<PAGE> 1
Filed Pursuant to Rule 424(b)(5)
Registration No. 333-33846
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS SUPPLEMENT IS NOT COMPLETE
AND MAY BE CHANGED. THIS PROSPECTUS SUPPLEMENT AND ACCOMPANYING PROSPECTUS
ARE NOT AN OFFER TO SELL THESE SECURITIES AND THEY ARE NOT SOLICITING ON
OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE
IS NOT PERMITTED.
Subject to Completion, dated June 7, 2000
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED MAY 30, 2000)
[VALERO ENERGY VALERO
CORP. LOGO] ENERGY CORPORATION
$
% Notes due
ISSUE PRICE: %
$
% Notes due
ISSUE PRICE: %
Interest payable and
The % notes will mature on , , and the %
notes will mature on , . Valero may redeem the notes in whole
or in part at any time at the redemption prices described on page S-63. The
Notes will be issued in minimum denominations of $1,000 increased in multiples
of $1,000.
INVESTING IN THE NOTES INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE
S-11 OF THIS PROSPECTUS SUPPLEMENT.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus supplement or the accompanying
prospectus. Any representation to the contrary is a criminal offense.
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS VALERO
<S> <C> <C> <C>
----------------------------------------------------------------------------------------------------
Per % Note due % % %
----------------------------------------------------------------------------------------------------
Total $ $ $
----------------------------------------------------------------------------------------------------
Per % Note due % % %
----------------------------------------------------------------------------------------------------
Total $ $ $
----------------------------------------------------------------------------------------------------
</TABLE>
The notes will not be listed on any national securities exchange. Currently,
there is no public market for the notes.
It is expected that delivery of the notes will be made to investors on or about
June , 2000.
J.P. MORGAN & CO.
CREDIT SUISSE FIRST BOSTON
MORGAN STANLEY DEAN WITTER
BMO NESBITT BURNS CORP.
, 2000
<PAGE> 2
No person is authorized to give any information or to make any representations
other than those contained or incorporated by reference in this prospectus
supplement or the accompanying prospectus, and, if given or made, such
information or representations must not be relied upon as having been
authorized. This prospectus supplement and the accompanying prospectus do not
constitute an offer to sell or the solicitation of an offer to buy securities
other than the securities described in this prospectus supplement or an offer to
sell or the solicitation of an offer to buy any securities in any circumstances
in which such offer or solicitation is unlawful. Neither the delivery of this
prospectus supplement or the accompanying prospectus, nor any sale made under
this prospectus supplement or the accompanying prospectus shall, under any
circumstances, create any implication that there has been no change in the
affairs of Valero since the date hereof or that the information contained or
incorporated by reference herein or therein is correct as of any time subsequent
to the date of such information.
As used in this prospectus supplement, the terms "Valero," "we" and "us" may,
depending upon the context, refer to Valero Energy Corporation, to one or more
of its consolidated subsidiaries or to all of them taken as a whole.
TABLE OF CONTENTS
<TABLE>
<S> <C>
PROSPECTUS SUPPLEMENT
Summary..................................................... S-3
Risk Factors................................................ S-11
Forward-Looking Information................................. S-17
The Benicia Acquisition and Related Financings.............. S-19
Use of Proceeds............................................. S-22
Capitalization.............................................. S-23
Unaudited Pro Forma Combined Financial Information.......... S-24
Selected Financial Data..................................... S-30
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. S-31
Business.................................................... S-49
Management.................................................. S-61
Description of the Notes.................................... S-63
Underwriting................................................ S-67
Legal Matters............................................... S-68
Experts..................................................... S-68
Information We Incorporate by Reference..................... S-68
Index to Financial Statements............................... F-1
PROSPECTUS
About This Prospectus....................................... 3
About Valero Energy Corporation............................. 3
Forward-Looking Information................................. 4
Use of Proceeds............................................. 5
Ratio of Earnings to Fixed Charges.......................... 6
Description of Debt Securities.............................. 6
Description of Capital Stock................................ 14
Description of Warrants..................................... 17
Plan of Distribution........................................ 18
Legal Matters............................................... 19
Experts..................................................... 20
Where You Can Find More Information......................... 20
Information We Incorporate by Reference..................... 20
</TABLE>
S-2
<PAGE> 3
SUMMARY
This summary contains basic information about us and our offering of the notes.
It does not contain all the information that is important to you. You should
read the following summary together with the more detailed information and
financial statements and notes to the financial statements contained elsewhere
or incorporated by reference in this prospectus supplement or the accompanying
prospectus, as described under the heading "Information We Incorporate by
Reference." To fully understand this offering, you should read all of these
documents.
Unless otherwise noted, the information included in this prospectus supplement
does not give effect to the Benicia acquisition.
VALERO ENERGY CORPORATION
Valero Energy Corporation is one of the largest and most geographically diverse
independent petroleum refining and marketing companies in the United States. As
of March 31, 2000, we owned five refineries in Texas, Louisiana and New Jersey,
providing us with core operations on both the Gulf Coast and the East Coast.
These refineries are located in Corpus Christi, Houston, and Texas City in
Texas, Krotz Springs, Louisiana and Paulsboro, New Jersey. In addition, on March
2, 2000, we entered into an agreement to purchase Exxon Mobil Corporation's
Benicia, California refinery and Exxon-branded California retail assets, which
consist of approximately 80 service station facilities and branded supplier
relationships with approximately 260 Exxon-branded service stations, thereby
establishing a significant presence on the West Coast and extending our
geographic reach from coast to coast. We refer to this acquisition as the
Benicia acquisition. The acquisition of the Benicia refinery and the branded
supplier relationships closed on May 15, 2000, and the acquisition of the
service station facilities is expected to close on or about June 15, 2000. On a
pro forma basis, after giving effect to the Benicia acquisition and our
financing plan, including this offering, discussed below in "The Benicia
Acquisition and Related Financings," we had revenue of $3.4 billion and $9.3
billion and net income of $45.9 million and $68.2 million for the three-month
period ended March 31, 2000 and the year ended December 31, 1999, respectively.
Valero produces premium, environmentally clean products such as reformulated
gasoline, low-sulfur diesel and oxygenates and is able to produce gasoline
meeting the specifications of the California Air Resources Board, or CARB
gasoline. We also produce a substantial slate of middle distillates, jet fuel
and petrochemicals. With the Benicia acquisition, our products are marketed in
35 states as well as to selected export markets.
We were incorporated in Delaware in 1981 as Valero Refining and Marketing
Company, a wholly owned subsidiary of our predecessor company. On July 31, 1997,
our stock was distributed, or spun off, by our predecessor company to its
shareholders, and we changed our name to Valero Energy Corporation. At the time
of the spin-off, Valero had approximately 530,000 barrels per day of refining
throughput capacity.
Since that time, we have continued to grow and enhance our competitive position
to become a premier, independent refining and marketing company. We are focused
on using innovative means of upgrading our facilities in order to efficiently
refine lower-cost feedstocks into higher value-added premium products. Including
the capacity of the Benicia refinery, we have increased our refining capacity by
approximately 79% since the spin-off.
Our strategic objectives include the following:
- Accretive Growth through Acquisitions. We regularly search for acquisition
opportunities that we believe will be accretive to earnings and cash flow and
provide acceptable rates of return. To be consistent with our operating
philosophy, we typically look at opportunities that offer refining capacity
in excess of 100,000 barrels per day with expansion or upgrading potential
and that are located near a coastal area or a major pipeline connection in
order to provide greater flexibility in accessing suppliers and customers.
S-3
<PAGE> 4
- Upgrading Refineries in a Cost-Effective Manner. We continually evaluate
ways to maximize the value of our refineries through cost-effective upgrades
and expansions. We believe refineries that are more flexible with regard to
feedstocks or that are able to produce higher value-added premium products
such as reformulated gasoline and low-sulfur diesel are better positioned to
exploit increases in refining margins and mitigate the effects of decreases
in refining margins than refineries that produce more conventional forms of
gasoline and distillates.
- Pursuit of Additional Cost Savings Initiatives. We continually attempt to
identify and implement cost savings initiatives at our refineries, including
improved maintenance practices, as well as reliability and operational
improvements.
- Increased Earnings Diversification. We continue to evaluate opportunities to
diversify earnings, including retail petroleum marketing, petrochemical
ventures, and other ancillary businesses.
- Dedication to Safety and Environmental Concerns. We continue to focus on and
devote significant time and resources to safety training and accountability
programs throughout our operations. We seek to be environmentally proactive
and will continue to actively monitor developments with the Environmental
Protection Agency's proposed air emissions reduction rules and other
regulatory changes.
THE BENICIA ACQUISITION AND RELATED FINANCINGS
On March 2, 2000, we executed a sale and purchase agreement for the purchase of
ExxonMobil's Benicia refinery and the related branded supplier relationships and
service station facilities for a purchase price of $895 million plus the value
of refinery inventories acquired in the transaction. The acquisition of the
Benicia refinery and the branded supplier relationships closed on May 15, 2000,
at which time the value of inventories was estimated to be approximately $123
million, and the acquisition of the service station facilities is expected to
close on or about June 15, 2000.
The Benicia refinery is located on the Carquinez Straits of the San Francisco
Bay. It is a highly complex refinery and has a throughput capacity of
approximately 160,000 barrels per day. The Benicia refinery produces a high
percentage of light products, with limited production of natural gas liquids and
other products. Approximately 95% of the gasoline produced by the Benicia
refinery meets the California Air Resources Board specifications for gasoline
sold in California. The Benicia refinery includes significant feedstock and
product storage facilities, deepwater docking facilities, a 20-inch pipeline and
truck rack facilities. Concurrently with the closing of the acquisition of the
Benicia refinery, we entered into a contract providing for ExxonMobil to supply
and for us to purchase up to 100,000 barrels per day of Alaska North Slope crude
oil from ExxonMobil at market-related prices.
The service station facilities include 10 company-operated sites and 70
lessee-dealer sites, 75 of which are in the San Francisco Bay area. Under
consent decrees related to the merger between Exxon Corporation and Mobil
Corporation, the Federal Trade Commission and the State of California ordered
that ExxonMobil withdraw the "Exxon" brand name from this area. As a result,
ExxonMobil has notified its dealers in this market area that their franchise
right to market "Exxon" branded products is being terminated effective June 15,
2000. We plan to introduce our own brand of retail petroleum products in the San
Francisco Bay area and have offered to the dealers at these locations a
franchise right to market products under the new Valero brand. The branded
supplier relationships are with up to 260 independently-owned and operated
distributor service stations that are located outside of the San Francisco Bay
area. These independently-owned and operated distributor gas station sites will
retain the right to use the Exxon brand, continue to accept the Exxon
proprietary credit card and receive Exxon brand support, while we will receive
the exclusive rights to offer the Exxon brand throughout the state of California
(except for the San Francisco Bay area) for a ten-year period. Many of the
independently-owned and operated distributor gas station sites and the service
station facilities also contain convenience stores.
The acquisition of the Benicia refinery and the branded supplier relationships
was initially funded through interim financing consisting of (i) borrowings of
$600 million under a bank bridge facility, (ii) borrowings
S-4
<PAGE> 5
of $298.5 million under our existing bank credit facilities and (iii) an
approximate $30 million interim lease arrangement to accommodate the acquisition
of the Benicia refinery's docking facility. In connection with the acquisition
of the service station facilities, we will (i) enter into a structured lease
arrangement with a commitment of up to $135 million, substantially all of which
will be used to acquire the service station facilities and replace the interim
lease arrangement for the acquisition of the Benicia refinery's docking
facility, and (ii) borrow an additional $8.5 million under our existing credit
facilities which will be used to pay certain transaction costs. It is expected
that the $600 million of borrowings under the bridge facility and $186.3 million
of borrowings under our existing bank credit facilities will be repaid with the
proceeds of this offering and two other concurrent offerings consisting of (i)
approximately $150 million of common stock and (ii) approximately $150 million
aggregate stated amount of premium equity participating security
units -- PEPS(SM) Units -- consisting of stock purchase contracts and trust
preferred securities. We also expect to continue to borrow under our existing
credit facilities amounts sufficient to fund the working capital needs of the
Benicia assets.
S-5
<PAGE> 6
THE OFFERING
Securities Offered......... $ million principal amount of % Notes due
$ million principal amount of % Notes due
Maturity Date.............. , for the Notes due
, for the Notes due
Interest Payment Dates..... and of each year, commencing
, 2000
Redemption................. At our option, we may redeem any or all of the
notes, in whole or in part, at any time, as
described on page S-63 under the heading
"Description of the Notes -- Optional Redemption"
in this prospectus supplement.
Ranking.................... The notes:
- are unsecured
- rank equally with all the existing and future
unsecured and unsubordinated debt of Valero
- are senior to any future subordinated debt
- are effectively junior to the secured debt and
to all existing and future debt and other
liabilities of our subsidiaries
Covenants.................. We will issue the notes under an indenture
containing covenants for your benefit. These
covenants restrict our ability, with certain
exceptions, to:
- incur debt secured by liens
- engage in sale/leaseback transactions
Use of Proceeds............ We estimate that we will receive net proceeds from
this offering of $ million, which we intend to
use, together with the net proceeds from the
concurrent offerings of common stock and PEPS
Units, to repay outstanding indebtedness incurred
under our bank bridge facility and our existing
credit facilities in connection with the Benicia
acquisition.
Concurrent offerings....... We are concurrently offering to the public
approximately $150 million of common stock and up
to $150 million aggregate stated amount of PEPS
Units. The common stock offering and the offering
of PEPS Units are not contingent on any other
offering. However, the closing of this offering is
contingent on the prior closing of both the common
stock offering and the offering of PEPS Units.
S-6
<PAGE> 7
SUMMARY CONSOLIDATED HISTORICAL AND
PRO FORMA FINANCIAL INFORMATION
The following tables set forth summary consolidated historical financial data
for each of the periods indicated and certain adjusted pro forma information.
Our historical financial information should be read in conjunction with our
consolidated financial statements and related notes. The pro forma as adjusted
statement of income data for the three months ended March 31, 2000 and the year
ended December 31, 1999 give effect to the Benicia acquisition and the related
interim financings as if such events occurred on January 1, 1999 and are further
adjusted to give effect to this offering, the PEPS Units offering and the common
stock offering. The pro forma balance sheet data gives effect to the Benicia
acquisition and the related interim financings as if such events occurred on
March 31, 2000 and is further adjusted to give effect to this offering, the PEPS
Units offering and the common stock offering. The unaudited pro forma
information set forth below is not necessarily indicative of the results that
actually would have been achieved had the Benicia acquisition been consummated
on the relevant dates noted above, or that may be achieved in the future. The
pro forma information should be read in conjunction with the pro forma financial
statements and the related notes included herein.
<TABLE>
<CAPTION>
PRO FORMA COMBINED
AS ADJUSTED
FOR THE OFFERINGS HISTORICAL
--------------------------- --------------------------------------------------------------
THREE MONTHS THREE MONTHS
ENDED YEAR ENDED ENDED MARCH 31, YEAR ENDED DECEMBER 31,
MARCH 31, DECEMBER 31, ----------------------- ------------------------------------
2000 1999 2000 1999 1999 1998(1)(2) 1997(3)
------------ ------------ ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Operating revenues.......... $3,423,416 $9,312,743 $2,928,617 $1,337,103 $7,961,168 $5,539,346 $5,756,220
Operating income (loss)..... 98,302 222,054 57,052 8,520 69,141 (51,198) 211,034
Income (loss) from
continuing operations..... 45,929 68,216 30,739 (2,716) 14,287 (47,291) 111,768
Income (loss) from
discontinued operations,
net of income taxes(4).... -- -- -- -- -- -- (15,672)
Net income (loss)........... 45,929 68,216 30,739 (2,716) 14,287 (47,291) 96,096
Less: preferred stock
dividend
requirements and
redemption
premium............. -- -- -- -- -- -- 4,592
Net income (loss) applicable
to common stock........... 45,929 68,216 30,739 (2,716) 14,287 (47,291) 91,504
Earnings (loss) per share of
common stock-- assuming
dilution:
Continuing operations..... $ .74 $ 1.10 $ .54 $ (.05) $ .25 $ (.84) $ 2.03
Discontinued operations... -- -- -- -- -- -- (.29)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total............... $ .74 $ 1.10 $ .54 $ (.05) $ .25 $ (.84) $ 1.74
========== ========== ========== ========== ========== ========== ==========
Dividends per share of
common stock.............. $ .08 $ .32 $ .08 $ .08 $ .32 $ .32 $ .42
CASH FLOW DATA:
Cash flow from continuing
operating activities...... $ 67,562 $ 563,402 $ 11,177 $ 148,419 $ 435,111 $ 165,825 $ 196,645
Cash flow used in continuing
investing activities...... (48,167) (242,326) (41,966) (69,074) (172,168) (566,268) (434,046)
Cash flow provided by (used
in) financing
activities................ (70,878) (272,430) (20,789) (77,201) (214,055) 401,707 275,548
OTHER FINANCIAL DATA:
EBITDA(5)................... $ 146,639 $ 408,421 $ 95,950 $ 45,111 $ 219,657 $ 244,523 $ 313,025
</TABLE>
(footnotes on next page)
S-7
<PAGE> 8
<TABLE>
<CAPTION>
MARCH 31, 2000
----------------------------------------------
PRO FORMA
PRO FORMA COMBINED
COMBINED AS ADJUSTED
FOR THE BENICIA FOR THE
HISTORICAL ACQUISITION(6) OFFERINGS(7)
---------- ---------------- --------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (excluding short-term debt and
current maturities on long-term debt)........... $ 131,557 $ 285,443 $ 285,443
Property, plant and equipment, net................ 1,985,184 2,700,804 2,700,804
Total assets...................................... 3,121,174 4,034,488 4,037,022
Total debt........................................ 771,655 1,678,669 1,392,359
Valero-obligated mandatorily redeemable preferred
capital trust securities of a subsidiary trust
holding solely Valero senior notes.............. -- -- 150,000
Total equity...................................... 1,108,704 1,108,704 1,247,548
</TABLE>
------------
(1) Includes the operations of the Paulsboro, New Jersey refinery beginning
September 17, 1998.
(2) The 1998 operating loss includes a $170.9 million write-down of inventories
to market value, which resulted in a $111.1 million reduction in net income,
or $1.98 per share.
(3) Includes the operations of the Texas City and Houston, Texas refineries and
the Krotz Springs, Louisiana refinery beginning May 1, 1997.
(4) Reflects the results of our former parent's natural gas related services
business for periods prior to the July 31, 1997 spin-off of our stock.
(5) Earnings before interest, taxes, depreciation and amortization ("EBITDA") is
presented as a measure of our ability to service our debt and to make
capital expenditures. It is not a measure of operating results and is not
presented in our consolidated financial statements.
(6) Gives effect to the Benicia acquisition, including (i) borrowings of $600
million under our bank bridge facility and (ii) borrowings of $307 million
under our existing credit facilities. Funding for the Benicia acquisition
also includes an assumed amount of approximately $130 million of structured
lease financing.
(7) The pro forma as adjusted balance sheet column gives effect to (i) the
offering of approximately $500 million aggregate principal amount of senior
notes pursuant to this offering, (ii) a concurrent offering of 5 million
shares of common stock at an assumed offering price of $30 per share and
(iii) a concurrent offering of approximately $150 million aggregate stated
amount of PEPS Units, as well as the application of the net proceeds from
such offerings to repay all amounts outstanding under our bank bridge
facility and reduce borrowings under our existing credit facilities. On May
31, 2000, the reported last sale price of the common stock on the NYSE was
$29 1/4 per share.
S-8
<PAGE> 9
SUMMARY REFINING OPERATING DATA
The following table sets forth certain operating results for the three months
ended March 31, 2000 and the year ended December 31, 1999 for Valero and the
Benicia refinery on a separate and combined basis. However, no changes in the
operations of the Benicia assets have been assumed and, therefore, the combined
data is not necessarily indicative of future performance. Volumes are stated in
thousand barrels per day or MBPD. 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. Refinery charges and
yields by component are expressed as percentages of total charges and yields,
respectively.
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
MARCH 31, 2000 DECEMBER 31, 1999
--------------------------- ----------------------------
VALERO BENICIA COMBINED VALERO BENICIA COMBINED
------ ------- -------- ------ ------- ---------
<S> <C> <C> <C> <C> <C> <C>
Sales volumes (MBPD).................... 1,002 155 1,157 1,033 144 1,177
Throughput volumes (MBPD)............... 744 158 902 712 137 849
Average throughput margin per barrel.... $ 3.62 $6.80 $ 4.17 $ 2.93 $7.77 $ 3.71
Operating costs per barrel(1):
Cash (fixed and variable)............. $ 1.95 $2.92 $ 2.10 $ 1.85 $4.37 $ 2.09
Depreciation and amortization......... .51 .41 .51 .53 .46 .54
------ ----- ------ ------ ----- ------
Total operating costs per
barrel...................... $ 2.46 $3.33 $ 2.61 $ 2.38 $4.83 $ 2.63
====== ===== ====== ====== ===== ======
Charges:
Crude oils:
Sour............................... 52% 81% 57% 48% 83% 54%
Heavy sweet........................ 9 -- 8 12 -- 10
Light sweet........................ 9 -- 7 9 -- 8
------ ----- ------ ------ ----- ------
Total crude oils.............. 70 81 72 69 83 72
High-sulfur resid..................... 4 5 5 3 4 3
Low-sulfur resid...................... 4 -- 3 6 -- 5
Other feedstocks and blendstocks...... 22 14 20 22 13 20
------ ----- ------ ------ ----- ------
Total charges................. 100% 100% 100% 100% 100% 100%
====== ===== ====== ====== ===== ======
Yields:
Gasolines and blendstocks............. 50% 72% 54% 51% 68% 54%
Distillates........................... 30 11 27 29 15 27
Petrochemicals........................ 5 -- 4 5 -- 4
Lubes and asphalts.................... 3 -- 2 3 -- 2
Other products........................ 12 17 13 12 17 13
------ ----- ------ ------ ----- ------
Total yields.................. 100% 100% 100% 100% 100% 100%
====== ===== ====== ====== ===== ======
</TABLE>
---------------
(1) The combined information reflects the adjustments made in the pro forma
statements of income.
S-9
<PAGE> 10
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth the ratio of earnings to fixed charges for the
periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
------------- -------------------------------------
2000 1999 1999 1998 1997 1996 1995
----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Ratio of earnings to fixed charges.... 3.42x -- 1.23x -- 4.08x 1.74x 2.61x
</TABLE>
We have computed the ratios of earnings to fixed charges by dividing earnings by
fixed charges. For this purpose, earnings consist of consolidated income from
continuing operations before income taxes and fixed charges (excluding
capitalized interest), with certain other adjustments. Fixed charges consist of
total interest, whether expensed or capitalized, including amortization of debt
expense and premiums or discounts related to outstanding indebtedness, and
one-third (the proportion deemed representative of the interest factor) of
rental expense. For the three months ended March 31, 1999, our earnings were
insufficient to cover fixed charges by $4.4 million. This deficiency was due
primarily to (i) depressed refined product margins resulting from weak refining
industry fundamentals and (ii) the effect of significant downtime at our Corpus
Christi refinery in early 1999 due to a major maintenance turnaround and
expansion of the heavy oil cracker and related units. For the year ended
December 31, 1998, our earnings were insufficient to cover fixed charges by
$80.6 million. This deficiency was due primarily to a $170.9 million pre-tax
charge to earnings to write down the carrying amount of our 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.
Prior to our spin-off from our predecessor company on July 31, 1997, our
predecessor company had preferred stock outstanding which was issued in
connection with the discontinued natural gas related services business. We had
no preferred stock outstanding with respect to continuing operations for any
period presented. As a result, the ratio of earnings to combined fixed charges
and preferred stock dividends is the same as the ratio of earnings to fixed
charges.
S-10
<PAGE> 11
RISK FACTORS
In considering whether to purchase our notes, you should carefully consider all
the information we have included or incorporated by reference in this prospectus
supplement and the accompanying prospectus. In particular, you should carefully
consider the risk factors described below. In addition, please read
"Forward-Looking Information" on page S-17 of this prospectus supplement and on
page 4 of the accompanying prospectus, where we describe additional
uncertainties associated with our business and the forward-looking statements in
this prospectus supplement and the accompanying prospectus.
REFINING MARGINS ARE VOLATILE.
Our financial results are primarily affected by the relationship, or margin,
between refined product prices and the prices for crude oil and other
feedstocks. The cost to acquire our feedstocks and the price at which we can
ultimately sell refined products depend upon numerous factors beyond our
control. Historically, refining margins have been volatile, and they are likely
to continue to be volatile in the future. In 1998, significant declines in
feedstock and refined product prices resulted in a non-cash inventory write-
down of $171 million which decreased earnings by $111 million. Until recently,
there was a substantial excess supply of refined products which led to low
product prices and weak refining margins. Recently there has been an improvement
in refining fundamentals and refining margins; however, we cannot assure you
that these improvements will continue or be sustainable.
Specific factors which may affect our refining margins include:
- the domestic and foreign supplies of refined products such as gasoline,
diesel, heating oil and petrochemicals;
- the domestic and foreign supplies of crude oil and other feedstocks;
- the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil price and production controls;
- the level of consumer demand, including seasonal fluctuations;
- refinery overcapacity or undercapacity;
- the actions taken by competitors, including both pricing and the expansion
and retirement of refining capacity in response to market conditions;
- environmental and other regulations at both the state and federal levels and
in foreign countries;
- political conditions in oil producing regions, including the Middle East;
- the level of foreign imports;
- accidents or other unscheduled shutdowns affecting our plants, machinery,
pipelines or equipment, or those of our suppliers or customers;
- changes in the cost or availability of transportation for feedstocks and
refined products;
- write-downs of inventories caused by a material decline in petroleum prices;
- the price, availability and acceptance of alternative fuels;
- cancellation of or failure to implement planned capital projects and realize
the various assumptions and benefits projected for such projects;
- irregular weather, which can unforeseeably affect the price or availability
of feedstocks and refined products;
- rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any
reserves and claims of product liability;
S-11
<PAGE> 12
- the introduction or enactment of federal or state legislation which may
adversely affect our business or operations; and
- overall economic conditions.
The interplay of these factors has historically resulted in a high level of
volatility in the energy markets, which makes it impossible to predict with any
certainty future refining margins.
OUR INTEGRATION OF THE OPERATIONS OF THE BENICIA REFINERY MAY NOT BE SUCCESSFUL.
As discussed more fully in "The Benicia Acquisition and Related Financings," we
acquired Exxon Mobil Corporation's Benicia refinery and branded supplier
relationships on May 15, 2000 and expect to acquire its service station
facilities on June 15, 2000. While our refining and marketing business has been
profitable, there is no assurance that, following the Benicia acquisition:
- the combined entities will be profitable,
- the combined entities will be able to achieve the level of performance we
anticipate, and
- the projected demand for and prices of refinery feedstocks and refined
products will be realized.
The success of the Benicia acquisition will depend on the ability of our
management to integrate the operations of the Benicia refinery with our existing
operations and to integrate various departments, systems and procedures. The
inability to integrate the operations of the Benicia refinery in a timely and
efficient manner could adversely affect our ability to realize our projected
financial results. Additionally, although we have conducted a due diligence
investigation of the Benicia refinery, the scope of that investigation,
particularly in light of the volume of environmental, litigation and other
matters, has necessarily been limited. Pursuant to the purchase agreement, we
are indemnified by ExxonMobil for any litigation pending at the time of the
Benicia acquisition and, subject to certain terms, conditions and limitations,
with respect to other matters. However, we cannot assure you that other material
matters will not subsequently be identified or that the matters now identified
will not later prove to be more significant or expose us to greater liabilities
than currently expected.
OUR LEVERAGE MAY LIMIT OUR FINANCIAL FLEXIBILITY.
As of March 31, 2000, we had approximately $771.7 million in total indebtedness.
We incurred substantial additional indebtedness in connection with the Benicia
acquisition. After giving effect to the Benicia acquisition and the related
financings, including this offering and the concurrent offerings of PEPS Units
and common stock, as of March 31, 2000, we would have had total debt of $1.4
billion, trust preferred securities issued as part of the PEPS Units in an
aggregate liquidation amount of $150 million, and stockholders' equity of $1.2
billion, resulting in a total debt to total capital ratio of 51.0% (80% of the
aggregate liquidation amount of trust preferred securities included in the PEPS
Units is deemed to be equity for purposes of this computation). In addition,
depending on prevailing financial, economic and market conditions, we may be
unable to consummate the concurrent offerings as described herein. If we are not
able to complete the offerings as contemplated, our credit rating may be
downgraded which may result in even higher borrowing costs. The interest rate
and fees under our $835 million revolving bank credit and letter of credit
facility are subject to adjustment based upon the credit ratings assigned to our
long-term debt. Accordingly, the amount of outstanding indebtedness and interest
expense may be greater than contemplated and stockholders' equity may be lower
than contemplated. We may also incur additional indebtedness in the future,
including in connection with other acquisitions, although our ability to do so
will be restricted by our existing $835 million bank credit facility. The level
of our indebtedness will have several important effects on our future
operations, including, among others:
- a significant portion of our cash flow from operations will be dedicated to
the payment of principal and interest on our indebtedness and will not be
available for other purposes;
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- covenants contained in our existing debt arrangements require us to meet
certain financial tests, which may affect our flexibility in planning for,
and reacting to, changes in our business, including possible acquisition
opportunities;
- our ability to obtain additional financing for working capital, capital
expenditures, acquisitions, general corporate and other purposes may be
limited;
- we may be at a competitive disadvantage to our competitors that are less
leveraged; and
- our vulnerability to adverse economic and industry conditions may increase.
Our ability to meet our debt service obligations and to reduce our total
indebtedness will be dependent upon our future performance, which will be
subject to general economic conditions, industry cycles and financial, business
and other factors affecting our operations, many of which are beyond our
control. We cannot assure you that our business will continue to generate
sufficient cash flow from operations to service our indebtedness. If we are
unable to generate sufficient cash flow from operations, we may be required to
sell assets, to refinance all or a portion of our indebtedness or to obtain
additional financings. We cannot assure you that any such refinancing will be
possible or that additional financing will be available on commercially
acceptable terms or at all.
Our $835 million bank credit facility imposes financial and other restrictions
on Valero. Covenants contained in the credit facility and relating to certain
other indebtedness of Valero limit, among other things, the incurrence of funded
indebtedness by Valero and its subsidiaries and require maintenance of a minimum
net worth and fixed-charge coverage ratio and a maximum debt-to-capitalization
ratio. There can be no assurance that the requirements of our credit facility or
such other indebtedness will be met in the future. Failure to comply with such
covenants may result in a default with respect to the related debt under the
credit facility or such other indebtedness and could lead to acceleration of
such debt or any instruments evidencing indebtedness that contain
cross-acceleration or cross-default provisions. In such a case, there can be no
assurance that Valero would be able to refinance or otherwise repay such
indebtedness.
COMPLIANCE WITH AND CHANGES IN ENVIRONMENTAL LAWS COULD ADVERSELY AFFECT OUR
PERFORMANCE.
We are subject to extensive federal, state and local environmental laws and
regulations, including those relating to the discharge of materials into the
environment, waste management, pollution prevention measures and characteristics
and composition of gasoline and diesel fuels. If we violate or fail to comply
with these laws and regulations, we could be fined or otherwise sanctioned.
Although our environmental policies and practices are designed to ensure
compliance with these laws and regulations, future developments and increasingly
stringent and complex regulations could require us to make additional unforeseen
expenditures relating to environmental matters. In 1999, we spent approximately
$7 million for capital expenditures to comply with environmental regulations,
and we currently estimate spending an additional $7 million and $22 million in
2000 and 2001, respectively. These estimates do not include any expenditures for
the installation of a flue gas scrubber at the Texas City refinery in connection
with our voluntary participation in the Governor's City Air Responsibility
Enterprise Program (estimated to be approximately $35 million over a two-year
period beginning in 2000 and which is being funded via a structured lease
financing arrangement), any expenditures for the installation of a flue gas
scrubber at the Paulsboro refinery in connection with a consent order issued by
the New Jersey Department of Environmental Protection (expected to be incurred
primarily in 2003) or estimated capital expenditures for the Benicia refinery
and the service station facilities. We currently estimate these Benicia-related
capital expenditures to be approximately $7 million in each of 2000 and 2001
based on the amount of due diligence that we have been able to conduct to date.
However, because environmental laws and regulations are increasingly becoming
more stringent and new environmental laws and regulations are continuously being
enacted or proposed, such as those relating to methyl tertiary butyl ether
(MTBE), CARB gasoline and the Tier II gasoline standard and the Maximum
Available Control Technology rule (MACT II rule) under the Clean Air Act, we
cannot predict with certainty the level of future expenditures that will be
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required for environmental matters. In addition, because some of our air
emissions are grandfathered under certain environmental laws, including those of
the Benicia refinery, any major upgrades in any of our refineries could require
material additional expenditures to comply with environmental laws and
regulations. These expenditures could have a material adverse effect on our
financial position, results of operations and liquidity.
In connection with the Benicia acquisition and our acquisitions of the Paulsboro
refinery and Basis Petroleum, Inc., we have been indemnified on a limited basis
for certain environmental matters, including those relating to remediation and
superfund liabilities. There can be no assurance that the indemnifying parties
will indemnify us or continue to indemnify us. In the event that the
indemnifying parties fail to do so, we could be liable for the costs of these
environmental matters, which could be material. See "Business--Environmental
Matters."
On May 17, 2000, the Environmental Protection Agency ("EPA") proposed
regulations to reduce the sulfur content for diesel fuel sold to highway
consumers by 97%, from 500 parts per million to 15 parts per million, beginning
June 1, 2006. In its release, the EPA estimated that the overall cost to fuel
producers of the reduction in sulfur content would be approximately 4 cents per
gallon. The American Petroleum Institute has released a statement supporting
sharp reductions in diesel fuel sulfur content, but strongly opposing the EPA's
"unrealistic" proposal. We are unable to predict whether the proposed
regulations will be adopted or the effect of the proposal on our business.
DISRUPTION OF OUR ABILITY TO OBTAIN CRUDE OIL COULD ADVERSELY AFFECT OUR
OPERATIONS.
Over 70% of Valero's total crude oil feedstock requirements are purchased
through term crude oil feedstock contracts totaling approximately 380,000 BPD.
The remainder of our crude oil feedstock requirements are purchased on the spot
market. The term agreements include contracts to purchase feedstocks from
various foreign national oil companies and various domestic integrated oil
companies. In particular, a significant portion of our feedstock requirements
are served through suppliers located in the Middle East, and we are, therefore,
subject to the political, geographic and economic risks attendant to doing
business with suppliers located in that area. In the event one or more of our
term contracts were terminated, we believe we would be able to find alternative
sources of supply. However, we cannot assure you that this situation will
continue. If we are unable to obtain adequate crude oil volumes or are only able
to obtain such volumes at unfavorable prices, our results of operations could be
materially adversely affected.
COMPETITORS WHO PRODUCE THEIR OWN SUPPLY OF FEEDSTOCKS, WHO HAVE EXTENSIVE
RETAIL OUTLETS OR WHO HAVE GREATER FINANCIAL RESOURCES MAY HAVE A COMPETITIVE
ADVANTAGE.
The refining and marketing industry is highly competitive with respect to both
feedstock supply and refined product markets. We compete with numerous other
companies for available supplies of crude oil and other feedstocks and for
outlets for our refined products. We do not produce any of our crude oil
feedstocks and, following the Benicia acquisition, will control only limited
retail outlets for our refined products. Many of our competitors, however,
obtain a significant portion of their feedstocks from company-owned production
and have extensive retail outlets. Competitors that have their own production or
extensive 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.
A number of our competitors also have materially greater financial and other
resources than we possess. Such competitors have a greater ability to bear the
economic risks inherent in all phases of the industry. In addition, we compete
with other industries that provide alternative means to satisfy the energy and
fuel requirements of our industrial, commercial and individual consumers. If we
are unable to compete effectively with our competitors, both within and outside
of our industry, our financial condition and results of operations could be
materially adversely affected.
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As a result of the Benicia acquisition, we are entering the California refining
and marketing market at a time when competition in the industry is increasing
and new technology is making refining more efficient. The addition of new
refining and marketing companies to the California market, as well as the
addition of new retail product providers, may increase the supply of refined
products available for sale in that state or increase competitive pressure, or
both, either of which could lead to lower prices and reduced margins. A
reduction in our anticipated margins in California could adversely affect our
prospective financial position, liquidity and results of operations.
THE OUTCOME OF THE UNOCAL PATENT DISPUTE MAY ADVERSELY AFFECT OUR BUSINESS.
