increased demand in areas currently designated as non-attainment and more cities
across the United States "opting in" to the federal RFG program. Worldwide,
demand for clean-burning fuels, such as RFG, is expected to continue to increase
resulting from the worldwide movement to reduce lead and certain other
pollutants and contaminants in gasoline. The increasing demand for clean-burning
fuels should sustain a strong demand for oxygenates such as MTBE.
Certain initiatives have been presented in California and Maine which
would restrict or potentially ban the use of MTBE as a gasoline component. If
MTBE were to be restricted or banned, the Company believes that its
MTBE-producing facility could be modified to produce other gasoline blendstocks
or other petrochemicals for a minimal capital investment.
The Company expects a continuation of the recent industry
consolidations through mergers and acquisitions, making for a more competitive
business environment while providing the Company with opportunities to expand
its operations. As refining margins merit, the Company expects to continue
making capital improvements at its refinery facilities to increase, among other
things, throughput capacity, conversion capability, operational efficiency, and
feedstock flexibility. The majority of such capital improvements are anticipated
to be performed during scheduled maintenance turnarounds.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by continuing operations decreased $30.8 million to
$165.8 million during 1998 compared to 1997 due to the decrease in income from
continuing operations discussed above under "Results of Operations," and an
increase in the amount of cash utilized for working capital purposes, as
detailed in Note 1 of Notes to Consolidated Financial Statements under
"Statements of Cash Flows." The changes in current assets and current
liabilities for both 1998 and 1997 were primarily attributable to a substantial
decrease in accounts payable offset to a large extent by a decrease in accounts
receivable. Accounts payable and accounts receivable decreased in both years due
to lower commodity prices. In 1997, the increased working capital requirement
resulting from the changes in accounts receivable and accounts payable was
partially offset by reduced inventories. During 1998, cash provided by operating
activities (approximately $166 million), along with net proceeds from bank and
other borrowings (approximately $429 million) and issuances of common stock
related to the Company's benefit plans, totaled approximately $602 million.
These funds were utilized to acquire the Paulsboro Refinery, fund capital
expenditures, deferred turnaround and catalyst costs and the earn-out payment to
Salomon in connection with the acquisition of Basis (see Note 3 of Notes to
Consolidated Financial Statements), pay common stock dividends, and purchase
treasury stock.
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
30
<PAGE> 34
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 December 31, 1998, outstanding borrowings and
letters of credit under this committed bank credit and letter of credit facility
totaled approximately $521 million. The Company also has numerous uncommitted
short-term bank credit facilities under which amounts ranging from $85 million
to $235 million may be borrowed, along with several uncommitted bank letter of
credit facilities totaling $285 million. As of December 31, 1998, $160 million
was outstanding under the short-term bank credit facilities, and letters of
credit totaling approximately $17 million were outstanding under the uncommitted
letter of credit facilities. See Notes 4 and 5 of Notes to Consolidated
Financial Statements.
During 1998, the Company undertook various initiatives to reduce its
exposure to increases in interest rates and increase its financial flexibility.
In March 1998, the Company converted the interest rate on $123.5 million of
industrial revenue bonds from variable to fixed, and increased its financial
flexibility by issuing $68.5 million of new industrial revenue bonds, using the
proceeds to reduce bank borrowings incurred in connection with the acquisition
of Basis. See Note 5 of Notes to Consolidated Financial Statements. In June
1998, the Company also enhanced its financial flexibility by filing a $600
million universal shelf registration statement with the Securities and Exchange
Commission. Securities registered pursuant to this registration statement
included common stock, preferred stock, debt securities and depositary shares.
The Company intends to use the net proceeds from any offerings under this shelf
registration for general corporate purposes, including capital expenditures,
acquisitions, repayment of debt, additions to working capital or other business
purposes. The registration statement was declared effective by the SEC on June
30, 1998. The Company intends to continue initiatives such as those described
above in 1999. By the end of the first quarter of 1999, the Company expects to
complete the refinancing of $25 million of taxable variable rate industrial
revenue bonds with tax-exempt fixed rate bonds. The Company is currently
contemplating the issuance of long-term debt of up to $300 million under its
shelf registration statement. Proceeds from such offering when and if issued
will be used to reduce bank borrowings, which will further enhance the Company's
liquidity and financial flexibility.
As described in Note 5 of Notes to Consolidated Financial Statements,
in December 1997, the Company issued $150 million principal amount of notes
("Notes") at an effective interest rate of 5.86% over the initial five years of
their term, also using the proceeds to reduce bank borrowings. If the 30-year
Treasury rate has decreased below 6.13% at the end of five years from the date
of issuance of the Notes, a third party will likely exercise its option to
purchase the Notes and the term of the Notes will be extended thirty years at
6.13% plus the Company's prevailing credit spread. If at the end of five years
from the date of issuance of the Notes, the 30-year Treasury rate is higher than
6.13% and as a result the third party does not exercise its purchase option,
then the Company will be required to repurchase the Notes at par.
During 1998, the Company expended approximately $567 million for
capital investments. This amount included (a) $335 million in connection with
the purchase of the Paulsboro Refinery, (b) $166 million for capital
expenditures, including approximately $16 million for environmental control and
protection and approximately $9 million for computer systems, (c) deferred
turnaround and catalyst costs of $56 million, and (d) $10 million for an
earn-out payment to Salomon in May 1998 pursuant to the terms of the Basis
purchase agreement as described in Note 3 of Notes to Consolidated Financial
Statements. For 1999, the Company currently expects to incur approximately $125
to $150 million for capital investments, including approximately $50 to $60
million for deferred
31
<PAGE> 35
turnaround and catalyst costs, and approximately $10 million for environmental
control and protection capital expenditures as described in Item 1. Business -
Environmental Matters.
In the third quarter of 1998, the Company's Board of Directors approved
a stock repurchase program allowing the Company to repurchase, from time to
time, up to $100 million of the Company's Common Stock. Through December 31,
1998, the Company has repurchased shares of Common Stock at a cost of
approximately $15 million to be used for employee benefit plans and other
general corporate purposes.
Dividends on the Company's Common Stock are considered quarterly by the
Company's Board of Directors, are determined by the Board on the basis of
earnings and cash flows, and may be paid only when approved by the Board. The
Company has declared dividends of $.08 per common share during each of the seven
quarters since the Restructuring on July 31, 1997.
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 the universal shelf registration statement
described above that may occur from time to time, the Company currently has no
other specific financing plans.
The Company's refining and marketing operations have a concentration of
customers in the oil refining industry and petroleum products markets. These
concentrations of customers may impact the Company's overall exposure to credit
risk, either positively or negatively, in that the customers in such industry
and markets may be similarly affected by changes in economic or other
conditions. However, the Company believes that its portfolio of accounts
receivable is sufficiently diversified to the extent necessary to minimize
potential credit risk. Historically, the Company has not had any significant
problems collecting its accounts receivable. The Company's accounts receivable
are not collateralized.
NEW ACCOUNTING PRONOUNCEMENTS
As discussed above under Segment Information and in Note 1 of Notes to
Consolidated Financial Statements, various new financial accounting
pronouncements have been issued by the FASB and AICPA which either became
effective for the Company's financial statements beginning in 1998 or become
effective in 1999 or 2000. 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, or is not expected to
have based on information currently available to the Company, a material effect
on the Company's consolidated financial statements.
32
<PAGE> 36
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); 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 and
scheduled completion dates:
<TABLE>
<CAPTION>
Scheduled
Compliance Plan Phase Completion Date
- ------------------------------------------------------------------------------------- ---------------
<S> <C>
o Form internal Year 2000 organizations, both at the corporate and refinery level,
to pursue relevant action plans. Completed
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. Completed*
o Assess the compliance of inventoried items by contacting the vendor or
manufacturer to determine whether the system is Year 2000 compliant. Completed*
</TABLE>
33
<PAGE> 37
<TABLE>
<CAPTION>
Scheduled
Compliance Plan Phase Completion Date
- ------------------------------------------------------------------------------------- ---------------
<S> <C>
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). Completed*
o Remediate the non-compliant high and medium priority items by implementing
the plans developed above. 8/31/99
o Validate Year 2000 compliance by testing, wherever possible, all high and
medium priority items. 8/31/99
o Develop contingency plans for all high and medium priority items that cannot
be tested. 9/30/99
</TABLE>
- --------------------
* Although the Company-wide inventory, assessment and planning phases have
been completed, other non-compliant items may be discovered during the
remediation and testing phases.
The Company currently anticipates that completion of its Year 2000
compliance plan will 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 may be required in the future. Presently, no
significant IT projects have been delayed due to the implementation of the
Company's Year 2000 compliance plan. The following table indicates, as of
February 19, 1999, the status of the Company's progress in completing its
compliance plan. The percentages reported below represent the estimated
percentage of total inventoried high and medium priority items that are now
remediated or tested, as the case may be.
<TABLE>
<CAPTION>
Remediated Tested
---------- ------
<S> <C> <C>
Business Systems..................................... 94% 4%
Plant Facilities..................................... 95 26
Office Facilities/Aviation........................... 89 89
</TABLE>
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 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 650 questionnaires have been sent to External Service Providers of
high, medium and low priority. An additional 100 Year 2000 questionnaires have
been sent to External Service Providers deemed to be critical. As of February
19, 1999, responses have been received for approximately 49% of the total
questionnaires sent (58% of critical service providers). An assessment of the
responses is expected to be completed by August 31, 1999 and contingency plans
are expected to be developed for all non-Year 2000 compliant External Service
Providers by September 30, 1999.
34
<PAGE> 38
COSTS
Total external costs incurred through December 31,1998 in connection
with the completion of the Company's Year 2000 compliance plan were less than
$200,000. The estimated total external costs to complete the Company's Year 2000
compliance plan is 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 scheduled completion dates 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 which
cause the compliance plan to fall behind schedule, the Company may need to
devote more resources to completing the plan and additional costs may be
incurred. If the Company were not able to 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 completed by
such time or that the Year 2000 problem will not adversely affect the Company
and its business.
CONTINGENCY PLANS
As discussed above under "State of Readiness," the Company currently
anticipates developing its contingency plans by September 30, 1999 based on the
results of the testing phase of its compliance plan for the Business Systems,
Plant Facilities and Office Facilities/Aviation business areas and the results
of its communications with critical External Service Providers.
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.
35
<PAGE> 39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COMMODITY PRICE RISK
As discussed in Item 1. Business - Factors Affecting Operating Results,
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 as fuel in the Company's refining operations. In order to reduce the risks
of these price fluctuations, the Company uses derivative commodity instruments
such as price swaps, options and futures contracts to hedge 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 such
as price swaps, options and futures contracts to hedge the price risk of
anticipated transactions. Such transactions include anticipated feedstock,
product and natural gas purchases, product sales and refining operating margins.
These instruments are used to lock in purchase or sales prices or components of
the 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 include price swaps, options, and futures. 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. See Note 1 of Notes to Consolidated Financial Statements under "Price
Risk Management Activities" and Note 6 for a discussion of the Company's
accounting policies and additional information related to its derivative
commodity instrument transactions.
The following table provides information about the Company's derivative
commodity instruments, which mature in 1999, held to hedge refining inventories
as of December 31, 1998 (dollars in thousands, except per barrel amounts).
<TABLE>
<CAPTION>
Fixed Price
--------------------
Payor Receiver
----- --------
<S> <C> <C>
Futures:
Volumes (Mbbls)............................. 4,958 5,274
Weighted average price (per bbl)............ $ 12.54 $ 13.51
Contract amount............................. $62,178 $71,242
Fair value.................................. $62,178 $71,242
</TABLE>
The following table provides information about the Company's derivative
commodity instruments held to hedge anticipated feedstock, product and natural
gas fuel purchases, product sales and refining margins as of December 31, 1998,
which mature in 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.
36
<PAGE> 40
<TABLE>
<CAPTION>
Fixed Price
-----------------------
Payor Receiver
------- --------
<S> <C> <C>
Swaps:
Notional volumes (Mbbls)........................... 1,860 4,650
Weighted average pay price (per bbl)............... $ 5.68 $ .83
Weighted average receive price (per bbl)........... $ 5.97 $ .64
Fair value......................................... $ 554 $ (853)
Notional volumes (MMBtus).......................... 5,700 1,200
Weighted average pay price (per MMBtu)............. $ 2.01 $ 1.93
Weighted average receive price (per MMBtu)......... $ 1.93 $ 2.32
Fair value......................................... $ (444) $ 460
Futures:
Volumes (Mbbls).................................... 45 --
Weighted average price (per bbl)................... $ 17.22 --
Contract amount.................................... $ 775 --
Fair value......................................... $ 671 --
</TABLE>
In addition to the above, as of December 31, 1998, 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 $17.04 per
barrel, and a negative fair value of approximately $23 million.
The following table provides information about the Company's derivative
commodity instruments held or issued for trading purposes as of December 31,
1998 and which mature in 1999 (dollars in thousands, except per barrel or per
MMBtu amounts). 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)............................ 15,150 9,050
Weighted average pay price (per bbl)................ $ 2.39 $ 1.77
Weighted average receive price (per bbl)............ $ 2.25 $ 1.90
Fair value.......................................... $(2,130) $ 1,244
Options:
Volumes (Mbbls)..................................... 400 400
Weighted average strike price (per bbl)............. $ 16.91 $ 16.91
Fair value.......................................... $ 641 $ 714
</TABLE>
37
<PAGE> 41
<TABLE>
<CAPTION>
Fixed Price
-------------------------
Payor Receiver
------- --------
<S> <C> <C>
Futures:
Volumes (Mbbls)..................................... 5,301 5,401
Weighted average price (per bbl).................... $ 14.66 $ 14.97
Contract amount..................................... $77,701 $ 80,865
Fair value.......................................... $72,583 $ 76,592
Volumes (MMBtus).................................... -- 250
Weighted average price (per MMBtu).................. -- $ 1.96
Contract amount..................................... -- $ 490
Fair value.......................................... -- $ 488
</TABLE>
In addition to the above, as of December 31, 1998, the Company was the
fixed price receiver under certain swap contracts for crack spreads that mature
in 2000 with notional volumes totaling approximately 1.7 million barrels, a
weighted average pay price of $2.10 per barrel, a weighted average receive price
of $2.30 per barrel, and a fair value of approximately $.3 million.
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 (see Note 5 of Notes to Consolidated
Financial Statements) 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 to reduce its
exposure to increases in interest rates and increase its financial flexibility.
38
<PAGE> 42
ITEM 8. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Valero Energy Corporation:
We have audited the accompanying consolidated balance sheets of Valero
Energy Corporation (a Delaware corporation) and subsidiaries as of December 31,
1998 and 1997, and the related consolidated statements of income, common stock
and other stockholders' equity and cash flows for each of the three years in the
period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Valero Energy
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
San Antonio, Texas
February 11, 1999
39
<PAGE> 43
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
December 31,
------------------------------------
1998 1997
--------------- ---------------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and temporary cash investments .......................................... $ 11,199 $ 9,935
Receivables, less allowance for doubtful accounts of $1,150 (1998) and
$1,275 (1997) .............................................................. 283,456 366,315
Inventories .................................................................. 316,405 369,355
Current deferred income tax assets ........................................... 4,851 17,155
Prepaid expenses and other ................................................... 23,799 26,265
--------------- ---------------
639,710 789,025
--------------- ---------------
PROPERTY, PLANT AND EQUIPMENT - including construction in
progress of $179,136 (1998) and $66,636 (1997), at cost ...................... 2,572,190 2,132,489
Less: Accumulated depreciation ............................................ 612,847 539,956
--------------- ---------------
1,959,343 1,592,533
--------------- ---------------
DEFERRED CHARGES AND OTHER ASSETS .............................................. 126,611 111,485
--------------- ---------------
$ 2,725,664 $ 2,493,043
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt .............................................................. $ 160,000 $ 122,000
Accounts payable ............................................................. 283,183 414,305
Accrued expenses ............................................................. 54,561 60,979
--------------- ---------------
497,744 597,284
--------------- ---------------
LONG-TERM DEBT ................................................................. 822,335 430,183
--------------- ---------------
DEFERRED INCOME TAXES .......................................................... 210,389 256,858
--------------- ---------------
DEFERRED CREDITS AND OTHER LIABILITIES ......................................... 109,909 49,877
--------------- ---------------
COMMON STOCKHOLDERS' EQUITY:
Common stock, $.01 par value - 150,000,000 shares authorized;
issued 56,314,798 (1998) and 56,136,032 (1997) shares ...................... 563 561
Additional paid-in capital ................................................... 1,112,726 1,110,654
Retained earnings (Accumulated deficit) ...................................... (17,618) 47,626
Treasury stock, 378,130 (1998) and -0- (1997) shares, at cost ................ (10,384) --
--------------- ---------------
1,085,287 1,158,841
--------------- ---------------
$ 2,725,664 $ 2,493,043
=============== ===============
</TABLE>
See Notes to Consolidated Financial Statements.