In April 1995, six major oil refiners filed a lawsuit against Unocal Corporation
concerning the validity of Unocal's claimed patent on certain gasoline
compositions required by the CARB Phase II regulations in California. 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 decision was appealed,
and in March 2000, a panel of the Court of Appeals for the Federal Circuit
affirmed the lower court decision and a subsequent petition for reconsideration
and for rehearing by the full court was denied. The ultimate outcome of the
litigation is uncertain. Unocal also has four other gasoline composition patents
not involved in the litigation. We were not a party to this lawsuit, but if we
were required to pay a royalty on the compositions claimed by Unocal's patents,
such payments could affect our operating results and alter the blending
economics for compositions not covered by the patents. All liabilities related
to any claim Unocal may have against ExxonMobil are being retained by
ExxonMobil. However, we will be responsible for any infringement liabilities
relating to gasoline produced from any of our other refineries and from the
Benicia refinery after the date of our acquisition of the Benicia refinery.
A SIGNIFICANT INTERRUPTION IN ONE OR MORE OF OUR REFINERIES COULD ADVERSELY
AFFECT OUR BUSINESS.
With the acquisition of the Benicia refinery, our refining activities are
conducted at six major refineries in Texas, Louisiana, New Jersey and
California. The refineries are our principal operating assets. As a result, our
operations could be subject to significant interruption if one or more of the
refineries were to experience a major accident, be damaged by severe weather or
other natural disaster, or otherwise be forced to shut down. Although we
maintain business interruption insurance against some types of risks in amounts
which we believe to be economically prudent, if any refinery were to experience
an interruption in operations, earnings therefrom could be materially adversely
affected.
A significant percentage of our operations take place along the Texas and
Louisiana Gulf Coast. At December 31, 1999, four of our five refineries were in
the Gulf Coast area, with three situated in Texas and one in Louisiana. As a
result, a variety of adverse conditions or events in that region, including
natural disasters, transportation problems, or state government regulation or
political developments could have a material adverse effect on our operations.
WE DO NOT HAVE AN OPERATING HISTORY IN THE RETAIL BUSINESS.
We do not have an operating history in the retail business, and our senior
management has limited experience in the retail business. Until we gain further
experience in this area, we will be reliant to a significant degree on the
expertise of the retail marketing and operations personnel hired from ExxonMobil
in connection with the acquisition of the retail assets. Our success in the
retail business will be, in large part, dependent upon market recognition of our
brands. We anticipate that we will need to incur certain costs to obtain or
maintain such recognition. Accordingly, the retail business may divert some of
our financial resources from our refining and marketing business. We cannot
assure you that our retail business will be successful. Our inability to achieve
success in our retail business could have a material adverse effect on our
overall financial position, results of operations and liquidity.
We will be permitted to use Exxon's service marks and other trade indicia to
sell retail products at specified service stations outside the San Francisco Bay
area. We do not have control over the Exxon brand name, and a decrease in the
strength, visibility or reputation of the Exxon brand name could
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adversely affect our ability to conduct a successful retail business, which in
turn could have a material adverse effect on our overall financial position,
liquidity and results of operations. We cannot give you assurance that the
acquisition of the service station facilities will be consummated on or about
June 15, 2000 or any time thereafter.
OUR OPERATIONS EXPOSE US TO MANY OPERATING RISKS, NOT ALL OF WHICH ARE INSURED.
Our refining and marketing operations are subject to various hazards common to
the industry, including explosions, fires, toxic emissions, maritime hazards,
and uncontrollable flows of oil and gas. They are also subject to the additional
hazards of loss from severe weather conditions. As protection against operating
hazards, we maintain insurance coverage against some, but not all, such
potential losses. Although we believe that our insurance is adequate and
customary for companies of a similar size engaged in operations similar to ours,
losses could occur for uninsurable or uninsured risks or in amounts in excess of
our existing insurance coverage. The occurrence of an event that is not fully
covered by our insurance could have an adverse impact on our financial condition
and results of operations.
THE BANNING OF THE USE OF MTBE COULD ADVERSELY AFFECT US.
The presence of MTBE in some water supplies in California and other states due
to gasoline leakage from underground and aboveground storage tanks, automobile
and tanker truck accidents, pipelines and certain other sources has led to
public concern that MTBE has contaminated drinking water supplies, and thereby
resulted in a possible health risk.
In March 1999, the Governor of California ordered the ban of the use of MTBE as
a gasoline component by the end of 2002. The California Air Resources Board has
also finalized the specifications for CARB Phase III gasoline, which
specifications become effective at the end of 2002. Valero estimates that the
cost for permitting and modification of the Benicia refinery in order to comply
with CARB Phase III specifications and eliminate MTBE as a gasoline component is
approximately $20 million. On May 24, 2000, Valero was served with a class
action complaint filed in the Southern District of New York. The complaint
attempts to certify a class action claim alleging that numerous gasoline
suppliers, including Valero, contaminated groundwater in the State of New York
with MTBE. In addition, numerous oil companies have been ordered by the
Environmental Protection Agency to help replace contaminated water supplies in
California. Although the Benicia refinery has not been involved in such order,
there can be no assurances that it will not be involved in such order or that it
or our other refineries will not be involved in other future litigation or other
proceedings involving the environmental effects of MTBE, or that such litigation
or proceedings will not have a material adverse effect on our overall financial
condition, results of operations or liquidity. Heightened public awareness has
also resulted in other states and the EPA either passing or proposing
restrictions on, or banning the use of, MTBE. If MTBE were to be restricted or
banned throughout the U.S., we believe that our MTBE-producing facilities, other
than the Benicia refinery discussed above, could be modified to produce other
gasoline blendstocks or other petrochemicals for a capital investment of
approximately $22 million. Because the volume of alternative products that could
be produced would be less than the current production of MTBE and the price of
such alternative products is currently lower than the price of MTBE, our results
of operations could potentially be materially adversely affected.
OUR ACQUISITION STRATEGY MAY NOT BE SUCCESSFUL AND MAY REQUIRE US TO INCUR
ADDITIONAL FINANCING.
A substantial portion of our growth over the last several years has been
attributed to acquisitions. A principal component of our strategy going forward
is to continue to acquire assets or businesses that are logical extensions of
our existing assets or businesses in order to increase cash flow and earnings.
Our ability to achieve this goal will be dependent upon a number of factors,
including our ability to (i) identify acceptable acquisition candidates, (ii)
consummate acquisitions on favorable terms, (iii) successfully integrate
acquired businesses and (iv) obtain financing to support our growth. We cannot
assure you that we will be successful in implementing our acquisition strategy
or that such strategy will improve operating results. In addition, the financing
of future acquisitions may require us to incur additional indebtedness, which
could limit our financial flexibility, or to issue additional equity, which
could result in further dilution of the ownership interest of existing
shareholders.
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PROVISIONS IN OUR CORPORATE DOCUMENTS AND DELAWARE LAW COULD DELAY OR PREVENT A
CHANGE IN OUR CONTROL.
The existence of some provisions in our corporate documents and Delaware law
could delay or prevent a change in control of Valero, even if that change might
be beneficial to our stockholders. In addition, we have adopted a stockholder
rights plan that would cause extreme dilution to any person or group who
attempts to acquire a significant interest in Valero without advance approval of
our board of directors. Delaware law imposes additional restrictions on mergers
and other business combinations between us and any holder of 15% or more of our
outstanding common stock.
FORWARD-LOOKING INFORMATION
This prospectus supplement, including the information we incorporate by
reference, contains certain estimates, predictions, projections and other
"forward-looking statements" (as defined in Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934) that involve
various risks and uncertainties. While these forward-looking statements, and any
assumptions upon which they are based, are made in good faith and reflect our
current judgment regarding the direction of our business, actual results will
almost always vary, sometimes materially, from any estimates, predictions,
projections, assumptions, or other future performance suggested herein. These
forward-looking statements can generally be identified by the words
"anticipate," "believe," "expect," "plan," "intend," "estimate," "project,"
"budget," "forecast," "will," "could," "should," "may" and similar expressions.
These forward-looking statements include, among other things, statements
regarding:
- the Benicia acquisition and our results of operations following the Benicia
acquisition;
- future refining margins, including gasoline and heating oil margins;
- the expected cost of feedstocks, including crude oil discounts, and refining
products;
- anticipated levels of crude oil and refined product inventories;
- our anticipated level of capital investments, including deferred turnaround
and catalyst costs and capital expenditures for regulatory compliance and
other purposes, and the effect of these capital investments on our results of
operations;
- refinery utilization rates;
- anticipated trends in the supply and demand for crude oil feedstocks and
refined products in the United States and elsewhere;
- expectations regarding environmental and other regulatory initiatives; and
- the effect of general economic and other conditions on refining industry
fundamentals.
We have based our forward-looking statements on our beliefs and assumptions
derived from information available to us at the time the statements are made.
Differences between actual results and any future performance suggested in our
forward-looking statements or projections could result from a variety of
factors, including the following:
- the domestic and foreign supplies of refined products such as gasoline,
diesel, heating oil and petrochemicals;
- the domestic and foreign supplies of crude oil and other feedstocks;
- the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil price and production controls;
- the level of consumer demand, including seasonal fluctuations;
- refinery overcapacity or undercapacity;
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- the actions taken by competitors, including both pricing and the expansion
and retirement of refining capacity in response to market conditions;
- environmental and other regulations at both the state and federal levels and
in foreign countries;
- political conditions in oil producing regions, including the Middle East;
- the level of foreign imports;
- accidents or other unscheduled shutdowns affecting our plants, machinery,
pipelines or equipment, or those of our suppliers or customers;
- changes in the cost or availability of transportation for feedstocks and
refined products;
- write-downs of inventories caused by a material decline in petroleum prices;
- the price, availability and acceptance of alternative fuels;
- cancellation of or failure to implement planned capital projects and realize
the various assumptions and benefits projected for such projects;
- irregular weather, which can unforeseeably affect the price or availability
of feedstocks and refined products;
- rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any
reserves and claims of product liability;
- the introduction or enactment of federal or state legislation which may
adversely affect our business or operations;
- changes in the credit ratings assigned to our debt securities and trade
credit; and
- overall economic conditions.
We caution you that any one of these factors or other factors described under
the heading "Risk Factors," or a combination of these factors, could materially
affect our future results of operations and whether our forward-looking
statements ultimately prove to be accurate. These forward-looking statements are
not guarantees of our future performance, and our actual results and future
performance may differ materially from those suggested in our forward-looking
statements. When considering these forward-looking statements, you should keep
in mind the factors described under the heading "Risk Factors" and other
cautionary statements in this prospectus supplement, the accompanying prospectus
and the documents we have incorporated by reference. We do not intend to update
these statements unless the securities laws require us to do so.
All subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
foregoing. We undertake no obligation to publicly release the result of any
revisions to any such forward-looking statements that may be made to reflect
events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events.
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THE BENICIA ACQUISITION AND RELATED FINANCINGS
THE ACQUISITION
On March 2, 2000, Valero and Exxon Mobil Corporation executed a sale and
purchase agreement pursuant to which Valero agreed to acquire ExxonMobil's
Benicia, California refinery and Exxon-branded California retail assets, which
consist of approximately 80 service station facilities (the "Service Station
Assets") and branded supplier relationships with approximately 260 Exxon-branded
service stations (the "Distribution Assets"), for a purchase price of $895
million plus an amount for refinery inventories acquired in the transaction
based on market-related prices at the time of closing. ExxonMobil agreed to sell
these assets as a result of consent decrees issued by the Federal Trade
Commission and the State of California providing that certain assets be divested
by ExxonMobil to satisfy anticompetitive issues in connection with the recent
merger of Exxon Corporation and Mobil Corporation. The consummation of the
Benicia acquisition has been approved by the Federal Trade Commission and the
Office of the Attorney General of the State of California. The purchase
agreement was amended on May 14, 2000 to provide, among other things, that the
closing of the purchase of the Benicia refinery and the Distribution Assets
would occur on May 15, 2000. The amendment also covered an environmental issue
relating to a request for information by the EPA under the Clean Air Act arising
subsequent to the original signing, certain employee matters and more specific
inventory determination procedures. The acquisition of the Benicia refinery and
the Distribution Assets closed on May 15, 2000, and the acquisition of the
Service Station Assets is expected to close on or about June 15, 2000. The
Benicia acquisition will be accounted for under the purchase method.
The purchase agreement, as amended, contains representations and warranties of
each of Valero and ExxonMobil, which survive the closing for one year, as well
as customary covenants. In addition, Valero will assume the environmental
liabilities of ExxonMobil with certain exceptions. ExxonMobil retained liability
for (i) pending penalties assessed for violations relating to the Benicia
refinery, (ii) pending lawsuits, (iii) all costs associated with compliance with
a variance issued in connection with control of nitrogen oxides, (iv) claims in
connection with offsite transportation and disposal of wastes prior to closing
asserted within three years of closing or asserted with respect to abandoned
disposal sites, (v) the capital costs incurred within five years of closing for
specified corrective action of groundwater and soil contamination, (vi) all
covered contamination at the Service Station Assets caused by ExxonMobil or its
lessees that is reflected in baseline reports prepared prior to closing, (vii)
the repair or replacement of any underground storage tanks at the Service
Station Assets found to be leaking prior to closing and (viii) fines and
penalties imposed within five years of closing arising out of a request for
information from the EPA relating to certain provisions of the Clean Air Act
that are attributable to actions taken prior to closing or untimely or
unresponsive responses to the request. ExxonMobil has agreed to indemnify Valero
for all losses related to these retained liabilities, provided that ExxonMobil
will indemnify Valero for losses related to covered contamination at the Service
Station Assets for a period of five years from the date of closing. In addition,
ExxonMobil will indemnify Valero for breaches of its representations and
warranties to the extent that the aggregate amount of Valero's losses resulting
from such breaches exceeds $1 million and ExxonMobil receives notice of such
losses within one year after the closing date.
The Benicia refinery is located on the Carquinez Straits of the San Francisco
Bay. It is considered a highly complex refinery and has a total throughput
capacity of approximately 160,000 barrels per day or "BPD." The Benicia refinery
produces a high percentage of light products, with limited production of other
products. It can produce approximately 110,000 BPD of gasoline, 14,000 BPD of
jet fuel, 11,000 BPD of diesel and 8,000 BPD of natural gas liquids.
Approximately 95% of the gasoline produced by the Benicia refinery meets the
California Air Resources Board ("CARB") II specifications for gasoline sold in
California. The refinery has significant liquid storage capacity, including
storage for crude oil and other feedstocks. Also included with the refinery
assets are a deepwater dock located offsite on the Carquinez Straits that is
capable of berthing large crude carriers, petroleum coke storage silos located
on an adjacent dock, a 20-inch crude pipeline connecting the refinery to a
southern California crude delivery system, and an adjacent truck terminal for
regional truck rack sales. Under the consent decrees, ExxonMobil was required to
offer the buyer of the divested assets a crude oil supply contract. As a
consequence, in
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connection with the closing of the acquisition of the Benicia refinery and the
Distribution Assets, Valero entered into a ten-year term contract providing for
ExxonMobil to supply and for Valero to purchase 100,000 BPD of Alaska North
Slope ("ANS") crude oil at market-related prices, to be reduced to 65,000 BPD on
January 1, 2001. Prior to January 1, 2001, Valero will have an option to reduce
the volume of ANS crude to 65,000 BPD with 90 days' prior notice. After January
1, 2001, Valero will have an option to reduce the required volumes by an
additional 20,000 BPD once per year.
The Service Station Assets include 10 company-operated service stations and 70
lessee-dealer service stations, 75 of which are in the San Francisco Bay area.
Under the consent decrees related to the merger between Exxon Corporation and
Mobil Corporation, the Federal Trade Commission and the State of California
ordered that ExxonMobil withdraw the "Exxon" brand name from the San Francisco
area. As a result, ExxonMobil has notified the dealers in this market area that
their franchise right to market "Exxon" branded products is being terminated
effective June 15, 2000. Valero plans to introduce its own brand of retail
petroleum products in the San Francisco Bay area and has offered to the dealers
at these locations a franchise right to market products under the new Valero
brand. Due to the timing requirements of ExxonMobil's franchise termination
notice to various dealers as described above, ExxonMobil cannot close the
acquisition of the Service Station Assets until (i) all of the dealers agree to
terminate their franchise agreements or (ii) June 15, 2000, whichever comes
first. Subsequent to the anticipated June 15, 2000 closing date, Valero plans to
offer those dealers who accept Valero's franchise offering an option to purchase
the stations that they are currently leasing. As part of the purchase option,
the dealers must enter into a fuels purchase agreement with Valero for a term of
15 years. The dealers will have 90 days to exercise or reject their purchase
option.
The Distribution Assets include up to 260 independently-owned and operated
distributor facilities which are located outside of the San Francisco Bay area.
The distributor locations will retain the right to use the Exxon brand, continue
to accept the Exxon proprietary credit card and receive Exxon brand support,
while Valero will receive the exclusive rights to offer the Exxon brand
throughout the state of California (except for the San Francisco Bay area) for a
ten-year period. In connection with the Benicia acquisition, ExxonMobil assigned
to Valero all of the existing Exxon California distributor contracts under which
the distributors will purchase Exxon branded products from Valero after the
acquisition.
THE FINANCING
Valero established with a group of banks a $600 million bridge loan facility
(the "Bridge Facility") to provide interim financing in connection with the
Benicia acquisition. The Bridge Facility has a term of one year, and Valero has
an option to extend for an additional two years. The Bridge Facility has
covenants similar to those contained in Valero's $835 million bank credit and
letter of credit facility (the "Credit Facility"). Any amounts borrowed under
the Bridge Facility bear interest at LIBOR plus an applicable margin. The Credit
Facility bears interest at either LIBOR plus a margin, a base rate or a money
market rate. The interest rate and fees under the Credit Facility are subject to
adjustment based upon the credit ratings assigned to Valero's long-term debt.
The Credit Facility includes certain restrictive covenants including a
fixed-charge coverage ratio, a debt-to-capitalization ratio, and a minimum net
worth test. Valero has amended its existing bank credit facilities to provide
for, among other things, the higher debt-to-capitalization limits necessary to
complete the Benicia acquisition. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
The acquisition of the Benicia refinery and the Distribution Assets was
initially funded through interim financing consisting of (i) borrowings of $600
million under the Bridge Facility, (ii) borrowings of $298.5 million under our
existing bank credit facilities, and (iii) an approximate $30 million interim
lease arrangement to accommodate the acquisition of the Benicia refinery's
docking facility. In connection with the acquisition of the Service Station
Assets, Valero will (i) enter into a structured lease arrangement with a
commitment of up to $135 million (the "Structured Lease Financing"),
substantially all of which will be used to acquire the Service Station Assets
and replace the interim lease arrangement for the acquisition of the Benicia
refinery's docking facility, and (ii) borrow an additional $8.5 million under
the Credit Facility which will be used to pay certain transaction costs. It is
expected that $600 million of borrowings under
S-20
<PAGE> 21
the Bridge Facility and $186.3 million of borrowings under the Credit Facility
will be repaid with the proceeds of this offering and two other concurrent
offerings consisting of (i) approximately $150 million of common stock (the
"Equity Offering") and (ii) approximately $150 million aggregate stated amount
of PEPS(SM) Units (the "PEPS Units Offering"). Valero also expects to continue
to borrow under its existing credit facilities to fund the working capital needs
of the Benicia assets. This offering, the Equity Offering and the PEPS Units
Offering are collectively referred to herein as the "Offerings".
At the closing of the Benicia acquisition, the financing is expected to be
provided as follows:
<TABLE>
<CAPTION>
AMOUNT
-------------
(IN MILLIONS)
<S> <C>
SOURCES OF FUNDS:
Borrowings under Bridge Facility................... $ 600.0
Borrowings under Credit Facility................... 307.0
Structured Lease Financing......................... 130.0
--------
Total sources of funds..................... $1,037.0
========
USES OF FUNDS:
Cash consideration to ExxonMobil................... $1,018.0
Estimated transaction costs........................ 19.0
--------
Total uses of funds........................ $1,037.0
========
</TABLE>
Valero intends to repay indebtedness incurred to finance the Benicia acquisition
with the proceeds of the Offerings as follows:
<TABLE>
<CAPTION>
AMOUNT
-------------
(IN MILLIONS)
<S> <C>
SOURCES OF FUNDS:
Proceeds from this offering........................ $500.0
Proceeds from the Equity Offering.................. 150.0
Proceeds from the PEPS Units Offering.............. 150.0
------
Total sources of funds..................... $800.0
======
USES OF FUNDS:
Repayment of borrowings under Bridge Facility...... $600.0
Repayment of borrowings under Credit Facility...... 186.3
Estimated expenses of Offerings.................... 13.7
------
Total uses of funds........................ $800.0
======
</TABLE>
S-21
<PAGE> 22
USE OF PROCEEDS
We estimate that the net proceeds we will receive from this offering will be
approximately $ million. Concurrently with this offering, we are also
offering to sell approximately $150 million of common stock and $150 million
aggregate stated amount of PEPS Units in separate offerings registered with the
SEC. The Equity Offering and the PEPS Units Offering are not contingent on any
other offering. The closing of this offering is contingent on the prior closing
of both the Equity Offering and the PEPS Units Offering.
Upon completion of the Benicia acquisition, we will have borrowed approximately
$600 million under our Bridge Facility, which currently bears interest at a rate
of LIBOR plus 1.50% and matures on May 15, 2001 unless Valero exercises its
option to extend the maturity, and approximately $307 million under our Credit
Facility, which currently bears interest at a rate of LIBOR plus 1.125% and
matures on November 27, 2002. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources" for more information on our Bridge Facility and Credit Facility.
We anticipate using the net proceeds of this offering, together with the
additional funds acquired from the concurrent offerings, to repay the Bridge
Facility and $186.3 million under our Credit Facility.
S-22
<PAGE> 23
CAPITALIZATION
The following table sets forth our capitalization (which includes our
consolidated subsidiaries) as of March 31, 2000 (i) on an historical basis, (ii)
as adjusted to give effect to the Benicia acquisition, including the incurrence
of borrowings of $600 million under the Bridge Facility and $307 million under
the Credit Facility in connection therewith, and (iii) as further adjusted to
reflect this offering, the sale by us of 5 million shares of common stock at an
assumed public offering price of $30 per share in the Equity Offering and the
PEPS Units Offering and the application of the net proceeds from these Offerings
as described under "Use of Proceeds" and "The Benicia Acquisition and Related
Financings." On May 31, 2000, the reported last sale price of our common stock
on the NYSE was $29 1/4 per share. The adjustments made for the implementation
of Valero's financing plan assume the ability to complete the Offerings under
the terms and pricing as described above, which Valero believes to be reasonable
in light of its knowledge of current market conditions and its expected credit
profile at the anticipated dates of the Offerings. There can be no assurance
that Valero will be able to complete any or all of the Offerings, or that the
proceeds from the Offerings will be in an amount as currently contemplated. The
closing of this offering is contingent upon the prior closing of both the Equity
Offering and the PEPS Units Offering. The Equity Offering and the PEPS Units
Offering are not contingent on the other Offerings. This table should be read in
conjunction with the consolidated financial statements of Valero and the
"Unaudited Pro Forma Combined Financial Statements" and the notes thereto
included elsewhere herein.
<TABLE>
<CAPTION>
MARCH 31, 2000
--------------------------------------------
PRO FORMA
PRO FORMA COMBINED
COMBINED FOR AS ADJUSTED
BENICIA FOR THE
HISTORICAL ACQUISITION(1) OFFERINGS
---------- -------------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Short-term debt............................................. $ 126,500 $ 126,500 $ 126,500
---------- ---------- ----------
Long-term debt:
Industrial revenue bonds.................................. 192,000 192,000 192,000
7.375% notes, due March 15, 2006.......................... 300,000 300,000 300,000
6.75% notes, due December 15, 2032........................ 150,000 150,000 150,000
Notes issued in this offering............................. -- -- 500,000
Credit Facility........................................... -- 307,014 120,704
Bridge Facility........................................... -- 600,000 --
Net unamortized premium and discount...................... 3,155 3,155 3,155
---------- ---------- ----------
Total long-term debt............................... 645,155 1,552,169 1,265,859
---------- ---------- ----------
Valero-obligated mandatorily redeemable preferred capital
trust securities of subsidiary trust holding solely Valero
senior notes(2)........................................... -- -- 150,000
---------- ---------- ----------
Stockholders' equity:
Common stock, par value $0.01, 150,000,000 shares
authorized; 56,331,166 shares issued; 61,331,166 shares
assumed issued as adjusted for the Equity Offering...... 563 563 613
Additional paid-in capital................................ 1,088,829 1,088,829 1,227,623(3)
Retained earnings......................................... 27,408 27,408 27,408
Treasury stock--398,632 shares, at cost................... (8,096) (8,096) (8,096)
---------- ---------- ----------
Total stockholders' equity......................... 1,108,704 1,108,704 1,247,548
---------- ---------- ----------
Total capitalization............................... $1,880,359 $2,787,373 $2,789,907
========== ========== ==========
</TABLE>
------------
(1) Funding for the Benicia acquisition also includes approximately $130 million
of assumed financing under a structured lease arrangement.
(2) The sole assets of the trust are senior notes of Valero. Upon prepayment of
such senior notes, the related capital trust securities are mandatorily
redeemable.
(3) Adjustments related to the Offerings include the following: (i) an increase
of $143.7 million representing the estimated proceeds of the Equity Offering
net of issuance costs and (ii) a reduction representing estimated
transaction fees and expenses and underwriters' discount on the PEPS Units
Offering of $4.9 million.
S-23
<PAGE> 24
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma combined financial statements give effect to
the Benicia acquisition and to the related interim financings and are further
adjusted to give effect to the Offerings. The unaudited pro forma combined
balance sheet as of March 31, 2000 is presented as if the Benicia acquisition
and the related interim financings had occurred on that date and is further
adjusted to give effect to the Offerings. The unaudited pro forma combined
statements of income for the three months ended March 31, 2000 and the year
ended December 31, 1999 assume that the Benicia acquisition and the related
interim financings occurred on January 1, 1999 and are further adjusted to give
effect to the Offerings. The Benicia acquisition is being accounted for using
the purchase method of accounting, with the purchase price allocated to the
assets acquired and liabilities assumed based on estimated fair values, pending
the completion of an independent appraisal. The unaudited pro forma combined
balance sheet does not give effect to the issuance of any shares of common stock
issuable upon settlement of the purchase contracts issued as part of the PEPS
Units.
The unaudited pro forma combined financial statements should be read in
conjunction with (i) the historical consolidated financial statements of Valero
and the Benicia refinery and related branded supplier relationships and service
station facilities which are included in this prospectus supplement beginning on
page F-2, and (ii) "Management's Discussion and Analysis of Financial Condition
and Results of Operations" of Valero included in this prospectus supplement
beginning on page S-31. The unaudited pro forma combined financial statements
are not necessarily indicative of the financial position that would have been
obtained or the financial results that would have occurred if the Benicia
acquisition and the related interim financings had been consummated on the dates
indicated, nor are they necessarily indicative of the financial position or
financial results which may be attained in the future. The pro forma
adjustments, as described in the Notes to Pro Forma Combined Financial
Statements, are based upon available information and upon certain assumptions
that Valero's management believes are reasonable.
S-24
<PAGE> 25
VALERO ENERGY CORPORATION
PRO FORMA COMBINED BALANCE SHEETS
MARCH 31, 2000
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
COMBINED COMBINED
FOR THE AS ADJUSTED
VALERO BENICIA PRO FORMA BENICIA OFFERINGS FOR THE
HISTORICAL HISTORICAL ADJUSTMENTS ACQUISITION ADJUSTMENTS OFFERINGS
---------- ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Current assets:
Cash and temporary cash investments...... $ 8,509 $ 99 $ (99)(a) $ 8,509 $ -- $ 8,509
Receivables, net......................... 403,557 44,998 (44,998)(a) 403,557 -- 403,557
Inventories.............................. 436,197 30,345 (30,345)(a) 591,083 -- 591,083
154,886(b)
Current deferred income tax assets....... 89,477 -- -- 89,477 -- 89,477
Prepaid expenses and other............... 22,591 3,224 (3,224)(a) 22,591 -- 22,591
---------- -------- --------- ---------- --------- ----------
960,331 78,666 76,220 1,115,217 -- 1,115,217
---------- -------- --------- ---------- --------- ----------
Property, plant and equipment.............. 2,711,907 901,641 (901,641)(a) 3,427,527 -- 3,427,527
715,620(b)
Less: Accumulated depreciation........... 726,723 426,191 (426,191)(a) 726,723 -- 726,723
---------- -------- --------- ---------- --------- ----------
1,985,184 475,450 240,170 2,700,804 -- 2,700,804
---------- -------- --------- ---------- --------- ----------
Deferred charges and other assets.......... 175,659 18,109 (18,109)(a) 218,467 2,534(A) 221,001
42,808(b)
---------- -------- --------- ---------- --------- ----------
$3,121,174 $572,225 $ 341,089 $4,034,488 $ 2,534 $4,037,022
========== ======== ========= ========== ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Short-term debt.......................... $ 126,500 $ -- $ -- $ 126,500 $ -- $ 126,500
Accounts payable......................... 732,561 37,768 (37,768)(a) 732,561 -- 732,561
Accrued expenses......................... 96,213 24,512 (24,512)(a) 97,213 -- 97,213
1,000(b)
---------- -------- --------- ---------- --------- ----------
955,274 62,280 (61,280) 956,274 -- 956,274
---------- -------- --------- ---------- --------- ----------
Long-term debt............................. 645,155 -- 907,014(b) 1,552,169 500,000(A) 1,265,859
(786,310)(A)
---------- -------- --------- ---------- --------- ----------
Deferred income taxes...................... 296,628 88,560 (88,560)(a) 296,628 -- 296,628
---------- -------- --------- ---------- --------- ----------
Deferred credits and other liabilities..... 115,413 11,503 (11,503)(a) 120,713 -- 120,713
5,300(b)
---------- -------- --------- ---------- --------- ----------
Valero-obligated mandatorily redeemable
preferred capital trust securities of
subsidiary trust holding solely Valero
senior notes............................. -- -- -- -- 150,000(A) 150,000
---------- -------- --------- ---------- --------- ----------
Common stockholders' equity:
Common stock............................. 563 -- -- 563 50(A) 613
Additional paid-in capital............... 1,088,829 -- -- 1,088,829 149,950(A) 1,227,623
(11,156)(A)
Retained earnings........................ 27,408 -- -- 27,408 -- 27,408
Treasury stock........................... (8,096) -- -- (8,096) -- (8,096)
ExxonMobil net investment................ -- 409,882 (409,882)(a) -- -- --
---------- -------- --------- ---------- --------- ----------
1,108,704 409,882 (409,882) 1,108,704 138,844 1,247,548
---------- -------- --------- ---------- --------- ----------
$3,121,174 $572,225 $ 341,089 $4,034,488 $ 2,534 $4,037,022
========== ======== ========= ========== ========= ==========
</TABLE>
See Notes to Pro Forma Combined Financial Statements.
S-25
<PAGE> 26
VALERO ENERGY CORPORATION
PRO FORMA COMBINED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
COMBINED COMBINED
FOR THE AS ADJUSTED
VALERO BENICIA PRO FORMA BENICIA OFFERINGS FOR THE
HISTORICAL HISTORICAL ADJUSTMENTS ACQUISITION ADJUSTMENTS OFFERINGS
---------- ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues.................. $2,928,617 $623,337 $(128,538)(c) $3,423,416 $ -- $3,423,416
---------- -------- --------- ---------- --------- ----------
Costs and expenses:
Cost of sales and operating
expenses........................ 2,827,341 567,535 (128,538)(c) 3,266,475 -- 3,266,475
612(d)
(670)(g)
2,096(g)
(2,000)(h)
369(h)
(2,700)(i)
2,430(i)
Selling and administrative
expenses........................ 19,669 7,501 2,020(d) 27,616 -- 27,616
875(e)
(3,000)(h)
561(h)
(100)(i)
90(i)
Depreciation expense.............. 24,555 6,723 (6,723)(f) 31,023 -- 31,023
6,468(f)
---------- -------- --------- ---------- --------- ----------
Total...................... 2,871,565 581,759 (128,210) 3,325,114 -- 3,325,114
---------- -------- --------- ---------- --------- ----------
Operating income.................... 57,052 41,578 (328) 98,302 -- 98,302
Other income (expense), net......... 2,647 (45) -- 2,602 -- 2,602
Interest and debt expense:
Incurred.......................... (14,147) -- (18,775)(j) (32,922) 15,749(C) (28,249)
(11,076)(C)
Capitalized....................... 1,387 -- -- 1,387 -- 1,387
Distributions on preferred
securities of subsidiary trust.... -- -- -- -- (2,813)(B) (2,813)
---------- -------- --------- ---------- --------- ----------
Income (loss) before income taxes... 46,939 41,533 (19,103) 69,369 1,860 71,229
Income tax expense (benefit)........ 16,200 16,923 (8,323)(k) 24,800 500(D) 25,300
---------- -------- --------- ---------- --------- ----------
Net income (loss)................... $ 30,739 $ 24,610 $ (10,780) $ 44,569 $ 1,360 $ 45,929
========== ======== ========= ========== ========= ==========
Earnings per share of common
stock............................. $ .55 $ .80 $ .75
Weighted average common shares
outstanding (in thousands)...... 55,874 55,874 60,874
Earnings per share of common
stock -- assuming dilution........ $ .54 $ .78 $ .74(E)
Weighted average common shares
outstanding (in thousands)...... 57,234 57,234 62,234(E)
</TABLE>
See Notes to Pro Forma Combined Financial Statements.
S-26
<PAGE> 27
VALERO ENERGY CORPORATION
PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
COMBINED COMBINED
FOR THE AS ADJUSTED
VALERO BENICIA PRO FORMA BENICIA OFFERINGS FOR THE
HISTORICAL HISTORICAL ADJUSTMENTS ACQUISITION ADJUSTMENTS OFFERINGS
---------- ---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues................. $7,961,168 $1,826,081 $(474,506)(c) $9,312,743 $ -- $9,312,743
---------- ---------- --------- ---------- -------- ----------
Costs and expenses:
Cost of sales and operating
expenses....................... 7,731,151 1,661,750 (474,506)(c) 8,873,531 -- 8,873,531
2,448(d)
(45,100)(g)
6,481(g)
(12,000)(h)
1,474(h)
(8,476)(i)
10,309(i)
Selling and administrative
expenses....................... 68,463 25,478 8,080(d) 98,875 -- 98,875
3,500(e)
(9,000)(h)
2,244(h)
(510)(i)
620(i)
Depreciation expense............. 92,413 26,474 25,870(f) 118,283 -- 118,283
(26,474)(f)
---------- ---------- --------- ---------- -------- ----------
Total..................... 7,892,027 1,713,702 (515,040) 9,090,689 -- 9,090,689
---------- ---------- --------- ---------- -------- ----------
Operating income................... 69,141 112,379 40,534 222,054 -- 222,054
Other income (expense), net........ 6,475 (825) -- 5,650 -- 5,650
Interest and debt expense:
Incurred......................... (61,182) -- (75,098)(j) (136,280) 62,993(C) (117,591)
(44,304)(C)
Capitalized...................... 5,753 -- -- 5,753 -- 5,753
Distributions on preferred
securities of subsidiary trust... -- -- -- -- (11,250)(B) (11,250)
---------- ---------- --------- ---------- -------- ----------
Income (loss) before income
taxes............................ 20,187 111,554 (34,564) 97,177 7,439 104,616
Income tax expense (benefit)....... 5,900 46,023 (18,123)(k) 33,800 2,600(D) 36,400
---------- ---------- --------- ---------- -------- ----------
Net income (loss).................. $ 14,287 $ 65,531 $ (16,441) $ 63,377 $ 4,839 $ 68,216
========== ========== ========= ========== ======== ==========
Earnings per share of common
stock............................ $ .25 $ 1.13 $ 1.12
Weighted average common shares
outstanding (in thousands)..... 56,086 56,086 61,086
Earnings per share of common
stock -- assuming dilution....... $ .25 $ 1.12 $ 1.10(E)
Weighted average common shares
outstanding (in thousands)..... 56,758 56,758 61,758(E)
</TABLE>
See Notes to Pro Forma Combined Financial Statements.
S-27
<PAGE> 28
VALERO ENERGY CORPORATION
NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
PRO FORMA ADJUSTMENTS RELATED TO THE BENICIA ACQUISITION
(a) To reverse the historical cost of the assets acquired and liabilities
assumed.
(b) To reflect the allocation of the purchase price, including transaction costs
incurred in the acquisition, to the assets acquired and liabilities assumed
based on their estimated fair values as follows (in thousands):
<TABLE>
<S> <C>
Inventories.............................................. $154,886
Property, plant and equipment............................ 715,620
Deferred charges and other assets........................ 42,808
Accrued expenses......................................... (1,000)
Deferred credits and other liabilities................... (5,300)
--------
$907,014
========
</TABLE>
The above also reflects borrowings of $600 million under the Bridge Facility and
$307 million under the Credit Facility, including related debt issuance costs of
$7.8 million, required to fund the Benicia acquisition.