40
<PAGE> 44
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
OPERATING REVENUES ........................................................ $ 5,539,346 $ 5,756,220 $ 2,757,853
------------- ------------- -------------
COSTS AND EXPENSES:
Cost of sales and operating expenses .................................... 5,271,473 5,426,438 2,581,836
Write-down of inventories to market value ............................... 170,929 -- --
Selling and administrative expenses ..................................... 69,482 53,573 31,248
Depreciation expense .................................................... 78,660 65,175 55,021
------------- ------------- -------------
Total ................................................................. 5,590,544 5,545,186 2,668,105
------------- ------------- -------------
OPERATING INCOME (LOSS) ................................................... (51,198) 211,034 89,748
LOSS ON INVESTMENT IN PROESA JOINT VENTURE ................................ -- -- (19,549)
OTHER INCOME, NET ......................................................... 586 6,978 7,418
INTEREST AND DEBT EXPENSE:
Incurred ................................................................ (37,819) (44,150) (41,418)
Capitalized ............................................................. 5,340 1,695 2,884
------------- ------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES ..................................................... (83,091) 175,557 39,083
INCOME TAX EXPENSE (BENEFIT) .............................................. (35,800) 63,789 16,611
------------- ------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS .................................. (47,291) 111,768 22,472
INCOME (LOSS) FROM DISCONTINUED OPERATIONS,
NET OF INCOME TAX EXPENSE (BENEFIT) OF
$(8,889) (1997) AND $24,389 (1996), RESPECTIVELY ........................ -- (15,672) 50,229
------------- ------------- -------------
NET INCOME (LOSS) ......................................................... (47,291) 96,096 72,701
Less: Preferred stock dividend requirements and redemption premium ..... -- 4,592 11,327
------------- ------------- -------------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK .............................. $ (47,291) $ 91,504 $ 61,374
============= ============= =============
EARNINGS (LOSS) PER SHARE OF COMMON STOCK:
Continuing operations ................................................... $ (.84) $ 2.16 $ .51
Discontinued operations ................................................. -- (.39) .89
------------- ------------- -------------
Total ................................................................. $ (.84) $ 1.77 $ 1.40
============= ============= =============
Weighted average common shares outstanding (in thousands) ............... 56,078 51,662 43,926
EARNINGS (LOSS) PER SHARE OF COMMON STOCK - ASSUMING DILUTION:
Continuing operations ................................................... $ (.84) $ 2.03 $ .44
Discontinued operations ................................................. -- (.29) .98
------------- ------------- -------------
Total ................................................................. $ (.84) $ 1.74 $ 1.42
============= ============= =============
Weighted average common shares outstanding (in thousands) ............... 56,078 55,129 50,777
DIVIDENDS PER SHARE OF COMMON STOCK ....................................... $ .32 $ .42 $ .52
</TABLE>
See Notes to Consolidated Financial Statements.
41
<PAGE> 45
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Retained
Convertible Number of Additional Unearned Earnings
Preferred Common Common Paid-in VESOP (Accumulated Treasury
Stock Shares Stock Capital Compensation Deficit) Stock
----------- ----------- ----------- ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 .............. $ 3,450 43,739,380 $ 43,739 $ 530,177 $ (11,318) $ 458,343 $ (178)
Net income ............................. -- -- -- -- -- 72,701 --
Dividends on Series A Preferred
Stock ................................ -- -- -- -- -- (587) --
Dividends on Convertible Preferred
Stock ................................ -- -- -- -- -- (10,781) --
Dividends on Common Stock .............. -- -- -- -- -- (22,837) --
Valero Employees' Stock Ownership
Plan compensation earned ............. -- -- -- -- 2,535 -- --
Shares repurchased and shares
issued pursuant to employee
stock plans and other ................ -- 446,133 447 9,956 -- -- 178
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1996 ............... 3,450 44,185,513 44,186 540,133 (8,783) 496,839 --
Net income ............................. -- -- -- -- -- 96,096 --
Dividends on Series A Preferred
Stock ................................ -- -- -- -- -- (32) --
Dividends on Convertible Preferred
Stock ................................ -- -- -- -- -- (5,387) --
Dividends on Common Stock .............. -- -- -- -- -- (21,031) --
Redemption/conversion of
Convertible Preferred Stock .......... (3,450) 6,377,432 6,377 (3,116) -- -- --
Special spin-off dividend to Energy .... -- -- -- (210,000) -- -- --
Recapitalization pursuant to the
Restructuring ........................ -- -- (55,533) 622,500 -- (518,859) --
Issuance of Common Stock in
connection with acquisition of
Basis Petroleum, Inc. ................ -- 3,429,796 3,430 110,570 -- -- --
Valero Employees' Stock Ownership
Plan compensation earned ............. -- -- -- -- 8,783 -- --
Shares repurchased and shares
issued pursuant to employee
stock plans and other ................ -- 2,143,291 2,101 50,567 -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1997 ............... -- 56,136,032 561 1,110,654 -- 47,626 --
Net loss ............................... -- -- -- -- -- (47,291) --
Dividends on Common Stock .............. -- -- -- -- -- (17,953) --
Shares repurchased and shares
issued pursuant to employee
stock plans and other ................ -- 178,766 2 2,072 -- -- (10,384)
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE, December 31, 1998 .............. $ -- 56,314,798 $ 563 $ 1,112,726 $ -- $ (17,618) $ (10,384)
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
42
<PAGE> 46
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations ........................... $ (47,291) $ 111,768 $ 22,472
Adjustments to reconcile income (loss) from continuing operations
to net cash provided by continuing operations:
Depreciation expense ........................................... 78,660 65,175 55,021
Amortization of deferred charges and other, net ................ 47,889 27,252 28,485
Write-down of inventories to market value ...................... 170,929 -- --
Loss on investment in Proesa joint venture ..................... -- -- 19,549
Changes in current assets and current liabilities .............. (46,179) (32,113) (7,796)
Deferred income tax expense (benefit) .......................... (31,700) 32,827 8,969
Changes in deferred items and other, net ....................... (6,483) (8,264) (6,246)
----------- ----------- -----------
Net cash provided by continuing operations ................... 165,825 196,645 120,454
Net cash provided by discontinued operations ................. -- 24,452 126,054
----------- ----------- -----------
Net cash provided by operating activities .................. 165,825 221,097 246,508
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures:
Continuing operations ............................................ (165,507) (69,284) (59,412)
Discontinued operations .......................................... -- (52,674) (69,041)
Deferred turnaround and catalyst costs ............................. (56,346) (10,860) (36,389)
Purchase of Paulsboro Refinery ..................................... (335,249) -- --
Acquisition of Basis Petroleum, Inc. ............................... -- (355,595) --
Earn-out payment in connection with Basis acquisition .............. (10,325) -- --
Other .............................................................. 1,159 1,693 2,678
----------- ----------- -----------
Net cash used in investing activities ............................ (566,268) (486,720) (162,164)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in short-term debt, net ................................... 38,000 155,088 57,728
Long-term borrowings ............................................... 538,434 1,530,809 44,427
Long-term debt reduction ........................................... (147,000) (1,217,668) (153,772)
Special spin-off dividend, including intercompany note settlement .. -- (214,653) --
Common stock dividends ............................................. (17,953) (21,031) (22,837)
Preferred stock dividends .......................................... -- (5,419) (11,368)
Issuance of common stock ........................................... 6,677 59,054 11,225
Purchase of treasury stock ......................................... (16,451) (9,293) (4,000)
Redemption of preferred stock ...................................... -- (1,339) (5,750)
----------- ----------- -----------
Net cash provided by (used in) financing activities .............. 401,707 275,548 (84,347)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY
CASH INVESTMENTS ................................................... 1,264 9,925 (3)
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD ................................................ 9,935 10 13
----------- ----------- -----------
CASH AND TEMPORARY CASH INVESTMENTS AT
END OF PERIOD ...................................................... $ 11,199 $ 9,935 $ 10
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
43
<PAGE> 47
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
In the discussion and Notes that follow, the "Company" refers to Valero
Energy Corporation ("Valero") and its consolidated subsidiaries. Valero was
incorporated in Delaware in 1981 under the name Valero Refining and Marketing
Company and became a publicly held corporation on July 31, 1997 pursuant to the
Restructuring described below. Prior to the Restructuring, Valero was a wholly
owned subsidiary of Valero Energy Corporation ("Energy") who was engaged in both
the refining and marketing business and the natural gas related services
business. Upon completion of the Restructuring, Valero Refining and Marketing
Company was renamed Valero Energy Corporation.
On July 31, 1997, Energy spun off Valero to Energy's stockholders by
distributing all of Valero's $.01 par value common stock ("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, with its remaining natural gas related services business,
merged with a wholly owned subsidiary of PG&E Corporation ("PG&E")(the
"Merger"). The Distribution and the Merger are collectively referred to as the
"Restructuring." In the discussion 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.
As a result of the Restructuring, Valero became a "successor
registrant" to Energy for financial reporting purposes under the federal
securities laws. Accordingly, for periods subsequent to the Restructuring, the
accompanying consolidated financial statements include the accounts of Valero
and its consolidated subsidiaries, while for periods prior to the Restructuring,
the accompanying consolidated financial statements include the accounts of
Energy restated to reflect Energy's natural gas related services business as
discontinued operations. All significant intercompany transactions have been
eliminated in consolidation. Certain prior period amounts have been reclassified
for comparative purposes.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenues generally are recorded when products have been delivered.
44
<PAGE> 48
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
PRICE RISK MANAGEMENT ACTIVITIES
The Company enters into 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. Price swaps, options
and futures contracts with third parties are used to hedge anticipated feedstock
and product purchases, product sales and refining operating margins by locking
in purchase or sales prices or components of the margins, including feedstock
discounts, crack spreads and premium product differentials. Hedges of
anticipated transactions are also accounted for under the deferral method with
gains and losses on these transactions recognized when the hedged transaction
occurs, or at such time as the amount of the hedged transaction, combined with
the hedging instrument, is not deemed to be recoverable.
The above noted contracts are designated at inception as a hedge when
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, 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, cash
transactions related to derivative contracts are included in changes in current
assets and current liabilities.
45
<PAGE> 49
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CASH AND TEMPORARY CASH INVESTMENTS
The Company's temporary cash investments are highly liquid, low-risk
debt instruments which have a maturity of three months or less when acquired.
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. Due to a significant decline in feedstock and refined product
prices during 1998, the Company reduced the carrying amount of its refinery
inventories to market value resulting in a $170.9 million pre-tax charge to
earnings. Materials and supplies are carried principally at weighted average
cost not in excess of market. Inventories as of December 31, 1998 and 1997 were
as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Refinery feedstocks ............................... $ 80,036 $ 73,360
Refined products and blendstocks .................. 174,125 239,513
Materials and supplies ............................ 62,244 56,482
------------ ------------
$ 316,405 $ 369,355
============ ============
</TABLE>
Refinery feedstock and refined product and blendstock inventory volumes
totaled 20.5 million barrels ("MMbbls") and 15.7 MMbbls as of December 31, 1998
and 1997, respectively. See Note 6 for information concerning the Company's
hedging activities related to its refinery feedstock and refined product
inventories.
PROPERTY, PLANT AND EQUIPMENT
Property additions and betterments include capitalized interest and
acquisition costs allocable to construction and property purchases.
The costs of minor property units (or components of property units),
net of salvage, retired or abandoned are charged or credited to accumulated
depreciation under the composite method of depreciation. Gains or losses on
sales or other dispositions of major units of property are credited or charged
to income.
46
<PAGE> 50
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Major classes of property, plant and equipment as of December 31, 1998
and 1997 were as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Crude oil processing facilities ................... $ 1,980,082 $ 1,652,430
Butane processing facilities ...................... 242,996 242,487
Other processing facilities ....................... 80,230 80,197
Other ............................................. 89,746 90,739
Construction in progress .......................... 179,136 66,636
--------------- ---------------
$ 2,572,190 $ 2,132,489
=============== ===============
</TABLE>
Provision for depreciation of property, plant and equipment is made
primarily on a straight-line basis over the estimated useful lives of the
depreciable facilities. During 1996, a detailed study of the Company's fixed
asset lives was completed by a third-party consultant for the majority of the
Company's then-existing processing facilities. As a result of such study, the
Company adjusted the weighted-average remaining lives of the assets subject to
the study, utilizing the composite method of depreciation, to better reflect the
estimated periods during which such assets are expected to remain in service.
The effect of this change in accounting estimate was an increase in income from
continuing operations for 1996 of approximately $3.6 million, or $.08 per share.
A summary of the principal rates used in computing the annual provision for
depreciation, primarily utilizing the composite method and including estimated
salvage values, is as follows:
<TABLE>
<CAPTION>
Weighted
Range Average
--------------- ---------------
<S> <C> <C>
Crude oil processing facilities.................... 3.2% - 5.1% 3.6%
Butane processing facilities....................... 3.3% 3.3%
Other processing facilities........................ 3.6% 3.6%
Other.............................................. 2.3% - 47.8% 18.6%
</TABLE>
DEFERRED CHARGES AND OTHER ASSETS
Catalyst and Refinery Turnaround Costs
Fixed-bed catalyst costs are deferred when incurred and amortized on a
straight-line basis over the estimated useful life of that catalyst, normally
one to three years. Refinery turnaround costs are deferred when incurred and
amortized on a straight-line basis over that period of time estimated to lapse
until the next turnaround occurs.
Technological Royalties and Licenses
Technological royalties and licenses are deferred when incurred and
amortized on a straight-line basis over the estimated useful life of each
particular royalty or license.
47
<PAGE> 51
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Other Deferred Charges and Other Assets
Other deferred charges and other assets include the Company's 20%
interest in Javelina Company ("Javelina"), a general partnership that owns a
refinery off-gas processing plant in Corpus Christi. The Company accounts for
its interest in Javelina on the equity method of accounting. Also included in
other deferred charges and other assets are prefunded benefit costs, debt
issuance costs and certain other costs.
ACCRUED EXPENSES
Accrued expenses as of December 31, 1998 and 1997 were as follows (in
thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------
1998 1997
----------- -----------
<S> <C> <C>
Accrued interest expense ......................... $ 3,620 $ 1,766
Accrued taxes .................................... 29,905 36,712
Accrued employee benefit costs ................... 12,165 19,237
Other ............................................ 8,871 3,264
----------- -----------
$ 54,561 $ 60,979
=========== ===========
</TABLE>
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments
approximate fair value, except for certain long-term debt and financial
instruments used in price risk management activities. See Notes 5 and 6.
STOCK-BASED COMPENSATION
The Company accounts for its employee stock compensation plans using
the "intrinsic value" method of accounting set forth in Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of the Company's
common stock at the date of the grant over the amount an employee must pay to
acquire the stock. Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," issued by the Financial Accounting
Standards Board ("FASB") in October 1995, encourages, but does not require
companies to measure and recognize in their financial statements a compensation
cost for stock-based employee compensation plans based on the "fair value"
method of accounting set forth in the statement. See Note 12 for the pro forma
effects on net income and earnings per share had compensation cost for the
Company's stock-based compensation plans been determined consistent with SFAS
No. 123.
48
<PAGE> 52
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
EARNINGS PER SHARE
The Company has presented basic and diluted earnings per share on the
face of the accompanying income statements in accordance with the provisions of
SFAS No. 128, "Earnings per Share," which was issued by the FASB in February
1997 and became effective for the Company's financial statements beginning with
the year ended December 31, 1997. Basic earnings per share is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution of the Company's outstanding stock options and
performance awards granted to employees in connection with the Company's stock
compensation plans (see Note 12) for all periods presented. For 1997 and 1996,
diluted earnings per share also reflected the potential dilution of the
Company's Convertible Preferred Stock (see Note 8). In determining basic
earnings per share for the years ended December 31, 1997 and 1996, dividends on
Energy's preferred stock were deducted from income from discontinued operations
as such preferred stock was issued in connection with Energy's natural gas
related services business. The weighted average number of common shares
outstanding for the years ended December 31, 1998, 1997 and 1996 was 56,077,671,
51,662,449 and 43,926,026, respectively.
A reconciliation of the basic and diluted per-share computations for
income from continuing operations is as follows (dollars and shares in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------------------------
1998 1997 1996
----------------------------- ---------------------------- ------------------------------
Per- Per- Per-
Share Share Share
Loss Shares Amt. Income Shares Amt. Income Shares Amt.
-------- ------ ------- -------- ------ ----- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Income (loss) from
continuing operations....... $(47,291) $111,768 $22,472
======== ======== =======
BASIC EARNINGS PER SHARE:
Income (loss) from
continuing operations
available to common
stockholders................ $(47,291) 56,078 $ (.84) $111,768 51,662 $2.16 $22,472 43,926 $ .51
======= ===== ======
EFFECT OF DILUTIVE SECURITIES:
Stock options................. -- -- -- 881 -- 425
Performance awards............ -- -- -- 91 -- 44
Convertible preferred stock -- -- -- 2,495 -- 6,382
-------- ------ ------- ------ ------- ------
DILUTED EARNINGS PER SHARE:
Income from continuing
operations available to
common stockholders plus
assumed conversions......... $(47,291) 56,078 $ (.84) $111,768 55,129 $2.03 $22,472 50,777 $ .44
======== ====== ====== ======== ====== ===== ======= ====== ======
</TABLE>
49
<PAGE> 53
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Various stock options and performance awards granted to employees in
connection with the Company's stock compensation plans were outstanding during
the year ended December 31, 1998 but were not included in the computation of
diluted earnings per share from continuing operations for such period because
the effect would have been antidilutive. Options to purchase approximately 5.5
million shares of common stock and performance awards totaling approximately
100,000 shares were outstanding at December 31, 1998.
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. 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) noncash write-downs of
inventories to market value in 1998 totaling $170.9 million and (ii) the current
assets and current liabilities of the Paulsboro Refinery and Basis as of their
acquisition dates in 1998 and 1997, respectively (see Note 3), both of which are
reflected separately in the Statements of Cash Flows. Also excluded from the
following table are changes in cash and temporary cash investments, current
deferred income tax assets, short-term debt and current maturities of long-term
debt.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Receivables, net ............................ $ 83,103 $ 36,287 $ (33,653)
Inventories ................................. (9,962) 37,007 (58,089)
Prepaid expenses and other .................. 1,980 (12,703) 3,243
Accounts payable ............................ (116,502) (95,318) 88,182
Accrued expenses ............................ (4,798) 2,614 (7,479)
------------ ------------ ------------
Total ..................................... $ (46,179) $ (32,113) $ (7,796)
============ ============ ============
</TABLE>
Cash flows related to interest and income taxes, including amounts
related to discontinued operations for periods up to and including July 31,
1997, were as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Interest paid (net of amount capitalized).... $ 30,735 $ 66,008 $ 105,519
Income tax refunds received.................. 15,513 -- 21
Income taxes paid............................ 5,284 24,526 19,064
</TABLE>
Noncash investing and financing activities for 1998 included various
adjustments to property, plant and equipment and certain current assets and
current liabilities resulting from the completion of an independent appraisal
performed in connection with the allocation of the Basis purchase price to the
assets acquired and liabilities assumed. Noncash investing and financing
activities for 1997 included the issuance of Energy common stock to
50
<PAGE> 54
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Salomon as partial consideration for the acquisition of the stock of Basis, and
an $18.3 million accrual as of December 31, 1997 related to the Company's
estimate of a contingent earn-out payment in 1998 in conjunction with such
acquisition. See Note 3. In addition, noncash investing and financing activities
for 1997 included 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 above under "Principles of Consolidation and
Basis of Presentation."
NEW ACCOUNTING PRONOUNCEMENTS
SFAS No. 130, "Reporting Comprehensive Income," was issued by the FASB
in June 1997 and became effective for the Company's financial statements
beginning in 1998. SFAS No. 130 establishes standards for reporting and display
of comprehensive income and its components in a full set of general-purpose
financial statements and requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. This statement requires that an enterprise classify
items of other comprehensive income by their nature in a financial statement and
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of a
statement of financial position. Reclassification of prior period financial
statements presented for comparative purposes is required. The Company had no
items of other comprehensive income during the years ended December 31, 1998,
1997 and 1996 and, accordingly, did not report a total amount for comprehensive
income in the accompanying consolidated financial statements.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes new
standards for reporting information about operating segments in annual financial
statements and requires selected operating segment information to be reported in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. This statement became effective for the Company's financial
statements beginning with the current year ended December 31, 1998, at which
time restatement of prior period segment information presented for comparative
purposes is required. Interim period information is not required until the
second year of application (i.e., 1999), at which time comparative information
is required. See Note 10 for the disclosures required under this statement.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS No. 132 standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets, and eliminates certain disclosures
that are no longer useful. This statement also became effective for the
Company's financial statements beginning with the current year ended December
31, 1998, at which time restatement of prior period disclosures presented for
comparative purposes is required unless the information is not readily
available. See Note 12 for the disclosures required under this statement.
51
<PAGE> 55
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 becomes effective for
the Company's financial statements beginning January 1, 1999, with its
requirements to be applied to costs incurred on or after such date. The adoption
of this SOP is not expected to 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. This statement becomes effective
for the Company's financial statements beginning January 1, 2000 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 (a) all freestanding
derivative instruments and (b) certain derivative instruments embedded in hybrid
contracts that exist at such date and were issued, acquired, or substantially
modified after December 31, 1997 (and, at the Company's election, that were
issued or acquired before January 1, 1998 and not substantively modified
thereafter). The Company has not yet determined the impact on its financial
statements of adopting this statement. However, adoption of this statement could
result in increased volatility in the Company's earnings and other comprehensive
income.
2. DISCONTINUED OPERATIONS
Revenues of the discontinued natural gas related services business were
$1.7 billion for the seven months ended July 31, 1997 and $2.4 billion for the
year ended December 31, 1996. These amounts are not included in operating
revenues as reported in the accompanying Consolidated Statements of Income.
Total interest expense for the discontinued natural gas related
services business was $32.7 million for the seven months ended July 31, 1997 and
$58.1 million for the year ended December 31, 1996. These amounts include
interest specifically attributed to such discontinued operations, plus an
allocated portion of interest on the corporate debt of Energy as 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.
52
<PAGE> 56
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. ACQUISITIONS
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 purchase price was $228
million plus approximately $107 million representing the value of inventories
and certain other items acquired in the transaction and was paid in cash from
borrowings under the Company's bank credit facilities. 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, pending the completion of an independent appraisal. Pursuant to the
purchase method of accounting, the accompanying 1998 Consolidated Statement of
Income includes the results of operations of the Paulsboro Refinery for the
period September 17 through December 31, 1998.
As part of the transaction, the Company and Mobil signed long-term
agreements for the Company to supply Mobil with fuels and lubricant basestocks
and for Mobil to continue to supply the Paulsboro Refinery with high-quality
crude feedstocks. In addition, 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 will be determined in September of each year beginning in 1999, are
limited to $20 million in any year and $50 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.
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 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.
As of December 31, 1998, 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 20 years.
53
<PAGE> 57
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 Valero. As a result, Basis was a part of the Company at the time of the
Restructuring. The primary assets acquired in the Basis acquisition included
petroleum refineries located in Texas at Texas City and Houston and in Louisiana
at Krotz Springs, and an extensive wholesale marketing business. 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 fair
values as determined by an independent appraisal. Pursuant to the purchase
method of accounting, the accompanying Consolidated Statements of Income include
the results of operations related to the Texas City, Houston and Krotz Springs
refineries commencing May 1, 1997.
Energy acquired the stock of Basis for approximately $470 million. This
amount included certain costs incurred in connection with the acquisition and
was net of $9.5 million received from Salomon in December 1997 representing a
final resolution between the parties relating to certain contingent
environmental obligations for which Salomon was responsible pursuant to the
purchase agreement. 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.
Pursuant to the purchase agreement, Salomon is entitled to receive payments in
any of the 10 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 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 are 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 earn-out amount for the year ended May 1, 1998
was $10.3 million and was paid to Salomon on May 29, 1998.
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information of the Company
for the years ended December 31, 1998, 1997 and 1996 assumes that the
acquisition of the Paulsboro Refinery occurred at the beginning of 1998 and 1997
and that the acquisition of Basis occurred at the beginning of 1997 and 1996.
Such pro forma information is not necessarily indicative of the results of
future operations. (Dollars in thousands, except per share amounts.)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Operating revenues ..................................... $ 6,246,790 $ 8,907,487 $ 10,125,626
Operating income ....................................... (14,422) 250,625 8,362
Income (loss) from continuing operations ............... (33,663) 123,440 (35,821)
Income (loss) from discontinued operations ............. -- (15,672) 50,229
Net income ............................................. (33,663) 107,768 14,408
</TABLE>
54
<PAGE> 58
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Earnings (loss) per common share:
Continuing operations..................................... (.60) 2.39 (.82)
Discontinued operations................................... -- (.39) .89
Total................................................. (.60) 2.00 .07
Earnings (loss) per common share - assuming dilution:
Continuing operations..................................... (.60) 2.24 (.82)
Discontinued operations................................... -- (.29) .89
Total................................................. (.60) 1.95 .07
</TABLE>
4. SHORT-TERM DEBT
The Company currently has several uncommitted short-term bank credit
facilities under which amounts ranging from $85 million to $235 million may be
borrowed. As of December 31, 1998, $160 million was outstanding under these
short-term bank credit facilities at an interest rate of approximately 6.5%.
These short-term credit facilities bear interest at each respective bank's
quoted money market rate, have no commitment or other fees or compensating
balance requirements and are unsecured and unrestricted as to use.
5. LONG-TERM DEBT AND BANK CREDIT FACILITIES
Long-term debt balances as of December 31, 1998 and 1997 were as
follows (in thousands):
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Industrial revenue bonds:
Tax-exempt Revenue Refunding Bonds:
Series 1997A, 5.45%, due April 1, 2027 ....................... $ 24,400 $ 24,400
Series 1997B, 5.40%, due April 1, 2018 ....................... 32,800 32,800
Series 1997C, 5.40%, due April 1, 2018 ....................... 32,800 32,800
Series 1997D, 5.13%, due April 1, 2009 ....................... 8,500 8,500
Tax-exempt Waste Disposal Revenue Bonds:
Series 1998, 5.6%, due April 1, 2032 ......................... 25,000 --
Series 1997, 5.6%, due December 1, 2031 ...................... 25,000 25,000
Taxable Waste Disposal Revenue Bonds,
Series 1998, 5.65% at December 31, 1998, due April 1, 2032 ... 43,500 --
6.75% notes, due December 15, 2032 (notes are callable or putable
on December 15, 2002) ............................................ 150,000 150,000
$835 million revolving bank credit and letter of credit facility,
approximately 6.1% at December 31, 1998, due November 28, 2002 ... 475,000 150,000
Unamortized premium .................................................. 5,335 6,683
------------ ------------
Total long-term debt (no current maturities) ................. $ 822,335 $ 430,183
============ ============
</TABLE>
55
<PAGE> 59
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company currently maintains a five-year, 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 December 31, 1998,
outstanding borrowings and letters of credit under this committed bank credit
and letter of credit facility totaled approximately $521 million. The Company
also has several uncommitted bank letter of credit facilities totaling $285
million, approximately $17 million of which was outstanding as of December 31,
1998.
In March 1998, the Company converted the interest rates on its $98.5
million of tax-exempt Revenue Refunding Bonds (the "Refunding Bonds") and $25
million of tax-exempt Waste Disposal Revenue Bonds (the "Revenue Bonds") from
variable rates to a weighted average fixed rate of approximately 5.4%. The
Refunding Bonds were issued in April 1997 in four series with due dates ranging
from 2009 to 2027, while the Revenue Bonds were issued in May 1997 in one series
and mature on December 1, 2031. Also in March 1998, the Gulf Coast Waste
Disposal Authority issued and sold for the benefit of the Company $25 million of
new tax-exempt Waste Disposal Revenue Bonds at a fixed interest rate of 5.6%,
and $43.5 million of new taxable variable rate Waste Disposal Revenue Bonds at
an initial interest rate of 5.7%, both of which mature on April 1, 2032. The
$43.5 million of taxable bonds bear interest at a variable rate determined
weekly, with the Company having the right to convert such rate to a daily,
weekly, short-term or long-term rate, or to a fixed rate. These variable rate
bonds are supported by a letter of credit issued under the Company's revolving
bank credit facility. On January 18, 1999, the Company received a $25 million
allocation from the Texas Bond Review Board bond lottery which the Company will
use to refinance $25 million of its taxable Waste Disposal Revenue Bonds with
tax-exempt bonds. The refinancing is expected to be completed by the end of the
first quarter of 1999.
In December 1997, the Company issued $150 million principal amount of
6.75% notes (the "Notes") for net proceeds of approximately $156 million. The
Notes are unsecured and unsubordinated and rank equally with all other unsecured
and unsubordinated obligations of the Company. The Notes were issued to the
Valero Pass-Through Asset Trust 1997-1 (the "Trust"), which funded the
acquisition of the Notes through a private placement of $150 million principal
amount of 6.75% Pass-Through Asset Trust Securities ("PATS"). The PATS represent
a fractional undivided beneficial interest in the Trust. In exchange for certain
consideration paid to the Trust, a third party has an option to purchase the
Notes under certain circumstances at par on December 15, 2002, at which time the
term of the Notes would be extended 30 years to December 15, 2032. If the third
party does not exercise its purchase option, then under the terms of the Notes,
the Company would be required to repurchase the Notes at par on December 15,
2002.
As of December 31, 1998, the Company's debt to capitalization ratio was
47.5% and the Company was in compliance with all covenants contained in its
various debt facilities.
56
<PAGE> 60
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Based on long-term debt outstanding at December 31, 1998, the Company
has no maturities of long-term debt during the next five years except for $475
million due in November 2002 under its revolving bank credit and letter of
credit facility. See above for maturities under the terms of the Notes.
As of December 31, 1998, the $518.5 million carrying amount of the
Company's variable rate industrial revenue bonds and revolving bank credit
facility approximated fair value, while the estimated fair value of the
Company's fixed rate industrial revenue bonds and 6.75% Notes, based on
borrowing rates available to the Company for long-term debt with similar terms
and average maturities, was approximately $298.2 million compared to a carrying
amount of $303.8 million. As of December 31, 1997, the carrying amounts of the
Company's industrial revenue bonds, all of which were variable rate at such
date, revolving bank credit facility, and 6.75% Notes approximated fair value.
6. PRICE RISK MANAGEMENT ACTIVITIES
HEDGING ACTIVITIES
The Company uses price swaps and futures, and in 1997 utilized options,
to hedge refinery feedstock 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. Swaps, options and
futures contracts held to hedge refining inventories at the end of 1998 and 1997
had remaining terms of less than one year. As of December 31, 1998 and 1997, 5%
and 14%, respectively, of the Company's refining inventory position was hedged.
As of December 31, 1998, no deferred hedge losses or gains were included as an
increase or decrease to refining inventories, while as of December 31, 1997,
$2.1 million of deferred hedge gains were included as a reduction of refining
inventories. The following table is a summary of the volumes for the Company's
contracts held or issued to hedge refining inventories as of December 31, 1998
and 1997 (in thousands of barrels). Volumes shown for swaps represent notional
volumes which are used to calculate amounts due under the agreements.
<TABLE>
<CAPTION>
1998 1997
--------------------- ----------------------
Fixed Price Fixed Price
--------------------- ----------------------
Payor Receiver Payor Receiver
----- -------- ----- --------
<S> <C> <C> <C> <C>
Swaps (Mbbls).............. -- -- -- 75
Options (Mbbls)............ -- -- 420 250
Futures (Mbbls)............ 4,958 5,274 315 2,657
</TABLE>
The Company also hedges anticipated transactions. Price swaps and
futures were used in 1998 and 1997, along with options in 1997, to hedge
anticipated feedstock and product purchases, product sales and refining
operating margins by locking in purchase or sales prices or components of the
margins, including the resid discount, the conventional gasoline crack spread
and premium product differentials. Price swaps were also used in 1998 to hedge
anticipated purchases of natural gas used as fuel in the Company's refining
operations. The majority of contracts hedging anticipated transactions mature in
1999 with certain contracts extending through 2002. There were no significant
explicit deferrals of hedging gains or losses related to these anticipated
transactions as of the end of either year. The following table is a summary of
the volumes for the Company's contracts held or issued to hedge
57
<PAGE> 61
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
anticipated feedstock and product purchases, product sales and refining margins
(in thousands of barrels) and anticipated natural gas fuel purchases (in million
BTUs) as of December 31, 1998 and 1997. Volumes shown for swaps represent
notional volumes which are used to calculate amounts due under the agreements.
<TABLE>
<CAPTION>
1998 1997
--------------------- ----------------------
Fixed Price Fixed Price
--------------------- ----------------------
Payor Receiver Payor Receiver
----- -------- ----- --------
<S> <C> <C> <C> <C>
Swaps: (Mbbls).......... 9,366 4,650 8,856 1,350
(MMBtus)......... 5,700 1,200 -- --
Futures (Mbbls).......... 45 -- 146 90
</TABLE>
The following table discloses the carrying amount and fair value of the
Company's contracts held or issued for non-trading purposes as of December 31,
1998 and 1997 (dollars in thousands):
<TABLE>
<CAPTION>
1998 1997
-------------------------- --------------------------
Assets (Liabilities) Assets (Liabilities)
-------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Swaps ............... $ (23,097) $ (23,380) $ -- $ (4,021)
Options ............. -- -- (1) (222)
Futures ............. (1,569) 8,393 1,849 45
---------- ---------- ---------- ----------
Total ............. $ (24,666) $ (14,987) $ 1,848 $ (4,198)
========== ========== ========== ==========
</TABLE>
TRADING ACTIVITIES
The Company enters into transactions for trading purposes using its
fundamental and technical analysis of market conditions to earn additional
revenues. The types of instruments used include price swaps, over-the-counter
and exchange-traded options, and futures. These contracts run for periods of up
to 24 months. As a result, contracts outstanding as of December 31, 1998 will
mature in 1999 or 2000. The following table is a summary of the volumes for the
Company's contracts held or issued for trading purposes as of December 31, 1998
and 1997 (in thousands of barrels for feedstock and product-related transactions
and in million BTUs for natural gas related transactions). Volumes shown for
swaps represent notional volumes which are used to calculate amounts due under
the agreements.
<TABLE>
<CAPTION>
1998 1997
--------------------- ----------------------
Fixed Price Fixed Price
--------------------- ----------------------
Payor Receiver Payor Receiver
------ -------- ----- --------
<S> <C> <C> <C> <C>
Swaps (Mbbls)............... 15,150 10,700 4,475 2,175
Options (Mbbls)............. 400 400 -- --
Futures: (Mbbls)............ 5,301 5,401 653 544
(MMBtus)............ -- 250 -- --
</TABLE>
58
<PAGE> 62
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table discloses the fair values of contracts held or
issued for trading purposes and net gains (losses) from trading activities as of
or for the periods ended December 31, 1998 and 1997 (dollars in thousands):
<TABLE>
<CAPTION>
Fair Value of Assets (Liabilities)
----------------------------------------------------------
Average Ending Net Gains (Losses)
-------------------------- -------------------------- --------------------------
1998 1997 1998 1997 1998 1997
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Swaps ......... $ 215 $ (95) $ (556) $ (235) $ 2,585 $ (1,143)
Options ....... 22 (76) 73 (963) 205 (109)
Futures ....... (448) 7,292 4,497 3,965 (1,758) 661
---------- ---------- ---------- ---------- ---------- ----------
Total ....... $ (211) $ 7,121 $ 4,014 $ 2,767 $ 1,032 $ (591)
========== ========== ========== ========== ========== ==========
</TABLE>
MARKET AND CREDIT RISK
The Company's price risk management activities involve the receipt or
payment of fixed price commitments into the future. These transactions give rise
to market risk, the risk that future changes in market conditions may make an
instrument less valuable. The Company closely monitors and manages its exposure
to market risk on a daily basis in accordance with policies approved by the
Company's Board of Directors. Market risks are monitored by a risk control group
to ensure compliance with the Company's stated risk management policy.
Concentrations of customers in the refining industry may impact the Company's
overall exposure to credit risk, in that the customers in such industry may be
similarly affected by changes in economic or other conditions. The Company
believes that its counterparties will be able to satisfy their obligations under
contracts.
7. REDEEMABLE 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.
8. CONVERTIBLE PREFERRED STOCK
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.
59
<PAGE> 63
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
9. PREFERRED SHARE PURCHASE RIGHTS
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 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.
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. 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 Rights will expire on June 30, 2007, unless
such date is extended or unless the Rights are earlier redeemed or exchanged by
the Company.
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, each holder of a
Right will 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, 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).
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.