(c) To exclude excise taxes collected on behalf of governmental agencies
associated with the operations acquired in the Benicia acquisition from
Operating Revenues and Cost of Sales to conform to Valero's accounting
policies.
(d) To reflect rent expense related to a structured lease financing arrangement
used to finance the acquisition of the Benicia refinery's dock facility,
which is included in Operating Expenses, and the Service Station Assets,
which is included in Selling and Administrative Expenses.
(e) To reflect amortization expense on $35 million of value assigned to Valero's
receipt of the exclusive right to offer the Exxon brand throughout
California (except for the San Francisco Bay area) for a ten-year period in
connection with Valero's acquisition of the Distribution Assets.
(f) To reverse historical depreciation expense and record depreciation expense
over an estimated life of 25 years based on the portion of the acquisition
cost allocated to property, plant and equipment.
(g) To conform the accounting for turnaround costs at the Benicia refinery from
the "expense as incurred" method followed by ExxonMobil to the "defer and
amortize" method followed by Valero.
(h) To reverse historical charges for various corporate and divisional
administrative expenses allocated to the acquired assets by ExxonMobil from
both Operating Expenses and Selling and Administrative Expenses and record
incremental corporate administrative expenses that would have been incurred
by Valero.
(i) To reverse historical expense related to various employee benefit programs
from both Operating Expenses and Selling and Administrative Expenses and
record expense that would have been incurred by Valero under its employee
benefit programs.
(j) To reflect interest expense on borrowings under the Bridge Facility of $12.2
million and $48.6 million for the three months ended March 31, 2000 and the
year ended December 31, 1999, respectively, and interest expense on
borrowings under the Credit Facility of $5.9 million and $23.7 million for
the three months ended March 31, 2000 and the year ended December 31, 1999,
respectively, required to fund the Benicia acquisition, as well as the
amortization of deferred debt issuance costs in the amount of $.7 million
and $2.8 million for the three months ended March 31, 2000 and the year
ended December 31, 1999, respectively.
S-28
<PAGE> 29
VALERO ENERGY CORPORATION
NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(k) To reflect the tax effect of the pro forma pre-tax income adjustments
related to the Benicia acquisition and adjust the effective tax rate to the
rate that would have been incurred by Valero with respect to the assets
acquired.
ADJUSTMENTS RELATED TO THE OFFERINGS
(A) To reflect the issuance of $500 million aggregate principal amount of senior
notes, 5 million shares of common stock at an assumed offering price of $30
per share and $150 million aggregate stated amount of PEPS Units, including
the incurrence of $2.5 million of issuance costs related to this offering,
$6.3 million of issuance costs related to the Equity Offering and $4.9
million of issuance costs related to the PEPS Units Offering, the net
proceeds from which are used to repay all amounts outstanding under the
Bridge Facility and reduce borrowings under the Credit Facility by $186.3
million. On May 31, 2000, the reported last sale price of the common stock
on the NYSE was $29 1/4.
(B) To reflect distributions on the $150 million aggregate liquidation amount of
trust preferred securities issued as part of the PEPS Units.
(C) To reflect the effect on interest expense of repaying all amounts
outstanding under the Bridge Facility ($12.2 million and $48.6 million for
the three months ended March 31, 2000 and the year ended December 31, 1999,
respectively) and reducing borrowings by $186.3 million under the Credit
Facility ($3.6 million and $14.4 million for the three months ended March
31, 2000 and the year ended December 31, 1999, respectively) with proceeds
from the Offerings ($11.1 million and $44.3 million for the three months
ended March 31, 2000 and the year ended December 31, 1999, respectively,
related to this offering based on an assumed rate of 8.8%). A 1/8% change
in the interest rate associated with borrowings incurred under this offering
would have a $.2 million and $.6 million effect on interest expense for the
three months ended March 31, 2000 and the year ended December 31, 1999,
respectively, and a 1/8% change in the interest rate associated with
remaining borrowings under the Credit Facility would have a $.2 million
effect on annual interest expense.
(D) To reflect the tax effect of the pre-tax income adjustments related to the
Offerings based on Valero's effective tax rate.
(E) Under the treasury stock method, the calculation of earnings per share does
not include any dilutive effect from any shares of common stock that may be
issued pursuant to the stock purchase contracts issued as part of the PEPS
Units.
S-29
<PAGE> 30
SELECTED FINANCIAL DATA
The following table sets forth selected financial data for each of the periods
indicated. This information should be read in conjunction with the consolidated
financial statements and related notes for the years ended December 31, 1999,
1998 and 1997 and the three months ended March 31, 2000 and 1999 included
herein, as well as the unaudited pro forma financial information and related
notes included herein. The selected consolidated financial data for the five
years ended December 31, 1999 are derived from our consolidated financial
statements, which have been audited by Arthur Andersen LLP, independent public
accountants. The financial data for the three months ended March 31, 2000 and
1999 are derived from unaudited consolidated financial statements. The unaudited
consolidated financial statements include all adjustments, consisting of normal
recurring accruals, that we consider necessary for a fair presentation of the
financial position and results of operations for these periods. Operating
results for the three months ended March 31, 2000 are not necessarily indicative
of the results that investors in our common stock should expect for the entire
fiscal year ending December 31, 2000. Some previously reported amounts have been
reclassified to conform with the current period presentation.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
----------------------- --------------------------------------------------------------
2000 1999 1999 1998(1)(2) 1997(3) 1996 1995
---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Operating revenues.................... $2,928,617 $1,337,103 $7,961,168 $5,539,346 $5,756,220 $2,757,853 $1,772,638
Operating income (loss)............... 57,052 8,520 69,141 (51,198) 211,034 89,748 123,755
Income (loss) from continuing
operations.......................... 30,739 (2,716) 14,287 (47,291) 111,768 22,472 58,242
Income (loss) from discontinued
operations, net of income
taxes(4)............................ -- -- -- -- (15,672) 50,229 1,596
Net income (loss)..................... 30,739 (2,716) 14,287 (47,291) 96,096 72,701 59,838
Less: preferred stock dividend
requirements and redemption
premium....................... -- -- -- -- 4,592 11,327 11,818
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss) applicable to common
stock............................... $ 30,739 $ (2,716) $ 14,287 $ (47,291) $ 91,504 $ 61,374 $ 48,020
========== ========== ========== ========== ========== ========== ==========
Earnings (loss) per share of common
stock:
Continuing operations............... $ .55 $ (.05) $ .25 $ (.84) $ 2.16 $ .51 $ 1.33
Discontinued operations............. -- -- -- -- (.39) .89 (.23)
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total......................... $ .55 $ (.05) $ .25 $ (.84) $ 1.77 $ 1.40 $ 1.10
========== ========== ========== ========== ========== ========== ==========
Earnings (loss) per share of common
stock--assuming dilution:
Continuing operations............... $ .54 $ (.05) $ .25 $ (.84) $ 2.03 $ .44 $ 1.16
Discontinued operations............. -- -- -- -- (.29) .98 .01
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total......................... $ .54 $ (.05) $ .25 $ (.84) $ 1.74 $ 1.42 $ 1.17
========== ========== ========== ========== ========== ========== ==========
Dividends per share of common stock... $ .08 $ .08 $ .32 $ .32 $ .42 $ .52 $ .52
CASH FLOW DATA:
Cash flow from continuing operating
activities.......................... $ 11,177 $ 148,419 $ 435,111 $ 165,825 $ 196,645 $ 120,454 $ 165,931
Cash flow used in continuing investing
activities.......................... (41,966) (69,074) (172,168) (566,268) (434,046) (93,123) (128,180)
Cash flow provided by (used in)
financing activities................ (20,789) (77,201) (214,055) 401,707 275,548 (84,347) (8,341)
OTHER FINANCIAL DATA:
EBITDA(5)............................. $ 95,950 $ 45,111 $ 219,657 $ 244,523 $ 313,025 $ 164,958 $ 214,318
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
----------------------- --------------------------------------------------------------
2000 1999 1999 1998(1)(2) 1997(3) 1996 1995
---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (excluding short-term
debt and current maturities on
long-term debt)..................... $ 131,557 $ 242,463 $ 109,876 $ 301,966 $ 313,741 $ 135,030 $ 135,257
Property, plant and equipment, net.... 1,985,184 1,974,763 1,984,514 1,959,343 1,592,533 1,232,210 1,229,627
Total assets.......................... 3,121,174 2,814,398 2,979,272 2,725,664 2,493,043 1,985,631 1,904,655
Total debt............................ 771,655 909,421 785,472 982,335 552,183 437,072 490,027
Total equity.......................... 1,108,704 1,080,579 1,084,769 1,085,287 1,158,841 1,075,825 1,024,213
</TABLE>
------------
(1) Includes the operations of the Paulsboro refinery beginning September 17,
1998.
(2) The 1998 operating loss includes a $170.9 million write-down of inventories
to market value, which resulted in a $111.1 million reduction in net income,
or $1.98 per share.
(3) Includes the operations of the Texas City, Houston and Krotz Springs
refineries beginning May 1, 1997.
(4) Reflects the results of our former parent's natural gas related services
business for periods prior to the July 31, 1997 spin-off of our common
stock.
(5) Earnings before interest, taxes, depreciation and amortization ("EBITDA") is
presented as a measure of our ability to service our debt and to make
capital expenditures. It is not a measure of operating results and is not
presented in our consolidated financial statements.
S-30
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Valero is one of the largest and most geographically diverse independent
petroleum refining and marketing companies in the United States. As of March 31,
2000, Valero owned five refineries in Texas, Louisiana and New Jersey, providing
it with core operations on both the Gulf Coast and the East Coast. These
refineries are located in Corpus Christi, Houston, and Texas City in Texas,
Krotz Springs, Louisiana and Paulsboro, New Jersey. In addition, on March 2,
2000, Valero entered into an agreement to purchase ExxonMobil's Benicia
refinery, the Service Station Assets and the Distribution Assets, thereby
establishing a significant presence on the West Coast and extending its
geographic reach from coast to coast. The acquisition of the Benicia refinery
and the Distribution Assets closed on May 15, 2000 and the acquisition of the
Service Station Assets is expected to close on or about June 15, 2000. The
acquisition of the Benicia refinery increased Valero's throughput capacity from
approximately 790,000 BPD to approximately 950,000 BPD.
Valero produces premium, environmentally clean products such as reformulated
gasoline, low-sulfur diesel and oxygenates and is able to produce CARB gasoline.
Valero also produces a substantial slate of middle distillates, jet fuel and
petrochemicals. Valero has distinguished itself among independent refiners by
cost effectively upgrading its refineries to not only increase output but also
increase overall refining complexity and flexibility, enhancing Valero's ability
to process lower cost feedstocks into higher value-added premium products.
Valero processes a wide slate of feedstocks including medium sour crude oils,
heavy sweet crudes and residual fuel oils, or resid, which can typically be
purchased at a discount to West Texas Intermediate, a benchmark crude oil.
Between 45% and 50% of Valero's total gasoline production is typically
reformulated gasoline ("RFG"), which sells at a premium over conventional grades
of gasoline. The Benicia refinery produces approximately 110,000 BPD of
gasoline, approximately 95% of which is CARB gasoline. Valero also produces over
75% of its distillate slate as low-sulfur diesel and jet fuel, which sell at a
premium over high-sulfur heating oil. In addition to its feedstock and product
advantages, Valero has synergies among its Gulf Coast refineries which allow
Valero to transfer intermediate feedstocks such as deasphalted oil, or DAO, and
atmospheric tower bottoms, or ATBs, among the Texas City, Houston and Corpus
Christi refineries. With the Benicia acquisition, Valero's products are marketed
in 35 states as well as to selected export markets.
FACTORS AFFECTING OPERATING RESULTS
Valero'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 Valero's
control, including the global, national and regional supply and demand for crude
oil, gasoline, diesel, heating oil and other feedstocks and 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 also 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. Expansion of existing facilities
and installation of additional refinery crude distillation and upgrading
facilities, price volatility, international political and economic developments
and other factors beyond Valero's control are likely to continue to play an
important role in refining industry economics. These factors can impact, among
other things, the level of inventories in the market resulting in price
volatility and a reduction in product margins. 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. For example, three consecutive unseasonably warm
winters in the Northeast resulted in reduced demand, unusually high inventories
and considerably lower prices for heating oil during 1999.
S-31
<PAGE> 32
A large portion of Valero's feedstock supplies are secured under term contracts.
There is no assurance, however, of renewal of these contracts upon their
expiration or that economically equivalent substitute supply contracts can be
secured. Feedstock supplies from international producers are loaded aboard
chartered vessels and are subject to the usual maritime hazards. If foreign
sources of crude oil or access to the marine system for delivering crude oil
were curtailed, Valero'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 its 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 Valero manufactures a significant portion of its gasoline as RFG and can
produce approximately 28,000 BPD of oxygenates, certain federal and state
clean-fuel programs significantly affect its operations and the markets in which
Valero sells refined products. In the future, Valero cannot control or with
certainty predict the effect these clean-fuel programs may have 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. Phase II of the federal RFG program became effective January
2000, further restricting the acceptable levels of nitrous oxides, volatile
organic compounds and toxics in gasoline. In order to meet the new restrictions,
refiners, including Valero, will necessarily need to reduce the sulfur, benzene
and vapor pressure of gasoline, which could effectively reduce the production
capacity of U.S. refiners.
Because Valero's refineries are generally more complex than many conventional
refineries and are designed to process heavy and sour crude oils, including
resid, its operating costs per barrel are generally higher than those of most
conventional refiners. But because Valero's primary feedstocks usually sell at
discounts to benchmark crude oil, Valero has generally been able to recover its
higher operating costs by generating higher margins than many conventional
refiners that use lighter and sweeter crudes as their principal feedstocks.
Moreover, through recent acquisitions, improvements in technology and
modifications to its operating units, Valero has improved its flexibility to
process different types of feedstocks, including heavy crude oils. Valero
expects its primary feedstocks will 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.
After the acquisition of the retail assets from ExxonMobil, Valero's earnings
and cash flow from operations will also be affected by the costs necessary to
achieve brand recognition and loyalty in the retail gasoline business and the
costs necessary to accept credit cards from consumers. See "Risk Factors -- We
do not have an operating history in the retail business."
OUTLOOK
During the last half of 1998 and throughout most of 1999, Valero operated in an
environment characterized by very weak refining industry fundamentals. These
weak industry fundamentals caused a significant increase in refined product
inventories and put downward pressure on refined product prices. OPEC's decision
in March 1999 to curtail crude oil production resulted in a reduced supply of
the heavier crude oils which are Valero's primary feedstocks, thus resulting in
higher feedstock costs and lower discounts. These conditions combined to create
an exceptionally difficult period for refiners, including Valero.
Beginning in late 1999, however, the weak refining industry fundamentals that
had prevailed during the latter half of 1998 and most of 1999 began to show
signs of improvement. In March 2000, OPEC met and agreed to increase crude oil
production. In addition, during the last several months of 1999 and into 2000,
refined product inventories fell dramatically. According to reports of the
Department of Energy and other
S-32
<PAGE> 33
industry publications, the decline in finished product inventory levels was
attributable to the following factors:
- Lower crude oil supplies resulting primarily from OPEC's decision in March
1999 to curtail production.
- Reduced refinery utilization rates in the U.S., to rates below 90% compared
to rates that were above 95% in early 1999.
- Colder weather in the Northeastern U.S. in early 2000.
- Strong economic growth in the U.S. and abroad.
Valero anticipates that refining industry margins for 2000 will benefit from
improved industry fundamentals. This expectation is based on several
assumptions, including the following:
- According to the International Energy Agency (April 2000 report), worldwide
crude oil demand for 2000 is projected to grow about 1.6 million barrels per
day, up from 1.2 million barrels per day growth in 1999. Valero expects that
increased production resulting from OPEC's decision to increase crude oil
production should more than offset this increased demand resulting in
improved feedstock discounts.
- The Department of Energy projects a growth in gasoline demand for 2000 of
over 1% as well as increased demand for low-sulfur diesel and jet fuel.
- The International Energy Agency and the Department of Energy project a
stronger demand for light products in Europe and Asia, which in turn is
expected to result in reduced available volumes for imports into the U.S.
- More stringent fuel specifications in the U.S. and Europe became effective at
the beginning of 2000 and Valero expects that this should result in a
reduction in refinery light product yields.
- The Oil and Gas Journal (December 20, 1999 survey) projected a slowdown in
increases to industry refining capacity.
- Petrochemical margins have improved significantly in 2000 as a result of the
improving worldwide economy and increased demand for petrochemical
feedstocks, which are used in both the petrochemical industry and as gasoline
blendstocks.
Thus far in the second quarter of 2000, refining industry margins have improved
from the already strong conditions that existed during the first quarter of
2000. Gasoline margins on average have increased from first quarter levels, and
are significantly in excess of second quarter 1999 margins, due to low inventory
levels and continued strong demand. Heating oil margins on average have also
dramatically improved from the negative margins experienced in the second
quarter of 1999 due to low inventories and cooler weather in the Northeast. In
addition, OPEC's agreement in March 2000 to increase crude oil production has
resulted in improved feedstock discounts and contributed, along with improving
supply and demand fundamentals, to higher petrochemical and lube oil margins and
other refined product margins.
During the second quarter of 2000, Valero incurred downtime in connection with a
scheduled maintenance turnaround of the fluid catalytic cracking unit at its
Paulsboro refinery (approximately 51 days) and certain unscheduled maintenance
of the heavy oil cracker at its Corpus Christi refinery (approximately 11 days).
Although this downtime will somewhat offset the improvement in margins during
the second quarter discussed above, Valero believes that capacity expansions and
operational improvements implemented during this downtime will benefit its
future operations. As refining margins merit, Valero 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 these capital improvements are expected to be
performed during scheduled maintenance turnarounds.
Valero expects demand, both domestically and worldwide, for clean-burning fuels
such as RFG to continue to increase as a result of the worldwide movement to
reduce lead and certain other pollutants and
S-33
<PAGE> 34
contaminants in gasoline. Valero expects this increasing demand for
clean-burning fuels to sustain increased demand for oxygenates such as MTBE.
However, public concern that MTBE has contaminated water supplies has resulted
in certain states and the EPA passing or proposing restrictions on or banning
the use of MTBE. If MTBE were to be restricted or banned throughout the U.S.,
Valero believes that its MTBE-producing facilities, other than the Benicia
refinery discussed below, could be modified to produce other gasoline
blendstocks or other petrochemicals for a capital investment of approximately
$22 million. (Valero estimates that the cost for permitting and modification of
the Benicia refinery in order to comply with CARB Phase III specifications and
eliminate MTBE as a gasoline component is approximately $20 million.) Since the
volume of alternative products that could be produced would be less than the
current production of MTBE and the price of such alternative products is
currently lower than the price of MTBE, Valero's results of operations could
potentially be materially adversely affected. Valero anticipates, however, that
if MTBE were to be restricted or banned, the resulting industry-wide shortage in
octane-enhancing components would cause a significant change in the economics
related to Valero's various alternative products, and as a result, such an
action would not be expected to have a material adverse effect on Valero. See
"Risk Factors -- The banning of the use of MTBE could adversely affect us."
Valero expects that various industry consolidations through mergers and
acquisitions will continue, making for a more competitive business environment
while providing Valero with potential opportunities to expand its operations.
The financial results of the assets purchased in the Benicia acquisition for
1998, 1999 and the quarter ended March 31, 2000 are set forth in the financial
statements included herein. Valero currently expects that the outlook for the
Benicia refinery will be consistent with the industry trends discussed above.
RESTRUCTURING
Valero was incorporated in Delaware in 1981 under the name Valero Refining and
Marketing Company as a wholly owned subsidiary of Valero Energy Corporation,
referred to as Old Valero. Old Valero was engaged in both the refining and
marketing business and the natural gas related services business. On July 31,
1997, Old Valero spun off Valero to Old Valero's stockholders by distributing
all of the common stock of Valero. Immediately after this distribution, Old
Valero, with its remaining natural gas related services business, merged with a
wholly owned subsidiary of PG&E Corporation. The distribution of Valero common
stock to Old Valero's stockholders and the merger of Old Valero with the
subsidiary of PG&E Corporation 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." As a result of the Restructuring, Valero became a "successor
registrant" to Old Valero for financial reporting purposes under the federal
securities laws. Accordingly, for periods before the Restructuring, the
following Management's Discussion and Analysis of Financial Condition and
Results of Operations, and the consolidated financial statements included
elsewhere in this prospectus supplement, reflect Old Valero's natural gas
related services business as discontinued operations of Valero.
S-34
<PAGE> 35
RESULTS OF OPERATIONS
First Quarter 2000 Compared to First Quarter 1999
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------
CHANGE
--------------------
2000 1999 AMOUNT %
------------ ------------ ------------ -----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Operating revenues......................... $ 2,928,617 $ 1,337,103 $ 1,591,514 119%
Cost of sales.............................. (2,683,680) (1,154,960) (1,528,720) (132)
Operating costs:
Cash (fixed and variable)................ (132,371) (119,442) (12,929) (11)
Depreciation and amortization............ (34,477) (35,127) 650 2
Selling and administrative expenses
(including related depreciation
expense)................................. (21,037) (19,054) (1,983) (10)
----------- ----------- -----------
Total operating income........... $ 57,052 $ 8,520 $ 48,532 570
=========== =========== ===========
Other income (expense), net................ $ 2,647 $ (79) $ 2,726 --(1)
Interest and debt expense, net............. $ (12,760) $ (12,457) $ (303) (2)
Income tax (expense) benefit............... $ (16,200) $ 1,300 $ (17,500) --(1)
Net income (loss).......................... $ 30,739 $ (2,716) $ 33,455 --(1)
Earnings (loss) per share of common stock-
assuming dilution........................ $ .54 $ (.05) $ .59 --(1)
Earnings before interest, taxes,
depreciation and amortization
("EBITDA")............................... $ 95,950 $ 45,111 $ 50,839 113
Ratio of EBITDA to interest incurred....... 6.8x 3.2x 3.6x 113
</TABLE>
------------
(1) Percentage variance is not meaningful.
S-35
<PAGE> 36
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------
CHANGE
------------
2000 1999 AMOUNT %
------ ------ ------ ---
<S> <C> <C> <C> <C>
Sales volumes (Mbbls per day)............................... 1,002 1,050 (48) (5)%
Throughput volumes (Mbbls per day).......................... 744 698 46 7
Average throughput margin per barrel........................ $ 3.62 $ 2.90 $ .72 25
Operating costs per barrel:
Cash (fixed and variable)................................. $ 1.95 $ 1.90 $ .05 3
Depreciation and amortization............................. .51 .56 (.05) (9)
------ ------ -----
Total operating costs per barrel.................. $ 2.46 $ 2.46 $ -- --
====== ====== =====
Charges:
Crude oils:
Sour................................................... 52% 51% 1% 2
Heavy sweet............................................ 9 11 (2) (18)
Light sweet............................................ 9 10 (1) (10)
------ ------ -----
Total crude oils.................................. 70 72 (2) (3)
High-sulfur residual fuel oil, or "resid"................. 4 3 1 33
Low-sulfur resid.......................................... 4 4 -- --
Other feedstocks and blendstocks.......................... 22 21 1 5
------ ------ -----
Total charges..................................... 100% 100% --% --
====== ====== =====
Yields:
Gasolines and blendstocks................................. 50% 51% (1)% (2)
Distillates............................................... 30 31 (1) (3)
Petrochemicals............................................ 5 4 1 25
Lubes and asphalts........................................ 3 2 1 50
Other products............................................ 12 12 -- --
------ ------ -----
Total yields...................................... 100% 100% --% --
====== ====== =====
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------
CHANGE
------------
2000 1999 AMOUNT %
------ ------ ------ ---
(DOLLARS PER BARREL)
<S> <C> <C> <C> <C>
Feedstocks:
West Texas Intermediate, or "WTI," crude oil.............. $28.90 $13.05 $15.85 121%
WTI less sour crude oil(1)................................ $ 2.38 $ 2.45 $(.07) (3)
WTI less sweet crude oil(2)............................... $ .45 $ .90 $(.45) (50)
Products (U.S. Gulf Coast):
Conventional 87 gasoline less WTI......................... $ 4.27 $ 1.67 $2.60 156
No. 2 fuel oil less WTI................................... $ 1.84 $ .31 $1.53 494
Propylene less WTI........................................ $ 2.32 $ (.30) $2.62 873
</TABLE>
------------
(1) The market reference differential for sour crude oil is based on U.S. Gulf
Coast posted prices for 50% Arab medium and 50% Arab light.
(2) The market reference differential for sweet crude oil is based on Platt's
posted prices for 50% light Louisiana sweet, or "LLS," and 50% Cusiana.
S-36
<PAGE> 37
General. Valero reported net income for the first quarter of 2000 of $30.7
million, or $.54 per share, compared to a net loss of $2.7 million, or $.05 per
share, for the first quarter of 1999. The increase in first quarter results was
due primarily to dramatically improved refining industry fundamentals which
resulted in a significant increase in refined product margins. Also contributing
to higher first quarter results was a 46,000 barrel-per-day increase in
throughput volumes. This was due in large part to the effect of a major
maintenance turnaround of the heavy oil cracker and related units at Valero's
Corpus Christi refinery in the first quarter of 1999, as well as certain unit
expansions implemented during that downtime. Partially offsetting the increases
in income resulting from these factors were higher cash operating costs, lower
income from trading activities, the nonrecurrence in 2000 of a benefit to income
in 1999 related to a permanent reduction in LIFO inventories and an increase in
income tax expense.
Operating Revenues. Operating revenues increased $1.6 billion, or 119%, to $2.9
billion during the first quarter of 2000 compared to the same period in 1999 due
to a $17.97, or 127%, increase in the average sales price per barrel, partially
offset by a 5% decrease in average daily sales volumes. The increase in sales
prices was due to significantly higher refined product prices resulting from
reduced refined product inventories which reached historically low levels in the
first quarter of 2000. This decline in inventory levels was attributable
primarily to lower crude oil supplies resulting from OPEC's decision in March
1999 to significantly reduce production, and to lower refinery utilization
rates. During most of the first quarter of 1999, sales prices were extremely
depressed due to excess refined product inventories prior to the OPEC decision
to curtail crude oil production.
Operating Income. Operating income increased $48.5 million to $57.1 million
during the first quarter of 2000 compared to the first quarter of 1999 due
primarily to an approximate $63 million increase in total throughput margins
(discussed below), partially offset by an approximate $13 million increase in
cash operating costs and an approximate $2 million increase in selling and
administrative expenses (including related depreciation expense). Cash operating
costs were higher due primarily to increased catalyst costs associated with
processing more lower-cost feedstocks, and higher fuel costs attributable mainly
to an increase in natural gas prices. Selling and administrative expenses
(including related depreciation expense) increased primarily as a result of an
increase in employee-related costs.
Total throughput margins (operating revenues less cost of sales) increased due
to (i) significantly higher gasoline and distillate margins resulting primarily
from the improved industry conditions noted above, (ii) the increase in
throughput volumes discussed above, and (iii) higher petrochemical margins
resulting from improving worldwide demand, most particularly in Asia. Partially
offsetting the increases in total throughput margins resulting from these
factors were (i) a decrease in feedstock discounts relative to WTI, (ii) lower
lube, fuel oil and other margins resulting mainly from higher crude oil prices,
(iii) a decrease in gains from trading activities from $12.8 million in the
first quarter of 1999 to $1.8 million in the first quarter of 2000, and (iv) the
nonrecurrence in 2000 of a $10.5 million benefit in the first quarter of 1999
resulting from the liquidation of LIFO inventories. The 1999 trading profits and
LIFO benefit were attributable to a steep increase in prices at the end of the
1999 first quarter.
Other Income. Other income (expense), net, increased by $2.7 million during the
first quarter of 2000 compared to the same period in 1999 due primarily to
improved results from Valero's 20% equity interest in the Javelina off-gas
processing plant in Corpus Christi attributable primarily to higher ethylene and
other product prices, partially offset by higher natural gas feedstock costs.
S-37
<PAGE> 38
Income Tax Expense. Income taxes increased from an income tax benefit of $1.3
million in the first quarter of 1999 to income tax expense of $16.2 million in
the first quarter of 2000 due primarily to a significant increase in pre-tax
income.
1999 Compared to 1998
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
CHANGE
------------------
1999 1998(1) AMOUNT %
----------- ----------- ----------- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Operating revenues......................... $ 7,961,168 $ 5,539,346 $ 2,421,822 44%
Cost of sales.............................. (7,200,584) (4,792,665) (2,407,919) (50)
Operating costs:
Cash (fixed and variable)................ (480,106) (435,542) (44,564) (10)
Depreciation and amortization............ (138,625) (119,524) (19,101) (16)
Selling and administrative expenses
(including related depreciation
expense)................................. (72,712) (71,884) (828) (1)
----------- ----------- -----------
Operating income, before inventory
write-down............................... 69,141 119,731 (50,590) (42)
Write-down of inventories to market
value.................................... -- (170,929) 170,929 --(2)
----------- ----------- -----------
Total operating income (loss).... $ 69,141 $ (51,198) $ 120,339 235
=========== =========== ===========
Other income, net.......................... $ 6,475 $ 586 $ 5,889 --(2)
Interest and debt expense, net............. $ (55,429) $ (32,479) $ (22,950) (71)
Income tax (expense) benefit............... $ (5,900) $ 35,800 $ (41,700) (116)
Net income (loss).......................... $ 14,287 $ (47,291)(3) $ 61,578 130
Earnings (loss) per share of common
stock--assuming dilution................. $ .25 $ (.84)(3) $ 1.09 130
Earnings before interest, taxes,
depreciation and amortization
("EBITDA")............................... $ 219,657 $ 244,523(4) $ (24,866) (10)
Ratio of EBITDA to interest incurred....... 3.6x 6.5x (2.9)x (45)
</TABLE>
------------
(1) Includes the operations of the Paulsboro refinery beginning September 17,
1998.
(2) Percentage variance is not meaningful.
(3) Includes a $111.1 million, or $1.98 per share, effect resulting from the
$170.9 million pre-tax write-down of inventories to market value.
(4) Excludes the $170.9 million pre-tax write-down of inventories to market
value.
S-38
<PAGE> 39
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
CHANGE
------------
1999 1998(1) AMOUNT %
------ ------- ------ ---
<S> <C> <C> <C> <C>
Sales volumes (MBPD)...................................... 1,033 894 139 16%
Throughput volumes (MBPD)(2).............................. 712 579 133 23
Average throughput margin per barrel...................... $ 2.93 $3.53(3) $(.60) (17)
Operating costs per barrel:
Cash (fixed and variable)............................... $ 1.85 $2.06 $(.21) (10)
Depreciation and amortization........................... .53 .57 (.04) (7)
------ ----- -----
Total operating costs per barrel................ $ 2.38 $2.63 $(.25) (10)
====== ===== =====
Charges:
Crude oils:
Sour................................................. 48% 37% 11% 30
Heavy sweet.......................................... 12 20 (8) (40)
Light sweet.......................................... 9 11 (2) (18)
------ ----- -----
Total crude oils................................ 69 68 1 1
High-sulfur residual fuel oil, or "resid"............... 3 9 (6) (67)
Low-sulfur resid........................................ 6 3 3 100
Other feedstocks and blendstocks........................ 22 20 2 10
------ ----- -----
Total charges................................... 100% 100% --% --
====== ===== =====
Yields:
Gasolines and blendstocks............................... 51% 53% (2)% (4)
Distillates............................................. 29 28 1 4
Petrochemicals.......................................... 5 4 1 25
Lubes and asphalts...................................... 3 1 2 200
Other products.......................................... 12 14 (2) (14)
------ ----- -----
Total yields.................................... 100% 100% --% --
====== ===== =====
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
CHANGE
------------
1999 1998 AMOUNT %
------ ------- ------ ---
(DOLLARS PER BARREL)
<S> <C> <C> <C> <C>
Feedstocks:
West Texas Intermediate, or "WTI," crude oil............ $19.28 $14.41 $4.87 34%
WTI less sour crude oil(4)(6)........................... $ 2.40 $ 2.74 $(.34) (12)
WTI less sweet crude oil(5)(6).......................... $ .57 $ .66 $(.09) (14)
WTI less high-sulfur resid (Singapore).................. $ 1.63 $ 1.57 $ .06 4
Products (U.S. Gulf Coast):
Conventional 87 gasoline less WTI....................... $ 2.53 $ 2.98 $(.45) (15)
No. 2 fuel oil less WTI................................. $ .33 $ 1.45 $(1.12) (77)
Propylene less WTI...................................... $ .93 $ 2.23 $(1.30) (58)
</TABLE>
------------
(1) Includes the operations of the Paulsboro refinery beginning September 17,
1998.
(2) Includes 173 MBPD and 46 MBPD for 1999 and 1998, respectively, related to
the Paulsboro refinery.
(3) Excludes an $.81 per barrel reduction resulting from the $170.9 million
pre-tax write-down of inventories to market value.
(4) The market reference differential for sour crude oil is based on U.S. Gulf
Coast posted prices for 50% Arab medium and 50% Arab light.
(5) The market reference differential for sweet crude oil is based on Platt's
posted prices for 50% light Louisiana sweet, or "LLS," and 50% Cusiana.
(6) The market reference differentials for 1999 and 1998 have been restated from
amounts reported in the 1999 Form 10-K to conform to market reference prices
used in 2000.
S-39
<PAGE> 40
General. Valero reported net income of $14.3 million, or $.25 per share, for the
year ended December 31, 1999 compared to a net loss of $47.3 million, or $.84
per share, for the year ended December 31, 1998. Non-cash inventory write-downs
resulting from significant declines in feedstock and refined product prices
reduced the total year 1998 results by $170.9 million. Before the effect of the
inventory write-downs, net income for 1998 was $63.8 million, or $1.14 per
share.
The 1999 results were well below 1998 levels, before the effects of the 1998
inventory write-downs, due to historically weak refining industry fundamentals
during the first half of 1999, the effect of significant downtime at Valero's
Corpus Christi refinery in early 1999 due to a major maintenance turnaround and
expansion of the heavy oil cracker and related units, and increased interest
expense. Partially offsetting these decreases in income were improvements in
industry conditions in the second half of 1999, a significant reduction in cash
operating costs (excluding the effect of the Paulsboro refinery) resulting from
Valero's comprehensive cost reduction efforts, and benefits to income related to
reductions in LIFO inventories during the first and fourth quarters of 1999.
Operating Revenues. Operating revenues increased $2.4 billion, or 44%, to $8.0
billion during 1999 compared to 1998 due to a $4.14, or 24%, increase in the
average sales price per barrel and a 16% increase in average daily sales
volumes. The increase in sales volumes was due primarily to the September 1998
acquisition of the Paulsboro refinery, while the increase in sales prices was
due primarily to higher crude oil prices attributable to OPEC production cuts
announced in March 1999 and lower refined product inventories in the second half
of the year.
Operating Income (Loss). Operating income increased $120.3 million, from a $51.2
million operating loss in 1998 to operating income of $69.1 million in 1999, due
in large part to the 1998 inventory write-downs of $170.9 million noted above.
Excluding the effect of these write-downs, operating income decreased $50.6
million, or 42%, during 1999 compared to 1998. This decrease was due primarily
to an approximate $98 million increase in operating costs attributable to a full
year of operations in 1999 for the Paulsboro refinery, and an approximate $9
million increase in depreciation expense and amortization of deferred turnaround
and catalyst costs for all refineries exclusive of the Paulsboro refinery.
Partially offsetting these decreases was an approximate $43 million reduction in
cash operating costs for all refineries exclusive of the Paulsboro refinery,
primarily due to lower maintenance expense, energy savings and improved energy
efficiencies, and reduced catalyst and chemical costs, all resulting from
Valero's cost savings initiatives implemented in early 1999. Also partially
offsetting the above-noted decreases in operating income was an increase in
total throughput margins of approximately $14 million.
Total throughput margins (operating revenues less cost of sales) increased in
1999 compared to 1998 due primarily to (i) the contribution from the Paulsboro
refinery resulting from a full year of operations in 1999, (ii) benefits from
higher sales volumes (excluding higher volumes resulting from the full-year
effect of Paulsboro refinery operations), including benefits resulting from the
liquidation of LIFO inventories in the first and fourth quarters of 1999 of
$10.5 million and $9.3 million, respectively, and (iii) benefits from trading
activities of approximately $17 million in 1999 compared to $1 million in 1998.
The positive effect on throughput margins resulting from these factors was
offset to a large extent by extremely depressed refining industry fundamentals
in the first half of 1999. Distillate and gasoline margins were significantly
below 1998 levels during this period (average distillate margins were negative
in the first half of 1999) as above-average refined product inventory levels
resulted in depressed refined product prices, while crude oil prices increased
due to the OPEC production cuts announced in March 1999. Furthermore,
petrochemical margins were lower during the first half of 1999 resulting from
depressed demand for petrochemical feedstocks due to the Asian economic crisis.