60
<PAGE> 64
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 prior to the time that a person or group has acquired
beneficial ownership of 15% or more of the Common Stock.
10. SEGMENT INFORMATION
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131, which superceded SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise," establishes
new standards for reporting information about operating segments in annual and
interim financial statements, requiring that public business enterprises report
financial and descriptive information about its reportable segments based on a
management approach. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas and major customers.
This statement became effective for the Company's financial statements beginning
with the current year ended December 31, 1998. Interim period information is not
required until the second year of application (i.e., 1999). In applying the
requirements of this statement, each of the Company's five refineries described
below were determined to be an operating segment as defined by the statement,
but have been aggregated as allowed by the statement for reporting purposes. As
a result, the Company continues to have one reportable segment, which is the
refining and wholesale marketing of premium, environmentally clean products.
The Company's principal products include reformulated and conventional
gasolines, low-sulfur diesel and oxygenates. The Company also produces a
substantial slate of middle distillates, jet fuel and petrochemicals, in
addition to lube oils and asphalt. The Company's operations consist primarily of
five petroleum refineries located in Texas at Corpus Christi, Texas City and
Houston, in Louisiana at Krotz Springs, and in New Jersey at Paulsboro, which
have a combined throughput capacity of approximately 735,000 BPD. The Company
currently markets its products to wholesale customers in 31 states and in
selected export markets in Latin America. Revenues from external customers for
the Company's principal products for the years ended December 31, 1998, 1997 and
1996 were as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
------------ ------------ -------------
<S> <C> <C> <C>
Gasoline and blending components.............................. $ 2,915,472 $ 3,059,610 $ 1,846,967
Distillates................................................... 1,271,287 1,124,958 336,975
Petrochemicals................................................ 194,453 293,935 123,747
NGLs and naphtha.............................................. 11,950 31,668 54,066
Lubes and asphalts............................................ 44,239 -- --
Other products and revenues................................... 1,101,945 1,246,049 396,098
------------ ------------ -------------
Total operating revenues.................................. $ 5,539,346 $ 5,756,220 $ 2,757,853
============ ============ =============
</TABLE>
61
<PAGE> 65
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In 1998, 1997 and 1996, the Company had no significant amount of export
sales and no significant foreign operations. In 1998 and 1997, no single
customer accounted for more than 10% of the Company's consolidated operating
revenues, while in 1996, approximately 11% of the Company's consolidated
operating revenues were derived from a major domestic oil company.
11. INCOME TAXES
Components of income tax expense (benefit) applicable to continuing
operations were as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal...................................................... $ (3,196) $ 29,501 $ 7,902
State........................................................ (904) 1,461 (260)
---------- ---------- ----------
Total current............................................. (4,100) 30,962 7,642
Deferred:
Federal...................................................... (31,700) 32,827 8,969
---------- ---------- ----------
Total income tax expense (benefit)........................ $ (35,800) $ 63,789 $ 16,611
========== ========== ==========
</TABLE>
The following is a reconciliation of total income tax expense (benefit)
applicable to continuing operations to income taxes computed by applying the
statutory federal income tax rate (35% for all years presented) to income (loss)
from continuing operations before income taxes (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Federal income tax expense (benefit) at the statutory rate..... $ (29,082) $ 61,445 $ 13,679
State income taxes, net of federal income tax effect........... (588) 950 (169)
Research and experimentation tax credit........................ (5,800) -- --
Other - net.................................................... (330) 1,394 3,101
---------- --------- ----------
Total income tax expense (benefit)........................ $ (35,800) $ 63,789 $ 16,611
========== ========= ==========
</TABLE>
62
<PAGE> 66
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The tax effects of significant temporary differences representing
deferred income tax assets and liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Deferred income tax assets:
Tax credit carryforwards........................................ $ 18,549 $ 14,287
Net operating loss carryforward ................................ 41,904 484
Compensation and employee benefit liabilities .................. 23,910 19,889
Environmental liabilities ...................................... 9,705 1,750
Lower of cost or market adjustment ............................. 8,578 --
Accrued liabilities and other .................................. 8,418 4,345
------------ ------------
Total deferred income tax assets ............................. $ 111,064 $ 40,755
============ ============
Deferred income tax liabilities:
Depreciation ................................................... $ (299,082) $ (263,641)
Other .......................................................... (17,520) (16,817)
------------ ------------
Total deferred income tax liabilities ........................ $ (316,602) $ (280,458)
============ ============
</TABLE>
As of December 31, 1998, the Company had federal net operating loss
carryforwards of approximately $120 million which are available to reduce future
federal taxable income and will expire in 2018 if not utilized. In addition, the
Company had an alternative minimum tax ("AMT") credit carryforward of
approximately $12.7 million, and a research and experimentation ("R&E") credit
carryforward of approximately $5.8 million, both of which are available to
reduce future federal income tax liabilities. The AMT credit carryforward has no
expiration date, while the R&E credit carryforward expires between 2004 and
2011. No valuation allowances were recorded against deferred income tax assets
as of December 31, 1998 and 1997.
The Company's taxable years through 1994 are closed to adjustment by
the Internal Revenue Service. The Company believes that adequate provisions for
income taxes have been reflected in its consolidated financial statements.
12. EMPLOYEE BENEFIT PLANS
PENSION PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company became the sponsor of Energy's pension plan at the time of
the Restructuring and, as a result, became solely responsible for (i) pension
liabilities existing immediately prior to the Restructuring to, or relating to,
Energy employees which became employees of PG&E after the Restructuring, which
will become payable upon the retirement of such employees, (ii) all liabilities
to, or relating to, former employees of Energy and the Company, and (iii) all
liabilities to, or relating to, current employees of the Company. In connection
with the Restructuring, Energy approved the establishment of a supplement to the
pension plan (the "1997 Window Plan") which permitted certain
63
<PAGE> 67
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
employees to retire from employment during 1997. Also, the Company became the
sponsor of Energy's nonqualified Supplemental Executive Retirement Plan
("SERP"), which is designed to provide additional pension benefits to executive
officers and certain other employees, and assumed all liabilities with respect
to current and former employees of both Energy and the Company under such plan.
The Company's pension plan, which is subject to the provisions of the
Employee Retirement Income Security Act of 1974 ("ERISA"), is designed to
provide eligible employees with retirement income. Participation in the plan
commences upon the completion of one year of continuous service. Upon becoming a
participant, all service since date of hire is included in determining vesting
and credited service, except for employees of the Company who were formerly
employed by Basis or Mobil (see Note 3. Acquisitions). For former Basis
employees who became employees of the Company, full credit was given for service
with Basis prior to May 1, 1997 for vesting and eligibility purposes, but for
benefit accrual purposes, only service on and after January 1, 1998 is counted
under the Plan. For former Mobil employees who became employees of the Company,
full credit was given for service with Mobil prior to September 17, 1998 for
vesting and eligibility purposes, but for benefit accrual purposes, only service
on and after such date is counted under the Plan. A participant generally vests
in plan benefits after five years of vesting service or upon reaching normal
retirement date.
The pension plan provides a monthly pension payable upon normal
retirement of an amount equal to a set formula which is based on the
participant's 60 consecutive highest months of compensation during the latest 10
years of credited service under the plan. All contributions to the plan are made
by the Company and contributions by participants are neither required nor
permitted. Company contributions, if and when permitted under ERISA, are
actuarially determined in an amount sufficient to fund the currently accruing
benefits and amortize any prior service cost over the expected life of the then
current work force. The Company's contributions to the pension plan and SERP in
1998, 1997 and 1996 were approximately $7.2 million, $8.8 million and $14.2
million, respectively. No contributions are currently anticipated to be required
in 1999.
The Company also provides certain health care and life insurance
benefits for retired employees, referred to herein as "postretirement benefits
other than pensions." Substantially all of the Company's employees may become
eligible for those benefits if, while still working for the Company, they either
reach normal retirement age or take early retirement. Health care benefits are
offered by the Company through a self-insured plan and a health maintenance
organization while life insurance benefits are provided through an insurance
company. The Company funds its postretirement benefits other than pensions on a
pay-as-you-go basis. At the time of the Restructuring, the Company became
responsible for all liabilities to former employees of both Energy and the
Company as well as current employees of the Company arising under Energy's
health care and life insurance programs. Employees of the Company who were
formerly employees of Basis and Mobil became eligible for postretirement
benefits other than pensions under the Company's plan effective May 1, 1997 and
September 17, 1998, respectively.
The following tables set forth for the Company's (i) pension plans,
including the SERP, and (ii) postretirement benefits other than pensions, the
funded status of the plans and amounts recognized in the Company's consolidated
financial statements as of December 31, 1998 and 1997, as well as changes in the
benefit obligation and plan assets for the years then ended (in thousands):
64
<PAGE> 68
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
-------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, January 1 .................... $ 129,430 $ 99,435 $ 32,721 $ 29,891
Service cost ................................. 6,934 3,710 1,703 1,028
Interest cost ................................ 9,031 7,298 2,411 1,841
Plan amendments .............................. 3,549 2,302 -- --
Acquisition of Paulsboro Refinery/Basis ...... -- -- 8,107 9,000
Curtailment resulting from Restructuring ..... -- (4,002) -- (8,750)
1997 Window Plan ............................. -- 3,168 -- 171
Participant contributions .................... -- -- 108 95
Benefits paid ................................ (6,967) (4,604) (1,826) (1,292)
Actuarial loss (gain) ........................ 10,453 22,123 (899) 737
---------- ---------- ---------- ----------
Benefit obligation, December 31 .................. $ 152,430 $ 129,430 $ 42,325 $ 32,721
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
-------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
CHANGE IN PLAN ASSETS:
Plan assets at fair value, January 1 ............. $ 121,393 $ 92,486 $ -- $ --
Actual return on plan assets ................. 17,644 24,698 -- --
Company contributions ........................ 7,192 8,813 1,718 1,197
Participant contributions .................... -- -- 108 95
Benefits paid ................................ (6,967) (4,604) (1,826) (1,292)
---------- ---------- ---------- ----------
Plan assets at fair value, December 31 ........... $ 139,262 $ 121,393 $ -- $ --
========== ========== ========== ==========
RECONCILIATION OF FUNDED STATUS, DECEMBER 31:
Plan assets at fair value ........................ $ 139,262 $ 121,393 $ -- $ --
Less: Benefit obligation ......................... 152,430 129,430 42,325 32,721
---------- ---------- ---------- ----------
Funded status .................................... (13,168) (8,037) (42,325) (32,721)
Unrecognized transition obligation (asset) ....... (1,057) (1,199) 4,388 4,705
Unrecognized prior service cost .................. 7,787 4,985 1,672 1,786
Unrecognized net loss ............................ 5,347 1,442 2,019 2,918
---------- ---------- ---------- ----------
Accrued benefit cost ......................... $ (1,091) $ (2,809) $ (34,246) $ (23,312)
========== ========== ========== ==========
AMOUNTS RECOGNIZED IN CONSOLIDATED BALANCE
SHEETS AS OF DECEMBER 31:
Prepaid benefit cost ............................. $ 8,145 $ 8,081 $ -- $ --
Accrued benefit liability ........................ (9,236) (10,890) (34,246) (23,312)
---------- ---------- ---------- ----------
Accrued benefit cost ......................... $ (1,091) $ (2,809) $ (34,246) $ (23,312)
========== ========== ========== ==========
</TABLE>
65
<PAGE> 69
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Total benefit cost for the years ended December 31, 1998, 1997 and 1996
included the following components (in thousands):
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
------------------------------------ ----------------------------------
Year Ended December 31, Year Ended December 31,
------------------------------------ ----------------------------------
1998 1997 1996 1998 1997 1996
-------- -------- -------- -------- -------- --------
COMPONENTS OF TOTAL BENEFIT COST:
<S> <C> <C> <C> <C> <C> <C>
Service cost ................................... $ 6,934 $ 3,710 $ 4,622 $ 1,703 $ 1,028 $ 1,091
Interest cost .................................. 9,031 7,298 6,309 2,411 1,842 1,716
Expected return on plan assets ................. (11,149) (9,563) (6,487) -- -- --
Amortization of transition obligation (asset) .. (142) (142) (142) 317 513 653
Amortization of prior service cost ............. 747 703 711 114 184 --
Amortization of net loss (gain) ................ 53 (154) 145 -- 46 110
-------- -------- -------- -------- -------- --------
Net periodic benefit cost .................. 5,474 1,852 5,158 4,545 3,613 3,570
Curtailment loss (gain) resulting from
the Restructuring .......................... -- (2,083) -- -- 576 --
1997 Window Plan ............................... -- 3,168 -- -- 171 --
-------- -------- -------- -------- -------- --------
Total benefit cost ......................... $ 5,474 $ 2,937 $ 5,158 $ 4,545 $ 4,360 $ 3,570
======== ======== ======== ======== ======== ========
</TABLE>
Amortization of prior service cost as shown in the above table is based
on the average remaining service period of employees expected to receive
benefits under the plan. The weighted-average assumptions used in computing the
actuarial present value of the pension benefit and other postretirement benefit
obligations for the years ended December 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
-------------------------------- ---------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
WEIGHTED-AVERAGE ASSUMPTIONS, DECEMBER 31:
Discount rate........................................ 6.75% 7.00% 6.75% 7.00%
Expected long-term rate of return on plan assets..... 9.25% 9.25% -- --
Rate of compensation increase........................ 4.00% 4.00% -- --
Health care cost trend rate.......................... -- -- 5.00% 5.00%
</TABLE>
For measurement purposes, the health care cost trend rate is assumed to
remain at five percent for all years subsequent to 1998. Assumed health care
cost trend rates have a significant effect on the amounts reported for health
care plans. A one percentage-point change in assumed health care cost trend
rates would have the following effects on postretirement benefits other than
pensions:
<TABLE>
<CAPTION>
One One
Percentage-Point Percentage-Point
Increase Decrease
---------------- ----------------
<S> <C> <C>
Effect on total of service and interest cost components......... $ 1,104 $ (873)
Effect on benefit obligation.................................... $ 8,541 $ (6,825)
</TABLE>
66
<PAGE> 70
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
PROFIT-SHARING/SAVINGS PLANS
The Company became the sponsor of Energy's qualified profit-sharing
plan (the "Thrift Plan") at the time of the Restructuring and, as a result,
became solely responsible for all Thrift Plan liabilities arising after the
Restructuring with respect to current Company employees and former employees of
both Energy and the Company. Each Energy employee participating in the Thrift
Plan prior to the Restructuring who became a PG&E employee subsequent to the
Restructuring had their account balance transferred to the PG&E savings plan.
The purpose of the Thrift Plan is to provide a program whereby
contributions of participating employees and their employers are systematically
invested to provide the employees an interest in the Company and to further
their financial independence. Participation in the Thrift Plan is voluntary and
is open to employees of the Company who become eligible to participate upon the
completion of one month of continuous service. Employees of the Company who were
formerly employed by Basis and Mobil became eligible to participate in the
Thrift Plan on January 1, 1998 and September 17, 1998, respectively, under the
same service requirements as required for other Company employees, with service
including prior employment with such respective company. Basis' previously
existing 401(k) profit-sharing and retirement savings plan was maintained for
former Basis employees who became employees of the Company through December 31,
1997 and was merged into the Company's Thrift Plan effective January 1, 1998.
Participating employees may contribute from 2% up to 22% of their total
annual compensation, subject to certain limitations, to the Thrift Plan.
Participants may elect to make such contributions on a before-tax and/or
after-tax basis, with federal income taxes on before-tax contributions being
deferred until such time as a distribution is made to the participant.
Participants' contributions to the Thrift Plan of up to 8% of their base annual
compensation are matched 75% by the Company, with an additional match of up to
25% subject to certain conditions. Participants' contributions in excess of 8%
of their base annual compensation are not matched by the Company. Up until
termination of the VESOP (see below) in 1997, the Company's matching
contributions were made to the VESOP in the amount of the VESOP's debt service,
with any excess made to the Thrift Plan. Subsequent to the VESOP termination,
all Company matching contributions were made to the Thrift Plan. Company
contributions to the Thrift Plan were $5,531,606 in 1998 and $2,247,491, net of
forfeitures, in 1997. There were no Company contributions to the Thrift Plan in
1996.
The Valero Employees' Stock Ownership Plan ("VESOP") was a leveraged
employee stock ownership plan established by Energy in 1989. The VESOP trustee
used the net proceeds from a $15 million private placement in 1989 and an $8
million loan from Energy in 1991 (collectively, the "VESOP Notes") to fund the
purchase of Energy common stock. In connection with effecting the Restructuring,
Energy's Board of Directors approved the termination of the VESOP in April 1997.
Subsequently, the VESOP trustee repaid the VESOP Notes in May 1997 with proceeds
from the sale of Energy common stock held in the VESOP suspense account and
allocated the remaining stock in the suspense account to VESOP participants.
VESOP account balances were available for distribution to participants as of
June 30, 1997 and all such balances were distributed by March 31, 1998.
67
<PAGE> 71
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
As noted above, prior to termination of the VESOP, the Company's annual
contribution to the Thrift Plan was reduced by the Company's contribution to the
VESOP for debt service. During 1997 and 1996, the Company contributed $586,000
and $3,372,000, respectively, to the VESOP, comprised of $58,000 and $525,000,
respectively, of interest on the VESOP Notes and $541,000 and $3,072,000,
respectively, of compensation expense. Dividends on VESOP shares of common stock
were recorded as a reduction of retained earnings. Dividends on allocated shares
of common stock were paid to participants. Dividends paid on unallocated shares
were used to reduce the Company's contributions to the VESOP during 1997 and
1996 by $13,000 and $225,000, respectively. VESOP shares of common stock were
considered outstanding for earnings per share computations.