Although industry conditions improved in the second half of 1999 as refined
product inventories declined due to both an increase in demand and reduced
refinery utilization rates, increasingly higher crude oil prices resulting from
a continuation of reduced OPEC production limited the improvement in product
margins during this period. Total throughput margins were also negatively
affected in 1999 compared to 1998 by a decrease in crude oil feedstock discounts
relative to WTI and reduced income from hedging activities under Valero's price
risk management program. In 1999, Valero's hedging activities resulted in a
reduction of total throughput margins of approximately $10 million compared to a
benefit of approximately $17 million in 1998. See "--Quantitative and
Qualitative
S-40
<PAGE> 41
Disclosures About Market Risk," Note 1 of Notes to Consolidated Financial
Statements for the year ended December 31, 1999 under "Price Risk Management
Activities," and Note 7 of Notes to Consolidated Financial Statements for the
year ended December 31, 1999 for additional information regarding Valero's
hedging and trading activities.
Other Income. Other income, net, increased by $5.9 million to $6.5 million
during 1999 compared to 1998 due primarily to improved results from Valero's 20%
equity interest in the Javelina off-gas processing plant in Corpus Christi (see
Note 1 of Notes to Consolidated Financial Statements for the year ended December
31, 1999 under "Deferred Charges and Other Assets") attributable primarily to
higher ethylene and other product prices, partially offset by higher natural gas
feedstock costs.
Net Interest and Debt Expense. Net interest and debt expense increased $22.9
million, or 71%, to $55.4 million during 1999 compared to 1998 primarily due to
the full-year effect of higher borrowings resulting from the acquisition of the
Paulsboro refinery in September 1998, and to a lesser extent, to an increase in
average interest rates.
Income Tax Expense (Benefit). Income taxes increased from a $35.8 million
benefit in 1998 to a $5.9 million expense in 1999 due primarily to the
significant increase in pre-tax income and, to a lesser extent, to the
recognition in 1998 of $5.8 million related to a research and experimentation
tax credit. See Note 12 of Notes to Consolidated Financial Statements for the
year ended December 31, 1999.
S-41
<PAGE> 42
1998 Compared to 1997
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
CHANGE
-------------------
1998(1) 1997(2) AMOUNT %
----------- ----------- --------- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<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)(3) $ 111,768 $(159,059) (142)
Loss from discontinued operations, net
of income tax benefit(4)............. $ -- $ (15,672) $ 15,672 100
Net income (loss)...................... $ (47,291)(3) $ 96,096 $(143,387) (149)
Net income (loss) applicable to common
stock................................ $ (47,291)(3) $ 91,504 $(138,795) (152)
Earnings (loss) per share of common
stock--assuming dilution:
Continuing operations................ $ (.84)(3) $ 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(5) $ 313,025 $ (68,502) (22)
Ratio of EBITDA to interest
incurred(6).......................... 6.5x 7.1x (.6)x (8)
</TABLE>
------------
(1) Includes the operations of the Paulsboro refinery beginning September 17,
1998.
(2) Includes the operations of the Texas City, Houston and Krotz Springs
refineries beginning May 1, 1997.
(3) Includes a $111.1 million, or $1.98 per share, effect resulting from the
$170.9 million pre-tax write-down of inventories to market value.
(4) Reflects the results of Old Valero's natural gas related services business
for periods prior to the July 31, 1997 Restructuring.
(5) Excludes the $170.9 million pre-tax write-down of inventories to market
value.
(6) Interest incurred for 1997 includes $18,164 of interest on corporate debt
that was allocated to continuing operations (see Note 4 of Notes to
Consolidated Financial Statements for the year ended December 31, 1999).
S-42
<PAGE> 43
OPERATING HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
CHANGE
------------
1998(1) 1997(2) AMOUNT %
------- ------- ------ ---
<S> <C> <C> <C> <C>
Sales volumes (MBPD)........................................ 894 630 264 42%
Throughput volumes (MBPD)................................... 579(3) 417(4) 162 39
Average throughput margin per barrel........................ $3.53(5) $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
===== ===== =====
Charges:
Crude oils:
Sour.................................................... 37% 26% 11% 42
Heavy sweet............................................. 20 21 (1) (5)
Light sweet............................................. 11 10 1 10
----- ----- -----
Total crude oils................................... 68 57 11 19
High-sulfur resid......................................... 9 17 (8) (47)
Low-sulfur resid.......................................... 3 3 -- --
Other feedstocks and blendstocks.......................... 20 23 (3) (13)
----- ----- -----
Total charges...................................... 100% 100% --% --
===== ===== =====
Yields:
Gasolines and blendstocks................................. 53% 53% --% --
Distillates............................................... 28 25 3 12
Petrochemicals............................................ 4 6 (2) (33)
Lubes and asphalts........................................ 1 -- 1 --
Other products............................................ 14 16 (2) (13)
----- ----- -----
Total yields....................................... 100% 100% --% --
===== ===== =====
</TABLE>
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
CHANGE
------------
1998 1997 AMOUNT %
------ ------ ------ ---
(DOLLARS PER BARREL)
<S> <C> <C> <C> <C>
Feedstocks:
WTI crude oil............................................. $14.41 $20.61 $(6.20) (30)%
WTI less sour crude oil(6)(8)............................. $ 2.74 $ 2.56 $ .18 7
WTI less sweet crude oil(7)(8)............................ $ .66 $ .36 $ .30 83
WTI less high-sulfur resid (Singapore).................... $ 1.57 $ 2.61 $(1.04) (40)
Products (U.S. Gulf Coast):
Conventional 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 beginning September 17,
1998.
(2) Includes the operations of the Texas City, Houston and Krotz Springs
refineries beginning May 1, 1997.
(3) Includes 46 MBPD related to the Paulsboro refinery.
(4) Includes 238 MBPD related to the Texas City, Houston and Krotz Springs
refineries.
(5) Excludes an $.81 per barrel reduction resulting from the $170.9 million
pre-tax write-down of inventories to market value.
(6) The market reference differential for sour crude oil is based on U.S. Gulf
Coast posted prices for 50% Arab medium and 50% Arab light.
(7) The market reference differential for sweet crude oil is based on Platt's
posted prices for 50% light Louisiana sweet, or "LLS," and 50% Cusiana.
(8) The market reference differentials for 1998 and 1997 have been restated from
amounts reported in the 1999 Form 10-K to conform to market reference prices
used in 2000.
S-43
<PAGE> 44
General. Valero 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. The
1998 results were reduced by non-cash inventory write-downs totaling $170.9
million.
Excluding the effects of the inventory write-downs, total year 1998 net income
($63.8 million, or $1.14 per share) was still well below 1997 levels due to
extremely weak refining industry fundamentals in the latter half of 1998.
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 beginning 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 Restructuring on July 31, 1997. In
determining earnings per share for the year ended December 31, 1997, dividends
on Old Valero's preferred stock were deducted from income from discontinued
operations as such preferred stock was issued in connection with Old Valero'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 the acquisitions of the Texas City, Houston, Krotz Springs and
Paulsboro refineries, 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.
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 beginning 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 Texas City, Houston, Krotz Springs and Paulsboro 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 Valero's price risk management program. In 1998, Valero's
hedging activities resulted in a benefit to total throughput margins of
approximately $17 million, while in 1997, the effect of hedging activities was
slightly negative. 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.
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
S-44
<PAGE> 45
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, 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 Valero's 20% equity
interest in the Javelina off-gas processing plant due primarily to lower
petrochemical and other product prices, partially offset by lower natural gas
feedstock costs.
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 in connection with the
Restructuring, 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.
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.
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 Old Valero's natural gas related services business for
the seven months ended July 31, 1997, prior to the Restructuring. See Note 4 of
Notes to Consolidated Financial Statements for the year ended December 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities decreased $137.2 million during the
first quarter of 2000 compared to the same period in 1999 due primarily to a
$177.1 million increase in the amount of cash utilized for working capital
purposes, as detailed in Note 4 of Notes to Consolidated Financial Statements
for the three months ended March 31, 2000, partially offset by the increase in
earnings discussed above under "Results of Operations." In the first quarter of
2000, amounts needed by Valero to finance feedstock and refined product
inventories increased significantly due to higher inventory levels as well as an
increase in commodity prices from December 31, 1999 to March 31, 2000. Although
this increase in inventories was somewhat offset by an increase in accounts
payable resulting from the higher volume of inventory purchases, Valero incurred
a net increase in cash utilized for working capital purposes in the 2000 period
of approximately $63 million. Included in the changes in current assets and
current liabilities for the 1999 period was an increase in both accounts
receivable and accounts payable due primarily to a significant increase in
commodity prices during that quarter. However, concerted efforts by Valero to
collect accounts receivable and reduce inventory levels resulted in a net
decrease in cash utilized for working capital purposes of approximately $114
million in the first quarter of 1999. During the first quarter of 2000, cash
provided by operating activities of $11.2 million, existing cash balances of
$51.6 million and issuances of common stock related to Valero's benefit plans of
$5.9 million were utilized to reduce bank borrowings by $13.5 million, fund
capital expenditures and deferred turnaround and catalyst costs of $42 million,
repurchase $8.7 million of shares of Valero's common stock and pay $4.5 million
of common stock dividends.
Net cash provided by operating activities increased $269.3 million to $435.1
million during 1999 compared to 1998, primarily as a result of proactive efforts
by Valero to reduce working capital levels. During 1999,
S-45
<PAGE> 46
both accounts receivable and accounts payable increased significantly as crude
oil, gasoline, and heating oil prices more than doubled from December 31, 1998
to December 31, 1999. However, concerted efforts by Valero to collect accounts
receivable, and the sale of receivables in September 1999 as described in Note 2
of Notes to Consolidated Financial Statements for the year ended December 31,
1999, helped reduce the increase in receivables resulting from higher commodity
prices. In addition, a significant reduction in inventory levels helped to
offset the effect of higher commodity prices on the carrying amount of Valero's
inventories. All of these factors combined to reduce cash utilized for working
capital purposes by $296.3 million during 1999. During 1998, cash utilized for
working capital purposes increased $46.2 million, as a substantial decrease in
accounts payable was offset to a large extent by a decrease in accounts
receivable, both of which resulted from a significant decrease in commodity
prices from December 31, 1997 to December 31, 1998. During 1999, cash provided
by (i) operating activities, including the sale of accounts receivable discussed
above, (ii) proceeds from the issuance of 7 3/8% notes (approximately $297.5
million) and Series 1999 tax-exempt Waste Disposal Revenue Bonds ($25 million),
and (iii) issuances of common stock related to Valero's benefit plans were
utilized to reduce bank borrowings, redeem $25 million of Series 1998 taxable
Waste Disposal Revenue Bonds, fund capital expenditures and deferred turnaround
and catalyst costs, pay common stock dividends, purchase treasury stock and add
to existing cash balances.
Valero 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 the Credit Facility bear interest at either LIBOR plus
a margin, a base rate or a money market rate. Valero 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
Valero's long-term debt. The Credit Facility includes certain restrictive
covenants including a fixed-charge coverage ratio, a debt-to-capitalization
ratio, and a minimum net worth test. In connection with the Benicia acquisition,
in April 2000, the Credit Facility was amended to, among other things, increase
the total debt-to-capitalization limit from 50% to 65%. This ratio will decrease
to 60% at the earlier of March 31, 2001 or upon the issuance of $300 million of
equity or equity linked securities, and will further decrease to 55% on
September 30, 2001. These amendments to the credit facility became effective
upon closing of the acquisition of the Benicia refinery and the Distribution
Assets. Valero also currently has various uncommitted short-term bank credit
facilities, along with various uncommitted bank letter of credit facilities.
In connection with the funding of the Benicia acquisition, Valero entered into a
$600 million bridge loan facility. The Bridge Facility has a term of one year
with an option to extend for an additional two years, and has covenants similar
to the Credit Facility. Borrowings under the Bridge Facility bear interest at
LIBOR plus an applicable margin. Borrowings under the Bridge Facility, along
with borrowings under Valero's existing credit facilities and an interim lease
arrangement, were used to finance the acquisition of the Benicia refinery and
the Distribution Assets. In connection with the acquisition of the Service
Station Assets, Valero will enter into a structured lease arrangement with a
commitment of up to $135 million, substantially all of which will be used to
acquire the Service Station Assets and replace the interim lease arrangement for
the acquisition of the Benicia refinery's docking facility. Valero intends to
use the proceeds from this offering, the Equity Offering and the PEPS Units
Offering to pay down all amounts outstanding under the Bridge Facility and use
the remaining proceeds to reduce borrowings under the Credit Facility.
As of March 31, 2000, $126.5 million was outstanding under Valero's various bank
credit facilities and letters of credit totaling approximately $234 million were
outstanding under its various letter of credit facilities. As of May 15, 2000,
$486 million was outstanding under Valero's various bank credit facilities, $600
million was outstanding under the Bridge Facility and letters of credit totaling
approximately $160 million were outstanding under its various letter of credit
facilities. After giving effect to the Benicia acquisition and the related
financings, including the Offerings, as of March 31, 2000, Valero would have
S-46
<PAGE> 47
had total debt of $1.4 billion, $150 million aggregate liquidation amount of
trust preferred securities issued as part of the PEPS Units, and stockholders'
equity of $1.2 billion.
As of March 31, 2000, Valero's debt to capitalization ratio was 41%, a decrease
from 42% as of December 31, 1999. After giving effect to the Benicia acquisition
and the related financings, including the Offerings, Valero's debt to
capitalization ratio would have been 51% at March 31, 2000 (with 80% of the
aggregate liquidation amount of trust preferred securities issued as part of the
PEPS Units deemed to be equity for purposes of this computation).
During 1999, Valero reduced its exposure to increases in interest rates and
increased its financial flexibility by (i) issuing $300 million of seven-year
7 3/8% notes under its $600 million universal shelf registration statement and
using the net proceeds to reduce variable rate bank borrowings and (ii)
refinancing $25 million of its taxable, variable-rate industrial revenue bonds
with tax-exempt 5.7% fixed-rate bonds. See Note 6 of Notes to Consolidated
Financial Statements for the year ended December 31, 1999.
As described in Note 3 of Notes to Consolidated Financial Statements for the
year ended December 31, 1999, Salomon Smith Barney Inc. is entitled to receive
payments from Valero in any of the ten years following the May 1997 acquisition
of Basis and Mobil is entitled to receive payments in any of the five years
following the September 1998 acquisition of the Paulsboro refinery, if certain
average refining margins during any of these years exceed a specified level. Due
to depressed refining margins during the years ended May 1999 and September
1999, no earn-out payments were due to Salomon or Mobil during 1999. Based on
actual margins since May and September of 1999, and estimated margin levels
through September of 2000, Valero currently expects that no earn-out payments
will be due to Salomon or Mobil during 2000.
During the first quarter of 2000, Valero expended approximately $42 million for
capital investments, including capital expenditures of $25 million and deferred
turnaround and catalyst costs of $17 million. For total year 2000, Valero
currently expects to incur approximately $240 million for capital investments,
including approximately $160 million for capital expenditures and approximately
$80 million for deferred turnaround and catalyst costs. The capital expenditure
estimate includes approximately $15 million for computer system projects and
approximately $7 million for projects related to environmental control and
protection. The capital expenditure estimate does not include estimated
expenditures related to the installation of a scrubber at the Texas City
refinery, which will be financed through a lease arrangement, and the
installation of a scrubber at the Paulsboro refinery, which Valero expects will
be incurred primarily in 2003. See "Risk Factors -- Compliance with and changes
in environmental laws could adversely affect our performance." In addition to
the above, Valero expects to incur approximately $40 million for the year 2000
for capital expenditures and deferred turnaround and catalyst costs related to
the Benicia refinery and the Service Station Assets. Any major upgrades in any
of Valero's refineries could require additional expenditures to comply with
environmental laws and regulations. However, because environmental laws and
regulations are increasingly becoming more stringent and new environmental laws
and regulations are continuously being enacted or proposed, Valero cannot
predict with certainty the level of future expenditures that will be required
for environmental matters.
During 1999, Valero expended approximately $173 million for capital investments,
including capital expenditures of $100 million and deferred turnaround and
catalyst costs of $73 million. Capital expenditures included approximately $12
million for computer system projects and approximately $7 million for projects
related to environmental control and protection. The deferred turnaround and
catalyst costs related primarily to (i) a major maintenance turnaround of the
heavy oil cracker and related units at the Corpus Christi refinery in the first
quarter, (ii) a catalyst change for the Corpus Christi hydrodesulfurization unit
in the second quarter, (iii) a turnaround and catalyst change of the Texas City
residfiner also in the second quarter, and (iv) a turnaround of the reformer at
the Paulsboro refinery in the fourth quarter.
Valero's Board of Directors approved in the third quarter of 1998 a common stock
repurchase program allowing repurchase of up to $100 million of its common
stock. Through December 31, 1998, Valero had repurchased common shares at a cost
of approximately $15 million, and during the fourth quarter of 1999
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<PAGE> 48
and the first quarter of 2000, Valero repurchased additional shares of its
common stock at a cost of approximately $13 million and $7 million,
respectively. The shares repurchased will be used primarily to meet requirements
under Valero's employee benefit plans.
Dividends on Valero's common stock are considered quarterly by Valero'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. Valero has declared a dividend
of $.08 per common share for each quarter since the Restructuring.
Valero believes it has sufficient funds from operations, and to the extent
necessary, from the public and private capital markets and bank markets, to fund
its ongoing operating requirements. Valero expects that, to the extent
necessary, it can raise additional funds from time to time through equity or
debt financings. However, there can be no assurances regarding the availability
of any future financings or whether such financings will be available on terms
acceptable to Valero.
Valero'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 Valero's overall exposure to credit risk, either
positively or negatively, in that these customers may be similarly affected by
changes in economic or other conditions. However, Valero believes that its
portfolio of accounts receivable is sufficiently diversified to the extent
necessary to minimize potential credit risk. Historically, Valero has not had
any significant problems collecting its accounts receivable. Valero's accounts
receivable are not collateralized. See Note 2 of Notes to Consolidated Financial
Statements for the year ended December 31, 1999 for information regarding a
program entered into by Valero in September 1999 to sell up to $100 million of
an undivided percentage ownership interest in a designated pool of accounts
receivable.
NEW ACCOUNTING PRONOUNCEMENTS
As discussed in Note 6 of Notes to Consolidated Financial Statements for the
three months ended March 31, 2000, certain new financial accounting
pronouncements have been issued by the FASB which will become effective for
Valero's financial statements beginning in either July 2000 or January 2001.
Except for SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," for which the impact has not yet been determined, the adoption of
these pronouncements is not expected to have a material effect on Valero's
consolidated financial statements.
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<PAGE> 49
BUSINESS
Valero is one of the largest and most geographically diverse independent
petroleum refining and marketing companies in the United States. As of March 31,
2000, Valero owned five refineries in Texas, Louisiana and New Jersey, providing
it with core operations on both the Gulf Coast and the East Coast. These
refineries are located in Corpus Christi, Houston, and Texas City in Texas,
Krotz Springs, Louisiana and Paulsboro, New Jersey. In addition, on March 2,
2000, Valero entered into an agreement to purchase ExxonMobil's Benicia
refinery, the Service Station Assets and the Distribution Assets, thereby
establishing a significant presence on the West Coast and extending its
geographic reach from coast to coast. The acquisition of the Benicia refinery
and the Distribution Assets closed on May 15, 2000 and the acquisition of the
Service Station Assets is expected to close on or about June 15, 2000. The
acquisition of the Benicia refinery increased Valero's throughput capacity from
approximately 790,000 BPD to approximately 950,000 BPD.
Valero produces premium, environmentally clean products such as reformulated
gasoline, low-sulfur diesel and oxygenates and is able to produce CARB gasoline.
Valero also produces a substantial slate of middle distillates, jet fuel and
petrochemicals. Valero has distinguished itself among independent refiners by
cost effectively upgrading its refineries to not only increase output but also
increase overall refining complexity and flexibility, enhancing Valero's ability
to process lower cost feedstocks into higher value-added premium products.
Valero processes a wide slate of feedstocks including medium sour crude oils,
heavy sweet crudes and residual fuel oils, or resid, which can typically be
purchased at a discount to West Texas Intermediate, a benchmark crude oil.
Between 45% and 50% of Valero's total gasoline production is typically RFG,
which sells at a premium over conventional grades of gasoline. The Benicia
refinery produces approximately 110,000 BPD of gasoline, approximately 95% of
which is CARB gasoline. Valero also produces over 75% of its distillate slate as
low-sulfur diesel and jet fuel, which sell at a premium over high-sulfur heating
oil. In addition to its feedstock and product advantages, Valero has synergies
among its Gulf Coast refineries which allow Valero to transfer intermediate
feedstocks such as deasphalted oil, or DAO, and atmospheric tower bottoms, or
ATBs, among the Texas City, Houston and Corpus Christi refineries. With the
Benicia acquisition, Valero's products are marketed in 35 states as well as to
selected export markets.
VALERO'S STRATEGIC DIRECTION
Valero intends to remain a premier, independent refining and marketing company
that focuses on innovative, efficient upgrading of its facilities to refine
lower-cost feedstocks into higher value-added premium products. Valero's
strategic objectives include the following:
- Accretive Growth through Acquisitions. Valero intends to continue to
selectively pursue acquisitions in order to increase growth and
diversification. As part of this strategy, Valero regularly searches for
acquisition opportunities that it believes will be accretive to earnings and
cash flow and provide acceptable rates of return. To be consistent with its
operating philosophy, Valero typically looks at opportunities that offer
refining capacity in excess of 100,000 barrels per day with expansion or
upgrading potential and that are located near a coastal area or a major
pipeline connection in order to provide greater flexibility in accessing
suppliers and customers. Valero believes the Benicia acquisition will be
immediately accretive to earnings and cash flow and provide geographic
diversification and important access to the West Coast.
- Upgrading Refineries in a Cost Effective Manner. Valero continually
evaluates ways to maximize the value of its refineries through cost-effective
upgrades and expansions. Valero believes refineries that are more flexible
with regard to feedstocks or that are able to produce higher value-added
premium products such as reformulated gasoline and low-sulfur diesel are
better positioned to exploit increases in refining margins and mitigate the
effects of decreases in refining margins than refineries that produce more
conventional forms of gasoline and distillates. During 2000, Valero plans to
expand the capacity of two of the Texas City refinery's three crude units by
approximately 37,000 BPD and its diesel
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<PAGE> 50
hydrotreater by approximately 14,000 BPD. Additionally, Valero plans to
expand the Paulsboro refinery's fluid catalytic cracking unit by 6,500 BPD
and its crude unit by approximately 2,000 BPD.
- Pursuit of Additional Cost Savings Initiatives. Valero continually attempts
to identify and implement cost saving initiatives. The components of Valero's
cost savings program include: (i) improving mechanical availability, (ii)
reducing maintenance costs, (iii) improving energy efficiency, (iv)
replicating best operating practices at all refineries, (v) improving
purchasing efficiencies through multi-refinery contracts, (vi) reducing
warehouse inventory and (vii) reducing the use of outside professional
services. In 1999, Valero implemented cost savings initiatives which resulted
in operating expense savings of over $40 million at its Gulf Coast
refineries, and expects to attain further operating cost reductions at all of
its refineries in 2000.
- Increased Earnings Diversification. Valero continues to evaluate several
strategies that offer opportunities to diversify earnings, including retail
petroleum marketing, petrochemical ventures, and other ancillary businesses.
The Benicia acquisition has facilitated Valero's entry into the retail
business.
- Dedication to Safety and Environmental Concerns. Valero continues to focus
on and devote significant time and resources to safety training and
accountability programs throughout its operations. Valero seeks to be
environmentally proactive and will continue to actively monitor developments
with the EPA's proposed air emissions reduction rules and other regulatory
changes. During 2000, Valero is installing a flue gas scrubber on the FCC
Unit at the Texas City refinery in connection with its voluntary
participation in the Governor's City Air Responsibility Enterprise Program.
REFINING, MARKETING AND FEEDSTOCK SUPPLY
Refining
Valero's six refineries have a combined total throughput capacity of
approximately 950,000 BPD. The following table lists the location of each of its
refineries and their respective feedstock throughput capacities.
<TABLE>
<CAPTION>
FEEDSTOCK THROUGHPUT
REFINERY LOCATION CAPACITY IN BPD
----------------- --------------------
<S> <C> <C>
Corpus Christi Refinery...................... Corpus Christi, Texas 215,000
Texas City Refinery.......................... Texas City, Texas 200,000
Paulsboro Refinery........................... Paulsboro, New Jersey 170,000
Houston Refinery............................. Houston, Texas 120,000
Krotz Springs Refinery....................... Krotz Springs, 85,000
Louisiana
Benicia Refinery............................. Benicia, California 160,000
-------
Total.............................. 950,000(1)
=======
</TABLE>
------------
(1) Crude unit capacity = 663,000 BPD
The Texas City, Houston and Krotz Springs refineries were acquired with the
acquisition of Basis Petroleum, Inc., a wholly owned subsidiary of Salomon Inc.,
on May 1, 1997. On September 16, 1998, the Paulsboro refinery was acquired from
Mobil Oil Corporation. On May 15, 2000, the Benicia refinery was acquired from
Exxon Mobil Corporation.
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 lower-cost heavy crude oil and resid into premium
products, such as RFG and CARB gasoline. The Corpus Christi refinery can produce
approximately 125,000 BPD of gasoline and gasoline-related products, 35,000 BPD
of low-sulfur diesel and 35,000 BPD of other products such as petrochemicals,
including propylene and xylene. The Corpus Christi refinery can produce most of
its gasoline as RFG and all of its diesel fuel as low-sulfur
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<PAGE> 51
diesel. The Corpus Christi refinery has substantial flexibility to vary its mix
of gasoline products to meet changing market conditions.
The Corpus Christi refinery's primary operating units include an 87,000 BPD
heavy oil cracker, or HOC, an 82,000 BPD hydrodesulfurization unit, or HDS unit,
a 36,000 BPD hydrocracker and a 37,000 BPD reformer complex. It also operates
certain units which produce oxygenate(1) such as MTBE (methyl tertiary butyl
ether) and TAME (tertiary amyl methyl ether). The Corpus Christi refinery can
produce approximately 24,000 BPD of oxygenates, which are blended into Valero's
gasoline production and also 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. 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.
A scheduled turnaround of certain of the Corpus Christi refinery's major
refining units was completed in the first quarter of 1999. Modifications made to
the HOC during the 1999 turnaround increased throughput capacity by
approximately 10,000 BPD. During the HOC turnaround, the HDS unit was further
modified, increasing its capacity to process high-sulfur crude oil from
approximately 50,000 BPD to 60,000 BPD, thereby increasing the refinery's
feedstock flexibility. During the third quarter of 1999, this refinery
experienced unplanned downtime as a precaution against the effects of Hurricane
Bret. Turnarounds of the hydrocracker and reformer complexes were completed in
January 2000, and turnarounds of the HDS and MTBE units are planned for the
fourth quarter of 2000.
Texas City Refinery. The Texas City refinery is capable of refining lower-cost
medium sour crudes into a slate of gasolines and distillates, including home
heating oil, low-sulfur diesel, kerosene and jet fuel. The Texas City refinery
can produce approximately 70,000 BPD of gasoline and 65,000 BPD of distillates.
Other products include chemical grade propylene and propane. The Texas City
refinery can also provide approximately 35,000 BPD of intermediate feedstocks
such as DAO and ATBs to the Corpus Christi refinery and/or the Houston refinery.
The refinery typically receives and delivers its feedstocks and products by
tanker and barge via deep water docking facilities along the Texas City Ship
Channel, and also has access to the Colonial, Explorer and TEPPCO pipelines for
distribution of its products.
The Texas City refinery's primary operating units include a 168,000 BPD crude
distillation complex and a 52,000 BPD fluid catalytic cracking unit, or FCC
Unit. During the latter part of 1996, an 85,000 BPD Residfiner (which reduces
the sulfur content and improves the cracking characteristics of the feedstocks
for the FCC Unit), and a 40,000 BPD Residual Oil Supercritical Extraction unit,
or ROSE unit (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 1999, the Texas City refinery entered into long-term hydrogen supply
arrangements with Air Liquide and Praxair, respectively, in order to mitigate
certain hydrogen supply problems encountered in previous years. A scheduled
turnaround was completed on the Residfiner and the ROSE unit in April 1999 and
one of the crude units in October 1999. In 2000, Valero intends to expand two of
the refinery's crude units by an aggregate of 37,000 BPD and the diesel
hydrotreating unit by 14,000 BPD. Additionally, the annual catalyst replacement
for the Residfiner is planned for the second quarter of 2000.
Paulsboro Refinery. On September 16, 1998, Valero Refining Company-New Jersey,
a wholly owned subsidiary of Valero, purchased substantially all of the assets
related to Mobil Oil Corporation's 155,000
---------------
(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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<PAGE> 52
BPD refinery in Paulsboro, New Jersey 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.
As part of the acquisition, Valero 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. In addition, Valero 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 Valero's total throughput
capacity by approximately 25%, improved its geographic diversity by providing
better access to Northeast markets and diversified its product mix through the
Paulsboro refinery's production of lubricant basestocks and asphalt.
The Paulsboro refinery processes primarily medium sour and heavy sour crudes
into a wide slate of gasoline and distillates, lubricant basestocks and asphalt.
The Paulsboro refinery can produce approximately 70,000 BPD of gasoline, 60,000
BPD of distillates, 15,000 BPD of asphalt and 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
25,000 BPD delayed coking unit, a 15,000 BPD asphalt unit and a 12,000 BPD
lubricants plant. Feedstocks and refined products are typically transported via
refinery-owned dock facilities along the Delaware River, Mobil's product
distribution system or the refinery's access to the Colonial pipeline, which
allows products to be sold into the New York Harbor market.
During 1999, scheduled turnarounds were completed on the distillate hydrotreater
and reformer units. The Paulsboro refinery experienced unscheduled processing
rate reductions and unit downtime during 1999, primarily associated with its FCC
Unit. A scheduled turnaround and 6,500 BPD expansion of the FCC Unit and 2,000
BPD expansion of one of the crude units are planned for the second quarter of
2000 in conjunction with scheduled turnarounds. A turnaround of the naphtha
hydrotreater and regeneration of the naphtha reformer catalyst are also planned
for the fourth quarter of 2000.
Houston Refinery. The Houston refinery is capable of processing both heavy
sweet and medium sour crude oils and can produce approximately 60,000 BPD of
gasoline and 30,000 BPD of distillates. The refinery also produces chemical
grade propylene. 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.
During the second quarter of 1999, the Houston refinery's naphtha reformer was
refurbished, which increased yields from the unit by 5,000 BPD and increased its
flexibility to produce a higher percentage of RFG and premium gasoline. The
Houston refinery experienced one unplanned outage of its FCC Unit during the
fourth quarter of 1999. No major turnarounds are currently planned for 2000.
Krotz Springs Refinery. The Krotz Springs refinery processes primarily local,
light Louisiana sweet crude oil and can produce approximately 40,000 BPD of
gasoline and 45,000 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. Built during the
1979-1982 time period, the refinery is a relatively new facility compared to
other U.S. refineries. Primary units include an 80,000 BPD crude distillation
complex, a 31,000 BPD FCC Unit and a 12,000 BPD reformer complex.
No significant turnarounds were undertaken by the Krotz Springs refinery in
1999. A turnaround of the reformer complex was completed in January 2000.
Benicia Refinery. The Benicia refinery is located on the Carquinez Straits of
the San Francisco Bay. It is considered a highly complex refinery and has a
total throughput capacity of 160,000 BPD. The Benicia refinery produces a high
percentage of light products, with limited production of other products. It can
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<PAGE> 53
produce approximately 110,000 BPD of gasoline, 14,000 BPD of jet fuel, 11,000
BPD of diesel and 8,000 BPD of natural gas liquids. Approximately 95% of the
gasoline produced by the Benicia refinery meets the CARB II specifications for
gasoline sold in California.
The Benicia refinery's operating units include a 135,000 BPD crude distillation
complex, a 72,000 BPD vacuum distillation unit, a 73,000 BPD FCC, a 28,000 BPD
fluidized coking unit, a 35,000 BPD hydrocracking unit, a 35,000 BPD reforming
unit and a 15,000 BPD alkylation unit. The Benicia refinery also has a 39,000
BPD FCC feed hydrotreater and a 45,000 BPD FCC gasoline hydrotreater. It has
significant liquid storage capacity including storage for crude oil and other
feedstocks. Also included with the refinery assets are a deepwater dock located
offsite on the Carquinez Straits which is capable of berthing large crude
carriers, petroleum coke storage silos located on an adjacent dock, a 20-inch
crude pipeline connecting the refinery to a southern California crude delivery
system, and an adjacent truck terminal for regional truck rack sales. In
addition, the sale and purchase agreement related to the acquisition of the
Benicia refinery provides for a ten-year term contract for ExxonMobil to supply
and for Valero to purchase 100,000 BPD of ANS crude oil at market-related
prices, to be reduced to 65,000 BPD on January 1, 2001. Prior to January 1,
2001, Valero will have an option to reduce the volume of ANS crude to 65,000 BPD
with 90 days prior notice. After January 1, 2001, Valero will have an option to
reduce the required volumes by an additional 20,000 BPD once per year.
Selected Refinery Operating Results. The following tables set forth certain
consolidated operating results for the Corpus Christi, Texas City, Paulsboro,
Houston and Krotz Springs refineries for the last three fiscal years, for the
Benicia refinery for 1999 and on a combined basis including Benicia for 1999
(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 Texas City,
Houston and Krotz Springs 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. Aggregate
refinery charges and yields are expressed as percentages of total charges and
yields, respectively.
<TABLE>
<CAPTION>
PRO FORMA
VALERO BENICIA COMBINED
YEAR ENDED DECEMBER 31, YEAR ENDED YEAR ENDED
------------------------ DECEMBER 31, DECEMBER 31,
1997 1998 1999 1999 1999
----- ----- ------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Refinery Throughput Volumes............ 417(1) 579(2) 712 137 849
Sales Volumes.......................... 630(1) 894(2) 1,033 144 1,177
Average Throughput Margin per Barrel... $4.35 $3.53 $ 2.93 $ 7.77 $ 3.71
Average Operating Cost per Barrel(3):
Cash (Fixed and Variable)............ $2.00 $2.06 $ 1.85 $ 4.37 $ 2.09
Depreciation and Amortization........ .61 .57 .53 .46 .54
----- ----- ------ ------ ------
Total Operating Cost per
Barrel..................... $2.61 $2.63 $ 2.38 $ 4.83 $ 2.63
===== ===== ====== ====== ======
</TABLE>
(footnotes on next page)
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<TABLE>
<CAPTION>
PRO FORMA
VALERO BENICIA COMBINED
YEAR ENDED DECEMBER 31, YEAR ENDED YEAR ENDED
------------------------ DECEMBER 31, DECEMBER 31,
1997 1998 1999 1999 1999
----- ----- ------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Charges:
Crude oils:
Sour.............................. 26% 37% 48% 83% 54%
Heavy sweet....................... 21 20 12 -- 10
Light sweet....................... 10 11 9 -- 8
----- ----- ------ ------ ------
Total crude oils............. 57 68 69 83 72
High-sulphur residual fuel oil....... 17 9 3 4 3
Low-sulphur residual fuel oil........ 3 3 6 -- 5
Other feedstocks and blendstocks..... 23 20 22 13 20
----- ----- ------ ------ ------
Total charges................ 100% 100% 100% 100% 100%
===== ===== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
PRO FORMA
VALERO BENICIA COMBINED
YEAR ENDED DECEMBER 31, YEAR ENDED YEAR ENDED
------------------------ DECEMBER 31, DECEMBER 31,
1997 1998 1999 1999 1999
----- ----- ------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Yields:
Gasolines and blendstocks............ 53% 53% 51% 68% 54%
Distillates.......................... 25 28 29 15 27
Petrochemicals....................... 6 4 5 -- 4
Lubes and asphalts................... -- 1 3 -- 2
Other products....................... 16 14 12 17 13
----- ----- ------ ------ ------
Total yields................. 100% 100% 100% 100% 100%
===== ===== ====== ====== ======
</TABLE>
------------
(1) For the eight months following the acquisition of Basis Petroleum, Inc.,
refinery throughput volumes and sales volumes were 543 MBPD and 740 MBPD,
respectively.
(2) For the fourth quarter of 1998 following the acquisition of the Paulsboro
Refiner, refinery throughput volumes and sales volumes were 640 MBPD and 949
MBPD, respectively.
(3) The combined information reflects the adjustments made in the pro forma
statements of income. No changes in the operations of the Benicia assets
have been assumed and, therefore, the combined data is not necessarily
indicative of future performance.