STOCK COMPENSATION PLANS
In connection with the Restructuring, all stock options held by Energy
employees under any of Energy's various stock compensation plans that were
granted prior to January 1, 1997 became 100% vested and immediately exercisable
upon the approval of the Restructuring by Energy's stockholders on June 18,
1997. For all options still outstanding at the time of the Distribution, each
option to purchase Energy Common Stock held by a current or former employee of
the Company was converted into an option to acquire shares of Company Common
Stock, and each option held by a current or former employee of Energy's natural
gas related services business was converted into an option to acquire shares of
PG&E common stock. In each case, the number of options and related exercise
prices were converted in such a manner so that the aggregate option value for
each holder immediately after the Restructuring was equal to the aggregate
option value immediately prior to the Restructuring. The other terms and
conditions of such converted options remained essentially unchanged. All
restricted stock issued pursuant to Energy's stock compensation plans became
fully vested either upon the approval of the Restructuring by Energy's
stockholders on June 18, 1997 or upon the completion of the Restructuring on
July 31, 1997.
As of December 31, 1998, the Company had various fixed and
performance-based stock compensation plans. The Company's Executive Stock
Incentive Plan ("ESIP"), which was maintained by Energy prior to the
Restructuring, authorizes the grant of various stock and stock-related awards to
executive officers and other key employees. Awards available under the ESIP
include options to purchase shares of Common Stock, restricted stock which vests
over a period determined by the Company's compensation committee, and
performance shares which vest upon the achievement of an objective performance
goal. A total of 2,500,000 shares of Company Common Stock may be issued under
the ESIP, of which no more than 1,000,000 shares may be issued as restricted
stock. The Company also has a non-qualified stock option plan (the "Stock Option
Plan") which, at the date of the Restructuring, replaced three non-qualified
stock option plans previously maintained by Energy. Awards under the Stock
Option Plan are granted to key officers, employees and prospective employees of
the Company. A total of 2,000,000 shares of Company Common Stock may be issued
under the Stock Option Plan. The Company also maintains an Executive Incentive
Bonus Plan, under which 200,000 shares of Company Common Stock may be issued,
that provides bonus compensation to key employees of the Company based on
individual contributions to Company profitability. Bonuses are payable either in
cash, Company Common Stock, or both. The Company also has a non-employee
director stock option plan, under which 200,000 shares of Company Common Stock
may be issued, and a non-employee director restricted stock plan, under which
100,000 shares of Company Common Stock may be issued. The number and
weighted-average grant-date fair value of shares of Company Common Stock granted
under the above-
68
<PAGE> 72
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
noted plans (other than shares related to stock options which are presented in a
separate table below) during 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------- --------------------------------------------- ---------------------
August 1 - December 31 January 1 - July 31
---------------------- ---------------------
Weighted- Weighted- Weighted- Weighted-
Average Average Average Average
Shares Grant-Date Shares Grant-Date Shares Grant-Date Shares Grant-Date
Plan Granted Fair Value Granted Fair Value Granted Fair Value Granted Fair Value
- --------------------------------- ---------- ---------- ------- ----------- -------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ESIP:
Restricted stock ............ 163,986 $ 31.51 6,250 $ 31.78 -- $ -- 97,000 $ 25.12
Performance awards .......... 54,000 31.25 -- -- 31,400 32.50 64,830 23.19
Executive Incentive Bonus Plan .. 2,516 31.25 -- -- 109,691 32.50 50,151 23.19
Non-employee Director
Restricted Stock Plan ....... -- -- 9,336 28.94 -- -- 6,650 26.31
</TABLE>
Under the terms of the ESIP, the Stock Option Plan and the non-employee
director stock option plan, the exercise price of the options granted will not
be less than the fair market value of Common Stock at the date of grant. Stock
options become exercisable pursuant to the individual written agreements between
the Company and the participants, generally in three equal annual installments
beginning one year after the date of grant, with unexercised options expiring
ten years from the date of grant. A summary of the status of the Company's stock
option plans, including options granted under the ESIP, the Stock Option Plan,
the non-employee director stock option plan and Energy's previously existing
stock compensation plans, as of December 31, 1998, 1997, and 1996, and changes
during the years then ended is presented in the table below. (Note: Shares
outstanding at July 31, 1997 prior to the Restructuring differs from shares
outstanding at August 1, 1997 after the Restructuring because the August 1
amount: (i) excludes options held by current or former employees of Energy's
natural gas related services business which were converted to PG&E options and
(ii) reflects the conversion of Energy options held by current or former
employees of the Company to an equivalent number of Company options.)
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- ------------------------------------------------ -------------------
August 1 - December 31 January 1 - July 31
---------------------- ----------------------
Weighted- Weighted- Weighted- Weighted-
Average Average Average Average
Exercise Exercise Exercise Exercise
Shares Price Shares Price Shares Price Shares Price
---------- --------- ---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of period ................... 3,780,418 $19.15 3,802,584 $19.05 4,229,092 $22.02 3,928,267 $20.69
Granted ......................... 2,047,755 23.98 36,550 29.35 1,365,875 33.71 757,920 27.44
Exercised ....................... (235,235) 15.80 (44,144) 17.21 (2,925,687) 21.81 (418,117) 19.28
Forfeited ....................... (65,942) 25.62 (14,572) 23.07 (17,028) 25.84 (38,978) 22.17
---------- ---------- ---------- ----------
Outstanding at end of period .... 5,526,996 21.01 3,780,418 19.15 2,652,252 28.25 4,229,092 22.02
========== ========== ========== ==========
Exercisable at end of period .... 2,524,643 18.16 1,758,479 15.08 1,288,977 22.47 2,525,957 21.71
Weighted-average fair value of
options granted ................ $ 5.53 $ 6.86 $ 8.09 $ 6.25
</TABLE>
69
<PAGE> 73
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The following table summarizes information about stock options
outstanding under the ESIP, the Stock Option Plan and the non-employee director
stock option plan as of December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------- -------------------------------
Range Number Weighted-Avg. Number
of Outstanding Remaining Weighted-Avg. Exercisable Weighted-Avg.
Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price
- --------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$11.47 - $16.95 1,091,026 5.4 years $ 13.42 1,091,026 $ 13.42
$18.03 - $34.91 4,435,970 8.7 22.87 1,433,617 21.77
---------- -----------
$11.47 - $34.91 5,526,996 8.0 21.01 2,524,643 18.16
========== ===========
</TABLE>
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1998, 1997 and 1996, respectively: riskfree
interest rates of 5.0 percent, 6.3 percent and 6.4 percent; expected dividend
yields of 1.4 percent, 1.5 percent and 1.9 percent; expected lives of 3.1 years,
3.2 years and 3.1 years; and expected volatility of 28.2 percent, 26.2 percent
and 25.5 percent.
For each share of stock that can be purchased thereunder pursuant to a
stock option, the Stock Option Plan provides, and the predecessor stock option
plans of Energy provided, that a SAR may also be granted. A SAR is a right to
receive a cash payment equal to the difference between the fair market value of
Common Stock on the exercise date and the option price of the stock to which the
SAR is related. SARs are exercisable only upon the exercise of the related stock
options. At the end of each reporting period within the exercise period, the
Company recorded an adjustment to compensation expense based on the difference
between the fair market value of Common Stock at the end of each reporting
period and the option price of the stock to which the SAR was related. A summary
of SAR balances as of July 31, 1997 and December 31, 1996 and changes during the
periods then ended is presented in the table below. There were no SARs
outstanding as of December 31, 1998 or 1997.
<TABLE>
<CAPTION>
1997 1996
----------------------- ----------------------
January 1 - July 31
-----------------------
Weighted- Weighted-
Average Average
No. of Exercise No. of Exercise
SARs Price SARs Price
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning
of period ..................... 89,087 $ 14.52 111,003 $ 14.52
Granted ........................... -- -- -- --
Exercised ......................... (88,087) 14.52 (21,316) 14.52
Forfeited ......................... (1,000) 14.52 (600) 14.52
-------- --------
Outstanding at end of period ...... -- -- 89,087 14.52
======== ========
Exercisable at end of period ...... -- -- 89,087 14.52
</TABLE>
70
<PAGE> 74
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its plans. Accordingly, no compensation cost has been recognized
for its fixed stock option plans. The after-tax compensation cost reflected in
net income for stock-based compensation plans was $3.0 million, $4.6 million and
$2.6 million for 1998, 1997 and 1996, respectively. Of the 1997 and 1996
amounts, $2.1 million and $1.4 million, respectively, related to the
discontinued natural gas related services business. Had compensation cost for
the Company's stock-based compensation plans been determined based on the fair
value at the grant dates for 1998, 1997 and 1996 awards under those plans
consistent with the method of SFAS No. 123, the Company's net loss and loss per
share for the year ended December 31, 1998 would have been increased, and the
Company's net income and earnings per share for the years ended December 31,
1997 and 1996 would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------
1998 1997 1996
----------- ---------- ----------
<S> <C> <C> <C>
Net Income (loss).................................. As Reported $(47,291) $96,096 $72,701
Pro Forma $(52,398) $92,304 $70,427
Earnings (loss) per share.......................... As Reported $ (.84) $ 1.77 $ 1.40
Pro Forma $ (.93) $ 1.70 $ 1.35
Earnings (loss) per share - assuming dilution...... As Reported $ (.84) $ 1.74 $ 1.42
Pro Forma $ (.93) $ 1.67 $ 1.38
</TABLE>
Because the SFAS No. 123 method of accounting has not been applied to
awards granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
13. LEASE AND OTHER COMMITMENTS
The Company has long-term operating lease commitments in connection with
land, office facilities and equipment, and various facilities and equipment used
in the storage, transportation and production of refinery feedstocks and/or
refined products. Long-term leases for land have remaining primary terms of up
to 25.7 years, while long-term leases for office facilities have remaining
primary terms of up to 2.8 years. The Company's long-term leases for production
equipment, feedstock and refined product storage facilities and transportation
assets have remaining primary terms of up to 13.1 years and in certain cases
provide for various contingent payments based on, among other things, throughput
volumes in excess of a base amount.
71
<PAGE> 75
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
Future minimum lease payments and minimum rentals to be received under
subleases as of December 31, 1998 for operating leases having initial or
remaining noncancelable lease terms in excess of one year are as follows (in
thousands):
<TABLE>
<S> <C>
1999............................................................................. $ 22,596
2000 ............................................................................ 15,703
2001............................................................................. 10,821
2002............................................................................. 3,995
2003............................................................................. 2,219
Remainder........................................................................ 16,652
---------
71,986
Less future minimum rentals to be received under subleases....................... 536
---------
$ 71,450
=========
</TABLE>
Consolidated rental expense under operating leases for continuing
operations amounted to approximately $47,779,000 , $39,578,000, and $26,739,000
for 1998, 1997 and 1996, respectively. Such amounts are included in the
accompanying Consolidated Statements of Income in "cost of sales and operating
expenses" and in "selling and administrative expenses" and include various
month-to-month and other short-term rentals in addition to rents paid and
accrued under long-term lease commitments.
In addition to commitments under operating leases, the Company also has
a commitment under a product supply arrangement to pay a reservation fee of
approximately $10.8 million annually through August 2002.
14. LITIGATION AND CONTINGENCIES
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,
72
<PAGE> 76
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 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.
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.
73
<PAGE> 77
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The results of operations by quarter for the years ended December 31,
1998 and 1997 were as follows (in thousands of dollars, except per share
amounts):
<TABLE>
<CAPTION>
1998 - Quarter Ended (1)
---------------------------------------------------------------------------
March 31 June 30 September 30 December 31 Total
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Operating revenues ............................ $ 1,362,359 $ 1,448,104 $ 1,338,649 $ 1,390,234 $ 5,539,346
Operating income (loss) (2) ................... (2,417) 64,324 13,726 (126,831) (51,198)
Income (loss) from continuing operations (2) .. (5,884) 39,939 4,311 (85,657) (47,291)
Income (loss) from discontinued operations .... -- -- -- -- --
Net income (loss) (2) ......................... (5,884) 39,939 4,311 (85,657) (47,291)
Earnings (loss) per common share:
Continuing operations (2) ................. (.11) .71 .08 (1.53) (.84)
Discontinued operations ................... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Total ................................. (.11) .71 .08 (1.53) (.84)
============= ============= ============= ============= =============
Earnings (loss) per common share -
assuming dilution:
Continuing operations (2) ................. (.11) .70 .08 (1.53) (.84)
Discontinued operations ................... -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Total ................................. (.11) .70 .08 (1.53) (.84)
============= ============= ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
1997 - Quarter Ended (3),(4)
---------------------------------------------------------------------------
March 31 June 30 September 30 December 31 Total
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Operating revenues ............................ $ 821,802 $ 1,362,624 $ 1,975,665 $ 1,596,129 $ 5,756,220
Operating income .............................. 38,413 55,800 94,107 22,714 211,034
Income from continuing operations ............. 19,811 27,598 51,993 12,366 111,768
Income (loss) from discontinued operations .... (4,371) (10,869) (432) -- (15,672)
Net income .................................... 15,440 16,729 51,561 12,366 96,096
Earnings (loss) per common share:
Continuing operations ..................... .45 .55 .93 .22 2.16
Discontinued operations ................... (.16) (.26) (.01) -- (.39)
------------- ------------- ------------- ------------- -------------
Total ................................. .29 .29 .92 .22 1.77
============= ============= ============= ============= =============
Earnings (loss) per common share -
assuming dilution:
Continuing operations ..................... .38 .50 .91 .22 2.03
Discontinued operations ................... (.08) (.20) (.01) -- (.29)
------------- ------------- ------------- ------------- -------------
Total ................................. .30 .30 .90 .22 1.74
============= ============= ============= ============= =============
</TABLE>
- ----------------
(1) Includes the operations of the Paulsboro Refinery commencing September 17,
1998.
(2) The first quarter, fourth quarter and total year 1998 operating income
(loss) includes the unfavorable effect of inventory write-downs to market
of $37,673, $133,256, and $170,929, respectively. These write-downs
resulted in a reduction in income (loss) from continuing operations and net
income (loss) for those quarters of $24,488, $86,616, and $111,104,
respectively, and a reduction in earnings (loss) per common share of $.43,
$1.55, and $1.98, respectively.
(3) Includes the operations of the Texas City, Houston and Krotz Springs
refineries commencing May 1, 1997.
(4) Amounts reflect Energy's natural gas related services business as
discontinued operations pursuant to the Restructuring.
74
<PAGE> 78
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information on directors required by Items 401 and 405 of
Regulation S-K is incorporated herein by reference to the Company's definitive
Proxy Statement which will be filed with the Commission by April 29, 1999.
Information concerning the Company's executive officers appears in Part
I of this Annual Report on Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. FINANCIAL STATEMENTS. The following Consolidated Financial Statements
of Valero Energy Corporation and its subsidiaries are included in Part II, Item
8 of this Form 10-K:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of independent public accountants..................................................................... 39
Consolidated balance sheets as of December 31, 1998 and 1997................................................. 40
Consolidated statements of income for the years ended December 31, 1998, 1997 and 1996....................... 41
Consolidated statements of common stock and other stockholders' equity for the years ended
December 31, 1998, 1997 and 1996........................................................................ 42
Consolidated statements of cash flows for the years ended December 31, 1998, 1997 and 1996................... 43
Notes to consolidated financial statements................................................................... 44
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES AND OTHER FINANCIAL INFORMATION. No
financial statement schedules are submitted because either they are inapplicable
or because the required information is included in the Consolidated Financial
Statements or notes thereto.
3. EXHIBITS. Filed as part of this Form 10-K are the following
exhibits:
2.1 -- Agreement and Plan of Merger, dated as of January 31, 1997,
as amended, by and among Valero Energy Corporation, PG&E
Corporation, and PG&E Acquisition Corporation--incorporated
by reference from Exhibit 2.1 to the Company's Registration
Statement on Form S-1 (File No. 333- 27013, filed May 13,
1997).
2.2 -- Form of Agreement and Plan of Distribution between Valero
Energy Corporation and Valero Refining and Marketing
Company--incorporated by reference from Exhibit 2.2 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
75
<PAGE> 79
2.3 -- Form of Tax Sharing Agreement among Valero Energy
Corporation, Valero Refining and Marketing Company and PG&E
Corporation-incorporated by reference from Exhibit 2.3 to
the Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
2.4 -- Form of Employee Benefits Agreement between Valero Energy
Corporation and Valero Refining and Marketing
Company--incorporated by reference from Exhibit 2.4 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
2.5 -- Form of Interim Services Agreement between Valero Energy
Corporation and Valero Refining and Marketing
Company--incorporated by reference from Exhibit 2.5 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
2.6 -- Stock Purchase Agreement dated as of April 22, 1997, among
Valero Energy Corporation, Valero Refining and Marketing
Company, Salomon Inc and Basis Petroleum,
Inc.--incorporated by reference from Exhibit 2.1 to the
Company's Current Report on Form 8-K.
3.1 -- Amended and Restated Certificate of Incorporation of Valero
Energy Corporation (formerly known as Valero Refining and
Marketing Company)--incorporated by reference from Exhibit
3.1 to the Company's Registration Statement on Form S-1
(File No. 333-27013, filed May 13, 1997).
3.2 -- By-Laws of Valero Energy Corporation (formerly known as
Valero Refining and Marketing Company)--incorporated by
reference from Exhibit 3.2 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
4.1 -- Rights Agreement between Valero Refining and Marketing
Company and Harris Trust and Savings Bank, as Rights
Agent--incorporated by reference from Exhibit 4.1 to the
Company's Registration Statement on Form S-8 (File No.
333-31709, filed July 21, 1997).
4.2 -- Amended and Restated Credit Agreement dated as of November
28, 1997, among Valero Energy Corporation, the Banks listed
therein, Morgan Guaranty Trust Company of New York, as
Administrative Agent, and Bank of Montreal, as Syndicating
Agent and Issuing Bank-- incorporated by reference from
Exhibit 4.2 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997.
*4.3 -- Amendment No. 1 to Credit Agreement dated December 23,
1998, among Valero Energy Corporation, the Banks listed
therein, Morgan Guaranty Trust Company of New York, as
Administrative Agent, and Bank of Montreal, as Syndicating
Agent and Issuing Bank.