For additional information regarding Valero's operating results for the three
years ended December 31, 1999, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Marketing
Including the Benicia acquisition, over 85% of Valero's product slate is
comprised of premium products such as gasoline and related components,
distillates, lubricant basestocks and petrochemicals, and Valero sells refined
products under spot and term contracts to bulk and truck rack customers at over
200 locations in 35 states throughout the United States and selected export
markets in Latin America. Currently, Valero markets over 200,000 BPD of gasoline
and distillates through truck rack facilities. The principal purchasers of its
products from truck racks are wholesalers and distributors in the Northeast,
Southeast, Midwest, West Coast 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, the Pacific Ocean and the
Atlantic Ocean, Valero's refineries are able to ship refined products throughout
the world. Interconnects with common-carrier pipelines give Valero the
flexibility to sell products in most major geographic regions of the United
States.
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<PAGE> 55
During 1999, approximately one-third of Valero's refined products were sold
pursuant to term contracts, and total product sales volumes averaged
approximately 1,033,000 BPD. Sales volumes included amounts produced at Valero's
refineries and amounts purchased from third parties and resold in connection
with its 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. In 1999, 13% of Valero's consolidated operating revenues
were derived from Mobil. Other than sales to Mobil, no single purchaser of
Valero's products accounted for more than 10% of total sales during 1999.
Approximately 70,000 BPD of Valero's RFG production is under contract at
market-related prices to gasoline marketers in Texas and the Northeast. Valero
also sells RFG into the spot market. When market conditions are favorable,
Valero can supply CARB gasoline to West Coast markets from its Corpus Christi
refinery. During 1999, approximately 2.7 million barrels of gasoline, including
1.6 million barrels of CARB Phase II gasoline, were delivered to California
purchasers.
For further discussion, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Operating Results" and
"--Outlook."
Feedstock Supply
Refinery acquisitions and capital improvements since 1997 have expanded and
diversified the slate of feedstocks Valero can process. Prior to these
investments, Valero's primary feedstock was resid processed at the Corpus
Christi refinery, representing 50-70% of total feedstocks. Approximately 60% of
Valero's feedstock slate is 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 low-sulfur crude oil and
intermediates, such as low-sulfur resid and coker gas oil, methanol and butane.
In 1999, approximately 80% of Valero's total crude oil feedstock requirements
were purchased through term feedstock contracts totaling approximately 425,000
BPD. The remainder of its crude oil feedstock requirements were 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 the event one or
more of its term contracts were terminated, Valero believes it would be able to
find alternative sources of supply without material adverse effect on its
business.
In connection with the Restructuring in 1997, Valero 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
as feedstock for the MTBE facilities at Corpus Christi and natural gasoline for
blending. Approximately 80% of the total methanol requirements for Valero's
refineries are obtained through a 50% joint venture interest in the methanol
plant in Clear Lake, Texas with Hoechst Celanese Chemical Group, Inc.
In connection with the Benicia acquisition, Valero entered into a ten-year
contract for ExxonMobil to supply 100,000 BPD of ANS crude oil at market-related
prices, to be reduced to 65,000 BPD on January 1, 2001, to the Benicia refinery.
Prior to January 1, 2001, Valero will have an option to reduce the volume of ANS
crude to 65,000 BPD with 90 days prior notice. After January 1, 2001, Valero
will have an option to reduce the required volumes by an additional 20,000 BPD
once per year.
Valero owns feedstock and refined product storage facilities and leases
feedstock and refined product storage facilities in various locations. Valero
believes its storage facilities are generally adequate for its refining and
marketing operations.
COMPETITION
Many of Valero's competitors in the petroleum industry are fully integrated
companies engaged on a national or international basis in many segments of the
petroleum business, including exploration, production, transportation, refining
and marketing, on scales much larger than Valero's. Such competitors may have
greater flexibility in responding to or absorbing market changes occurring in
one or more of such
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segments. All of Valero's crude oil and feedstock supplies are purchased from
third party sources, while some competitors have proprietary sources of crude
oil available for their own refineries.
The refining industry is highly competitive with respect to both feedstock
supply and marketing. Valero competes with numerous other companies for
available supplies of feedstocks and for outlets for its refined products.
Valero does not produce any of its crude oil feedstocks and, following the
Benicia acquisition, will control only limited retail outlets for its refined
products. Many of its competitors, however, obtain a significant portion of
their feedstocks from company-owned production and have extensive retail
outlets. Competitors that have their own production or extensive 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.
Valero 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 opportunities to expand its operations. As refining margins merit,
Valero expects to continue making capital improvements to increase the
throughput capacity of its refinery facilities and increase their operational
flexibility.
ENVIRONMENTAL MATTERS
Valero's operations are subject to environmental regulation by federal, state
and local authorities, including but not limited to, the Environmental
Protection Agency ("EPA"), the Texas Natural Resource Conservation Commission,
the New Jersey Department of Environmental Protection, the Louisiana Department
of Environmental Quality and, following the Benicia acquisition, the California
Environmental Protection Agency. 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
Valero's operations include the Clean Air Act, the Clean Water Act, the
Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA,
and the Solid Waste Disposal Act, as amended by the Resource Conservation and
Recovery Act, or 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.
In May 2000, the EPA proposed regulations to reduce the sulfur content for
diesel fuel sold to highway consumers by 97%, from 500 parts per million to 15
parts per million, beginning June 1, 2006. In its release, the EPA estimated
that the overall cost to fuel producers of the reduction in sulfur content would
be approximately 4 cents per gallon. The American Petroleum Institute has
released a statement supporting sharp reductions in diesel fuel sulfur content,
but strongly opposing the EPA's "unrealistic" proposal. Valero is unable to
predict whether the proposed regulations will be adopted or the effect that the
proposal would have on its business or results of operations.
In February 2000, the Tier II gasoline standard was published by the EPA
pursuant to the Clean Air Act in final form. The standard will ultimately
require the sulfur content in gasoline to be reduced to 30 parts per million and
the regulation will be phased in beginning in 2004. Valero has determined that
modifications will be required at all of its refineries as a result of the Tier
II standard. Valero currently plans to begin implementing those modifications in
2001 and expects all modifications to be complete by 2006. Valero believes that
the costs of such modifications should not have a material adverse effect on its
financial position, results of operations or liquidity.
EPA has proposed a Maximum Available Control Technology rule, or MACT II rule,
under the Clean Air Act that is to become final in late 2000. The MACT II rule,
as proposed, contains a three-year compliance schedule for refiners to install
any pollution control technology that may be required in order to meet emissions
limitations of the rule applicable to FCC units, sulfur recovery units and
reformers. Once the MACT II rule is finalized and published, Valero will
determine what capital improvements will be required. Based on information
currently available, Valero does not anticipate that material capital
expenditures will be required to comply with the MACT II rule.
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As a result of heightened public concern that MTBE has contaminated drinking
water supplies, initiatives have been passed in California seeking to ban the
use of MTBE as a gasoline component by the end of 2002, or earlier, if feasible,
in California. In addition, other states and the EPA have either passed or
proposed or are considering proposals to restrict or ban the use of MTBE. If
MTBE were to be restricted or banned throughout the United States, Valero's
operations could potentially be materially adversely affected. Furthermore,
there can be no assurance that Valero will not be named in any future proceeding
or litigation relating to the environmental effects of MTBE or that such
proceeding or litigation will not have a material adverse effect on Valero's
overall financial condition, results of operations or liquidity. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Outlook."
CERCLA and RCRA, and related state law, subject Valero to the potential
obligation to remove or mitigate the environmental impact of the disposal or
release of certain pollutants from Valero's facilities and at formerly owned or
operated sites or third party waste disposal sites. Under CERCLA, Valero 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." Pursuant to the terms of the Basis Petroleum, Inc. acquisition, Salomon
agreed to indemnify Valero from third party claims, including "superfund"
liability associated with any pre-closing activities with respect to the
refineries acquired as part of the acquisition, subject to certain terms,
conditions and limitations. See Note 3 of Notes to Consolidated Financial
Statements for the year ended December 31, 1999 for information regarding the
settlement of certain contingent environmental obligations for which Salomon was
responsible in connection with Valero's acquisition of Basis. As described below
under "Legal Proceedings," Valero has received notice of a claim under CERCLA
for alleged contamination of the plaintiffs' marine loading and tankering
facilities. Based on the information available to Valero, Valero believes that
some or all of any Valero liability would be covered by the Salomon indemnity.
Valero has not otherwise received any claims under CERCLA for any sites or costs
not covered by Salomon's indemnity of Valero.
In connection with the acquisition of the Paulsboro refinery, Mobil agreed to
indemnify Valero for certain environmental matters and conditions existing on or
prior to the acquisition and Valero 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 from the closing date, (ii) governmental fines and/or penalties for a
period of five years from the closing date, (iii) required remediation of known
environmental conditions for a period of five years from the closing date,
subject to a cumulative deductible, (iv) required remediation of unknown
environmental conditions for a period of seven years from the closing date,
subject to a sharing arrangement with a cap on Valero's obligation and subject
to a cumulative deductible, and (v) certain capital expenditures required by a
governmental entity for a three-year period from the closing date, to the extent
required to cure a breach of certain representations of Mobil concerning
compliance with environmental laws, subject to a specified deductible. Valero'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, 1999, Valero has accrued approximately $20 million representing its
best estimate of costs to be borne by Valero related to these remediation
obligations. The majority of such costs are expected to be incurred in
relatively level amounts over the next 19 years. See Note 3 of Notes to
Consolidated Financial Statements for the year ended December 31, 1999.
In connection with the Benicia acquisition, Valero will assume the environmental
liabilities of ExxonMobil with certain exceptions. ExxonMobil retained liability
for (i) pending penalties assessed for violations relating to the Benicia
refinery, (ii) pending lawsuits, (iii) all costs associated with compliance with
a variance issued in connection with control of nitrogen oxides, (iv) claims in
connection with offsite transportation and disposal of wastes prior to closing
asserted within three years of closing or asserted with respect to abandoned
disposal sites, (v) the capital costs incurred within five years of closing for
specified corrective action of groundwater and soil contamination, (vi) all
covered contamination at the Service Station Assets caused by ExxonMobil or its
lessees that is reflected in baseline reports prepared prior to
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closing, (vii) the repair or replacement of any underground storage tanks at the
Service Station Assets found to be leaking prior to closing and (viii) fines and
penalties imposed within five years of closing arising out of a request for
information from the EPA relating to certain provisions of the Clean Air Act
that are attributable to actions taken prior to closing or untimely or
unresponsive responses to the request. ExxonMobil has agreed to indemnify Valero
for all losses related to these retained liabilities, provided that ExxonMobil
will indemnify Valero for losses related to covered contamination at the Service
Station Assets for a period of five years from the date of closing. In addition,
ExxonMobil will indemnify Valero for breaches of its representations and
warranties to the extent that the aggregate amount of Valero's losses resulting
from such breaches exceeds $1 million and ExxonMobil receives notice of such
losses within one year after the closing date.
There can be no assurance that these indemnifying parties will indemnify or
continue to indemnify Valero pursuant to the terms of these acquisitions. In the
event that these indemnifying parties fail to do so, Valero could be liable for
the costs of the environmental matters covered under these indemnities, the
costs of which could be material.
Valero 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 permitting process 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.
As part of Valero's efforts to permit all of its "grandfathered" emissions
sources and achieve operational flexibility and increased production capability,
a flue gas scrubber is being installed on the FCC Unit at the Texas City
refinery in connection with Valero's voluntary participation in the Governor's
City Air Responsibility Enterprise Program and additional emission control
devices are planned for the Houston refinery. Installation of the flue gas
scrubber will cost approximately $35 million over a two-year period, beginning
in 2000, and is being funded through a structured lease financing arrangement.
The Corpus Christi refinery was issued a flexible operating permit by the Texas
Natural Resources Conservation Commission on March 1, 1999, and the Commission
approved a flexible operating permit for the Texas City refinery on February 9,
2000.
In 1999, capital expenditures for Valero attributable to compliance with
environmental regulations were approximately $7 million and are currently
estimated to be $7 million for 2000 and $22 million for 2001. The foregoing
estimates for 2000 and 2001 do not include expenditures for the installation of
the flue gas scrubber at the Texas City refinery discussed above, expenditures
for the installation of the flue gas scrubber at the Paulsboro refinery
discussed in "-- Legal Proceedings" below (expected to be incurred primarily in
2003), any amounts related to constructed facilities for which the portion of
expenditures relating to compliance with environmental regulations is not
determinable or any capital expenditures for the Benicia refinery and the
Service Station Assets. Valero currently estimates these Benicia-related capital
expenditures to be approximately $7 million in each of 2000 and 2001 based on
the amount of due diligence that it has been able to conduct to date.
Governmental regulations are complex, subject to different interpretations and
becoming increasingly more stringent. 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. In addition, because certain air
emissions at the refineries, including those at the Benicia refinery, have been
grandfathered under particular environmental laws, any major upgrades in any of
Valero's refineries could require potentially material additional expenditures
to comply with environmental laws and regulations.
EMPLOYEES
As of April 30, 2000, Valero had 2,528 employees. Valero believes its
relationship with its employees is good.
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PROPERTIES
Valero's properties include its six refineries described above and related
facilities located in the States of Texas, Louisiana, New Jersey and California.
See "--Refining, Marketing and Feedstock Supply" for additional information
regarding properties of Valero. Valero believes that its facilities are
generally adequate for their respective operations and that its facilities are
maintained in a good state of repair. Valero is the lessee under a number of
cancelable and non-cancelable leases for certain real properties, including
office facilities and various facilities and equipment used to store, transport
and produce refinery feedstocks and/or refined products. See Note 14 of Notes to
Consolidated Financial Statements for the year ended December 31, 1999.
LEGAL PROCEEDINGS
In connection with the acquisition of the Paulsboro refinery from Mobil, Valero
Refining Company-New Jersey, a wholly owned subsidiary of Valero, assumed
certain environmental liabilities associated with the refinery, including
obligations under the New Jersey Department of Environmental Protection
("NJDEP") Administrative Consent Orders dated September 10, 1979, September 29,
1980, May 10, 1991, and August 27, 1998, related to ongoing site remediation.
Additionally, Valero has received two New Jersey Department of Environmental
Protection Administrative Orders and Notices of Civil Administrative Penalty
Assessment related to particulate tests of the Paulsboro refinery's FCC Unit.
Although these orders and assessments related to emissions from the FCC Unit
that occurred after Valero's acquisition of the refinery, they related to
conditions existing prior to the acquisition. On May 5, 2000, Valero entered
into a comprehensive administrative consent order with the NJDEP to resolve all
pending enforcement actions and related but unasserted claims regarding
particulate emissions from the refinery. The order authorizes an expansion of
the refinery allowing for production of RFG, provides for interim emissions
limits, and requires a penalty payment of $600,000 on the particulate emissions
issues. Under the order, Valero also agreed to install a wet-gas scrubber on the
refinery's FCC Unit by December 31, 2003. Valero believes that the terms of the
foregoing settlement will not have a material adverse effect on its operations,
financial position or liquidity.
On June 11, 1999, the Texas Natural Resources Conservation Commission notified
Valero of its commencement of proceedings against Valero's Texas City refinery
concerning certain record keeping deficiencies and alleged emissions
exceedances, most of which occurred prior to Valero's acquisition of the
refinery. Corrective action was immediately taken and all contested matters have
been resolved pursuant to an agreed order dated December 20, 1999, under which
Valero paid an agreed penalty of $174,455.
In 1986, Valero filed suit against M.W. Kellogg Company for damages arising from
certain alleged design and construction defects in connection with a major
construction project at the Corpus Christi refinery. Ingersoll-Rand Company was
added as a defendant in 1989. In 1991, the trial court granted summary judgment
against Valero based in part on certain exculpatory provisions in various
agreements connected with the project. In 1993, the court of appeals affirmed
the summary judgment and the Texas Supreme Court denied review. Subsequent to
the summary judgment, Kellogg and Ingersoll-Rand brought indemnity claims
against Valero for attorney's fees and expenses incurred in defending the
original action. In 1996, the trial court rendered summary judgment against
Kellogg and Ingersoll-Rand based on procedural grounds, and the court of appeals
affirmed that ruling in 1997. However, in 1999, the Texas Supreme Court reversed
the court of appeals and remanded Kellogg's and Ingersoll-Rand's claims for
attorney's fees and expenses to the 117th State District Court, Nueces County,
Texas.
Valero has received notice of, but has not been served with, a complaint filed
April 28, 2000 in the U.S. District Court for the Southern District of Texas,
Galveston Division (Texas City Terminal Railway Co. v. Marathon Ashland
Petroleum, LLC, et al.). The complaint alleges that several companies, including
Valero, are liable under CERCLA, other environmental laws and tort law theories
for alleged contamination of the plaintiffs' marine loading and tankering
facilities. Based on the information available to Valero, Valero believes that
some or all of any Valero liability would be covered by an indemnity from
Salomon Inc. provided in connection with Valero's acquisition from Salomon of
Basis Petroleum, Inc.
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On May 24, 2000, Valero was served with a class action complaint filed in the
U.S. District Court for the Southern District of New York. The complaint
attempts to certify a class action claim alleging that numerous gasoline
suppliers, including Valero, contaminated groundwater in the State of New York
with MTBE.
Litigation Relating to Discontinued Operations
Old Valero and certain of its natural gas related subsidiaries, and Valero, have
been sued by Teco Pipeline Company in the 215th State District Court, Harris
County, Texas regarding the operation of the 340-mile West Texas Pipeline in
which a subsidiary of Old Valero holds a 50% undivided interest. The case was
filed April 24, 1996. In 1985, a subsidiary of Old Valero sold a 50% undivided
interest in the pipeline and entered into a joint venture through an ownership
agreement and an operating agreement, with the purchaser of the interest. In
1988, Teco succeeded to that purchaser's 50% interest. A subsidiary of Old
Valero has at all times been the operator of the pipeline. Despite the written
ownership and operating agreements, the plaintiff contends that a separate,
unwritten partnership agreement exists, and that the defendants have exercised
improper control over this alleged partnership's affairs. The plaintiff also
contends that the defendants acted in bad faith and negatively affected the
economics of the joint venture in order to provide financial advantages to
facilities or entities owned by the defendants, and by allegedly taking 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. Old Valero's
motion to require arbitration of the case as required in the written agreements
was denied by the trial court, but Old Valero appealed, and in August 1999, the
court of appeals ruled in Old Valero's favor and ordered arbitration of the
entire dispute. Teco has since waived efforts to further appeal this ruling, and
an arbitration panel has been selected. Valero has been formally added to this
proceeding. The arbitration panel has scheduled the arbitration hearing for
October 2000. Although PG&E previously acquired Teco and now owns both Teco and
Old Valero, PG&E's Teco acquisition agreement purports to assign the benefit or
detriment of this lawsuit to the former shareholders of Teco. In connection with
the Restructuring, Valero has agreed to indemnify Old Valero with respect to
this lawsuit for 50% of any final judgment or settlement amount up to $30
million, and 100% of that part of any final judgment or settlement amount over
$30 million.
General
Valero is also a party to additional claims and legal proceedings arising in the
ordinary course of business. Valero believes it is unlikely that the final
outcome of any of the claims or proceedings to which it is a party would have a
material adverse effect on its financial 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 Valero's results of operations, financial position or
liquidity. See also "Risk Factors -- The outcome of the Unocal patent dispute
may adversely affect our business" for an additional discussion of litigation
related matters.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
<TABLE>
<CAPTION>
NAME AGE POSITIONS HELD WITH VALERO
---- --- --------------------------
<S> <C> <C>
William E. Greehey........................ 63 Chairman of the Board, President and Chief
Executive Officer
Gregory C. King........................... 39 Senior Vice President and Chief Operating
Officer
John D. Gibbons........................... 46 Vice President and Chief Financial Officer
Keith D. Booke............................ 41 Vice President and Chief Administrative
Officer
S. Eugene Edwards......................... 43 Vice President
John F. Hohnholt.......................... 47 Vice President
Dr. Donald M. Carlton..................... 62 Director
Jerry D. Choate........................... 61 Director
Robert G. Dettmer......................... 68 Director
Ruben M. Escobedo......................... 62 Director
Lowell H. Lebermann....................... 60 Director
Dr. Ronald K. Calgaard.................... 62 Director
Dr. Susan Kaufman Purcell................. 57 Director
</TABLE>
MR. GREEHEY served as Chief Executive Officer and a director of Old Valero from
1979, and as Chairman of the Board of Old Valero from 1983. He retired from his
position as Chief Executive Officer in June 1996 but, upon request of the Board
of Old Valero, resumed this position in November 1996. Mr. Greehey has served as
Valero's Chairman of the Board and Chief Executive Officer since the
Restructuring, positions he also held with Valero prior to the Restructuring
when Valero was a wholly owned subsidiary of Old Valero, and was elected
President of Valero upon the retirement of Edward C. Benninger at the end of
1998. Mr. Greehey also serves as a director of Santa Fe Snyder Corp.
MR. KING was elected Senior Vice President and Chief Operating Officer of Valero
in 1999. Prior to that time he had served as Vice President and General Counsel
since 1997. He joined Old Valero 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 Valero in 1998. Previously,
he was elected Vice President--Finance and Treasurer of Valero in 1997, and was
elected Treasurer of Old Valero in 1992. He joined Old Valero in 1981 and held
various other positions with Old Valero prior to the Restructuring.
MR. BOOKE was elected Vice President and Chief Administrative Officer in 1999.
Until that time he had served as Vice President--Administration and Human
Resources since 1998. Prior to that he served as Vice President--Administration
of Valero since 1997 and Vice President-Investor Relations of Old Valero since
1994. He joined Old Valero in 1983 and held various other positions with Old
Valero prior to the Restructuring.
MR. EDWARDS was elected Vice President of Valero in January 1998 and functions
as head of the Supply, Marketing and Transportation Division. Mr. Edwards joined
Old Valero in 1982 and held various positions within Old Valero's refining
operations, planning and economics, business development and marketing
departments prior to the Restructuring.
MR. HOHNHOLT was elected Vice President of Valero in January 1998 and functions
as the head of the Refining Operations Division. Prior to that he was General
Manager of the Corpus Christi refinery. Mr. Hohnholt joined Old Valero in 1982
and held various positions within Old Valero's refining operations and
engineering departments prior to the Restructuring.
DR. CARLTON was elected as a director of Valero in 1999. Until his retirement on
December 31, 1998, Dr. Carlton served as President and Chief Executive Officer
of Radian International LLC, an Austin,
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Texas based engineering and technology firm that is a part of the Dames and
Moore Group. Dr. Carlton also serves as a director of Central and Southwest
Corp., National Instruments Corp. and Salomon Smith Barney Concert Investment
Series.
MR. CHOATE was elected as a director of Valero in 1999. Mr. Choate retired from
Allstate Corporation at the end of 1998 where he had served as Chairman of the
Board and Chief Executive Officer since January 1, 1995. Mr. Choate also serves
as a director of Amgen, Inc. and Van Kampen Mutual Funds.
MR. DETTMER was elected as a director of Valero in 1991. He retired from
PepsiCo, Inc. in 1996 after serving as Executive Vice President and Chief
Financial Officer since 1986. Mr. Dettmer also serves as a director of Allied
Worldwide, Inc.
MR. ESCOBEDO was elected as a director of Valero in 1994. He has been with his
own public accounting firm, Ruben Escobedo & Company, CPAs, in San Antonio,
Texas since its formation in 1977. Mr. Escobedo also serves as a director of
Cullen/Frost Bankers, Inc. and previously served as a director of Valero Natural
Gas Company, an affiliate of Old Valero, from 1989 to 1994.
MR. LEBERMANN was elected as a director of Valero in 1986. He has been President
of Centex Beverage, Inc., a wholesale beverage distributor in Austin, Texas,
since 1981. Mr. Lebermann is also a director of Station Casinos, Inc.
DR. CALGAARD was elected as a director of Valero in 1996. He served as President
of Trinity University, San Antonio, Texas, from 1979 until his retirement in
1999. Dr. Calgaard currently serves as Chief Operating Officer of Austin Calvert
& Flavin Inc. in San Antonio, and is a director of Luby's Cafeteria, Inc.,
Plymouth Commercial Mortgage Fund and The Trust Company. He also served as a
director of Valero Natural Gas Company, an affiliate of Old Valero, from 1987
until 1994.
DR. PURCELL was elected as a director of Valero in 1994. She has served as Vice
President of the Americas Society in New York, New York since 1989 and is also
Vice President of the Council of the Americas. She is a consultant for several
international and national firms and serves on the boards of The Argentina Fund
and Scudder Global High Income Fund.
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DESCRIPTION OF THE NOTES
The following description of the particular terms of the notes supplements the
description in the accompanying prospectus of the general terms and provisions
of the debt securities, to which description reference is hereby made.
GENERAL
The % Notes due , (the " Notes") will mature on ,
. The % Notes due (the " Notes" and, together with the
Notes, the "Notes") will mature on , . The Notes will
be issued in fully registered form only in minimum denominations of $1,000
increased in multiples of $1,000.
Interest on the Notes will accrue at the respective rates per annum shown on the
cover of this prospectus supplement and will be payable semi-annually on
and , beginning , 2000, to the persons in whose
names the Notes are registered at the close of business on and
preceding the respective interest payment dates, except that interest
payable at maturity shall be paid to the same persons to whom principal of the
Notes is payable.
Each series of Notes will constitute series of debt securities to be issued
under an indenture dated as of December 12, 1997, between Valero and The Bank of
New York, as Trustee, the terms of which are more fully described in the
accompanying prospectus. The Notes and any future debt securities issued under
the indenture will be unsecured obligations of Valero and will rank on a parity
with all other unsecured and unsubordinated indebtedness of Valero. The
indenture does not limit the aggregate principal amount of debt securities that
may be issued thereunder and provides that debt securities may be issued
thereunder from time to time in one or more additional series. The indenture
does not limit Valero's ability to incur additional indebtedness.
The Notes will not be subject to any sinking fund.
OPTIONAL REDEMPTION
Each series of Notes will be redeemable, in whole or in part, at the option of
Valero at any time at a redemption price equal to the greater of (i) 100% of the
principal amount of the applicable series of Notes, and (ii) as determined by
the Quotation Agent (as defined below), the sum of the present values of the
remaining scheduled payments of principal and interest thereon (not including
any portion of those payments of interest accrued as of the date of redemption)
discounted to the date of redemption on a semi-annual basis (assuming a 360-day
year consisting of twelve 30-day months) at the Adjusted Treasury Rate (as
defined below) plus basis points plus, in each case, accrued interest thereon
to the date of redemption.
"Adjusted Treasury Rate" means, with respect to any date of redemption, the rate
per annum equal to the semi-annual equivalent yield to maturity of the
Comparable Treasury Issue, assuming a price for the Comparable Treasury Issue
(expressed as a percentage of its principal amount) equal to the Comparable
Treasury Price for that date of redemption.
"Comparable Treasury Issue" means the United States Treasury security selected
by the Quotation Agent as having a maturity comparable to the remaining term of
the series of Notes to be redeemed that would be utilized, at the time of
selection and in accordance with customary financial practice, in pricing new
issues of corporate debt securities of comparable maturity to the remaining term
of those Notes.
"Comparable Treasury Price" means, with respect to any date of redemption, (i)
the average of the Reference Treasury Dealer Quotations for the date of
redemption, after excluding the highest and lowest Reference Treasury Dealer
Quotations, or (ii) if the Trustee obtains fewer than three Reference Treasury
Dealer Quotations, the average of all such Reference Treasury Dealer Quotations.
"Quotation Agent" means the Reference Treasury Dealer appointed by Valero.
S-63
<PAGE> 64
"Reference Treasury Dealers" means (i) each of J.P. Morgan Securities Inc.,
Credit Suisse First Boston Corporation and Morgan Stanley & Co. Incorporated and
their respective successors; provided, however, that if any of the foregoing
shall cease to be a primary U.S. Government securities dealer in New York City
(a "Primary Treasury Dealer"), Valero shall substitute another Primary Treasury
Dealer; and (ii) any other Primary Treasury Dealer selected by Valero.
"Reference Treasury Dealer Quotations" means, with respect to each Reference
Treasury Dealer and any date of redemption, the average, as determined by the
Trustee, of the bid and asked prices for the Comparable Treasury Issue
(expressed in each case as a percentage of its principal amount) quoted in
writing to the Trustee by that Reference Treasury Dealer at 5:00 p.m., New York
City time, on the third Business Day preceding that date of redemption.
Notice of any redemption will be mailed at least 30 days but not more than 60
days before the date of redemption to each holder of the applicable series of
Notes to be redeemed. Unless Valero defaults in payment of the redemption price,
on and after the date of redemption, interest will cease to accrue on the Notes
or portions thereof called for redemption.
SAME-DAY SETTLEMENT AND PAYMENT
The Notes will trade in the same-day funds settlement system of The Depository
Trust Company ("DTC") until maturity or until Valero issues the Notes in
definitive form. DTC will therefore require secondary market trading activity in
the Notes to settle in immediately available funds. Valero can give no assurance
as to the effect, if any, of settlement in immediately available funds on
trading activity in the Notes.
FURTHER ISSUES
We may from time to time, without notice to or the consent of the registered
holders of the Notes, create and issue further notes ranking equally and ratably
with the Notes in all respects (or in all respects except for the payment of
interest accruing prior to the issue date of such further notes or except for
the first payment of interest following the issue date of such further notes),
so that such further notes shall be consolidated and form a single series with
the Notes and shall have the same terms as to status, redemption or otherwise as
the Notes. Any further notes shall be issued subject to an agreement
supplemental to the indenture.
BOOK-ENTRY SYSTEM; DELIVERY AND FORM
General
Each series of the Notes will be issued in the form of one or more fully
registered global securities (each a "Global Security"). The Global Securities
will be deposited with the Trustee as custodian for DTC and registered in the
name of Cede & Co. ("Cede") as DTC's nominee. For purposes of this prospectus
supplement, "Global Security" refers to the Global Security or Global Securities
representing the entire issue of each series of the Notes. Except in the limited
circumstances described below, the Notes will not be issued in definitive
certificated form. A Global Security may be transferred, in whole and not in
part, only to another nominee of DTC.
Valero understands as follows with respect to the rules and operating procedures
of DTC, which affect transfers of interests in a Global Security.
DTC
DTC is a limited purpose trust company organized under the New York Banking Law,
a "banking organization" within the meaning of the New York Banking Law, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
was
S-64
<PAGE> 65
created to hold securities for its participants ("Participants") and to
facilitate the clearance and settlement of securities transactions, such as
transfers and pledges, between Participants through electronic computerized
book-entry changes in the accounts of its Participants, thereby eliminating the
need for physical movement of certificates. Participants include securities
brokers and dealers, banks, trust companies and clearing corporations and may
include certain other organizations, such as the underwriters. DTC is owned by a
number of Participants and by the New York Stock Exchange, Inc., the American
Stock Exchange, Inc. and the National Association of Securities Dealers, Inc.
Indirect access to the DTC system also is available to others such as banks,
brokers, dealers and trust companies that clear through or maintain a custodial
relationship with a Participant, either directly or indirectly ("Indirect
Participants").
Persons who are not Participants may beneficially own Notes held by DTC only
through Participants or Indirect Participants. Beneficial ownership of Notes may
be reflected (i) for investors who are Participants, in the records of DTC, (ii)
for investors holding through a Participant, in the records of such Participant,
whose aggregate interests on behalf of all investors holding through such
Participant will be reflected in turn in the records of DTC, or (iii) for
investors holding through an Indirect Participant, in the records of such
Indirect Participant, whose aggregate interests on behalf of all investors
holding through such Indirect Participant will be reflected in turn in the
records of a Participant. Accordingly, transfers of beneficial ownership in a
Global Security can only be effected through DTC, a Participant or an Indirect
Participant. Each of the underwriters is a Participant or an Indirect
Participant.
Interests in a Global Security will be shown on, and transfers thereof will be
effected only through, records maintained by DTC and its Participants. Each
Global Security will trade in DTC's Same-Day Funds Settlement System until
maturity, and secondary market trading activity for each Global Security will
therefore settle in immediately available funds. The laws of some states require
that certain persons take physical delivery in definitive form of securities.
Consequently, the ability to transfer beneficial interests in a Global Security
to such persons may be limited.
So long as Cede, as the nominee of DTC, is the registered owner of a Global
Security, Cede for all purposes will be considered the sole holder of the
applicable series of Notes under the indenture. Except as provided below, owners
of beneficial interests in a Global Security will not be entitled to have Notes
registered in their names, will not receive or be entitled to receive physical
delivery of Notes in definitive form, and will not be considered the holders
thereof under the indenture. Accordingly, any person owning a beneficial
interest in a Global Security must rely on the procedures of DTC and, if such
person is not a Participant in DTC, on the procedures of the Participant through
which such person, directly or indirectly, owns its interest, to exercise any
rights of a holder of Notes.
Because DTC can only act on behalf of Participants, who in turn act on behalf of
Indirect Participants and certain banks, the ability of an owner of a beneficial
interest in the Notes to pledge such Notes to persons or entities that do not
participate in the DTC system, or otherwise take actions in respect of such
Notes, may be affected by the lack of a physical certificate for such Notes.
Payment of principal of and interest on the Notes will be made to Cede, the
nominee for DTC, as the registered owner of each Global Security. Neither Valero
nor the Trustee will have any responsibility or liability for any aspect of the
records relating to or payments made on account of beneficial ownership
interests in a Global Security or for maintaining, supervising or reviewing any
records relating to such beneficial ownership interests.
Upon receipt of any payment of principal of or interest on a Global Security,
Valero understands that it is the practice of DTC to credit the Participants'
accounts with payments in amounts proportionate to their respective beneficial
interests in the principal amount of that Global Security as shown on the
records of DTC. Payments by Participants to owners of beneficial interests in
the Global Security held through such Participants will be the responsibility of
such Participants, as is now the case with securities held for the accounts of
customers registered in "street name."
DTC will take any action permitted to be taken by a holder of Notes only at the
direction of one or more Participants to whose account with DTC the Notes are
credited and only in respect of such portion of the
S-65
<PAGE> 66
aggregate principal amount of the applicable series of Notes as to which such
Participant or Participants has or have given such direction. The Trustee will
act upon instructions received from DTC in respect of the aggregate percentages
of interests in the applicable series of Notes necessary for the Trustee to take
action pursuant to the indenture.
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of Notes among its Participants, it is under no obligation to perform
or continue to perform such procedures and such procedures may be discontinued
at any time. Neither Valero nor the Trustee will have any responsibility for the
performance by DTC or its Participants or Indirect Participants of their
respective obligations under the rules and procedures governing their
operations.
If an Event of Default (as defined in the accompanying prospectus) has occurred
and is continuing and all principal and accrued interest in respect of the Notes
shall have become immediately due and payable or if DTC is at any time
unwilling, unable or ineligible to continue as depositary for any Global
Security and a successor depository is not appointed by Valero within 60 days,
Valero will issue individual certificated Notes in definitive form in exchange
for such Global Security. In addition, Valero may at any time determine not to
have the Notes represented by Global Securities, and, in such event, will issue
individual certificated Notes in definitive form in exchange for such Global
Securities. In any such instance, an owner of a beneficial interest in a Global
Security will be entitled to physical delivery of individual certificated Notes
in definitive form equal in principal amount to such beneficial interest in such
Global Securities and to have all such certificated Notes registered in its
name. Individual certificated Notes so issued in definitive form will be issued
in denominations of US$1,000 and integral multiples thereof and will be issued
in registered form only, without coupons.
Initial Settlements
Investors electing to hold their Notes through DTC will follow the settlement
practices applicable to U.S. corporate debt obligations. The securities custody
accounts of investors will be credited with their holdings against payment in
same-day funds on the settlement date.
Secondary Market Trading
Because the purchaser determines the place of delivery, it is important to
establish at the time of trading any Notes the location of both the purchaser's
and seller's accounts to ensure that settlement can be made on the desired value
date.
Trading between DTC Participants
Secondary market trading between DTC Participants will be settled using the
procedures applicable to U.S. corporate debt obligations in same-day funds.
S-66
<PAGE> 67
UNDERWRITING
Subject to the terms and conditions set forth in the Underwriting Agreement
dated June , 2000, Valero has agreed to sell to each of the Underwriters named
below, severally, and each of the Underwriters has severally agreed to purchase,
the principal amount of the Notes set forth opposite its name below:
<TABLE>
<CAPTION>
PRINCIPAL PRINCIPAL
AMOUNT OF AMOUNT OF
UNDERWRITER NOTES NOTES
----------- --------- ---------
<S> <C> <C>
J.P. Morgan Securities Inc. ........................... $ $
Credit Suisse First Boston Corporation.................
Morgan Stanley & Co. Incorporated......................
BMO Nesbitt Burns Corp. ...............................
-------- --------
Total........................................ $ $
======== ========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, if the
Underwriters take any of the Notes, then the Underwriters are obligated to take
and pay for all of the Notes.
The Notes and the Notes are a new issue of securities with no
established trading market and will not be listed on any national securities
exchange. The Underwriters have advised Valero that they intend to make a market
of the Notes, but they have no obligation to do so and may discontinue market
making at any time without providing notice. No assurance can be given as to the
liquidity of any trading market for the Notes.