+10.1 -- Valero Energy Corporation Executive Incentive Bonus Plan,
as amended, dated as of April 23, 1997--incorporated by
reference from Exhibit 10.1 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.2 -- Valero Energy Corporation Executive Stock Incentive Plan,
as amended, dated as of April 23, 1997--incorporated by
reference from Exhibit 10.2 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
76
<PAGE> 80
+10.3 -- Valero Energy Corporation Stock Option Plan, as amended,
dated as of April 23, 1997-- incorporated by reference from
Exhibit 10.3 to the Company's Registration Statement on
Form S-1 (File No. 333-27013, filed May 13, 1997).
+10.4 -- Valero Energy Corporation Restricted Stock Plan for
Non-Employee Directors, as amended, dated as of April 23,
1997--incorporated by reference from Exhibit 10.4 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
+10.5 -- Valero Energy Corporation Non-Employee Director Stock
Option Plan, as amended, dated as of April 23,
1997--incorporated by reference from Exhibit 10.5 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
+10.6 -- Executive Severance Agreement between Valero Energy
Corporation and William E. Greehey, dated as of December
15, 1982, as adopted and ratified by Valero Refining and
Marketing Company--incorporated by reference from Exhibit
10.6 to the Company's Registration Statement on Form S-1
(File No. 333-27013, filed May 13, 1997).
+10.7 -- Schedule of Executive Severance Agreements--incorporated
by reference from Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (File No. 333-27013,
filed May 13, 1997).
+10.8 -- Form of Indemnity Agreement between Valero Refining and
Marketing Company and William E. Greehey-incorporated by
reference from Exhibit 10.8 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.9 -- Schedule of Indemnity Agreements--incorporated by reference
from Exhibit 10.9 to the Company's Registration Statement
on Form S-1 (File No. 333-27013, filed May 13, 1997).
+10.10 -- Form of Incentive Bonus Agreement between Valero Refining
and Marketing Company and Gregory C. King--incorporated by
reference from Exhibit 10.10 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.11 -- Schedule of Incentive Bonus Agreements--incorporated by
reference from Exhibit 10.11 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.12 -- Employment Agreement between Valero Refining and Marketing
Company and William E. Greehey, dated as of June 18,
1997--incorporated by reference from Exhibit 10.12 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997.
+10.13 -- Employment Agreement between Valero Refining and Marketing
Company and Edward C. Benninger, dated as of June 18,
1997--incorporated by reference from Exhibit 10.13 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997.
77
<PAGE> 81
+10.14 -- Form of Management Stability Agreement between Valero
Energy Corporation and Gregory C. King--incorporated by
reference from Exhibit 10.14 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997.
+10.15 -- Schedule of Management Stability Agreements--incorporated
by reference from Exhibit 10.15 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1997.
*+10.16 -- Consulting Agreement between Valero Energy Corporation and
Edward C. Benninger, effective as of January 1, 1999.
*+10.17 -- Letter Agreement between Valero Energy Corporation and
Edward C. Benninger, dated as of December 15, 1998.
*11.1 -- Computation of Earnings Per Share.
*12.1 -- Computation of Ratio of Earnings to Fixed Charges.
*21.1 -- Valero Energy Corporation subsidiaries, including state or
other jurisdiction of incorporation or organization.
*23.1 -- Consent of Arthur Andersen LLP, dated February 26, 1999.
*24.1 -- Power of Attorney, dated February 25, 1999 (set forth on
the signatures page of this Form 10-K).
**27.1 -- Financial Data Schedule (reporting financial information as
of and for the year ended December 31, 1998).
- --------------
* Filed herewith
+ Identifies management contracts or compensatory plans or arrangements
required to be filed as an exhibit hereto pursuant to Item 14(c) of Form
10-K.
** 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-K in accordance with Item 601(c) of Regulation S-K
and Section 401 of Regulation S-T.
Copies of exhibits filed as a part of this Form 10-K may be obtained by
stockholders of record at a charge of $.15 per page, minimum $5.00 each request.
Direct inquiries to Jay D. Browning, Corporate Secretary, Valero Energy
Corporation, P.O. Box 500, San Antonio, Texas 78292.
Pursuant to paragraph 601(b)(4)(iii)(A) of Regulation S-K, the
registrant has omitted from the foregoing listing of exhibits, and hereby agrees
to furnish to the Commission upon its request, copies of certain instruments,
each relating to long-term debt not exceeding 10% of the total assets of the
registrant and its subsidiaries on a consolidated basis.
(b) REPORTS ON FORM 8-K. The Company did not file any Current Reports on
Form 8-K during the quarter ended December 31, 1998.
78
<PAGE> 82
For the purposes of complying with the rules governing Form S-8 under
the Securities Act of 1933, the undersigned registrant hereby undertakes as
follows, which undertaking shall be incorporated by reference into registrant's
Registration Statements on Form S-8 No. 333-31709 (filed July 21, 1997), No.
333-31721 (filed July 21, 1997), No. 333-31723 (filed July 21, 1997) and No.
333-31727 (filed July 21, 1997):
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act of 1933 and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
79
<PAGE> 83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
VALERO ENERGY CORPORATION
(Registrant)
By /s/ William E. Greehey
---------------------------
(William E. Greehey)
Chairman of the Board and
Chief Executive Officer
Date: February 25, 1999
80
<PAGE> 84
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE
APPEARS BELOW HEREBY CONSTITUTES AND APPOINTS WILLIAM E. GREEHEY, JOHN D.
GIBBONS AND JAY D. BROWNING, OR ANY OF THEM, EACH WITH POWER TO ACT WITHOUT THE
OTHER, HIS TRUE AND LAWFUL ATTORNEY-IN-FACT AND AGENT, WITH FULL POWER OF
SUBSTITUTION AND RESUBSTITUTION, FOR HIM AND IN HIS NAME, PLACE AND STEAD, IN
ANY AND ALL CAPACITIES, TO SIGN ANY OR ALL SUBSEQUENT AMENDMENTS AND SUPPLEMENTS
TO THIS ANNUAL REPORT ON FORM 10-K, AND TO FILE THE SAME, OR CAUSE TO BE FILED
THE SAME, WITH ALL EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION
THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING UNTO EACH SAID
ATTORNEY-IN- FACT AND AGENT FULL POWER TO DO AND PERFORM EACH AND EVERY ACT AND
THING REQUISITE AND NECESSARY TO BE DONE IN AND ABOUT THE PREMISES, AS FULLY TO
ALL INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON, HEREBY QUALIFYING
AND CONFIRMING ALL THAT SAID ATTORNEY-IN-FACT AND AGENT OR HIS SUBSTITUTE OR
SUBSTITUTES MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE HEREOF.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
Director, Chairman of the
Board, President and Chief
Executive Officer (Principal
/s/ William E. Greehey Executive Officer) February 25, 1999
- ----------------------------------
(William E. Greehey)
Chief Financial Officer
(Principal Financial and
/s/ John D. Gibbons Accounting Officer) February 25, 1999
- ----------------------------------
(John D. Gibbons)
/s/ Edward C. Benninger Director February 25, 1999
- ----------------------------------
(Edward C. Benninger)
/s/ Ronald K. Calgaard Director February 25, 1999
- ----------------------------------
(Ronald K. Calgaard)
Director
- ----------------------------------
(Robert G. Dettmer)
/s/ Ruben M. Escobedo Director February 25, 1999
- ----------------------------------
(Ruben M. Escobedo)
/s/ James L. Johnson Director February 25, 1999
- ----------------------------------
(James L. Johnson)
/s/ Lowell H. Lebermann Director February 25, 1999
- ----------------------------------
(Lowell H. Lebermann)
/s/ Susan Kaufman Purcell Director February 25, 1999
- ----------------------------------
(Susan Kaufman Purcell)
</TABLE>
81
<PAGE> 85
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
2.1 -- Agreement and Plan of Merger, dated as of January 31, 1997,
as amended, by and among Valero Energy Corporation, PG&E
Corporation, and PG&E Acquisition Corporation--incorporated
by reference from Exhibit 2.1 to the Company's Registration
Statement on Form S-1 (File No. 333- 27013, filed May 13,
1997).
2.2 -- Form of Agreement and Plan of Distribution between Valero
Energy Corporation and Valero Refining and Marketing
Company--incorporated by reference from Exhibit 2.2 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
</TABLE>
<PAGE> 86
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
2.3 -- Form of Tax Sharing Agreement among Valero Energy
Corporation, Valero Refining and Marketing Company and PG&E
Corporation-incorporated by reference from Exhibit 2.3 to
the Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
2.4 -- Form of Employee Benefits Agreement between Valero Energy
Corporation and Valero Refining and Marketing
Company--incorporated by reference from Exhibit 2.4 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
2.5 -- Form of Interim Services Agreement between Valero Energy
Corporation and Valero Refining and Marketing
Company--incorporated by reference from Exhibit 2.5 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
2.6 -- Stock Purchase Agreement dated as of April 22, 1997, among
Valero Energy Corporation, Valero Refining and Marketing
Company, Salomon Inc and Basis Petroleum,
Inc.--incorporated by reference from Exhibit 2.1 to the
Company's Current Report on Form 8-K.
3.1 -- Amended and Restated Certificate of Incorporation of Valero
Energy Corporation (formerly known as Valero Refining and
Marketing Company)--incorporated by reference from Exhibit
3.1 to the Company's Registration Statement on Form S-1
(File No. 333-27013, filed May 13, 1997).
3.2 -- By-Laws of Valero Energy Corporation (formerly known as
Valero Refining and Marketing Company)--incorporated by
reference from Exhibit 3.2 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
4.1 -- Rights Agreement between Valero Refining and Marketing
Company and Harris Trust and Savings Bank, as Rights
Agent--incorporated by reference from Exhibit 4.1 to the
Company's Registration Statement on Form S-8 (File No.
333-31709, filed July 21, 1997).
4.2 -- Amended and Restated Credit Agreement dated as of November
28, 1997, among Valero Energy Corporation, the Banks listed
therein, Morgan Guaranty Trust Company of New York, as
Administrative Agent, and Bank of Montreal, as Syndicating
Agent and Issuing Bank-- incorporated by reference from
Exhibit 4.2 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997.
*4.3 -- Amendment No. 1 to Credit Agreement dated December 23,
1998, among Valero Energy Corporation, the Banks listed
therein, Morgan Guaranty Trust Company of New York, as
Administrative Agent, and Bank of Montreal, as Syndicating
Agent and Issuing Bank.
+10.1 -- Valero Energy Corporation Executive Incentive Bonus Plan,
as amended, dated as of April 23, 1997--incorporated by
reference from Exhibit 10.1 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.2 -- Valero Energy Corporation Executive Stock Incentive Plan,
as amended, dated as of April 23, 1997--incorporated by
reference from Exhibit 10.2 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
</TABLE>
<PAGE> 87
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
+10.3 -- Valero Energy Corporation Stock Option Plan, as amended,
dated as of April 23, 1997-- incorporated by reference from
Exhibit 10.3 to the Company's Registration Statement on
Form S-1 (File No. 333-27013, filed May 13, 1997).
+10.4 -- Valero Energy Corporation Restricted Stock Plan for
Non-Employee Directors, as amended, dated as of April 23,
1997--incorporated by reference from Exhibit 10.4 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
+10.5 -- Valero Energy Corporation Non-Employee Director Stock
Option Plan, as amended, dated as of April 23,
1997--incorporated by reference from Exhibit 10.5 to the
Company's Registration Statement on Form S-1 (File No.
333-27013, filed May 13, 1997).
+10.6 -- Executive Severance Agreement between Valero Energy
Corporation and William E. Greehey, dated as of December
15, 1982, as adopted and ratified by Valero Refining and
Marketing Company--incorporated by reference from Exhibit
10.6 to the Company's Registration Statement on Form S-1
(File No. 333-27013, filed May 13, 1997).
+10.7 -- Schedule of Executive Severance Agreements--incorporated
by reference from Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (File No. 333-27013,
filed May 13, 1997).
+10.8 -- Form of Indemnity Agreement between Valero Refining and
Marketing Company and William E. Greehey-incorporated by
reference from Exhibit 10.8 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.9 -- Schedule of Indemnity Agreements--incorporated by reference
from Exhibit 10.9 to the Company's Registration Statement
on Form S-1 (File No. 333-27013, filed May 13, 1997).
+10.10 -- Form of Incentive Bonus Agreement between Valero Refining
and Marketing Company and Gregory C. King--incorporated by
reference from Exhibit 10.10 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.11 -- Schedule of Incentive Bonus Agreements--incorporated by
reference from Exhibit 10.11 to the Company's Registration
Statement on Form S-1 (File No. 333-27013, filed May 13,
1997).
+10.12 -- Employment Agreement between Valero Refining and Marketing
Company and William E. Greehey, dated as of June 18,
1997--incorporated by reference from Exhibit 10.12 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997.
+10.13 -- Employment Agreement between Valero Refining and Marketing
Company and Edward C. Benninger, dated as of June 18,
1997--incorporated by reference from Exhibit 10.13 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1997.
</TABLE>
<PAGE> 88
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
+10.14 -- Form of Management Stability Agreement between Valero
Energy Corporation and Gregory C. King--incorporated by
reference from Exhibit 10.14 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997.
+10.15 -- Schedule of Management Stability Agreements--incorporated
by reference from Exhibit 10.15 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1997.
*+10.16 -- Consulting Agreement between Valero Energy Corporation and
Edward C. Benninger, effective as of January 1, 1999.
*+10.17 -- Letter Agreement between Valero Energy Corporation and
Edward C. Benninger, dated as of December 15, 1998.
*11.1 -- Computation of Earnings Per Share.
*12.1 -- Computation of Ratio of Earnings to Fixed Charges.
*21.1 -- Valero Energy Corporation subsidiaries, including state or
other jurisdiction of incorporation or organization.
*23.1 -- Consent of Arthur Andersen LLP, dated February 26, 1999.
*24.1 -- Power of Attorney, dated February 25, 1999 (set forth on
the signatures page of this Form 10-K).
**27.1 -- Financial Data Schedule (reporting financial information as
of and for the year ended December 31, 1998).
</TABLE>
- --------------
* Filed herewith
+ Identifies management contracts or compensatory plans or arrangements
required to be filed as an exhibit hereto pursuant to Item 14(c) of Form
10-K.
** 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-K in accordance with Item 601(c) of Regulation S-K
and Section 401 of Regulation S-T.
Copies of exhibits filed as a part of this Form 10-K may be obtained by
stockholders of record at a charge of $.15 per page, minimum $5.00 each request.
Direct inquiries to Jay D. Browning, Corporate Secretary, Valero Energy
Corporation, P.O. Box 500, San Antonio, Texas 78292.
Pursuant to paragraph 601(b)(4)(iii)(A) of Regulation S-K, the
registrant has omitted from the foregoing listing of exhibits, and hereby agrees
to furnish to the Commission upon its request, copies of certain instruments,
each relating to long-term debt not exceeding 10% of the total assets of the
registrant and its subsidiaries on a consolidated basis.
(b) REPORTS ON FORM 8-K. The Company did not file any Current Reports on
Form 8-K during the quarter ended December 31, 1998.
<PAGE> 1
EXHIBIT 4.3
CONFORMED COPY
AMENDMENT NO. 1 TO CREDIT AGREEMENT
AMENDMENT dated as of December 23, 1998 to the Amended and Restated
Credit Agreement dated as of November 28, 1997 ( the "CREDIT AGREEMENT") among
VALERO ENERGY CORPORATION (the "BORROWER"), the BANKS party thereto (the
"BANKS"), MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Administrative Agent
(the "ADMINISTRATIVE AGENT") and Bank of Montreal, as Syndication Agent and
Issuing Bank. The parties hereto agree as follows:
SECTION 1. Defined Terms; References. Unless otherwise specifically
defined herein, each capitalized term used herein which is defined in the Credit
Agreement has the meaning assigned to such term in the Credit Agreement. Each
reference to "hereof", "hereunder", "herein" and "hereby" and each other similar
reference and each reference to "this Agreement" and each other similar
reference contained in the Credit Agreement shall, after this Amendment becomes
effective, refer to the Credit Agreement as amended hereby.
SECTION 2. Amendment of Section 6.08. Section 6.08 of the Credit
Agreement is amended to read as follows:
SECTION 6.08. Debt. Consolidated Debt of the Borrower will at
no time exceed 50% of the sum of Consolidated Debt of the Borrower plus
the Consolidated Net Worth of the Borrower plus the involuntary
liquidation value of outstanding shares of redeemable preferred stock
of the Borrower.
SECTION 3. Year 2000. The following new Section 5.13 is added at the
end of Article 5 of the Credit Agreement.
SECTION 5.13. Year 2000 Compliance. The Borrower has (i)
initiated a review and assessment of all material areas of the business
operations of it and its Subsidiaries (including those areas affected
by suppliers and vendors) that could be adversely affected by the "YEAR
2000 PROBLEM" (that is, the risk that computer applications used by it
or any of its Subsidiaries (or their respective suppliers and vendors)
may be unable to recognize and perform properly date-sensitive
functions involving certain dates prior to and any date after December
31, 1999), (ii) developed a plan and timeline for addressing the Year
2000 Problem on a timely basis and (iii) to date, implemented such plan
substantially in accordance with such timetable. The Borrower
reasonably believes that all computer applications (including those of
suppliers and vendors material to the operations of the Borrower and
its Subsidiaries) that are material to the business or operations of
the Borrower or any of its Subsidiaries will on a timely basis be able
to perform properly date-sensitive functions for all dates before and
from and after January 1, 2000 (that is, be "YEAR 2000 COMPLIANT"),
except to the extent that a failure to do so could not reasonably be
expected to have a material adverse effect on the business, financial
condition or results of operations of the Borrower and its
Subsidiaries, taken as a whole.
SECTION 4. Increase of Interest Rates. The Pricing Schedule attached to
the Credit Agreement (the "EXISTING PRICING SCHEDULE") is deleted and replaced
by the Pricing Schedule attached to this Amendment (the "NEW PRICING SCHEDULE").