The Underwriters initially propose to offer part of each series of Notes
directly to the public at the offering prices described on the cover page and
part to certain dealers at a price that represents a concession not in excess of
% of the principal amount of the Notes and % of the principal amount of
the Notes. Any Underwriter may allow, and any such deal may reallow, a
concession not in excess of % of the principal amount of the Notes and
% of the principal amount of the Notes to certain other dealers. After
the initial offering of the Notes, the Underwriters may from time to time vary
the offering price and other selling terms.
Valero has also agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended,
or to contribute to payments which the Underwriters may be required to make in
respect of any such liabilities.
In connection with the offering of the Notes, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Notes. Specifically, the Underwriters may over allot in connection with the
offering of the Notes, creating a syndicate short position. In addition, the
Underwriters may bid for, and purchase, Notes in the open market to cover
syndicate short positions or to stabilize the price of the Notes. Finally, the
underwriting syndicate may reclaim selling concessions allowed for distributing
the Notes in the offering of the Notes, if the syndicate repurchases previously
distributed Notes in syndicate covering transactions, stabilization transactions
or otherwise. Any of these activities may stabilize or maintain the market price
of the Notes above independent market levels. The Underwriters are not required
to engage in any of these activities, and may end any of them at any time.
Expenses associated with this offering, to be paid by Valero, are estimated to
be $ .
Morgan Guaranty Trust Company of New York ("MGT"), an affiliate of J.P. Morgan
Securities Inc., is the administrative agent and lead lender under the Credit
Facility and the Bridge Facility and will receive a portion of the net proceeds
from this offering. Under the Conduct Rules of the National Association of
Securities Dealers (the "NASD"), special considerations apply to a public
offering of securities where more than 10% of the net proceeds thereof will be
paid to a participating underwriter or any of its affiliates. Because more than
10% of the aggregate proceeds form this offering will be paid to MGT, the
offering of the Notes is being conducted pursuant to Rule 2710(c)(8) of the NASD
Conduct Rules.
S-67
<PAGE> 68
In the ordinary course of their respective businesses, the Underwriters and
their affiliates have engaged, any may in the future engage, in commercial
banking or investment banking transactions with Valero and its affiliates or
performed other financial services for all or any part of them. J.P. Morgan
Securities Inc., Credit Suisse First Boston Corporation and Morgan Stanley & Co.
Incorporated served as underwriters in Valero's public offering of notes in
March 1999. J.P. Morgan Securities Inc., Morgan Stanley & Co. Incorporated and
Credit Suisse First Boston Corporation are also serving as underwriters for the
PEPS Units Offering and the Equity Offering.
LEGAL MATTERS
Baker Botts L.L.P., Houston, Texas will pass on the validity of the Notes
offered in this prospectus supplement. Davis Polk & Wardwell will pass upon some
legal matters for the underwriters in connection with this offering.
EXPERTS
Valero's audited consolidated financial statements included in this prospectus
supplement and incorporated by reference from its annual report on Form 10-K for
the year ended December 31, 1999 have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and is included in this prospectus supplement and incorporated by
reference in reliance upon the authority of said firm as experts in accounting
and auditing in giving said report.
The financial statements of Exxon California Refinery, Terminal and Retail
Assets Business (as defined in the Sale and Purchase Agreement between Exxon
Mobil Corporation and Valero Refining Company -- California) as of December 31,
1999 and 1998 and for each of the three years in the period ended December 31,
1999 included in this prospectus supplement have been so included in reliance on
the report of PricewaterhouseCoopers LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
INFORMATION WE INCORPORATE BY REFERENCE
We are incorporating by reference information we file with the SEC, which means
that we are disclosing important information to you by referring you to those
documents. The information we incorporate by reference is an important part of
this prospectus supplement, and information that we file later with the SEC
automatically will update and supersede this information. We incorporate by
reference the documents listed below and any future filings we make with the SEC
under Section 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934
until we sell all the securities:
- our annual report on Form 10-K for the year ended December 31, 1999;
- our quarterly report on Form 10-Q for the three months ended March 31, 2000;
- our current report on Form 8-K dated May 15, 2000 and filed with the SEC on
May 30, 2000;
- our current report on Form 8-K/A dated May 15, 2000 and filed with the SEC on
June 1, 2000, which amends our current report on Form 8-K dated May 15, 2000
and filed with the SEC on May 30, 2000 and amends and supercedes our current
report on Form 8-K dated March 17, 2000 and filed with the SEC on March 20,
2000. As a result, your attention is directed to the most recent information
contained in this current report on Form 8-K/A.
S-68
<PAGE> 69
You may request a copy of these filings (other than an exhibit to those filings
unless we have specifically incorporated that exhibit by reference into the
filing), at no cost, by writing or telephoning us at the following address:
Valero Energy Corporation
One Valero Place
San Antonio, Texas 78212
Attention: Investor Relations
Telephone: (210) 370-2139
S-69
<PAGE> 70
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
VALERO ENERGY CORPORATION AND SUBSIDIARIES
Report of Independent Public Accountants.................. F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998................................................... F-3
Consolidated Statements of Income for the Years Ended
December 31, 1999, 1998 and 1997....................... F-4
Consolidated Statements of Common Stock and Other
Stockholders' Equity................................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998
and 1997............................................... F-6
Notes to Consolidated Financial Statements for the Year
Ended December 31, 1999................................ F-7
Consolidated Balance Sheets as of March 31, 2000
(unaudited) and December 31, 1999...................... F-35
Consolidated Statements of Income for the Three Months
Ended March 31, 2000 and 1999 (unaudited).............. F-36
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2000 and 1999 (unaudited).............. F-37
Notes to Consolidated Financial Statements for the Three
Months Ended March 31, 2000............................ F-38
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS
BUSINESS (AS DEFINED IN THE SALE AND PURCHASE AGREEMENT
BETWEEN EXXON MOBIL CORPORATION AND VALERO REFINING
COMPANY -- CALIFORNIA)
Report of Independent Accountants......................... F-45
Balance Sheet as of December 31, 1999 and 1998............ F-46
Statement of Income for the Years Ended December 31, 1999,
1998 and 1997.......................................... F-47
Statement of Cash Flows for the Years Ended December 31,
1999, 1998 and 1997.................................... F-48
Statement of Changes in Exxon Mobil Corporation Net
Investment............................................. F-49
Notes to Financial Statements as of December 31, 1999..... F-50
Balance Sheet as of March 31, 2000 (unaudited) and
December 31, 1999...................................... F-56
Statement of Income for the Three Months Ended March 31,
2000 and 1999 (unaudited).............................. F-57
Statement of Cash Flows for the Three Months Ended March
31, 2000 and 1999 (unaudited).......................... F-58
Notes to Financial Statements as of March 31, 2000........ F-59
</TABLE>
F-1
<PAGE> 71
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, 1999
and 1998, 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, 1999. 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, 1999 and 1998, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Antonio, Texas
February 18, 2000
F-2
<PAGE> 72
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1999 1998
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and temporary cash investments....................... $ 60,087 $ 11,199
Receivables, less allowance for doubtful accounts of
$3,038 (1999) and $1,150 (1998)........................ 372,542 283,456
Inventories............................................... 303,388 316,405
Current deferred income tax assets........................ 79,307 4,851
Prepaid expenses and other................................ 13,534 23,799
---------- ----------
828,858 639,710
---------- ----------
Property, plant and equipment -- including construction in
progress of $114,747 (1999) and $179,136 (1998), at
cost...................................................... 2,686,684 2,572,190
Less: Accumulated depreciation............................ 702,170 612,847
---------- ----------
1,984,514 1,959,343
---------- ----------
Deferred charges and other assets........................... 165,900 126,611
---------- ----------
$2,979,272 $2,725,664
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........................................... $ -- $ 160,000
Accounts payable.......................................... 616,895 283,183
Accrued expenses.......................................... 102,087 54,561
---------- ----------
718,982 497,744
---------- ----------
Long-term debt.............................................. 785,472 822,335
---------- ----------
Deferred income taxes....................................... 275,521 210,389
---------- ----------
Deferred credits and other liabilities...................... 114,528 109,909
---------- ----------
Common stockholders' equity:
Common stock, $.01 par value -- 150,000,000 shares
authorized; issued 56,331,166 (1999) and 56,314,798
(1998) shares.......................................... 563 563
Additional paid-in capital................................ 1,092,348 1,112,726
Accumulated deficit....................................... (3,331) (17,618)
Treasury stock, 264,464 (1999) and 378,130 (1998) shares,
at cost................................................ (4,811) (10,384)
---------- ----------
1,084,769 1,085,287
---------- ----------
$2,979,272 $2,725,664
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-3
<PAGE> 73
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Operating revenues....................................... $7,961,168 $5,539,346 $5,756,220
---------- ---------- ----------
Costs and expenses:
Cost of sales and operating expenses................... 7,731,151 5,271,473 5,426,438
Write-down of inventories to market value.............. -- 170,929 --
Selling and administrative expenses.................... 68,463 69,482 53,573
Depreciation expense................................... 92,413 78,660 65,175
---------- ---------- ----------
Total.......................................... 7,892,027 5,590,544 5,545,186
---------- ---------- ----------
Operating income (loss).................................. 69,141 (51,198) 211,034
Other income, net........................................ 6,475 586 6,978
Interest and debt expense:
Incurred............................................... (61,182) (37,819) (44,150)
Capitalized............................................ 5,753 5,340 1,695
---------- ---------- ----------
Income (loss) from continuing operations before income
taxes.................................................. 20,187 (83,091) 175,557
Income tax expense (benefit)............................. 5,900 (35,800) 63,789
---------- ---------- ----------
Income (loss) from continuing operations................. 14,287 (47,291) 111,768
Loss from discontinued operations, net of income tax
benefit of $8,889 (1997)............................... -- -- (15,672)
---------- ---------- ----------
Net income (loss)........................................ 14,287 (47,291) 96,096
Less: Preferred stock dividend requirements and
redemption premium.................................. -- -- 4,592
---------- ---------- ----------
Net income (loss) applicable to common stock............. $ 14,287 $ (47,291) $ 91,504
========== ========== ==========
Earnings (loss) per share of common stock:
Continuing operations.................................. $ .25 $ (.84) $ 2.16
Discontinued operations................................ -- -- (.39)
---------- ---------- ----------
Total.......................................... $ .25 $ (.84) $ 1.77
========== ========== ==========
Weighted average common shares outstanding
(in thousands)...................................... 56,086 56,078 51,662
Earnings (loss) per share of common stock -- assuming
dilution:
Continuing operations.................................. $ .25 $ (.84) $ 2.03
Discontinued operations................................ -- -- (.29)
---------- ---------- ----------
Total.......................................... $ .25 $ (.84) $ 1.74
========== ========== ==========
Weighted average common shares outstanding
(in thousands)...................................... 56,758 56,078 55,129
Dividends per share of common stock...................... $ .32 $ .32 $ .42
</TABLE>
See Notes to Consolidated Financial Statements.
F-4
<PAGE> 74
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
RETAINED
CONVERTIBLE NUMBER OF ADDITIONAL UNEARNED EARNINGS
PREFERRED COMMON COMMON PAID-IN VESOP (ACCUMULATED TREASURY
STOCK SHARES STOCK CAPITAL COMPENSATION DEFICIT) STOCK
----------- ---------- -------- ---------- ------------ ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996............ $ 3,450 44,185,513 $44,186 $ 540,133 $(8,783) $ 496,839 $ --
Net income.......................... -- -- -- -- -- 96,096 --
Dividends on redeemable 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 Old
Valero............................ -- -- -- (210,000) -- -- --
Recapitalization in connection with
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
in connection with 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
in connection with 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)
Net income.......................... -- -- -- -- -- 14,287 --
Dividends on common stock........... -- -- -- (17,931) -- -- --
Shares repurchased and shares issued
in connection with employee stock
plans and other................... -- 16,368 -- (2,447) -- -- 5,573
------- ---------- -------- ---------- ------- --------- --------
Balance, December 31, 1999............ $ -- 56,331,166 $ 563 $1,092,348 $ -- $ (3,331) $ (4,811)
======= ========== ======== ========== ======= ========= ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE> 75
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
--------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Income (loss) from continuing operations................. $ 14,287 $ (47,291) $ 111,768
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by continuing
operations:
Depreciation expense.................................. 92,413 78,660 65,175
Amortization of deferred charges and other, net....... 46,610 47,889 27,252
Write-down of inventories to market value............. -- 170,929 --
Changes in current assets and current liabilities..... 296,255 (46,179) (32,113)
Deferred income tax expense (benefit)................. (9,400) (31,700) 32,827
Changes in deferred items and other, net.............. (5,054) (6,483) (8,264)
--------- --------- -----------
Net cash provided by continuing operations.......... 435,111 165,825 196,645
Net cash provided by discontinued operations........ -- -- 24,452
--------- --------- -----------
Net cash provided by operating activities........ 435,111 165,825 221,097
--------- --------- -----------
Cash flows from investing activities:
Capital expenditures:
Continuing operations................................. (100,594) (165,507) (69,284)
Discontinued operations............................... -- -- (52,674)
Deferred turnaround and catalyst costs................... (72,681) (56,346) (10,860)
Purchase of Paulsboro Refinery........................... -- (335,249) --
Acquisition of Basis Petroleum, Inc. .................... -- -- (355,595)
Earn-out payment in connection with Basis acquisition.... -- (10,325) --
Other.................................................... 1,107 1,159 1,693
--------- --------- -----------
Net cash used in investing activities............ (172,168) (566,268) (486,720)
--------- --------- -----------
Cash flows from financing activities:
Increase (decrease) in short-term debt, net.............. (160,000) 38,000 155,088
Long-term borrowings..................................... 922,794 538,434 1,530,809
Long-term debt reduction................................. (961,000) (147,000) (1,217,668)
Special spin-off dividend, including intercompany note
settlement............................................ -- -- (214,653)
Common stock dividends................................... (17,931) (17,953) (21,031)
Preferred stock dividends................................ -- -- (5,419)
Issuance of common stock................................. 15,620 6,677 59,054
Purchase of treasury stock............................... (13,538) (16,451) (9,293)
Redemption of preferred stock............................ -- -- (1,339)
--------- --------- -----------
Net cash provided by (used in) financing
activities..................................... (214,055) 401,707 275,548
--------- --------- -----------
Net increase in cash and temporary cash investments........ 48,888 1,264 9,925
Cash and temporary cash investments at beginning of
period................................................... 11,199 9,935 10
--------- --------- -----------
Cash and temporary cash investments at end of period....... $ 60,087 $ 11,199 $ 9,935
========= ========= ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE> 76
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
As used in this report, the terms "Valero" and the "Company" may, depending upon
the context, refer to Valero Energy Corporation, one or more of its consolidated
subsidiaries, or all of them taken as a whole.
The Company was incorporated in Delaware in 1981 under the name Valero Refining
and Marketing Company as a wholly owned subsidiary of Valero Energy Corporation,
referred to as Old Valero. Old Valero was engaged in both the refining and
marketing business and the natural gas related services business. On July 31,
1997, Old Valero spun off the Company to Old Valero's stockholders by
distributing to them all of the Company's common stock. Immediately after this
distribution, Old Valero, with its remaining natural gas related services
business, merged with a wholly owned subsidiary of PG&E Corporation. The
spin-off of the Company to Old Valero's stockholders and the merger of Old
Valero with PG&E are collectively referred to as the "Restructuring." Upon
completion of the Restructuring, the Company's name was changed from Valero
Refining and Marketing Company to Valero Energy Corporation.
As a result of the Restructuring, the Company became a "successor registrant" to
Old Valero for financial reporting purposes under the federal securities laws.
Accordingly, for periods after the Restructuring, the accompanying consolidated
financial statements include the accounts of Valero and its consolidated
subsidiaries, while for periods before the Restructuring, the accompanying
consolidated financial statements include the accounts of Old Valero restated to
reflect its 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.
PRICE RISK MANAGEMENT ACTIVITIES
The Company uses derivative commodity instruments such as price swaps, options
and futures contracts with third parties to hedge certain 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. 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 uses derivative commodity instruments such as price swaps,
options and futures contracts with third parties to hedge the price risk of
anticipated transactions. These instruments are used to hedge anticipated
feedstock, product and natural gas purchases, product sales, and refining
operating margins by locking in purchase or sales prices or components of
refining operating 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
F-7
<PAGE> 77
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
when the hedged transaction occurs, or when the amount of the hedged
transaction, combined with the hedging instrument, is not deemed to be
recoverable.
Derivative commodity 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 this
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 uses derivative commodity instruments such as price swaps,
options and futures contracts with third parties for trading purposes using its
fundamental and technical analysis of market conditions to earn additional
income. 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."
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 under the weighted average cost method. During the first
quarter of 1999, LIFO inventory quantities were reduced causing prior year LIFO
costs, which were lower than current year replacement costs, to be charged to
cost of sales. This LIFO liquidation resulted in a decrease in cost of sales of
$10.5 million and an increase in net income of $6.8 million, or $.12 per share.
An additional LIFO liquidation in the fourth quarter of 1999 resulted in a
decrease in cost of sales of $9.3 million and an increase in net income of $6.1
million, or $.11 per share. At December 31, 1999, the replacement cost of the
Company's LIFO inventories exceeded their LIFO carrying values by approximately
$146 million. During 1998, the Company incurred pre-tax inventory write-downs
totaling $170.9 million due to a significant decline in feedstock and refined
product prices. Materials and supplies are carried principally at weighted
average cost not in excess of market. Inventories as of December 31, 1999 and
1998 were as follows (in thousands):
F-8
<PAGE> 78
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Refinery feedstocks......................................... $ 61,649 $ 80,036
Refined products and blendstocks............................ 183,519 174,125
Materials and supplies...................................... 58,220 62,244
-------- --------
$303,388 $316,405
======== ========
</TABLE>
Refinery feedstock and refined product and blendstock inventory volumes totaled
15.2 million barrels and 20.5 million barrels as of December 31, 1999 and 1998,
respectively. See Note 7 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.
Major classes of property, plant and equipment as of December 31, 1999 and 1998
were as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Crude oil processing facilities............................. $2,123,518 $1,980,082
Butane processing facilities................................ 243,050 242,996
Other processing facilities................................. 80,230 80,230
Other....................................................... 125,139 89,746
Construction in progress.................................... 114,747 179,136
---------- ----------
$2,686,684 $2,572,190
========== ==========
</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. 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% 3.5%
Butane processing facilities................................ 3.3% 3.3%
Other processing facilities................................. 3.6% 3.6%
Other....................................................... 2.3% - 47.8% 15.5%
</TABLE>
F-9
<PAGE> 79
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
DEFERRED CHARGES AND OTHER ASSETS
Refinery Turnaround Costs
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. As of December 31, 1999 and 1998, the balance of deferred
turnaround costs was $49.2 million and $27.4 million, respectively.
Fixed-Bed Catalyst 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. As of December 31, 1999 and 1998, the balance of deferred
catalyst costs was $16.8 million and $13.1 million, respectively.
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.
Other Deferred Charges and Other Assets
Other deferred charges and other assets include the Company's 20% interest in
Javelina Company, a general partnership that owns a refinery off-gas processing
plant in Corpus Christi, Texas. 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, 1999 and 1998 were as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1999 1998
-------- -------
<S> <C> <C>
Accrued interest expense.................................... $ 9,906 $ 3,620
Accrued taxes............................................... 52,020 29,905
Accrued employee benefit costs.............................. 21,053 12,414
Other....................................................... 19,108 8,622
-------- -------
$102,087 $54,561
======== =======
</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 6 and 7.
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," encourages, but does not require companies to measure
and recognize in their financial statements a compensation cost for stock-
F-10
<PAGE> 80
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
based employee compensation plans based on the "fair value" method of accounting
set forth in the statement. See Note 13 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.
EARNINGS PER SHARE
Basic and diluted earnings per share are presented on the face of the
accompanying income statements in accordance with the provisions of SFAS No.
128, "Earnings per Share," which 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 13) for all periods presented. For
1997, diluted earnings per share also reflected the potential dilution of Old
Valero's convertible preferred stock (see Note 9). In determining basic earnings
per share for the year ended December 31, 1997, dividends on Old Valero's
convertible preferred stock were deducted from income from discontinued
operations as this preferred stock was issued in connection with Old Valero's
natural gas related services business. The weighted average number of common
shares outstanding for the years ended December 31, 1999, 1998 and 1997 was
56,086,381, 56,077,671 and 51,662,449, respectively.
A reconciliation of the basic and diluted per-share computations for income
(loss) from continuing operations is as follows (dollars and shares in
thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------------------
1999 1998 1997
------------------------- -------------------------- --------------------------
PER- PER- PER-
SHARE SHARE SHARE
INCOME SHARES AMT. LOSS SHARES AMT. INCOME SHARES AMT.
------- ------- ----- -------- ------- ----- -------- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Income (loss) from
continuing operations... $14,287 $(47,291) $111,768
======= ======== ========
BASIC EARNINGS PER SHARE:
Income (loss) from
continuing operations
available to common
stockholders............ $14,287 56,086 $.25 $(47,291) 56,078 $(.84) $111,768 51,662 $2.16
==== ===== =====
EFFECT OF DILUTIVE
SECURITIES:
Stock options............. -- 292 -- -- -- 881
Performance awards........ -- 380 -- -- -- 91
Convertible preferred
stock................... -- -- -- -- -- 2,495
------- ------- -------- ------- -------- -------
DILUTED EARNINGS PER
SHARE:
Income (loss) from
continuing operations
available to common
stockholders plus
assumed conversions..... $14,287 56,758 $.25 $(47,291) 56,078 $(.84) $111,768 55,129 $2.03
======= ======= ==== ======== ======= ===== ======== ======= =====
</TABLE>
Because the Company reported a net loss from continuing operations for the year
ended December 31, 1998, various stock options and performance awards which were
granted to employees in connection with the Company's stock compensation plans
and were outstanding during 1998 were not included in the computation of diluted
earnings per share because the effect would have been antidilutive. At
F-11
<PAGE> 81
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
December 31, 1998, options to purchase approximately 5.5 million common shares
and performance awards totaling approximately 100,000 shares were outstanding.
STATEMENTS OF CASH FLOWS
In order to determine net cash provided by continuing operations, income (loss)
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 Petroleum,
Inc. 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,
-------------------------------
1999 1998 1997
-------- --------- --------
<S> <C> <C> <C>
Receivables, net.................................... $(89,086) $ 83,103 $ 36,287
Inventories......................................... 11,180 (9,962) 37,007
Prepaid expenses and other.......................... 10,265 1,980 (12,703)
Accounts payable.................................... 326,536 (116,502) (95,318)
Accrued expenses.................................... 37,360 (4,798) 2,614
-------- --------- --------
Total..................................... $296,255 $ (46,179) $(32,113)
======== ========= ========
</TABLE>
Cash flows related to interest and income taxes, including amounts related to
discontinued operations for the seven months ended July 31, 1997, were as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Interest paid (net of amount capitalized)............... $49,023 $30,735 $66,008
Income tax refunds received............................. 7,530 15,513 --
Income taxes paid....................................... 13,582 5,284 24,526
</TABLE>
Noncash investing and financing activities for 1999 and 1998 included various
adjustments to property, plant and equipment and certain current assets and
current liabilities resulting from the completion of independent appraisals
performed in connection with the September 1998 acquisition of the Paulsboro
Refinery and the May 1997 acquisition of Basis, and the allocation of the
respective purchase prices to the assets acquired and liabilities assumed.
Noncash investing and financing activities for 1997 included the issuance of Old
Valero common stock to 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 this 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 Restructuring discussed above under
"Principles of Consolidation and Basis of Presentation."
F-12
<PAGE> 82
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This SOP provides
guidance for determining when to capitalize or expense costs incurred to develop
or obtain internal-use software. This statement became effective for the
Company's financial statements beginning January 1, 1999, with its requirements
applied to costs incurred on or after this date. The adoption of this SOP did
not have a material effect on the Company's consolidated financial statements.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes in a
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. As issued, this statement was to become effective for the
Company's financial statements beginning January 1, 2000. However, in June 1999,
the FASB issued SFAS No. 137 which delayed for one year the effective date of
SFAS No. 133. As a result, SFAS No. 133 will become effective for the Company's
financial statements beginning January 1, 2001 and is not allowed to be applied
retroactively to financial statements of prior periods. At this effective date,
SFAS No. 133 must be applied to (i) all freestanding derivative instruments and
(ii) all embedded derivative instruments required by the statement to be
separated from their host contracts (or, at the Company's election, only those
derivatives embedded in hybrid instruments issued, acquired or substantively
modified on or after either January 1, 1998 or January 1, 1999). The Company is
currently evaluating the impact on its financial statements of adopting this
statement. Adoption of this statement could result in increased volatility in
the Company's earnings and other comprehensive income.
2. ACCOUNTS RECEIVABLE
In September 1999, the Company entered into an agreement with a financial
institution to sell up to $100 million of an undivided percentage ownership
interest in a designated pool of accounts receivable. As of December 31, 1999,
proceeds of $100 million had been received under this program and were used to
reduce indebtedness under the Company's bank credit facilities.
3. ACQUISITIONS
PAULSBORO REFINERY
On September 16, 1998, the Company and Mobil Oil Corporation 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 refinery in Paulsboro, New Jersey. 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 fair values as determined by an independent appraisal. Under the
purchase method of accounting, the accompanying Consolidated Statements of
Income include the results of operations of the Paulsboro Refinery beginning
September 17, 1998.
F-13
<PAGE> 83
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
As part of 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 these years exceed a specified level. Any
payments under this earn-out arrangement, which are determined in September of
each year beginning in 1999, are limited to $20 million in any year and $50
million in the aggregate. No earn-out amount was due for the year ended
September 16, 1999.
In connection with the acquisition of the Paulsboro Refinery, Mobil agreed to
indemnify the Company for certain environmental matters and conditions existing
on or prior to the acquisition and the Company agreed to assume Mobil's
environmental liabilities, with certain limited exceptions (including
"superfund" liability for off-site waste disposal). Mobil's indemnities and the
periods of indemnification, measured from the September 16, 1998 closing date,
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, 1999,
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 these costs are expected to be incurred in relatively level amounts
over the next 19 years.
BASIS PETROLEUM, INC.
Effective May 1, 1997, Old Valero acquired the outstanding common stock of Basis
Petroleum, Inc., a wholly owned subsidiary of Salomon Inc. Prior to the
Restructuring, Old Valero transferred the stock of Basis to the Company
resulting in Basis being 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. Under 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
beginning May 1, 1997.
The stock of Basis was acquired 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 under the purchase agreement. The
purchase price was paid, in part, with 3,429,796 shares of Old Valero common
stock having a fair market value of $114 million, with the remainder paid in
cash from borrowings under Old Valero's bank credit facilities. As part of 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 these 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. The
earn-out amount for the year ended May 1, 1998 was $10.3 million, while no
earn-out amount was due for the year ended May 1, 1999.
F-14
<PAGE> 84
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information of the Company for the
years ended December 31, 1998 and 1997 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. This 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
---------- ----------
<S> <C> <C>
Operating revenues.......................................... $6,246,790 $8,907,487
Operating income (loss)..................................... (14,422) 250,625
Income (loss) from continuing operations.................... (33,663) 123,440
Loss from discontinued operations........................... -- (15,672)
Net income (loss)........................................... (33,663) 107,768
Earnings (loss) per common share:
Continuing operations..................................... (.60) 2.39
Discontinued operations................................... -- (.39)
Total............................................. (.60) 2.00
Earnings (loss) per common share -- assuming dilution:
Continuing operations..................................... (.60) 2.24
Discontinued operations................................... -- (.29)
Total............................................. (.60) 1.95
</TABLE>
4. DISCONTINUED OPERATIONS
Revenues of the discontinued natural gas related services business were $1.7
billion for the seven months ended July 31, 1997. This amount is not included in
operating revenues as reported in the accompanying 1997 Consolidated Statement
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. This amount
includes interest specifically attributed to the natural gas related services
business, plus an allocated portion of interest on Old Valero's corporate debt
as Old Valero'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.
5. SHORT-TERM DEBT
The Company currently has various uncommitted short-term bank credit facilities
under which amounts up to $240 million may be borrowed. As of December 31, 1999,
there were no borrowings outstanding under these facilities. These short-term
bank 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.
F-15
<PAGE> 85
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
6. LONG-TERM DEBT AND BANK CREDIT FACILITIES
Long-term debt balances as of December 31, 1999 and 1998 were as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<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 1999, 5.7%, due April 1, 2032................... 25,000 --
Series 1998, 5.6%, due April 1, 2032................... 25,000 25,000
Series 1997, 5.6%, due December 1, 2031................ 25,000 25,000
Taxable Waste Disposal Revenue Bonds,
Series 1998, 6.5% at December 31, 1999, due April 1,
2032................................................. 18,500 43,500
7.375% notes, due March 15, 2006............................ 300,000 --
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 7% at December 31, 1999, due
November 28, 2002......................................... 140,000 475,000
Net unamortized premium and discount........................ 3,472 5,335
-------- --------
Total long-term debt (no current maturities)...... $785,472 $822,335
======== ========
</TABLE>
The Company currently maintains an unsecured $835 million revolving bank credit
and letter of credit facility that matures in November 2002 and is available for
general corporate purposes including working capital needs and letters of
credit. Borrowings under this facility bear interest at either LIBOR plus a
margin, a base rate or a money market rate. The Company is also charged various
fees and expenses in connection with this facility, including a facility fee and
various letter of credit fees. The interest rate and fees under this 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, 1999, outstanding borrowings under this committed
facility totaled $140 million, while letters of credit outstanding were
approximately $25 million. The Company also has various uncommitted bank letter
of credit facilities totaling $285 million, approximately $88 million of which
was outstanding as of December 31, 1999.
In March 1999, the Company completed a public offering of $300 million principal
amount of 7 3/8% notes which are due on March 15, 2006. The notes were issued
under the Company's $600 million universal shelf registration statement which
was previously declared effective by the SEC on June 30, 1998. Net proceeds from
the financing of approximately $297.5 million were used to pay down borrowings
under the Company's bank credit facilities.
In March 1999, 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 which have a fixed interest rate of 5.7% and mature on April 1, 2032. The
proceeds from the sale of these tax-exempt fixed-rate bonds were used to redeem
$25 million of the $43.5 million of taxable variable-rate Waste Disposal Revenue
Bonds which were issued in March 1998 at an initial interest rate of 5.7% and
also mature on April 1, 2032. The
F-16
<PAGE> 86
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
remaining $18.5 million of Series 1998 taxable bonds bear interest at a variable
rate determined weekly, with the Company having the right to convert this rate
to a daily, weekly, short-term or long-term rate, or to a fixed rate. In March
1998, the Gulf Coast Waste Disposal Authority issued and sold for the benefit of
the Company $25 million of tax-exempt Waste Disposal Revenue Bonds at a fixed
interest rate of 5.6%. Additionally, the Company converted the interest rates on
its $98.5 million of Series 1997 tax-exempt Revenue Refunding Bonds and $25
million of Series 1997 tax-exempt Waste Disposal Revenue Bonds from variable
rates to a weighted average fixed rate of approximately 5.4%. The Series 1997
Revenue Refunding Bonds were issued in four series with due dates ranging from
2009 to 2027, while the Series 1997 Waste Disposal Revenue Bonds were issued in
one series and mature on December 1, 2031.
In December 1997, the Company issued $150 million principal amount of 6.75%
notes for net proceeds of approximately $156 million. These 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, or 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, or 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, 1999, the Company's debt to capitalization ratio was 42%, a
decrease from 47.5% as of December 31, 1998.
Based on long-term debt outstanding at December 31, 1999, the Company has no
maturities of long-term debt during the next five years except for $140 million
due in November 2002 under its revolving bank credit and letter of credit
facility. See above for maturities under the terms of the 6.75% notes issued in
1997.
As of December 31, 1999 and 1998, the carrying amounts of the Company's taxable
industrial revenue bonds and revolving bank credit facility approximated fair
value due to their variable interest rates. For the Company's fixed-rate
industrial revenue bonds, 7.375% notes and 6.75% notes, their estimated fair
value as of December 31, 1999 was approximately $563 million compared to a
carrying amount of $627 million. As of December 31, 1998, the estimated fair
value of the Company's fixed-rate industrial revenue bonds and 6.75% notes was
approximately $298.2 million compared to a carrying amount of $303.8 million.
The fair values of these instruments were estimated based on borrowing rates
available to the Company for long-term debt with similar terms and average
maturities.
7. PRICE RISK MANAGEMENT ACTIVITIES
The Company is exposed to market risks related to the volatility of crude oil
and refined product prices, as well as volatility in the price of natural gas
used in the Company's refining operations. In order to reduce the risks of these
price fluctuations, the Company uses derivative commodity instruments to hedge
certain refinery inventories and anticipated transactions. The Company also uses
derivative commodity instruments for trading purposes. In the tables below
detailing the Company's open derivative commodity instruments as of December 31,
1999 and 1998, the total gain or (loss) as of either date on price swaps is the
net of the fixed price payor and receiver fair value amounts, while the total
gain or (loss) on options and futures is (i) the excess of the fair value amount
over the contract amount for fixed price payor positions, combined with (ii) the
excess of the contract amount over the fair value amount for fixed price
receiver positions. As discussed above in Note 1 under Price Risk Management
Activities, gains and losses on
F-17
<PAGE> 87
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
hedging activities are deferred and recognized when the hedged transaction
occurs while gains and losses on trading activities are recognized currently.
HEDGING ACTIVITIES
The Company uses derivative commodity instruments such as price swaps, options
and futures contracts with third parties to hedge certain 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 and futures contracts held to hedge refining
inventories at the end of 1999 and 1998 had remaining terms of less than one
year. As of December 31, 1999 and 1998, 19.5% and 5%, respectively, of the
Company's refining inventory position was hedged. As of December 31, 1999, $2.1
million of deferred hedge losses were included as an increase in refining
inventories, while no deferred hedge losses or gains were included in refining
inventories as of December 31, 1998.
The following table provides information about the Company's derivative
commodity instruments held to hedge refining inventories as of December 31, 1999
(which mature in 2000) and December 31, 1998 (which matured in 1999)(dollars in
thousands, except amounts per barrel, or bbl). Volumes shown for swaps represent
notional volumes which are used to calculate amounts due under the agreements.
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
(MATURE IN 2000) (MATURED IN 1999)
------------------- ------------------
FIXED PRICE FIXED PRICE
------------------- ------------------
PAYOR RECEIVER PAYOR RECEIVER
-------- -------- ------- --------
<S> <C> <C> <C> <C>
Swaps:
Notional volumes (thousands of barrels, or
Mbbls).................................... 1,200 2,850 -- --
Weighted average pay price (per bbl)......... $ 1.87 $ 1.68 -- --
Weighted average receive price (per bbl)..... $ 1.70 $ 1.88 -- --
Fair value................................... $ (203) $ 568 -- --
Futures:
Volumes (Mbbls).............................. 6,821 7,410 4,958 5,274
Weighted average price (per bbl)............. $ 27.72 $ 28.71 $ 12.54 $ 13.51
Contract amount.............................. $189,061 $212,729 $62,178 $71,242
Fair value................................... $186,176 $208,327 $62,178 $71,242
</TABLE>
The Company also uses derivative commodity instruments such as price swaps,
options and futures contracts with third parties to hedge the price risk of
anticipated transactions. In 1999 and 1998, price swaps and futures were 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, conventional gasoline and heating oil
crack spreads and premium product differentials. Price swaps were also used in
1999 and 1998 to hedge anticipated purchases of natural gas used in the
Company's refining operations. The majority of contracts hedging anticipated
transactions mature in 2000 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 1999 or 1998.
F-18
<PAGE> 88
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
The following table provides information about the Company's derivative
commodity instruments held to hedge anticipated feedstock, product and natural
gas purchases, product sales and refining margins as of December 31, 1999 (which
mature in 2000) and December 31, 1998 (which matured in 1999)(dollars in
thousands, except amounts per barrel or per million British thermal units, or
MMBtus). Volumes shown for swaps represent notional volumes which are used to
calculate amounts due under the agreements.
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
(MATURE IN 2000) (MATURED IN 1999)
------------------ -----------------
FIXED PRICE FIXED PRICE
------------------ -----------------
PAYOR RECEIVER PAYOR RECEIVER
------- -------- ------ --------
<S> <C> <C> <C> <C>
Swaps:
Notional volumes (Mbbls)....................... 6,000 7,950 1,860 4,650
Weighted average pay price (per bbl)........... $ 1.87 $ 1.70 $ 5.68 $ .83
Weighted average receive price (per bbl)....... $ 1.66 $ 2.04 $ 5.97 $ 64
Fair value..................................... $(1,287) $2,704 $ 554 $ (853)
Notional volumes (billion Btus, or BBtus)...... -- -- 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)................................ 105 101 45 --
Weighted average price (per bbl)............... $ 23.66 $24.22 $17.22 --
Contract amount................................ $ 2,484 $2,446 $ 775 --
Fair value..................................... $ 2,501 $2,446 $ 671 --
</TABLE>
In addition to the above, as of December 31, 1999 and 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, have
notional volumes totaling approximately 7.5 million barrels, and have a weighted
average pay price of $20.11 per barrel. As of December 31, 1999, these swaps had
a weighted average receive price of $18.02 per barrel and a net unrecognized
fair value of approximately $7.4 million. As of December 31, 1998, these swaps
had a weighted average receive price of $17.04 per barrel with no unrecognized
fair value.
TRADING ACTIVITIES
The Company also uses derivative commodity instruments such as price swaps,
options and futures contracts with third parties for trading purposes using its
fundamental and technical analysis of market conditions to earn additional
income. These contracts run for periods of up to 24 months. As a result,
contracts outstanding as of December 31, 1999 will mature in 2000 or 2001.
F-19
<PAGE> 89
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
The following table provides information about the Company's derivative
commodity instruments held or issued for trading purposes as of December 31,
1999 (which mature in 2000 or 2001) and December 31, 1998 (which matured in 1999
or 2000) (dollars in thousands, except amounts per barrel or per million British
thermal units). Volumes shown for swaps represent notional volumes which are
used to calculate amounts due under the agreements.
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
---------------------------------------- -------------------------------------
MATURE IN 2000 MATURE IN 2001 MATURED IN 1999 MATURE IN 2000
------------------- ------------------ ------------------ ----------------
FIXED PRICE FIXED PRICE FIXED PRICE FIXED PRICE
------------------- ------------------ ------------------ ----------------
PAYOR RECEIVER PAYOR RECEIVER PAYOR RECEIVER PAYOR RECEIVER
-------- -------- ------- -------- ------- -------- ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Swaps:
Notional volumes (Mbbls)............... 21,600 23,125 600 600 15,150 9,050 -- 1,650
Weighted average pay price (per bbl)... $ 2.93 $ 2.43 $ 1.95 $ 1.91 $ 2.39 $ 1.77 -- $ 2.10
Weighted average receive price (per
bbl)................................. $ 2.94 $ 2.62 $ 1.90 $ 2.18 $ 2.25 $ 1.90 -- $ 2.30
Fair value............................. $ 204 $ 4,377 $ (28) $ 163 $(2,130) $ 1,244 -- $ 330
Options:
Volumes (Mbbls)........................ 1,400 1,400 -- -- 400 400 -- --
Weighted average strike price (per
bbl)................................. $ 24.36 $ 24.36 -- -- $ 16.91 $ 16.91 -- --
Contract amount........................ $ (11) $ (220) -- -- $ 723 $ 707 -- --
Fair value............................. $ 200 $ 200 -- -- $ 641 $ 714 -- --
Futures:
Volumes (Mbbls)........................ 25,933 26,158 3,125 3,125 5,301 5,401 -- --
Weighted average price (per bbl)....... $ 21.39 $ 21.48 $ 19.48 $ 18.90 $ 14.66 $ 14.97 -- --
Contract amount........................ $554,604 $561,979 $60,883 $59,050 $77,701 $80,865 -- --
Fair value............................. $621,949 $623,768 $60,938 $60,938 $72,583 $76,592 -- --
Volumes (BBtus)........................ 750 750 -- -- -- 250 -- --
Weighted average price (per MMBtu)..... $ 2.77 $ 2.69 -- -- -- $ 1.96 -- --
Contract amount........................ $ 2,074 $ 2,020 -- -- -- $ 490 -- --
Fair value............................. $ 1,747 $ 1,747 -- -- -- $ 488 -- --
</TABLE>
The following table discloses the net gains (losses) from trading activities and
average fair values of contracts held or issued for trading purposes for the
periods ended December 31, 1999 and 1998 (dollars in thousands):
<TABLE>
<CAPTION>
AVERAGE FAIR VALUE
NET GAINS (LOSSES) OF ASSETS (LIABILITIES)
------------------- ------------------------
1999 1998 1999 1998
------- ------- ----------- --------
<S> <C> <C> <C> <C>
Swaps...................................... $13,521 $ 2,585 $ 1,127 $215
Options.................................... (115) 205 391 22
Futures.................................... 3,764 (1,758) (2,953) 448
------- -------
Total............................ $17,170 $ 1,032
======= =======
</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 these customers may be similarly affected by changes in
F-20
<PAGE> 90
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
economic or other conditions. The Company believes that its counterparties will
be able to satisfy their obligations under contracts.
8. REDEEMABLE PREFERRED STOCK
On March 30, 1997, Old Valero redeemed the remaining 11,500 outstanding shares
of its $8.50 Series A cumulative preferred stock. The redemption price was $104
per share, plus dividends accrued to the redemption date of $.685 per share.
9. CONVERTIBLE PREFERRED STOCK
In April 1997, Old Valero called all of its outstanding $3.125 convertible
preferred stock for redemption on June 2, 1997. The redemption price was $52.188
per share, plus accrued dividends of $.0086 per share for the one-day period
from June 1 to June 2, 1997. This preferred stock was convertible into Old
Valero common stock at a price of $27.03 per share, or approximately 1.85 shares
of Old Valero common stock for each share of convertible preferred stock. Before
the redemption, substantially all of the outstanding shares of convertible
preferred stock were converted into Old Valero common stock.
10. PREFERRED SHARE PURCHASE RIGHTS
Each outstanding share of the Company's common stock is accompanied by one
Preferred Share Purchase Right, or Right. With certain exceptions, 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 at a
price of $100 per one one-hundredth of a share, subject to adjustment for
certain recapitalization events.
The Rights are transferable only with the common stock until the earlier of (i)
10 days following a public announcement that a person or group of affiliated or
associated persons, any such person, group or associates being referred to as 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
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 an Acquiring Person having beneficial ownership of 15% or more of the
Company's outstanding common stock (the earlier of the date of the occurrence of
(i) or (ii) being called the Rights Separation Date), or (iii) the earlier
redemption or expiration of the Rights. The Rights are not exercisable until the
Rights Separation Date. At any time prior to the acquisition by an Acquiring
Person of beneficial ownership of 15% or more of 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 extended or the Rights
are earlier redeemed or exchanged by the Company.
If 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 of the Right at its then current exercise price, that
number of shares of common stock of the acquiring company which at the time of
the transaction will have a market value of two times the exercise price of the
Right. In the event that any Acquiring Person becomes the beneficial owner of
15% or more of 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 an Acquiring Person acquires beneficial ownership of 15% or
more of the outstanding common stock and prior to the acquisition by the
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
F-21
<PAGE> 91
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
the Acquiring Person which have become void), at an exchange ratio of one share
of common stock, or one one-hundredth of a share of Junior Preferred Stock, per
Right (subject to adjustment).
Until a Right is exercised, the holder will have no rights as a stockholder of
the Company including, without limitation, the right to vote or to receive
dividends.
The Rights may have certain anti-takeover effects. The Rights will cause
substantial dilution to any Acquiring Person 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 an Acquiring Person has acquired
beneficial ownership of 15% or more of the common stock.
11. SEGMENT INFORMATION
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 785,000 barrels per day. In applying the requirements
of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," the Company's five refineries, each of which represents an
operating segment as defined by the statement, have been aggregated as allowed
by the statement for reporting purposes. As a result, the Company has 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 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, 1999, 1998 and 1997 were as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Gasolines and blendstocks........................ $4,381,112 $3,040,103 $3,209,552
Distillates...................................... 1,848,621 1,270,859 1,124,958
Petrochemicals................................... 258,850 166,769 269,418
Lubes and asphalts............................... 178,653 44,239 --
Other products and revenues...................... 1,293,932 1,017,376 1,152,292
---------- ---------- ----------
Total operating revenues............... $7,961,168 $5,539,346 $5,756,220
========== ========== ==========
</TABLE>
In 1999, 1998 and 1997, the Company had no significant amount of export sales
and no significant foreign operations. In 1999, 13% of the Company's
consolidated operating revenues were derived from sales to Mobil Oil
Corporation, while in 1998 and 1997, no single customer accounted for more than
10% of the Company's consolidated operating revenues.
F-22
<PAGE> 92
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
12. INCOME TAXES
Components of income tax expense (benefit) applicable to continuing operations
were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1999 1998 1997
------- -------- -------
<S> <C> <C> <C>
Current:
Federal.............................................. $14,896 $ (3,196) $29,501
State................................................ 404 (904) 1,461
------- -------- -------
Total current................................ 15,300 (4,100) 30,962
Deferred:
Federal.............................................. (9,400) (31,700) 32,827
------- -------- -------
Total income tax expense (benefit)........... $ 5,900 $(35,800) $63,789
======= ======== =======
</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,
----------------------------
1999 1998 1997
------- -------- -------
<S> <C> <C> <C>
Federal income tax expense (benefit) at the statutory
rate................................................. $ 7,065 $(29,082) $61,445
State income taxes, net of federal income tax effect... 263 (588) 950
Research and experimentation tax credit................ -- (5,800) --
Basis difference on disposition of investment.......... (1,894) -- --
Other -- net........................................... 466 (330) 1,394
------- -------- -------
Total income tax expense (benefit)........... $ 5,900 $(35,800) $63,789
======= ======== =======
</TABLE>
The tax effects of significant temporary differences representing deferred
income tax assets and liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1999 1998
--------- ---------
<S> <C> <C>
Deferred income tax assets:
Tax credit carryforwards.................................. $ 34,131 $ 18,549
Net operating loss carryforward........................... 48,682 41,904
Compensation and employee benefit liabilities............. 28,437 23,910
Environmental liabilities................................. 9,868 9,705
Inventory and related adjustments......................... 36,047 8,578
Accrued liabilities and other............................. 9,585 8,418
--------- ---------
Total deferred income tax assets.................. $ 166,750 $ 111,064
========= =========
Deferred income tax liabilities:
Depreciation.............................................. $(334,077) $(299,082)
Other..................................................... (28,887) (17,520)
--------- ---------
Total deferred income tax liabilities............. $(362,964) $(316,602)
========= =========
</TABLE>
F-23
<PAGE> 93
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
As of December 31, 1999, the Company had federal net operating loss
carryforwards of approximately $139 million which are available to reduce future
federal taxable income, some of which will expire in 2018 and the remainder in
2019 if not utilized. In addition, the Company had an alternative minimum tax
credit carryforward of approximately $28 million, and a research and
experimentation credit carryforward of approximately $6 million, both of which
are available to reduce future federal income tax liabilities. The alternative
minimum tax credit carryforward has no expiration date, while the research and
experimentation credit carryforward expires between 2004 and 2011. No valuation
allowances were recorded against deferred income tax assets as of December 31,
1999 and 1998.
The Company's taxable years through 1995 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.
13. EMPLOYEE BENEFIT PLANS
PENSION PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company's pension plan, which is subject to the provisions of the Employee
Retirement Income Security Act of 1974, or 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 Mobil or Basis (see Note 3). 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 this date is counted under the plan. 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. A participant generally vests in plan benefits
after five years of vesting service or upon reaching normal retirement.
At the time of the Restructuring, the Company became solely responsible for (i)
pension liabilities existing immediately prior to the Restructuring to, or
relating to, Old Valero employees which became employees of PG&E after the
Restructuring, which will become payable upon their retirement, (ii) all
liabilities to, or relating to, former employees of Old Valero and the Company,
and (iii) all liabilities to, or relating to, current employees of the Company.
In connection with the Restructuring, Old Valero approved the establishment of a
supplement to the pension plan, referred to as the 1997 Window Plan, which
permitted certain employees to retire from employment during 1997. Also, the
Company became the sponsor of Old Valero's nonqualified Supplemental Executive
Retirement Plan, or 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 Old Valero and
the Company under this plan.
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 1999, 1998 and 1997 were
approximately $7.4 million, $7.2 million and $8.8 million, respectively, and are
currently estimated to be $4.8 million in 2000.
F-24
<PAGE> 94
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
The Company also provides certain health care and life insurance benefits for
retired employees, referred to as postretirement benefits other than pensions.
Substantially all of the Company's employees may become eligible for these
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.
Employees of the Company who were formerly employees of Mobil and Basis became
eligible for postretirement benefits other than pensions under the Company's
plan effective September 17, 1998 and May 1, 1997, respectively. At the time of
the Restructuring, the Company became responsible for all liabilities to former
employees of both Old Valero and the Company as well as current employees of the
Company arising under Old Valero's health care and life insurance programs.
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, 1999 and 1998, as well as changes in the
benefit obligation and plan assets for the years then ended (in thousands):
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, January 1.................. $152,430 $129,430 $ 42,325 $ 32,721
Service cost................................. 9,466 6,934 2,047 1,703
Interest cost................................ 10,114 9,031 2,818 2,411
Plan amendments.............................. -- 3,549 -- --
Acquisition of Paulsboro Refinery............ -- -- -- 8,107
Participant contributions.................... -- -- 131 108
Benefits paid................................ (6,399) (6,967) (1,986) (1,826)
Actuarial loss (gain)........................ (2,269) 10,453 (2,706) (899)
-------- -------- -------- --------
Benefit obligation, December 31................ $163,342 $152,430 $ 42,629 $ 42,325
======== ======== ======== ========
CHANGE IN PLAN ASSETS:
Plan assets at fair value, January 1........... $139,262 $121,393 $ -- $ --
Actual return on plan assets................. 31,498 17,644 -- --
Company contributions........................ 7,354 7,192 1,855 1,718
Participant contributions.................... -- -- 131 108
Benefits paid................................ (6,399) (6,967) (1,986) (1,826)
-------- -------- -------- --------
Plan assets at fair value, December 31......... $171,715 $139,262 $ -- $ --
======== ======== ======== ========
RECONCILIATION OF FUNDED STATUS, DECEMBER 31:
Plan assets at fair value...................... $171,715 $139,262 $ -- $ --
Less: Benefit obligation....................... 163,342 152,430 42,629 42,325
-------- -------- -------- --------
Funded status.................................. 8,373 (13,168) (42,629) (42,325)
Unrecognized transition obligation (asset)..... (913) (1,057) 4,071 4,388
Unrecognized prior service cost................ 6,921 7,787 1,558 1,672
Unrecognized net (gain) loss................... (16,121) 5,347 (688) 2,019
-------- -------- -------- --------
Accrued benefit cost......................... $ (1,740) $ (1,091) $(37,688) $(34,246)
======== ======== ======== ========
</TABLE>
F-25
<PAGE> 95
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
AMOUNTS RECOGNIZED IN CONSOLIDATED BALANCE
SHEETS AS OF DECEMBER 31:
Prepaid benefit cost........................... $ 15,054 $ 8,145 $ -- $ --
Accrued benefit liability...................... (16,794) (9,236) (37,688) (34,246)
-------- -------- -------- --------
Accrued benefit cost......................... $ (1,740) $ (1,091) $(37,688) $(34,246)
======== ======== ======== ========
</TABLE>
Total benefit cost for the years ended December 31, 1999, 1998 and 1997 included
the following components (in thousands):
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
----------------------------- ------------------------
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------------- ------------------------
1999 1998 1997 1999 1998 1997
-------- -------- ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
COMPONENTS OF TOTAL BENEFIT COST:
Service cost............................... $ 9,466 $ 6,934 $ 3,710 $2,047 $1,703 $1,028
Interest cost.............................. 10,114 9,031 7,298 2,818 2,411 1,842
Expected return on plan assets............. (12,642) (11,149) (9,563) -- -- --
Amortization of transition obligation
(asset).................................. (144) (142) (142) 317 317 513
Amortization of prior service cost......... 866 747 703 114 114 184
Amortization of net loss (gain)............ 343 53 (154) -- -- 46
-------- -------- ------- ------ ------ ------
Net periodic benefit cost................ 8,003 5,474 1,852 5,296 4,545 3,613
Curtailment loss (gain) resulting from the
Restructuring............................ -- -- (2,083) -- -- 576
1997 Window Plan........................... -- -- 3,168 -- -- 171
-------- -------- ------- ------ ------ ------
Total benefit cost............... $ 8,003 $ 5,474 $ 2,937 $5,296 $4,545 $4,360
======== ======== ======= ====== ====== ======
</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, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
---------------- --------------
1999 1998 1999 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
WEIGHTED-AVERAGE ASSUMPTIONS, DECEMBER 31:
Discount rate...................................... 7.50% 6.75% 7.50% 6.75%
Expected long-term rate of return on plan assets... 9.25% 9.25% -- --
Rate of compensation increase...................... 5.05% 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 after 1999. Assumed health care cost trend rates
have a significant effect on the amounts reported
F-26
<PAGE> 96
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
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........................................... $1,073 $ (891)
Effect on benefit obligation........................... $7,948 $(6,729)
</TABLE>
PROFIT-SHARING/SAVINGS PLANS
The Company is the sponsor of the Valero Energy Corporation Thrift Plan which is
a qualified employee profit-sharing 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 Mobil and Basis became
eligible to participate in the Thrift Plan on September 17, 1998 and January 1,
1998, respectively, under the same service requirements as required for other
Company employees, with service including prior employment with Mobil or Basis.
Effective January 1999, former Mobil employees who became employees of the
Company could elect to transfer their balances from the Mobil employee savings
plan into the Thrift Plan or maintain these amounts in the Mobil plan. For
former Basis employees who became employees of the Company, Basis' previously
existing 401(k) profit-sharing and retirement savings plan was maintained
through December 31, 1997 and was merged into the Company's Thrift Plan
effective January 1, 1998. At the time of the Restructuring, the Company became
solely responsible for all Thrift Plan liabilities arising after the
Restructuring with respect to current Company employees and former employees of
both Old Valero and the Company. Each Old Valero employee participating in the
Thrift Plan before the Restructuring who became a PG&E employee after the
Restructuring had their account balance transferred to the PG&E savings plan.
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 these contributions on either a before-tax or after-tax basis,
or both, with federal income taxes on before-tax contributions being deferred
until a distribution is made to the participant. Participants' contributions 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 the termination in 1997 of the Valero Employees' Stock
Ownership Plan, or VESOP, a leveraged employee stock ownership plan established
by Old Valero in 1989, 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. After the VESOP termination, all Company matching contributions
were made to the Thrift Plan. Company contributions to the Thrift Plan were
$6,670,841, $5,298,870 and $2,247,491 (net of forfeitures) for the years 1999,
1998 and 1997, respectively. During 1997, the Company contributed $586,000 to
the VESOP. This amount consisted of $58,000 of interest on the VESOP's debt and
$541,000 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 by
$13,000. VESOP shares of common stock were considered outstanding for earnings
per share computations.
F-27
<PAGE> 97
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
STOCK COMPENSATION PLANS
The Company has various fixed and performance-based stock compensation plans.
The Company's Executive Stock Incentive Plan, or ESIP, which was maintained by
Old Valero before 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,
performance shares which vest upon the achievement of an objective performance
goal, and restricted stock which vests over a period determined by the Company's
compensation committee. (Note: All restricted stock issued before the
Restructuring under Old Valero's stock compensation plans became fully vested
either upon the approval of the Restructuring by Old Valero's stockholders on
June 18, 1997 or upon the completion of the Restructuring on July 31, 1997.) 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 which, at the date of the
Restructuring, replaced three non-qualified stock option plans previously
maintained by Old Valero. 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 this 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-noted plans (other than shares related to
stock options which are presented in a separate table below) during 1999, 1998
and 1997 were as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------- -------------------- -------------------------------------------
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............. 26,000 $20.30 163,986 $31.51 6,250 $31.78 -- $ --
Performance awards........... 225,500 21.31 54,000 31.25 -- -- 31,400 32.50
Executive Incentive Bonus
Plan......................... 59,937 19.25 2,516 31.25 -- -- 109,691 32.50
Non-employee director
restricted stock plan........ 4,190 21.48 -- -- 9,336 28.94 -- --
</TABLE>
Under the terms of the ESIP, the stock option plan and the non-employee director
stock option plan, the exercise price of options granted will not be less than
the fair market value of the Company's common stock at the date of grant. Stock
options become exercisable pursuant to the individual written agreements between
the Company and the participants, usually in three equal annual installments
beginning one year after the date of grant, with unexercised options generally
expiring ten years from the date of grant. In connection with the Restructuring,
all stock options held by Old Valero employees under any of Old Valero'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 Old
Valero's stockholders on June 18, 1997. For all options still outstanding at the
time of the Restructuring, each option to purchase Old Valero 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
F-28
<PAGE> 98
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
employee of Old Valero'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 so that the aggregate
option value for each holder immediately after the Restructuring was equal to
the aggregate option value immediately before the Restructuring. The other terms
and conditions of these converted options remained essentially unchanged.
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 Old Valero's previously existing stock compensation plans, as of
December 31, 1999, 1998, and 1997, and changes during the years then ended is
presented in the table below. (Note: The outstanding shares at July 31, 1997
before the Restructuring are different from the outstanding shares at August 1,
1997 after the Restructuring because the August 1 amount: (i) reflects the
conversion of Old Valero options held by current or former employees of the
Company to an equivalent number of Company options and (ii) excludes options
held by current or former employees of Old Valero's natural gas related services
business which were converted to PG&E options.)
<TABLE>
<CAPTION>
1999 1998 1997
--------------------- --------------------- ----------------------------------------------
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.................... 5,528,996 $21.01 3,780,418 $19.15 3,802,584 $19.05 4,229,092 $22.02
Granted..................... 1,580,062 20.29 2,049,755 24.00 36,550 29.35 1,365,875 33.71
Exercised................... (17,806) 14.77 (235,235) 15.80 (44,144) 17.21 (2,925,687) 21.81
Forfeited................... (29,677) 23.41 (65,942) 25.62 (14,572) 23.07 (17,028) 25.84
--------- --------- --------- ----------
Outstanding at end of
period.................... 7,061,575 20.86 5,528,996 21.01 3,780,418 19.15 2,652,252 28.25
========= ========= ========= ==========
Exercisable at end of
period.................... 3,788,724 19.93 2,524,643 18.16 1,758,479 15.08 1,288,977 22.47
Weighted-average fair value
of options granted........ $6.61 $5.53 $6.86 $8.09
</TABLE>
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, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ----------------------------
NUMBER WEIGHTED-AVG. NUMBER
RANGE OF OUTSTANDING REMAINING WEIGHTED-AVG. EXERCISABLE WEIGHTED-AVG.
EXERCISE PRICES AT 12/31/99 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/99 EXERCISE PRICE
--------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$11.47 - $17.50............... 1,725,563 6.4 years $14.95 1,078,001 $13.43
$18.03 - $25.57............... 4,651,457 7.9 21.53 2,448,342 21.60
$28.06 - $34.91............... 684,555 8.1 31.19 262,381 31.12
--------- ---------
$11.47 - $34.91............... 7,061,575 7.6 20.86 3,788,724 19.93
========= =========
</TABLE>
The fair value of each option grant was estimated on the grant date using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1999, 1998 and 1997, respectively: risk-free
interest rates of 5.5 percent, 5.0 percent and 6.3 percent; expected dividend
yields of 1.6 percent, 1.4 percent and 1.5 percent; expected lives of 3.2 years,
3.1 years and 3.2 years; and expected volatility of 42.3 percent, 28.2 percent
and 26.2 percent. As a result of insufficient stock price history for Valero
subsequent to the Restructuring, the expected volatility assumption for grants
in 1998 and 1997 was
F-29
<PAGE> 99
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
based on the stock price history of Old Valero, whereas the expected volatility
assumption for 1999 grants was based on the stock price history of Valero
subsequent to the Restructuring.
For each common share that can be purchased in connection with a stock option,
the stock option plan provides, and the predecessor stock option plans of Old
Valero provided, that a stock appreciation right, or 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
during 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. There were no SARs outstanding as of December 31, 1999, 1998 or
1997. A summary of SAR activity for the seven months ended July 31, 1997 is
presented in the table below.
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
NO. OF EXERCISE
SARS PRICE
------- ---------
<S> <C> <C>
Outstanding at January 1, 1997.............................. 89,087 $14.52
Granted..................................................... -- --
Exercised................................................... (88,087) 14.52
Forfeited................................................... (1,000) 14.52
-------
Outstanding at July 31, 1997................................ -- --
=======
</TABLE>
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 $4 million, $3 million and $4.6
million for 1999, 1998 and 1997, respectively. Of the 1997 amount, $2.1 million
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 1999, 1998 and 1997
awards under those plans consistent with the method of SFAS No. 123, the
Company's net income and earnings per share for the years ended December 31,
1999 and 1997 would have been reduced, and the Company's net loss and loss per
share for the year ended December 31, 1998 would have increased to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1999 1998 1997
------- -------- -------
<S> <C> <C> <C> <C>
Net income (loss)............................ As Reported $14,287 $(47,291) $96,096
Pro Forma $ 7,869 $(52,398) $92,304
Earnings (loss) per share.................... As Reported $ .25 $ (.84) $ 1.77
Pro Forma $ .14 $ (.93) $ 1.70
Earnings (loss) per share -- assuming
dilution................................... As Reported $ .25 $ (.84) $ 1.74
Pro Forma $ .14 $ (.93) $ 1.67
</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.
F-30
<PAGE> 100
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
14. 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 refined
products. Long-term leases for land have remaining primary terms of up to 24.7
years, while long-term leases for office facilities have remaining primary terms
of up to 2.5 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 5.25 years and in certain cases provide for
various contingent payments based on, among other things, throughput volumes in
excess of a base amount.
Future minimum lease payments and minimum rentals to be received under subleases
as of December 31, 1999 for operating leases having initial or remaining
noncancelable lease terms in excess of one year are as follows (in thousands):
<TABLE>
<S> <C>
2000...................................................... $ 30,834
2001...................................................... 25,426
2002...................................................... 17,082
2003...................................................... 11,979
2004...................................................... 9,576
Remainder................................................. 8,432
--------
103,329
Less future minimum rentals to be received under
subleases............................................... 78
--------
$103,251
========
</TABLE>
Consolidated rental expense under operating leases for continuing operations
amounted to approximately $57,005,000, $47,779,000, and $39,578,000 for 1999,
1998 and 1997, respectively. These amounts are included in the accompanying
Consolidated Statements of Income under "Cost of sales and operating expenses"
and "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. In addition, during
1999, in order to secure a firm supply of hydrogen for the Texas City Refinery,
the Company entered into long-term hydrogen supply arrangements with initial
terms of approximately 15 years. Under these agreements, the Company is
obligated to make fixed minimum payments of approximately $4.9 million annually,
as well as other minimum payments which vary based on certain natural gas
reference prices.
15. LITIGATION AND CONTINGENCIES
LITIGATION RELATING TO DISCONTINUED OPERATIONS
Old Valero and certain of its natural gas related subsidiaries, and the Company,
have been sued by Teco Pipeline Company regarding the operation of the 340-mile
West Texas Pipeline in which a subsidiary of Old Valero holds a 50% undivided
interest. In 1985, a subsidiary of Old Valero sold a 50% undivided interest in
the pipeline and entered into a joint venture through an ownership agreement and
an operating agreement, with the purchaser of the interest. In 1988, Teco
succeeded to that purchaser's 50% interest. A subsidiary of Old Valero has at
all times been the operator of the pipeline. Despite the written ownership and
operating agreements, the plaintiff contends that a separate, unwritten
partnership agreement exists,
F-31
<PAGE> 101
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
and that the defendants have exercised improper control over this alleged
partnership's affairs. The plaintiff also contends that the defendants acted in
bad faith and negatively affected the economics of the joint venture in order to
provide financial advantages to facilities or entities owned by the defendants,
and by allegedly taking 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. Old Valero's motion to require arbitration of the
case as required in the written agreements was denied by the trial court, but
Old Valero appealed, and in August 1999, the court of appeals ruled in Old
Valero's favor and ordered arbitration of the entire dispute. Teco has since
waived efforts to further appeal this ruling, and an arbitration panel has been
selected. The Company has been formally added to this proceeding. The
arbitration panel has scheduled the arbitration hearing for October 2000.
Although PG&E previously acquired Teco and now owns both Teco and Old Valero,
PG&E's Teco acquisition agreement purports to assign the benefit or detriment of
this lawsuit to the former shareholders of Teco. In connection with the
Restructuring, the Company has agreed to indemnify Old Valero with respect to
this lawsuit for 50% of any final judgment or settlement amount up to $30
million, and 100% of that part of any final judgment or settlement amount over
$30 million.
OTHER LITIGATION
In 1986, the Company filed suit against M.W. Kellogg Company for damages arising
from certain alleged design and construction defects in connection with a major
construction project at the Corpus Christi Refinery. Ingersoll-Rand Company was
added as a defendant in 1989. In 1991, the trial court granted summary judgment
against Valero based in part on certain exculpatory provisions in various
agreements connected with the project. In 1993, the court of appeals affirmed
the summary judgment and the Texas Supreme Court denied review. Subsequent to
the summary judgment, Kellogg and Ingersoll-Rand brought indemnity claims
against Valero for attorney's fees and expenses incurred in defending the
original action. In 1996, the trial court rendered summary judgment against
Kellogg and Ingersoll-Rand based on procedural grounds, and the court of appeals
affirmed that ruling in 1997. However, in 1999, the Texas Supreme Court reversed
the court of appeals and remanded Kellogg's and Ingersoll-Rand's claims for
attorney's fees and expenses to the trial court. The Company has denied that it
has any liability with respect to these claims and has raised several
substantive defenses to these claims in the trial court.
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 it is a party would
have a material adverse effect on its 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 or financial condition.
F-32
<PAGE> 102
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The Company's results of operations by quarter for the years ended December 31,
1999 and 1998 were as follows (in thousands of dollars, except per share
amounts):
<TABLE>
<CAPTION>
1999 -- QUARTER ENDED
-----------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
---------- ---------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C>
Operating revenues............. $1,337,103 $1,824,450 $2,161,938 $2,637,677 $7,961,168
Operating income (loss)........ 8,520 (20,733) 47,438 33,916 69,141
Net income (loss).............. (2,716) (22,085) 22,612 16,476 14,287
Earnings (loss) per common
share........................ (.05) (.39) .40 .29 .25
Earnings (loss) per common
share -- assuming dilution... (.05) (.39) .40 .29 .25
</TABLE>
<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)
Net income (loss)(2)........... (5,884) 39,939 4,311 (85,657) (47,291)
Earnings (loss) per common
share(2)..................... (.11) .71 .08 (1.53) (.84)
Earnings (loss) per common
share -- assuming
dilution(2).................. (.11) .70 .08 (1.53) (.84)
</TABLE>
---------------
(1) Includes the operations of the Paulsboro Refinery beginning 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 net income for those periods of $24,488, $86,616, and
$111,104, respectively, and a reduction in earnings per common share of
$.43, $1.55, and $1.98, respectively.
17. SUBSEQUENT EVENTS
PROPOSED ACQUISITION OF CALIFORNIA REFINING AND MARKETING ASSETS
On March 2, 2000, Valero and ExxonMobil Corporation executed a sale and purchase
agreement for the purchase by Valero of ExxonMobil's Benicia, California
refinery and all Exxon-branded California retail assets for a purchase price of
$895 million plus an amount representing the value of inventories acquired in
the transaction, which will be based on market-related prices at closing.
ExxonMobil agreed to sell these assets as a result of Consent Decrees issued by
the Federal Trade Commission and the State of California providing that certain
assets be divested by ExxonMobil to satisfy anticompetitive issues in connection
with the recent merger of Exxon Corporation and Mobil Corporation. Valero's
acquisition of the ExxonMobil California assets is pending approval from the
Federal Trade Commission and the State of California.
The Benicia Refinery is located on the Carquinez Straits of the San Francisco
Bay. It is considered a highly complex refinery and has a rated crude oil
capacity of 130,000 barrels per day. The Benicia Refinery produces a high
percentage of light products, with limited production of natural gas liquids and
other products. Over 95% of the gasoline produced by the Benicia Refinery meets
the California Air Resources Board specifications for gasoline sold in
California. The refinery has significant liquid storage capacity including
storage for crude oil and other feedstocks. Also included with the refinery
assets are a deepwater dock located offsite on the Carquinez Straits which is
capable of berthing large crude carriers,
F-33
<PAGE> 103
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1999 -- (CONTINUED)
petroleum coke storage silos located on an adjacent dock, a 20-inch crude
pipeline connecting the refinery to a southern California crude delivery system,
and an adjacent truck terminal for regional truck rack sales. Under the Consent
Decrees, ExxonMobil was required to offer the buyer of the divested assets a
crude oil supply contract. As a consequence, the sale and purchase agreement
includes a contract allowing Valero to purchase up to 100,000 barrels per day of
Alaska North Slope crude oil at market-related prices delivered to the Benicia
Refinery.
The retail assets include 10 company-owned and operated sites and 70
company-owned lessee-dealer sites, 75 of which are in the San Francisco Bay
area. Under the Consent Decrees, the Federal Trade Commission and the State of
California ordered that ExxonMobil withdraw the "Exxon" brand name from this
area. As a result, ExxonMobil has notified the dealers in this market area that
their franchise right to market "Exxon" branded products is being terminated
effective June 15, 2000. Valero will offer its own brand to market retail
petroleum products at these locations. Due to the timing requirements of
ExxonMobil's franchise termination notice to various dealers as described above,
ExxonMobil cannot close the transaction until (i) all of the dealers agree to
terminate their franchise agreements or (ii) June 15, 2000, whichever comes
first.
Also included in the retail assets are up to 260 independently-owned and
operated distributor facilities which are located outside of the San Francisco
Bay area. The distributor locations will retain the right to use the Exxon
brand, continue to accept the Exxon proprietary credit card and receive Exxon
brand support, while Valero will receive the exclusive rights to offer the Exxon
brand throughout the state (except for the San Francisco Bay area) for a
ten-year period. In connection with the acquisition, ExxonMobil will assign to
Valero all of the existing Exxon California distributor contracts under which
the distributors will purchase Exxon branded products from Valero after the
acquisition. Valero will supply distributors either directly through a refined
products pipeline or indirectly through petroleum product exchange transactions.
The acquisition will be funded through a mix of debt, equity and structured
lease financing. The debt would be a combination of borrowings under Valero's
existing bank credit facility and new term debt. The equity component will be
between $250 million and $350 million of some combination of common stock and
convertible preferred stock, including mandatory convertible preferred stock. In
case any of these financing sources are not finalized or available at the
closing date, Valero will close the purchase with interim financing consisting
of (i) a committed $600 million bank bridge facility which has been established
and (ii) borrowings under its existing bank credit facilities with related
amendments to these facilities providing for a higher debt-to-capitalization
limit (which amendments will be underwritten by the provider of the bridge
financing).
It is anticipated that the transaction will close on June 15, 2000; however,
there can be no assurance that the transaction will close on this date or that
all of the conditions required to close the transaction will be met.
OTHER
On January 20, 2000, the Company's Board of Directors declared a regular
quarterly cash dividend of $.08 per common share payable March 15, 2000, to
holders of record at the close of business on February 16, 2000.
F-34
<PAGE> 104
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2000 AND DECEMBER 31, 1999
<TABLE>
<CAPTION>
MARCH 31,
2000 DECEMBER 31,
(UNAUDITED) 1999
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and temporary cash investments....................... $ 8,509 $ 60,087
Receivables, less allowance for doubtful accounts of
$3,221 (2000) and $3,038 (1999)........................ 403,557 372,542
Inventories............................................... 436,197 303,388
Current deferred income tax assets........................ 89,477 79,307
Prepaid expenses and other................................ 22,591 13,534
---------- ----------
960,331 828,858
---------- ----------
Property, Plant and Equipment -- including construction in
progress of $128,860 (2000) and $114,747 (1999), at
cost...................................................... 2,711,907 2,686,684
Less: Accumulated depreciation......................... 726,723 702,170
---------- ----------
1,985,184 1,984,514
---------- ----------
Deferred charges and other assets........................... 175,659 165,900
---------- ----------
$3,121,174 $2,979,272
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........................................... $ 126,500 $ --
Accounts payable.......................................... 732,561 616,895
Accrued expenses.......................................... 96,213 102,087
---------- ----------
955,274 718,982
---------- ----------
Long-term debt.............................................. 645,155 785,472
---------- ----------
Deferred income taxes....................................... 296,628 275,521
---------- ----------
Deferred credits and other liabilities...................... 115,413 114,528
---------- ----------
Common stockholders' equity:
Common stock, $.01 par value -- 150,000,000 shares
authorized; issued 56,331,166 (2000 and 1999) shares... 563 563
Additional paid-in capital................................ 1,088,829 1,092,348
Retained earnings (accumulated deficit)................... 27,408 (3,331)
Treasury stock, 398,632 (2000) and 264,464 (1999) shares,
at cost................................................ (8,096) (4,811)
---------- ----------
1,108,704 1,084,769
---------- ----------
$3,121,174 $2,979,272
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-35
<PAGE> 105
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
---------- ----------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
(UNAUDITED)
<S> <C> <C>
Operating revenues.......................................... $2,928,617 $1,337,103
---------- ----------
Costs and expenses:
Cost of sales and operating expenses...................... 2,827,341 1,287,347
Selling and administrative expenses....................... 19,669 18,188
Depreciation expense...................................... 24,555 23,048
---------- ----------
Total............................................. 2,871,565 1,328,583
---------- ----------
Operating income............................................ 57,052 8,520
Other income (expense), net................................. 2,647 (79)
Interest and debt expense:
Incurred.................................................. (14,147) (14,288)
Capitalized............................................... 1,387 1,831
---------- ----------
Income (loss) before income taxes........................... 46,939 (4,016)
Income tax expense (benefit)................................ 16,200 (1,300)
---------- ----------
Net income (loss)........................................... $ 30,739 $ (2,716)
========== ==========
Earnings (loss) per share of common stock................... $ .55 $ (.05)
Weighted average common shares outstanding (in
thousands)............................................. 55,874 56,057
Earnings (loss) per share of common stock -- assuming
dilution.................................................. $ .54 $ (.05)
Weighted average common shares outstanding (in
thousands)............................................. 57,234 56,057
Dividends per share of common stock......................... $ .08 $ .08
</TABLE>
See Notes to Consolidated Financial Statements.