The New Pricing Schedule shall apply to interest and fees accruing under the
Credit Agreement on and after the date hereof. The Existing Pricing Schedule
shall continue to apply to interest and fees accruing under the Credit Agreement
prior to the date hereof.
SECTION 5. Representations of Borrower. The Borrower represents and
warrants that (i) the representations and warranties of the Borrower set forth
in Article 5 of the Credit Agreement will be true on and as of the Amendment
Effective Date and (ii) no Default will have occurred and be continuing on such
date.
SECTION 6. Governing Law. This Amendment shall be governed by and
construed in accordance with the laws of the State of New York.
SECTION 7. Counterparts. This Amendment may be signed in any number of
counterparts, each of which shall be an original, with the same effect as if the
signatures thereto and hereto were upon the same instrument.
<PAGE> 2
SECTION 8. Effectiveness. This Amendment shall become effective on the
date when the following conditions are met (the "AMENDMENT EFFECTIVE DATE"):
(a) the Administrative Agent shall have received from each of
the Borrower and the Required Banks a counterpart hereof signed by such
party or facsimile or other written confirmation (in form satisfactory
to the Administrative Agent) that such party has signed a counterpart
hereof; and
(b) the Administrative Agent shall have received an amendment
fee for the account of each Bank that has delivered to the
Administrative Agent on or before the close of business (New York City
time) on December 21, 1998 a counterpart hereof signed by such Bank or
facsimile or other written confirmation (in form satisfactory to the
Administrative Agent) that such party has signed a counterpart hereof,
such fee in an amount equal to .05% of such Bank's Commitment.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed by their respective authorized officers as of the day and year
first above written.
VALERO ENERGY CORPORATION
By /s/ John D. Gibbons
-----------------------------------
Title: Chief Financial Officer and
Treasurer
MORGAN GUARANTY TRUST
COMPANY OF NEW YORK
By /s/ Stacey Haimes
-----------------------------------
Title: Vice President
BANK OF MONTREAL
By /s/ Mary Lee Latta
-----------------------------------
Title: Director
BANK OF TOKYO-MITSUBISHI,
LTD.
By /s/ I. Otani
-----------------------------------
Title: Deputy General Manager
BANKBOSTON, N.A.
By /s/ Terrence Ronan
-----------------------------------
Title: Director
BANQUE NATIONALE DE
PARIS, HOUSTON AGENCY
By /s/ Henry F. Setina
-----------------------------------
Title: Vice President
BHF-BANK
AKTIENGESELLSCHAFT
By /s/ John Sykes
-----------------------------------
Title: Vice President
By /s/ Peter Leibman
-----------------------------------
Title: Assistant Treasurer
<PAGE> 3
CIBC INC.
By /s/ Michael A.G. Corkum
-----------------------------------
Title: Authorized Signatory
CREDIT LYONNAIS NEW YORK
BRANCH
By /s/ Phillippe Soustra
-----------------------------------
Title: Senior Vice President
THE FIRST NATIONAL BANK OF
CHICAGO
By /s/ Dixon P. Schultz
-----------------------------------
Title: First Vice President
THE FUJI BANK, LIMITED
By /s/ Raymond Ventura
-----------------------------------
Title: Vice President & Manager
ROYAL BANK OF CANADA
By /s/ Gil J. Benard
-----------------------------------
Title: Senior Manager
SOCIETE GENERALE
By /s/ Richard A. Gould
-----------------------------------
Title: Director
TORONTO DOMINION (TEXAS),
INC.
By /s/ Alva J. Jones
-----------------------------------
Title: Vice President
BARCLAYS BANK PLC
By /s/ J. Onischuk
-----------------------------------
Title: Associate Director
CHRISTIANIA BANK, NEW YORK
BRANCH
By /s/ William S. Phillips
-----------------------------------
Title: First Vice President
By /s/ Peter M. Dodge
-----------------------------------
Title: Senior Vice President
DEN NORSKE BANK ASA
By /s/ Byron L. Cooley
-----------------------------------
Title: Senior Vice President
<PAGE> 4
By /s/ Charles E. Hall
-----------------------------------
Title: Senior Vice President
GUARANTY FEDERAL BANK,
F.S.B.
By /s/ Jim R. Hamilton
-----------------------------------
Title: Vice President
THE INDUSTRIAL BANK OF
JAPAN, LIMITED, NEW YORK
BRANCH
By /s/ Kazutoshi Kuwahara
-----------------------------------
Title: Executive Vice President,
Houston Office
THE BANK OF NOVA SCOTIA
By /s/ F. C. H. Ashby
-----------------------------------
Title: Senior Manager, Loan
Operations
CREDIT AGRICOLE INDOSUEZ
By /s/ David Bouhl
-----------------------------------
Title: First Vice President, Head
of Corporate Banking Chicago
By /s/ Katherine L. Abbott
-----------------------------------
Title: First Vice President
THE DAI-ICHI KANGYO BANK,
LTD.
By /s/ Matthew G. Murphy
-----------------------------------
Title: Vice President
THE FROST NATIONAL BANK
By /s/ Jim Crosby
-----------------------------------
Title: Senior Vice President
MELLON BANK, N.A.
By /s/ Roger E. Howard
-----------------------------------
Title: Vice President
THE SANWA BANK, LIMITED
By /s/ Takuro Ojima
-----------------------------------
Title: Assistant Vice President
UBS AG, STAMFORD BRANCH
By /s/ M.C. Hansen
-----------------------------------
Title: Associate Director
By /s/ Robert W. Casey Jr.
-----------------------------------
Title: Executive Director
<PAGE> 5
PRICING SCHEDULE
The "EURO-DOLLAR MARGIN", "FACILITY FEE RATE" and "LETTER OF CREDIT RATE" for
any day are the respective percentages set forth below in the applicable row
under the column corresponding to the Status that exists on such day:
<TABLE>
<CAPTION>
Status Level I Level II Level III Level IV Level V
<S> <C> <C> <C> <C> <C>
Euro-Dollar 0.360% 0.390% 0.600% 0.750% 1.125%
Margin
Facility Fee 0.090% 0.110% 0.150% 0.250% 0.375%
Rate
Letter of Credit
Rate
Performance 0.1800% 0.1950% 0.3000% 0.3750% 0.5625%
Financial 0.360% 0.390% 0.600% 0.750% 1.125%
</TABLE>
For purposes of this Schedule, the following terms have the following
meanings (subject to the last paragraph of this Schedule):
"LEVEL I STATUS" exists at any date if, at such date, the Borrower's
long-term debt is rated at least BBB+ by S&P or at least Baa1 by Moody's.
"LEVEL II STATUS" exists at any date if, at such date, (i) the
Borrower's long-term debt is rated at least BBB by S&P or at least Baa2 by
Moody's and (ii) Level I Status does not exist.
"LEVEL III STATUS" exists at any date if, at such date, (i) the
Borrower's long-term debt is rated at least BBB- by S&P or at least Baa3 by
Moody's and (ii) neither Level I Status nor Level II Status exists.
"LEVEL IV STATUS" exists at any date if, at such date, (i) the
Borrower's long-term debt is rated at least BB+ by S&P and at least Ba1 by
Moody's and (ii) none of Level I Status, Level II Status and Level III Status
exists.
"LEVEL V STATUS" exists at any date if, at such date, no other Status
exists.
"STATUS" refers to the determination of which of Level I Status, Level
II Status, Level III Status, Level IV Status or Level V Status exists at any
date.
The credit ratings to be utilized for purposes of this Schedule are
those assigned to the senior unsecured long-term debt securities of the Borrower
without third-party credit enhancement, and any rating assigned to any other
debt security of the Borrower shall be disregarded. The rating in effect at any
date is that in effect at the close of business on such date.
So long as the Borrower is rated at least BB- by S&P and at least Ba3
by Moody's, if the Borrower is split-rated and the ratings differential is one
level, the higher of the two ratings will apply (e.g., BBB/Baa3 results in Level
II Status). If the Borrower is split-rated and the ratings differential is more
than one level, the average of the two ratings (or the higher of two
intermediate ratings) shall be used (e.g., BBB-/Ba1 results in Level III Status,
as does BBB/Ba2).
<PAGE> 1
EXHIBIT 10.16
CONSULTING AGREEMENT
This Consulting Agreement (this "Agreement"), effective as of January
1, 1999 (the "Effective Date"), is entered into between Valero Energy
Corporation, a Delaware corporation ("Valero"), and Edward C. Benninger ("Mr.
Benninger" or "Consultant").
WHEREAS, Mr. Benninger will retire from employment with Valero and its
affiliates, subsidiaries and/or partnerships ("Affiliates") effective December
31, 1998;
WHEREAS, Valero wishes to procure the consulting services of Mr.
Benninger from time to time in connection with the operations and management of
Valero;
WHEREAS, Mr. Benninger agrees to provide consulting services to Valero
during the term of this Agreement as set forth herein;
NOW, THEREFORE, in exchange for the consideration described herein, the
parties hereto agree as follows:
1. CONSULTING SERVICES. Mr. Benninger shall make himself available during
the term of this Agreement to consult with the officers and directors of Valero
and its Affiliates and their designees regarding the fiscal policy, operations
and management of Valero, which consulting services may include:
a. general management consulting services, including advice and the
implementation thereof, and the planning and programming necessary for
effective direction and control of the activities of management;
b. specialized management services as to the preparation and
implementation of particular projects and plans; and
c. other duties customarily incidental to the position of a business
consultant to a corporation in the refining and marketing business.
2. TERM. The respective duties and obligations of the parties hereto shall
commence on January 1, 1999 and terminate on December 31, 1999.
3. COMPENSATION. In consideration for Mr. Benninger's availability to
Valero and for all services rendered by Mr. Benninger:
a. Valero shall pay Mr. Benninger an annual fee of $175,000, payable
in monthly installments of $14,583.33 on or before the 1st day of each
month commencing January 1, 1999 and ending December 1, 1999;
b. Valero shall also pay all reasonably necessary travel, lodging
and other expenses incurred by Mr. Benninger in connection with the
performance of services hereunder;
c. Valero shall reimburse Mr. Benninger's monthly membership dues to
the Dominion Country Club during the term of this Agreement; and
d. Mr. Benninger will be furnished tax planning services of the type
furnished to executive officers of Valero by an independent certified
public accounting firm for 1999 and continuing into 2000 for so long as
reasonably necessary to complete preparation and filing of Mr.
Benninger's federal income tax return for 1999.
4. DEATH; DISABILITY.
a. In the event of Mr. Benninger's death during the term of this
Agreement, Valero shall pay in equal monthly installments to the
beneficiary designated by Mr. Benninger, or his estate if no such
beneficiary has been
<PAGE> 2
designated in writing to Valero, the balance of the consulting fees
which Mr. Benninger would have earned and received if he had served as
a consultant pursuant to this Agreement until December 31, 1999.
b. If during the term of this Agreement Mr. Benninger becomes unable
to perform his duties hereunder as a result of illness or physical
injury Valero shall pay in equal monthly installments to Mr. Benninger
the balance of the consulting fees which Mr. Benninger would have
earned and received if he had served as a consultant pursuant to this
Agreement until December 31, 1999.
5. LIMITATION ON AUTHORITY. Without express written authorization from
Valero pursuant to a duly executed power of attorney, Mr. Benninger shall not
incur any debt on behalf of Valero or bind Valero under any contract, agreement,
note, mortgage or otherwise.
6. INDEPENDENT CONTRACTOR.
a. It is understood and agreed that in the performance of consulting
services pursuant to this Agreement, Mr. Benninger shall act as an
independent contractor. Mr. Benninger shall employ his own means and
methods of accomplishing the projects and tasks in performing services
for Valero and shall not be subjected to the control of Valero in
respect to the details of such work.
b. It is expressly understood and stipulated that no
employer-employee relationship exists between Mr. Benninger and Valero,
and that this Agreement does not and is not intended to create an
employer-employee relationship. Mr. Benninger will not by reason of
providing Consulting Services be eligible for any employee benefits of
Valero, nor will Valero make deductions from its fees to Mr. Benninger
for taxes, Federal Insurance Contribution Act contributions, insurance,
bonds, or any other amounts of any kind. Mr. Benninger represents that
he will pay to the proper individuals or federal, state or local
authorities all taxes, licenses and fees levied by any governmental
authority including, but not limited to, unemployment compensation, old
age benefits, income tax withholding, self-employment taxes, social
security taxes or any other taxes or duties on, or withholding of, fees
paid to Mr. Benninger.
7. TERMINATION BY COMPANY. Company shall have the right to terminate
Consultant's services and this Agreement as hereinafter provided.
a. Termination for Cause. Company shall have the right to terminate
this Agreement for cause. As used herein, "cause" shall mean and be
strictly limited to:
i. Consultant's conviction of a crime constituting a felony
under federal or state law and involving moral turpitude; or
ii. the continued material impairment of abilities of
Consultant to fulfill responsibilities under this Agreement as a
result of alcoholism or drug dependency after written notice of
such material impairment from Company and the failure to correct
such impairment within 60 days from the date such notice is
given; or
iii. the continued willful refusal by Consultant to fulfill
responsibilities under this Agreement after written notice of
such willful refusal from Company and the failure to correct such
refusal within 30 days from the date such notice is given.
If Company terminates this Agreement pursuant to the provisions of this
paragraph, all compensation or other benefits due Consultant pursuant to
Paragraph 3 shall be paid by Company to Consultant up to the date of such
termination, and upon such payment, all obligations of Company to Consultant
hereunder shall be totally and completely satisfied, and Company shall have no
further obligations of any type to Consultant pursuant to this Agreement.
b. Termination other than for Cause. Company shall have the right to
terminate Consultant's employment under this Agreement without cause,
and Consultant's employment under this Agreement shall be deemed
terminated, upon the giving of written notice to such effect by Company
to Consultant. A termination of
2
<PAGE> 3
employment other than as a result of death or disability under
Paragraph 4 or in accordance with paragraph 11(a) shall be deemed a
termination without cause. In the event of termination without cause,
Consultant shall receive all of the payments and benefits to which he
is entitled pursuant to paragraph 3 as though he had served as a
consultant pursuant to this Agreement until December 31, 1999.
c. Termination upon Certain Events. In the event Company (including
for purposes of this paragraph any successor corporation which acquires
all or substantially all the assets of Company or is the surviving
corporation in a merger with Company) ceases to have any securities
issued by it listed on the New York Stock Exchange or Company ceases to
be a corporation that is obligated under the Securities Exchange Act of
1934 ("1934 Act") to file periodic reports pursuant to Section 13
thereunder, or Consultant shall in any way be denied by Company the
right or ability to perform his duties, the occurrence of any such
change in status of Company or Consultant shall be deemed to be a
termination of Consultant's services by Company under this Agreement
without cause and the obligations and rights of Company and Consultant
set forth in paragraph 11(b) shall apply as of the date of any such
change in status.
8. INDEMNITY; LIMITATION ON DAMAGES.
a. Valero hereby agrees to indemnify, defend, save and hold harmless
Mr. Benninger from and against any and all claims, damages, losses,
liabilities, costs or expenses which Mr. Benninger may incur or suffer
arising from or as a result of (i) any breach by Valero of any
representation, warranty or covenant made or given by Valero; and (ii)
the gross negligence, bad faith or wilful misconduct of Valero while
Mr. Benninger is engaged at Valero's premises or while performing
services for Valero pursuant to this Agreement.
b. Mr. Benninger hereby agrees to indemnify, defend, save and hold
harmless Valero from and against any and all claims, damages, losses,
liabilities, costs or expenses which it may incur or suffer arising
from or as a result of (i) any breach by Mr. Benninger of any
representation, warranty or covenant made or given by Mr. Benninger;
and (ii) the gross negligence, bad faith or wilful misconduct of Mr.
Benninger while engaged at Valero's premises or while performing
services for Valero pursuant to this Agreement.
c. Valero and Mr. Benninger agree that under no circumstances shall
either be liable to the other, or to any other party, for any special,
consequential or punitive damages arising out of or resulting from any
act or omission in connection with this Agreement, or with the
execution, delivery, performance or breach of this Agreement or any
part thereof, or with the failure or alleged failure to execute,
delivery or perform this Agreement or any part thereof.
9. AGREEMENT TO COOPERATE. Mr. Benninger agrees to cooperate with Valero
and its representatives as reasonably requested by Valero by responding to
questions, attending meetings, depositions, administrative proceedings and court
hearings, executing documents and cooperating with Valero and its legal counsel
with respect to claims and litigation of which Mr. Benninger has personal or
corporate knowledge. Mr. Benninger further agrees to maintain in strict
confidence any information or knowledge regarding current and/or future claims
against or litigation or administrative hearing involving Valero. Mr. Benninger
agrees that any communication with a party adverse to Valero, or with a
representative, agent or legal counsel for any such party, concerning any
pending or future claims or litigation or administrative hearing shall be solely
and exclusively through legal counsel for Valero. Valero agrees to pay all
reasonable expenses incurred by Mr. Benninger while providing assistance to
Valero or its counsel in accordance with the terms of this provision.
10. SURVIVAL. The parties respective obligations under Sections 8 and 9
shall survive any termination of this Agreement.
11. NOTICES. Any notice given under this Agreement shall be sufficient, if
in writing, and mailed by either registered or certified mail, return receipt
requested, postage prepaid to Valero at its principal place of business and to
Mr. Benninger at Mr. Benninger's last known residence address.
12. ASSIGNMENT. The rights and obligations of Valero under this Agreement
shall inure to the benefit of and shall be binding upon the successors and
assigns of Valero. Because of the personal nature of this Agreement, this
Agreement may not be assigned by Mr. Benninger but may be assigned by Valero to
an Affiliate of Valero upon notice to Mr. Benninger.
3
<PAGE> 4
13. WAIVERS. The waiver by any party hereto of a breach of any provision of
this Agreement shall not operate or be construed as a waiver of any subsequent
breach of any party.
14. INVALID PROVISIONS. The invalidity or unenforceability of a particular
provision of this Agreement shall not affect the other provisions hereof, and
this Agreement shall be construed in all respects as if such invalid or
unenforceable provisions were omitted.
15. ENTIRE AGREEMENT. This Agreement embodies the entire agreement between
the parties hereto relating to the subject matter hereof, and supersedes and
replaces in their entirety all prior understandings and agreements relating to
the subject matter hereof. This Agreement may be amended or supplemented only by
an instrument in writing executed jointly by Mr. Benninger and an authorized
officer of Valero.
16. APPLICABLE LAW. This Agreement shall be subject to and governed by the
laws of the State of Texas. Venue for any action hereon or hereunder shall lie
in Bexar County, Texas, and Mr. Benninger hereby consents thereto.
In Witness Whereof, this Agreement is executed as of the Effective
Date.
By: /s/ Edward C. Benninger
--------------------------------------
Edward C. Benninger
VALERO ENERGY CORPORATION
By: /s/ William E. Greehey
--------------------------------------
William E. Greehey
Chief Executive Officer
4
<PAGE> 1
EXHIBIT 10.17
December 15, 1998
Mr. Edward C. Benninger
21 Devon Wood
San Antonio, Texas 78257
Re: Letter Agreement Concerning
Retirement From Employment
--------------------------
Dear Ed:
This Letter Agreement is for the purpose of reducing to writing the
agreement between you (sometimes referred to herein as "you" or "your") and
VALERO ENERGY CORPORATION ("Valero") concerning your retirement from employment
with Valero. Accordingly, the parties have agreed as follows:
1. Your retirement from Valero will be effective as of December 31, 1998
(the "Effective Date") and, except as otherwise specifically provided in this
Letter Agreement, all rights and benefits shall be measured as of the Effective
Date. Further, except as otherwise specifically provided in this Letter
Agreement, all rights and benefits associated with your employment with Valero
will terminate as of the Effective Date.
2. As of the Effective Date, you shall resign and be deemed to have
resigned as President of Valero and from all positions as an Officer and all
positions as Director held with Valero's subsidiaries and affiliated entities.
Attached as Exhibit 1 is a series of letters that you will execute and deliver
to Valero and each of its subsidiaries of which you are an officer or director
as further evidence of such resignations. You agree to serve the remainder of
your current term as a member of the Board of Directors of Valero and not stand
for reelection to the Board after the end of the current term. As of January 1,
1999, you will be eligible to participate in the non-employee director
compensation plans of Valero.
3. You will be eligible to receive bonus compensation relating to your
employment during 1998 in such amount as the Board of Directors of Valero shall
determine, if any, at the customary time annual bonuses for 1998 performance are
determined and paid to other executive officers of Valero. Except as otherwise
expressly set forth herein, from and after the Effective Date, you will not be
eligible to participate in any other bonus plan or executive equity plan
available to employees of Valero.
4. (a) As of the Effective Date, any of your restricted stock grants
that have not fully vested shall immediately fully vest. Valero will issue you
share certificates representing the 10,800 shares of Valero Common Stock, $.01
par value, granted to you pursuant to the Restricted Stock Bonus Agreement
between you and Valero dated January 28, 1998 as soon as practicable following
January 1, 1999. Upon such issuance of the stock to you in accordance with your
deferment election, Valero's obligation to you under the Restricted Stock Bonus
Agreement will be fully satisfied and that Agreement will automatically
terminate.
(b) As of the Effective Date, any of your options to purchase
shares of Valero Common Stock, $.01 par value stock that have not fully vested
shall immediately fully vest, and all options will remain exercisable according
to their original terms and until the expiration date set forth in the
agreements between you and Valero governing those options. Exhibit 2 shows the
number of your options, the exercise price and their respective expiration dates
as of the Effective Date.
(c) Exhibit 2 sets forth the number of Performance Shares granted
to you, their grant dates and your deferment elections. Performance Share awards
for the cycle ending December 31, 1998 shall be earned at the performance level
(quartile ranking) pursuant to the established performance criteria set forth in
the award agreements, and all remaining Performance Share awards shall vest on
January 4, 1999 and be deemed earned at the target level (2nd quartile).
<PAGE> 2
5. As of the Effective Date, Valero will enter into a consulting
agreement with you for a one-year period ending December 31, 1999, substantially
in the form of the Consulting Agreement attached as Exhibit 3 ("Consulting
Agreement"). During this period, Valero will call upon you for advice and
counsel as appropriate. Pursuant to the terms of the Consulting Agreement,
Valero will (i) pay you a consulting fee of $175,000, payable in installments of
$14,583.33 per month, (ii) pay travel and other incidental expenses, (iii)
reimburse your monthly membership dues to the Dominion Country Club, and (iv)
furnish you tax planning services for 1999.
6. As of the Effective Date, Valero will:
(a) provide you off-site office facilities and secretarial and
other office services reasonably commensurate with your position as former
President of Valero, for a period of two years, at 7990 West IH 10, San Antonio,
Texas, or such other facility as mutually agreed to by the parties if suitable
space is not available at that location; and
(b) transfer to you the corporate Dominion Country Club membership
assigned to you during your employment and shall pay or reimburse you for any
membership transfer fees required for such transfer. The parties acknowledge
that, pursuant to the Consulting Agreement, Valero will reimburse your monthly
membership dues to the Dominion Country Club during the term of the Consulting
Agreement, and upon termination of the Consulting Agreement, you will be solely
responsible for all dues and expenses associated with your membership.
7. (a) As of the Effective Date and in accordance with and subject to
your rights and eligibility thereunder, you will be entitled to elect the option
of your choice as described in Valero's Thrift Plan, the Valero Excess Thrift
Plan, Valero's Executive Deferred Compensation Plan, Valero's Pension Plan and
Valero's Supplemental Executive Retirement Plan ("SERP") in order to receive
benefits that have accrued under each plan.
(b) As of the Effective Date, you will be entitled to receive
retiree medical consistent with coverage amounts and/or deductibles and costs as
provided to Valero retirees.
(c) A total of eight "points" under the SERP will be added to your
years of credited service, or your age, or divided between both in such
proportion that total eight, as you elect at the time of retirement. The amount
per month equal to the difference between your normal monthly retirement benefit
under the Pension Plan and the SERP with the eight added points shall constitute
a supplemental monthly retirement payment, payable at the time each payment is
made under the Pension Plan. The eight points will also be applied to any other
age or service related benefits.
(d) Attached as Exhibit 4 are calculations of benefits and balances
under each plan described in this paragraph 7 as of the Effective Date.
8. As of the Effective Date, all agreements between you and Valero or any
Affiliate in effect on the Effective Date (other than this Agreement, the
Consulting Agreement and the Indemnity Agreement dated August 1, 1997 between
you and Valero, a copy of which is attached as Exhibit 5), including the
Employment Agreement dated effective July 31, 1997 between you and Valero and
the Executive Severance Agreement dated December 15, 1982 between you and
Valero, are terminated, all potential rights thereunder are waived, and such
agreements are forever void and of no further force or effect, and any and all
such agreements are superseded in their entirety by this Agreement.
9. Any payments and considerations to be provided hereunder will be
subject to applicable federal, state and local taxes and related withholding
obligations.
10. In consideration of the agreements and commitments of Valero contained
herein, you hereby release and relinquish all rights, claims and entitlements,
except such rights as are specified herein, relating to your employment and
resignation from Valero.
11. You agree to cooperate with Valero and its representatives, as
reasonably requested by Valero and in such manner as will not unreasonably
impinge on your professional and personal commitments, by responding to
questions, attending meetings, depositions, administrative proceedings and court
hearings, executing documents and cooperating with Valero and its legal counsel
with respect to claims and litigation of which you have personal or corporate
knowledge. During the
<PAGE> 3
term of the Consulting Agreement, no additional fees or compensation will be
paid to you for cooperating with Valero and its legal counsel with respect to
such claims and litigation. For any such activities rendered at the request of
Valero and its legal counsel after the term of the Consulting Agreement, you
shall receive such reasonable compensation as shall be mutually agreed upon by
you and Valero.
12. The terms of this Letter Agreement shall be kept in strict confidence
by you and Valero and shall not be voluntarily disclosed nor communicated to any
person or entity not a party of this Letter Agreement without the prior written
consent of both parties; provided, however, you or Valero may disclose the
contents of this Letter Agreement (i) to counsel, accountants and financial
advisors to the extent necessary, provided that such parties shall be made aware
of and agree to maintain the confidential nature of this Letter Agreement, and
(ii) pursuant to any disclosure determined by counsel to be necessary under any
valid law, rule or regulation, or any action of any court or any regulatory
agency having jurisdiction.
13. You agree that under no circumstances shall either party be liable to
the other, or to any other party, for any special, consequential or punitive
damages arising out of or resulting from any act or omission in connection with
this Agreement, or with the execution, delivery, performance or breach of this
Agreement or any part thereof, or with the failure or alleged failure to
execute, deliver or perform this Agreement or any part thereof.
14. Any notice given under this Agreement shall be sufficient if given and
received in writing, and mailed by either registered or certified mail, return
receipt requested, to Valero at its principal place of business and to you at
your last known residence address.
15. (a) This Letter Agreement, together with the Consulting Agreement
and the Indemnity Agreement, contain the entire understanding between the
parties and shall supersede any and all prior contracts between the parties
except as contemplated herein.
(b) The parties agree that this Letter Agreement shall be
construed in accordance with the laws of the State of Texas and venue for any
action brought in connection herewith shall rest in Bexar County, Texas.
(c) This Letter Agreement shall be binding on you and your heirs,
executors, administrators and legal representatives and on Valero and its
successors and assigns.
(d) Should any term, provision or paragraph of this Letter
Agreement be found to be invalid, void or unenforceable, it shall not affect the
validity or enforcement of the remaining provisions which shall remain in full
force and effect as if this Letter Agreement had been executed without such
invalid, void or unenforceable provision having been included.
If you are in agreement with the foregoing terms and conditions please
indicate your approval and acceptance as provided below.
Very truly yours,
VALERO ENERGY CORPORATION
William E. Greehey
Chief Executive Officer
APPROVED, ACCEPTED
AND AGREED:
- ------------------------------
Edward C. Benninger
Date:
-------------------------
<PAGE> 4
<TABLE>
<CAPTION>
List of Exhibits:
- -----------------
<S> <C>
Exhibit 1 Resignation Letters
Exhibit 2 Stock Options, Restricted Stock and Performance Shares
Exhibit 3 Form of the Consulting Agreement
Exhibit 4 Calculations of benefits and balances under Thrift, Excess Thrift, Deferred
Compensation, Pension and Supplemental Executive Retirement Plans
Exhibit 5 Indemnity Agreement dated August 1, 1997
</TABLE>
<PAGE> 1
EXHIBIT 11.1
VALERO ENERGY CORPORATION AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
COMPUTATION OF BASIC EARNINGS PER SHARE:
Income (loss) from continuing operations.............................. $ (47,291) $ 111,768 $ 22,472
============ =========== ===========
Income (loss) from discontinued operations,
net of income taxes................................................ $ -- $ (15,672) $ 50,229
Less: Preferred stock dividend requirements
and redemption premium............................................. -- (4,592) (11,327)
------------ ----------- -----------
Income (loss) from discontinued operations
applicable to common stock......................................... $ -- $ (20,264) $ 38,902
============ =========== ===========
Weighted average number of shares of
common stock outstanding........................................... 56,077,671 51,662,449 43,926,026
============ =========== ===========
Earnings (loss) per share:
Continuing operations.............................................. $ (.84) $ 2.16 $ .51
Discontinued operations............................................ -- (.39) .89
------------ ----------- -----------
Total........................................................... $ (.84) $ 1.77 $ 1.40
============ =========== ===========
COMPUTATION OF EARNINGS PER SHARE
ASSUMING DILUTION:
Income (loss) from continuing operations assuming dilution............ $ (47,291) $ 111,768 $ 22,472
============ =========== ===========
Income (loss) from discontinued operations, net of
income taxes....................................................... $ -- $ (15,672) $ 50,229
Less: Preferred stock dividend requirements
and redemption premium............................................. -- (4,592) (11,327)
Add: Reduction of preferred stock dividends applicable
to the assumed conversion of Convertible Preferred Stock
at the beginning of the period..................................... -- 4,522 10,781
------------ ----------- -----------
Income (loss) from discontinued operations applicable to
common stock assuming full dilution ............................... $ -- $ (15,742) $ 49,683
============ =========== ===========
Weighted average number of shares of
common stock outstanding........................................... 56,077,671 51,662,449 43,926,026
Effect of dilutive securities:
Stock options...................................................... --(a) 880,864 424,986
Performance awards................................................. --(a) 91,151 44,050
Convertible preferred stock........................................ -- 2,494,905 6,381,798
------------ ----------- -----------
Weighted average number of shares of
common stock outstanding assuming dilution.......................... 56,077,671 55,129,369 50,776,860
============ =========== ===========
Earnings (loss) per share - assuming dilution:
Continuing operations.............................................. $ (.84) $ 2.03 $ .44
Discontinued operations............................................ -- (.29) .98
------------ ----------- -----------
Total........................................................... $ (.84) $ 1.74 $ 1.42
============ =========== ===========
</TABLE>
(a) Various stock options and performance awards granted to employees in
connection with the Company's stock compensation plans were outstanding
during 1998 but were not included in the computation of diluted earnings
per share from continuing operations for such period because the effect
would have been antidilutive.
<PAGE> 1
EXHIBIT 12.1
VALERO ENERGY CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Pretax income (loss) from continuing operations........... $ (83,091) $ 175,557 $ 39,083 $ 88,696 $ 28,803
Add (Deduct):
Net interest expense (1).............................. 32,479 42,455 38,534 40,935 38,710
Amortization of previously capitalized interest....... 4,900 4,865 4,801 5,497 5,419
Interest portion of rental expense (2)................ 15,926 13,193 8,913 8,059 3,004
Distributions in excess of (less than)
equity in earnings of joint ventures (1).......... 2,965 (1,851) (3,899) (4,304) (2,437)
----------- --------- --------- --------- ---------
Earnings as defined................................... $ (26,821) $ 234,219 $ 87,432 $ 138,883 $ 73,499
=========== ========= ========= ========= =========
Net interest expense (1).................................. $ 32,479 $ 42,455 $ 38,534 $ 40,935 $ 38,710
Capitalized interest...................................... 5,340 1,695 2,884 4,117 1,885
Interest portion of rental expense (2).................... 15,926 13,193 8,913 8,059 3,004
----------- --------- --------- --------- ---------
Fixed charges as defined.............................. $ 53,745 $ 57,343 $ 50,331 $ 53,111 $ 43,599
=========== ========= ========= ========= =========
Ratio of earnings to fixed charges (4).................... (3) 4.08x 1.74x 2.61x 1.69x
=========== ========= ========= ========= =========
</TABLE>
- ---------------------
(1) During 1994 through September 1997, the Company guaranteed its pro rata
share of the debt of Javelina Company, an equity method investee in which
the Company holds a 20% interest. The interest expense related to the
guaranteed debt is not included in the computation of the ratio as the
Company was not required to satisfy the guarantee.
(2) The interest portion of rental expense represents one-third of rents, which
is deemed representative of the interest portion of rental expense.
(3) For 1998, earnings were insufficient to cover fixed charges by $80.6
million. Such deficiency was due primarily to a $170.9 million pre-tax
charge to earnings to write down the carrying amount of the Company's
refinery inventories to market value. Excluding the effect of the inventory
write-down, the ratio of earnings to fixed charges would have been 2.68x.
(4) The Company paid no dividends on preferred stock with respect to its
continuing operations during the periods indicated; therefore, the ratio of
earnings to combined fixed charges and preferred stock dividends is the
same as the ratio of earnings to fixed charges.
<PAGE> 1
EXHIBIT 21.1
Valero Energy Corporation
Schedule of Subsidiaries
<TABLE>
<CAPTION>
NAME OF SUBSIDIARY STATE OF ORGANIZATION
- -------------------------------------------- ---------------------
<S> <C>
Valero Energy Corporation Delaware
Valero Corporate Services Company Delaware
Valero Coal Company Delaware
Valero Producing Company Delaware
VMGA Company Delaware
Valero Refining and Marketing Company Delaware
Valero Natural Gas Pipeline Company Delaware
Valero Marketing and Supply Company Delaware
Valero Refining Company-Louisiana Delaware
Valero Refining Company-New Jersey Delaware
Valero Refining Company-Texas Texas
Valero Javelina Company Delaware
Valero Mediterranean Company Delaware
Valero MTBE Investments Company Delaware
Valero MTBE Operating Company Delaware
Valero Technical Services Company Delaware
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K into the Company's previously filed
Registration Statements on Form S-8 (file Nos. 333-31709, 333-31721, 333-31723
and 333-31727) and Form S-3 (File No. 333-56599).
ARTHUR ANDERSEN LLP
San Antonio, Texas
February 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 11,199
<SECURITIES> 0
<RECEIVABLES> 284,606
<ALLOWANCES> 1,150
<INVENTORY> 316,405
<CURRENT-ASSETS> 639,710
<PP&E> 2,572,190
<DEPRECIATION> 612,847
<TOTAL-ASSETS> 2,725,664
<CURRENT-LIABILITIES> 497,744
<BONDS> 822,335
0
0
<COMMON> 563
<OTHER-SE> 1,084,724
<TOTAL-LIABILITY-AND-EQUITY> 2,725,664
<SALES> 5,539,346
<TOTAL-REVENUES> 5,539,346
<CGS> 5,590,544
<TOTAL-COSTS> 5,590,544
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 32,479
<INCOME-PRETAX> (83,091)
<INCOME-TAX> (35,800)
<INCOME-CONTINUING> (47,291)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (47,291)
<EPS-PRIMARY> (.84)
<EPS-DILUTED> (.84)
</TABLE>