F-36
<PAGE> 106
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
--------- ---------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $ 30,739 $ (2,716)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation expense................................... 24,555 23,048
Amortization of deferred charges and other, net........ 8,043 13,827
Changes in current assets and current liabilities...... (63,089) 113,981
Deferred income tax expense (benefit).................. 11,200 (1,300)
Changes in deferred items and other, net............... (271) 1,579
--------- ---------
Net cash provided by operating activities......... 11,177 148,419
--------- ---------
Cash flows from investing activities:
Capital expenditures...................................... (25,229) (38,871)
Deferred turnaround and catalyst costs.................... (16,741) (30,053)
Other, net................................................ 4 (150)
--------- ---------
Net cash used in investing activities............. (41,966) (69,074)
--------- ---------
Cash flows from financing activities:
Increase (decrease) in short-term debt, net............... 126,500 (97,000)
Long-term borrowings...................................... 60,000 448,323
Long-term debt reduction.................................. (200,000) (426,000)
Common stock dividends.................................... (4,469) (4,486)
Issuance of common stock.................................. 5,912 2,586
Purchase of treasury stock................................ (8,732) (624)
--------- ---------
Net cash used in financing activities............. (20,789) (77,201)
--------- ---------
Net increase (decrease) in cash and temporary cash
investments............................................... (51,578) 2,144
Cash and temporary cash investments at beginning of
period.................................................... 60,087 11,199
--------- ---------
Cash and temporary cash investments at end of period........ $ 8,509 $ 13,343
========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
F-37
<PAGE> 107
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000
1. BASIS OF PRESENTATION
As used in this report, the term "Valero" may, depending upon the context, refer
to Valero Energy Corporation, one or more of its consolidated subsidiaries, or
all of them taken as a whole.
The consolidated financial statements included in this report have been prepared
by Valero without audit, in accordance with the rules and regulations of the
Securities and Exchange Commission, or SEC. However, all adjustments have been
made to these financial statements which are, in the opinion of Valero's
management, necessary for a fair presentation of Valero's results of operations
for the periods covered. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted as permitted under the
SEC's rules and regulations, although Valero believes that the disclosures are
adequate to make the information presented not misleading.
2. PROPOSED ACQUISITION OF CALIFORNIA REFINING AND MARKETING ASSETS
On March 2, 2000, Valero and Exxon Mobil Corporation executed a sale and
purchase agreement under which Valero agreed to acquire ExxonMobil's Benicia,
California refinery (the "Benicia Refinery") and Exxon-branded California retail
assets, which consist of approximately 80 service stations (the "Service Station
Assets") and branded supplier relationships with approximately 260 Exxon-branded
service stations (the "Distribution Assets") (collectively, the "Benicia
Acquisition"). The agreement provides for Valero to acquire the Benicia
Refinery, the Distribution Assets and the Service Station Assets for a purchase
price of $895 million plus an amount for refinery inventories acquired in the
transaction based on market-related prices at the time of closing. ExxonMobil
agreed to sell these assets as a result of consent decrees issued by the Federal
Trade Commission and the State of California providing that certain assets be
divested by ExxonMobil to satisfy anticompetitive issues in connection with the
recent merger of Exxon Corporation and Mobil Corporation. The consummation of
the Benicia Acquisition has been approved by the Federal Trade Commission and
the Office of the Attorney General of the State of California. There are
expected to be two closings for the Benicia Acquisition. The acquisition of the
Benicia Refinery and the Distribution Assets is expected to close on or about
May 15, 2000, and the acquisition of the Service Station Assets is expected to
close on or about June 15, 2000.
In connection with the Benicia Acquisition, Valero will assume the environmental
liabilities of ExxonMobil with certain exceptions. ExxonMobil will retain
liability for (i) pending penalties assessed for violations relating to the
Benicia Refinery, (ii) pending lawsuits, (iii) all costs associated with
compliance with a variance issued in connection with control of nitrogen oxides,
(iv) claims in connection with offsite transportation and disposal of wastes
prior to closing that are asserted within three years of closing or asserted
with respect to abandoned disposal sites, (v) the capital costs incurred within
five years of closing for specified corrective action of groundwater and soil
contamination, (vi) all covered contamination at the Service Station Assets
caused by ExxonMobil or its lessees that is reflected in baseline reports
prepared prior to closing and (vii) the repair or replacement of any underground
storage tanks at the Service Station Assets found to be leaking prior to
closing. ExxonMobil has agreed to indemnify Valero for all losses related to
these retained liabilities, provided that ExxonMobil will indemnify Valero for
losses related to covered contamination at the Service Station Assets for a
period of five years from the date of closing. In addition, ExxonMobil will
indemnify Valero for breaches of its representations and warranties to the
extent that the aggregate amount of Valero's losses resulting from such breaches
exceeds $1 million and ExxonMobil receives notice of such losses within one year
after the closing date.
The Benicia Refinery is located on the Carquinez Straits of the San Francisco
Bay. It is considered a highly complex refinery and has a total throughput
capacity of 160,000 barrels per day, or "BPD." The
F-38
<PAGE> 108
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000 -- (CONTINUED)
Benicia Refinery produces a high percentage of light products, with limited
production of other products. It can produce approximately 110,000 BPD of
gasoline, 14,000 BPD of jet fuel, 11,000 BPD of diesel and 8,000 BPD of natural
gas liquids. Over 95% of the gasoline produced by the Benicia Refinery meets the
California Air Resources Board ("CARB") II specifications for gasoline sold in
California. Valero believes that the Benicia Refinery could be modified to
produce gasoline meeting the CARB III specifications which become effective
January 2003 with a capital investment of approximately $20 million. The
refinery has significant liquid storage capacity including storage for crude oil
and other feedstocks. Also included with the refinery assets are a deepwater
dock located offsite on the Carquinez Straits which is capable of berthing large
crude carriers, petroleum coke storage silos located on an adjacent dock, a
20-inch crude pipeline connecting the refinery to a southern California crude
delivery system, and an adjacent truck terminal for regional truck rack sales.
Under the consent decrees, ExxonMobil was required to offer the buyer of the
divested assets a crude oil supply contract. As a consequence, the sale and
purchase agreement provides for a ten-year term contract for ExxonMobil to
supply and for Valero to purchase 100,000 BPD of Alaska North Slope ("ANS")
crude oil at market-related prices, to be reduced to 65,000 BPD on January 1,
2001. Prior to January 1, 2001, Valero will have an option to reduce the volume
of ANS crude to 65,000 BPD with 90 days prior notice. After January 1, 2001,
Valero will have an option to reduce the required volumes by an additional
20,000 BPD once per year.
The Service Station Assets include 10 company-owned and operated service
stations and 70 company-owned lessee-dealer service stations, 75 of which are in
the San Francisco Bay area. Under the consent decrees, the Federal Trade
Commission and the State of California ordered that ExxonMobil withdraw the
"Exxon" brand name from the San Francisco Bay area. As a result, ExxonMobil has
notified the dealers in this market area that their franchise right to market
"Exxon" branded products is being terminated effective June 15, 2000. Valero
plans to introduce its own brand of retail petroleum products in the San
Francisco Bay area and has offered to the dealers at these locations a franchise
right to market products under the new Valero brand. Due to the timing
requirements of ExxonMobil's franchise termination notice to the Bay-area
dealers as described above, ExxonMobil cannot close the acquisition of the
Service Station Assets until (i) all of the dealers agree to terminate their
franchise agreements or (ii) June 15, 2000, whichever comes first. Subsequent to
the anticipated June 15, 2000 closing date, Valero plans to offer those dealers
who accept Valero's franchise offering an option to purchase the stations that
they are currently leasing. As part of the purchase option, the dealers must
enter into a fuels purchase agreement with Valero for a term of 15 years. The
dealers will have 90 days to exercise or reject their purchase option.
The Distribution Assets include up to 260 independently-owned and operated
distributor facilities which are located outside of the San Francisco Bay area.
The distributor locations will retain the right to use the Exxon brand, continue
to accept the Exxon proprietary credit card and receive Exxon brand support,
while Valero will receive the exclusive rights to offer the Exxon brand
throughout the state (except for the San Francisco Bay area) for a ten-year
period. In connection with the Benicia Acquisition, ExxonMobil will assign to
Valero all of the existing Exxon California distributor contracts under which
the distributors will purchase Exxon-branded products from Valero after the
acquisition.
Valero established with a group of banks a $600 million bridge loan facility to
provide interim financing in connection with the Benicia Acquisition. The bridge
facility has a term of one year, and Valero has an option to extend the term for
an additional two years. The bridge facility has covenants similar to those
contained in Valero's $835 million revolving bank credit and letter of credit
facility. Any amounts borrowed under the bridge facility bear interest at LIBOR
plus an applicable margin. Additionally, Valero has amended its existing bank
credit and letter of credit facility to provide for, among other things, higher
debt-to-capitalization limits necessary to complete the Benicia Acquisition.
These amendments, which become effective upon closing of the acquisition of the
Benicia Refinery and the Distribution Assets,
F-39
<PAGE> 109
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000 -- (CONTINUED)
increase the total debt-to-capitalization limit from 50% to 65%. This ratio will
decrease to 60% at the earlier of March 31, 2001 or upon the issuance of $300
million of certain equity securities, and will further decrease to 55% on
September 30, 2001.
The acquisition of the Benicia Refinery and the Distribution Assets will be
initially funded through interim financing consisting of (i) the $600 million
bank bridge facility described above, (ii) borrowings under Valero's existing
bank credit facilities and (iii) an interim lease arrangement to accommodate the
acquisition of the Benicia Refinery's dock facility. It is expected that this
interim financing will be repaid and the acquisition of the Service Station
Assets will be funded through a mix of debt, equity and structured lease
financing.
Although Valero anticipates that the acquisition will be completed as described
above, there can be no assurance that the transaction will close on the
above-noted dates, that it will be funded as described, or that all of the
conditions required to close the transaction will be met. If completed, this
acquisition will be accounted for under the purchase method of accounting.
Accordingly, the results of operations of the acquired refining and retail
assets will be included in the consolidated financial statements of Valero
beginning on the respective effective dates of the transaction.
On March 31, 2000, Valero filed a $1.3 billion universal shelf registration
statement on Form S-3 with the SEC, which has not yet been declared effective,
to register various securities including common stock, preferred stock,
warrants, debt securities and trust preferred securities.
3. 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 under the weighted average cost method. At March 31, 2000,
the replacement cost of Valero's LIFO inventories exceeded their LIFO carrying
values by approximately $194 million. Materials and supplies are carried
principally at weighted average cost not in excess of market. Inventories as of
March 31, 2000 and December 31, 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
--------- ------------
<S> <C> <C>
Refinery feedstocks....................................... $115,790 $ 61,649
Refined products and blendstocks.......................... 264,417 183,519
Materials and supplies.................................... 55,990 58,220
-------- --------
$436,197 $303,388
======== ========
</TABLE>
F-40
<PAGE> 110
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000 -- (CONTINUED)
4. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net income
(loss) has been adjusted by, among other things, changes in current assets and
current liabilities. The changes in Valero'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 changes in "Cash and temporary cash investments," "Current
deferred income tax assets" and "Short-term debt."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
2000 1999
--------- --------
<S> <C> <C>
Receivables, net............................................ $ (31,015) $(13,463)
Inventories................................................. (132,809) 16,060
Prepaid expenses and other.................................. (9,057) (1,543)
Accounts payable............................................ 115,666 121,961
Accrued expenses............................................ (5,874) (9,034)
--------- --------
Total............................................. $ (63,089) $113,981
========= ========
</TABLE>
Cash flows related to interest and income taxes were as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
----------------
2000 1999
------- ------
<S> <C> <C>
Interest paid (net of amount capitalized)................... $13,621 $6,989
Income tax refunds received................................. -- 7,212
Income taxes paid........................................... 3,051 5
</TABLE>
F-41
<PAGE> 111
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000 -- (CONTINUED)
5. EARNINGS PER SHARE
The computation of basic and diluted per-share amounts, as required by the
Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 128, is as follows (dollars and shares in
thousands, except per-share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------
2000 1999
------------------------ ------------------------
PER- PER-
NET SHARE NET SHARE
INCOME SHARES AMT. (LOSS) SHARES AMT.
------- ------ ----- ------- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Net income (loss)....................... $30,739 $(2,716)
======= =======
Basic Earnings Per Share:
Net income (loss) available to common
stockholders....................... $30,739 55,874 $.55 $(2,716) 56,057 $(.05)
==== =====
Effect Of Dilutive Securities:
Stock options......................... -- 838 -- --
Performance awards.................... -- 522 -- --
------- ------ ------- ------
Diluted Earnings Per Share:
Net income (loss) available to common
stockholders plus assumed
conversions........................ $30,739 57,234 $.54 $(2,716) 56,057 $(.05)
======= ====== ==== ======= ====== =====
</TABLE>
Because Valero reported a net loss for the three months ended March 31, 1999,
various stock options and performance awards which were granted to employees in
connection with Valero's stock compensation plans and were outstanding during
such period were not included in the computation of diluted earnings per share
because the effect would have been antidilutive. At March 31, 1999, options to
purchase approximately 6.4 million common shares and performance awards totaling
approximately 317,000 common shares were outstanding.
6. NEW ACCOUNTING PRONOUNCEMENTS
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain
Transactions involving Stock Compensation." This interpretation clarifies the
application of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," for certain issues including, among other things, (i) the
definition of employee for purposes of applying Opinion 25, (ii) the criteria
for determining whether a plan qualifies as a noncompensatory plan, (iii) the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and (iv) the accounting for an exchange of stock
compensation awards in a business combination. This interpretation will become
effective for Valero's financial statements beginning July 1, 2000, including
the effects of applying this interpretation to certain specific events that
occur after either December 15, 1998 or January 12, 2000. The adoption of this
interpretation is not expected to have a material effect on Valero'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
F-42
<PAGE> 112
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000 -- (CONTINUED)
met. Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the income statement, and
requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting. As issued, this
statement was to become effective for Valero's financial statements beginning
January 1, 2000. However, in June 1999, the FASB issued SFAS No. 137 which
delayed for one year the effective date of SFAS No. 133. As a result, SFAS No.
133 will become effective for Valero's financial statements beginning January 1,
2001 and is not allowed to be applied retroactively to financial statements of
prior periods. At this effective date, SFAS No. 133 must be applied to (i) all
freestanding derivative instruments and (ii) all embedded derivative instruments
required by the statement to be separated from their host contracts (or, at
Valero's election, only those derivatives embedded in hybrid instruments issued,
acquired or substantively modified on or after either January 1, 1998 or January
1, 1999). Valero is currently evaluating the impact on its financial statements
of adopting this statement. Adoption of this statement could result in increased
volatility in Valero's earnings and other comprehensive income.
7. LITIGATION AND CONTINGENCIES
Prior to July 31, 1997, Valero was a wholly owned subsidiary of Valero Energy
Corporation, referred to as Old Valero. Old Valero was engaged in both the
refining and marketing business and the natural gas related services business.
On July 31, 1997, Old Valero spun off Valero to Old Valero's stockholders and,
with its remaining natural gas related services business, merged with a wholly
owned subsidiary of PG&E Corporation (the "Restructuring"). Old Valero and
certain of its natural gas related subsidiaries, and Valero, have been sued by
Teco Pipeline Company regarding the operation of the 340-mile West Texas
Pipeline in which a subsidiary of Old Valero holds a 50% undivided interest. In
1985, a subsidiary of Old Valero sold a 50% undivided interest in the pipeline
and entered into a joint venture with the purchaser of the 50% interest through
an ownership agreement and an operating agreement. In 1988, Teco succeeded to
that purchaser's 50% interest. A subsidiary of Old Valero has at all times been
the operator of the pipeline. Despite the written ownership and operating
agreements, the plaintiff contends that a separate, unwritten partnership
agreement exists, and that the defendants have exercised improper control over
this alleged partnership's affairs. The plaintiff also contends 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 taking 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. Old Valero's motion to require
arbitration of the case as required in the written agreements was denied by the
trial court, but Old Valero appealed, and in August 1999, the court of appeals
ruled in Old Valero's favor and ordered arbitration of the entire dispute. Teco
has since waived efforts to further appeal this ruling, and an arbitration panel
has been selected. Valero has been formally added to this proceeding. The
arbitration panel has scheduled the arbitration hearing for October 2000.
Although PG&E acquired Teco and now owns both Teco and Old Valero, PG&E's Teco
acquisition agreement purports to assign the benefit or detriment of this
lawsuit to the former shareholders of Teco. In connection with the
Restructuring, Valero has agreed to indemnify Old Valero with respect to this
lawsuit for 50% of any final judgment or settlement amount up to $30 million,
and 100% of that part of any final judgment or settlement amount over $30
million.
In 1986, Valero filed suit against M.W. Kellogg Company for damages arising from
certain alleged design and construction defects in connection with a major
construction project at the Corpus Christi Refinery. Ingersoll-Rand Company was
added as a defendant in 1989. In 1991, the trial court granted summary judgment
against Valero based in part on certain exculpatory provisions in various
agreements connected with the project. In 1993, the court of appeals affirmed
the summary judgment and the Texas Supreme
F-43
<PAGE> 113
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 2000 -- (CONTINUED)
Court denied review. Subsequent to the summary judgment, Kellogg and
Ingersoll-Rand brought indemnity claims against Valero for attorneys' fees and
expenses incurred in defending the original action. In 1996, the trial court
rendered summary judgment against Kellogg and Ingersoll-Rand based on procedural
grounds, and the court of appeals affirmed that ruling in 1997. However, in
1999, the Texas Supreme Court reversed the court of appeals and remanded
Kellogg's and Ingersoll-Rand's claims for attorneys' fees and expenses to the
trial court.
Valero is also a party to additional claims and legal proceedings arising in the
ordinary course of business. Valero believes it is unlikely that the final
outcome of any of the claims or proceedings to which it is a party would have a
material adverse effect on its financial 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 Valero's results of operations or financial condition.
8. SUBSEQUENT EVENTS
On May 4, 2000, Valero's Board of Directors declared a regular quarterly cash
dividend of $.08 per common share payable June 14, 2000, to holders of record at
the close of business on May 30, 2000.
Valero disclosed in its Annual Report on Form 10-K for the year ended December
31, 1999, that it had received two New Jersey Department of Environmental
Protection ("NJDEP") Administrative Orders and Notices of Civil Administrative
Penalty Assessment related to particulate emissions from the fluid catalytic
cracking unit ("FCC Unit") at Valero's Paulsboro Refinery. These orders and
assessments related to emissions from the FCC Unit that occurred after Valero's
acquisition of the refinery, but that related to conditions existing prior to
the acquisition. On May 5, 2000, Valero entered into a comprehensive
administrative consent order with the NJDEP to resolve all pending enforcement
actions and related but unasserted claims regarding particulate emissions from
the refinery. The order authorizes an expansion of the refinery allowing for
production of reformulated gasoline ("RFG"), provides for interim emissions
limits, and requires a penalty payment of $600,000 on the particulate emissions
issues. Under the order, Valero also agreed to install a wet-gas scrubber on the
refinery's FCC Unit by December 31, 2003. Valero believes that the terms of the
foregoing settlement will not have a material adverse effect on its operations
or financial condition.
F-44
<PAGE> 114
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Exxon Mobil Corporation
In our opinion, the accompanying balance sheet and the related statements of
income, of cash flows and of changes in Exxon Mobil Corporation net investment
present fairly, in all material respects, the financial position of the Exxon
California Refinery, Terminal and Retail Assets Business (as defined in the Sale
and Purchase Agreement between Exxon Mobil Corporation and Valero Refining
Company--California) at December 31, 1999 and 1998, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States. These financial statements are the responsibility of Exxon
Mobil Corporation's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
financial statements in accordance with auditing standards generally accepted in
the United States, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 3 to the financial statements, Exxon Mobil Corporation
changed its method of accounting for the cost of start-up activities in 1998.
PricewaterhouseCoopers LLP
Houston, Texas
May 10, 2000
F-45
<PAGE> 115
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
BALANCE SHEET
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 4 $ 246
Receivables............................................... 41,039 28,002
Inventories............................................... 41,680 38,218
Other current assets...................................... 3,922 10,124
-------- --------
Total current assets.............................. 86,645 76,590
Property, plant and equipment, net.......................... 476,687 478,928
Prepaids and deferred charges............................... 8,422 6,940
Other noncurrent assets..................................... 7,360 6,587
-------- --------
Total assets...................................... $579,114 $569,045
======== ========
LIABILITIES AND EXXON MOBIL CORPORATION NET INVESTMENT
Current liabilities:
Accounts payable.......................................... $ 23,949 $ 19,142
Payroll and benefits payable.............................. 2,080 2,000
Taxes other than income taxes............................. 17,481 10,263
Deferred income tax....................................... 1,147 2,451
Other current liabilities................................. 5,932 3,311
-------- --------
Total current liabilities......................... 50,589 37,167
Long-term deferred income taxes............................. 85,654 71,575
Deferred credits and other liabilities...................... 6,057 1,430
-------- --------
Total liabilities................................. 142,300 110,172
Exxon Mobil Corporation net investment...................... 436,814 458,873
-------- --------
Total liabilities and Exxon Mobil Corporation net
investment....................................... $579,114 $569,045
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-46
<PAGE> 116
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
STATEMENT OF INCOME
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues:
Sales and other operating revenue, including excise
taxes:
Unrelated parties................................... $1,818,355 $1,611,327 $1,793,767
Related parties..................................... 7,726 13,698 20,529
---------- ---------- ----------
1,826,081 1,625,025 1,814,296
---------- ---------- ----------
Costs and expenses:
Crude oil and product purchases........................ 962,718 785,040 1,060,502
Operating expenses..................................... 214,506 160,291 188,282
Selling, general and administrative expenses........... 25,478 27,961 30,705
Depreciation and amortization.......................... 26,474 22,748 20,983
Excise taxes........................................... 474,506 497,714 414,370
Taxes other than income taxes.......................... 10,020 9,957 9,493
Loss on property, plant and equipment sales............ 825 740 418
---------- ---------- ----------
Total costs and expenses....................... 1,714,527 1,504,451 1,724,753
---------- ---------- ----------
Income before income taxes............................... 111,554 120,574 89,543
Income taxes............................................. 46,023 48,317 36,549
---------- ---------- ----------
Income before cumulative effect of accounting change..... 65,531 72,257 52,994
Cumulative effect of accounting change................... (2,925)
---------- ---------- ----------
Net income............................................... $ 65,531 $ 69,332 $ 52,994
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-47
<PAGE> 117
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:-
Net income................................................ $ 65,531 $ 69,332 $ 52,994
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 26,474 22,748 20,983
Deferred income taxes.................................. 12,775 14,411 19,335
Cumulative effect of accounting change................. 2,925
Loss on sale of property, plant and equipment.......... 825 740 418
Increase in accounts receivable........................ (13,037) (11,483) 16,820
Decrease (increase) in inventories..................... (3,462) 4,312 (13,052)
Decrease (increase) in other current assets............ 6,202 (5,044) (2,876)
Decrease (increase) in prepaids and deferred charges... (1,482) 3,440 4,263
Decrease (increase) in other noncurrent assets......... (773) (3,587) (1,529)
Increase (decrease) in accounts payable and accrued
liabilities.......................................... 7,508 (1,909) 507
Decrease (increase) in taxes other than income......... 7,218 23,094 (4,557)
Increase in deferred credits and other liabilities..... 4,627 413 1,017
-------- -------- --------
Net cash provided by operating activities......... 112,406 119,392 94,323
-------- -------- --------
Cash flows from investing activities:
Additions to property, plant and equipment................ (25,058) (37,866) (31,267)
-------- -------- --------
Net cash used in investing activities............. (25,058) (37,866) (31,267)
-------- -------- --------
Cash flows from financing activities:
Net cash distributions to Exxon Mobil Corporation........... (87,590) (81,413) (63,023)
-------- -------- --------
Net cash used in financing activities............. (87,590) (81,413) (63,023)
-------- -------- --------
Net increase (decrease) in cash............................. (242) 113 33
Cash at beginning of year................................... 246 133 100
-------- -------- --------
Cash at end of year......................................... $ 4 $ 246 $ 133
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-48
<PAGE> 118
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
STATEMENT OF CHANGES IN EXXON MOBIL CORPORATION NET INVESTMENT
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Exxon Mobil Corporation net investment at December 31,
1996...................................................... $480,983
Net income................................................ 52,994
Net cash distributions to Exxon Mobil Corporation......... (63,023)
--------
Exxon Mobil Corporation net investment at December 31,
1997...................................................... 470,954
Net income................................................ 69,332
Net cash distributions to Exxon Mobil Corporation......... (81,413)
--------
Exxon Mobil Corporation net investment at December 31,
1998...................................................... 458,873
Net income................................................ 65,531
Net cash distributions to Exxon Mobil Corporation......... (87,590)
--------
Exxon Mobil Corporation net investment at December 31,
1999...................................................... $436,814
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-49
<PAGE> 119
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. BUSINESS DESCRIPTION AND BASIS OF PRESENTATION
Exxon Mobil Corporation (ExxonMobil) operates a refinery and marketing assets in
the state of California which are collectively referred to herein as the Exxon
California Refinery, Terminal and Retail Assets Business (the Business). The
Business is engaged in the manufacturing, purchasing and marketing of petroleum
products in the state of California. Operating assets primarily consist of: (a)
the Benicia Refinery, located in the San Francisco Bay area, including a
deepwater dock, (b) a 20-inch crude pipeline and an adjacent truck terminal for
regional truck rack sales and (c) Exxon-branded retail assets comprised of 80
marketing sites, of which ten are ExxonMobil owned and operated and 70 are owned
by ExxonMobil and leased to dealers. The retail assets owned by ExxonMobil are
primarily located in the San Francisco Bay area. In addition, there are 260
independently owned and operated, Exxon-branded retail assets located throughout
California.
On March 2, 2000, ExxonMobil agreed to sell to Valero Refining
Company--California (a subsidiary of Valero Energy Corporation) these assets as
a result of Consent Decrees issued by the Federal Trade Commission and the state
of California, which provided that certain assets be divested by ExxonMobil in
connection with the merger of Exxon Corporation and Mobil Corporation. The
anticipated closing date for the refinery sale is May 15, 2000 with a secondary
close for the remaining assets scheduled for June 15, 2000. The accompanying
financial statements do not include any adjustments that might result from the
proposed sale.
The accompanying financial statements represent a carve-out financial statement
presentation of the Business' operations and reflect ExxonMobil historical cost
basis. The financial statements include allocations and estimates of direct and
indirect ExxonMobil administrative costs attributable to the Business'
operations. The methods by which such amounts are attributed or allocated are
deemed reasonable by management. However, these allocations and estimates are
not necessarily indicative of the costs and expenses that would have resulted if
the Business had been operated as a separate entity.
2. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates that affect the
reported amounts of assets, liabilities, revenues and expenses and the
disclosure of contingent assets and liabilities. Actual results could differ
from these estimates.
Revenue Recognition
Revenues associated with sales of petroleum products and all other items are
recorded when title passes to the customer.
Inventories
Inventories are carried at lower of current market value or cost. Cost of crude
oil and refined products inventories is determined under the last-in, first-out
(LIFO) method. Crude oil and product purchases are reflected in the income
statement at cost. Costs include applicable purchase costs and operating
expenses but not general and administrative expenses or research and development
costs. Inventory is adjusted for any ExxonMobil consolidated LIFO effect at the
end of each period. Cost of materials and supplies is determined under the
average cost method.
F-50
<PAGE> 120
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999--(CONTINUED)
Property, Plant and Equipment
Property, plant and equipment is carried at cost, less accumulated depreciation.
Depreciation, based on cost less estimated salvage value of the asset, is
determined under the straight-line method. When a major facility depreciated on
an individual basis is sold or otherwise disposed of, any gain or loss is
reflected in income. Expenditures for maintenance and repairs, including those
for refinery turnarounds, are expensed as incurred.
Assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amounts may not be recoverable. ExxonMobil estimates
undiscounted future cash flows to judge the recoverability of carrying amounts.
Environmental Conservation
Liabilities for environmental conservation are recorded when it is probable that
obligations have been incurred and the amounts can be reasonably estimated.
These liabilities are not reduced by possible recoveries from third parties, and
projected cash expenditures are not discounted.
Income Taxes
Historically, the Business' results have been included in the consolidated
federal income tax returns filed by ExxonMobil. The income tax provision for
each period presented represents the current and deferred income taxes that
would have resulted if the Business were a stand-alone taxable entity filing its
own income tax returns. Accordingly, the calculation of tax provisions and
deferred taxes necessarily require certain assumptions, allocations and
estimates which management believes are reasonable to reflect the tax reporting
for the Business as a stand-alone taxpayer.
Fair Value of Financial Instruments
The reported amounts of financial instruments such as receivables and payables
approximate fair value because of their short maturities.
3. ACCOUNTING CHANGE
The American Institute of Certified Public Accountants' Statement of Position
98-5, "Reporting on the Costs of Start-up Activities", was implemented by
ExxonMobil in the fourth quarter of 1998, effective as of January 1, 1998. This
statement requires that costs of start-up activities and organizational costs be
expensed as incurred. The cumulative effect of this accounting change on years
prior to 1998 applicable to the Business was a charge of $2.9 million (net of $2
million income tax effect).
4. EXXON MOBIL CORPORATION NET INVESTMENT, ALLOCATIONS AND RELATED-PARTY
TRANSACTIONS
For purposes of these carve-out financial statements, payables and receivables
related to transactions between the Business and ExxonMobil, as well as
liabilities and refunds related to current income taxes, are included as a
component of the Exxon Mobil Corporation net investment. Such amounts related to
current income taxes are deemed to have been paid in cash to ExxonMobil in the
year in which the income taxes were recorded.
The Business purchased crude oil from ExxonMobil, at transfer prices that were
intended to reflect market prices, in the amounts of $755 million, $565 million
and $802 million for the years ended December 31, 1999, 1998 and 1997,
respectively. The Business' sales of refined products to ExxonMobil for the
years ended December 31, 1999, 1998 and 1997, were $8 million, $14 million and
$21 million, respectively.
F-51
<PAGE> 121
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999--(CONTINUED)
Throughout the period covered by the financial statements, ExxonMobil provided
the Business with certain services, including data processing, legal, human
resources and financial services and certain corporate-funded research programs.
Charges for these services were allocated based on various formulas that
incorporate indicators such as expenditures, personnel head counts and refinery
throughputs. Such charges amounted to $21 million, $20 million and $22 million
for the years ended December 31, 1999, 1998 and 1997, respectively. These
amounts include research and development expenses of $3 million, $2 million and
$2 million, respectively. ExxonMobil uses a centralized cash management system
under which cash receipts of the Business are remitted to ExxonMobil and cash
disbursements of the Business are funded by ExxonMobil. No interest has been
charged or credited on transactions with ExxonMobil.
5. EMPLOYEE BENEFIT PLANS
ExxonMobil has noncontributory defined benefit pension plans covering
substantially all employees of the Business. Benefits under these plans are
based primarily upon years of service and final earnings. The funding policy for
all plans provides that payments to the pension trusts shall be equal to the
minimum funding requirements of the Employee Retirement and Income Security Act,
plus such additional amounts as may be approved.
ExxonMobil also has defined benefit retiree life and health insurance plans
covering most of the Business' employees upon their retirement. Health benefits
are primarily provided through comprehensive hospital, surgical and major
medical benefit provisions subject to various cost-sharing features.
For the purposes of these carve-out financial statements, the Business is
considered to be participating in multiemployer benefit plans of ExxonMobil.
For 1999, 1998 and 1997, the Business' allocated share of compensation expense
related to these plans was approximately $3 million for each of the three years.
6. INCOME TAXES
Income tax provisions and related assets and liabilities are determined on a
stand-alone basis (Note 2).
Income tax provision consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------- ---------------------------- ----------------------------
CURRENT DEFERRED TOTAL CURRENT DEFERRED TOTAL CURRENT DEFERRED TOTAL
------- -------- ------- ------- -------- ------- ------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Federal.................... $26,035 $ 9,330 $35,365 $27,098 $11,958 $39,056 $16,571 $12,048 $28,619
State...................... 7,213 3,445 10,658 6,808 2,453 9,261 643 7,287 7,930
------- ------- ------- ------- ------- ------- ------- ------- -------
Total.............. $33,248 $12,775 $46,023 $33,906 $14,411 $48,317 $17,214 $19,335 $36,549
======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
A reconciliation of federal statutory tax rate (35%) to total provisions
follows:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Statutory rate applied to income before income taxes.... $39,044 $42,201 $31,340
State income taxes (net of federal income tax benefit
and California business tax credits).................. 6,928 6,019 5,154
Other................................................... 51 97 55
------- ------- -------
Total provisions.............................. $46,023 $48,317 $36,549
======= ======= =======
</TABLE>
F-52
<PAGE> 122
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999--(CONTINUED)
Deferred tax assets and liabilities resulted from the following temporary
differences as of December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------- -------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Accrued liabilities....................................... $ 3,898 $ 1,519
------- -------
Total deferred tax assets......................... 3,898 1,519
------- -------
Deferred tax liabilities:
Depreciation.............................................. 75,524 62,390
Inventory................................................. 2,935 3,154
Other..................................................... 12,240 10,001
------- -------
Total deferred tax liabilities.................... 90,699 75,545
------- -------
Net deferred tax liabilities...................... $86,801 $74,026
======= =======
</TABLE>
7. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
1999 1998
------- -------
(IN THOUSANDS)
<S> <C> <C>
Crude oil................................................... $12,892 $ 7,872
Refined products............................................ 17,416 16,111
Materials and supplies...................................... 11,372 14,235
------- -------
Total inventories................................. $41,680 $38,218
======= =======
</TABLE>
The LIFO method accounted for 73% and 63% of total inventory at December 31,
1999 and 1998, respectively. The aggregate replacement cost of inventories was
estimated to exceed their LIFO carrying values by $115 million and $39 million
at December 31, 1999 and 1998, respectively.
8. OTHER CURRENT ASSETS
Other current assets consist of the following:
<TABLE>
<CAPTION>
1999 1998
------ -------
(IN THOUSANDS)
<S> <C> <C>
Prepaid expenses............................................ $ 7,853
Catalyst.................................................... $2,699 1,937
Other....................................................... 1,223 334
------ -------
Total............................................. $3,922 $10,124
====== =======
</TABLE>
F-53
<PAGE> 123
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999--(CONTINUED)
9. PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Refining.................................................... $811,868 $788,295
Marketing................................................... 84,300 83,990
-------- --------
896,168 872,285
Less--accumulated depreciation and amortization............. 419,481 393,357
-------- --------
Total property, plant and equipment, net.......... $476,687 $478,928
======== ========
</TABLE>
The depreciation lives used in computing the annual provision for depreciation
are substantially as follows:
<TABLE>
<S> <C>
Refining............................................... 25-33 years
Marketing.............................................. 3-21 years
</TABLE>
10. LEASES
The Business leases a wide variety of facilities and equipment under operating
leases, including office equipment and transportation equipment. Rent expense
approximated $5 million, $4 million and $3 million for December 31, 1999, 1998
and 1997, respectively.
11. CONTINGENCIES AND COMMITMENTS
ExxonMobil is the subject of, or party to, a number of pending or threatened
legal actions, contingencies and commitments relating to the Business involving
a variety of matters, including laws and regulations relating to the
environment. The more significant of these matters are discussed below.
Environmental Matters
The Business is subject to federal, state and local environmental laws and
regulations that in the future may require ExxonMobil to take action to correct
or reduce the effects on the environment of prior disposal or release of
chemical or petroleum substances, including MTBE, by ExxonMobil or other
parties. These laws generally provide for control of pollutants released into
the environment and require responsible parties to undertake remediation of
hazardous waste disposal sites. Penalties may be imposed for noncompliance. At
December 31, 1999 and 1998, accrued liabilities for remediation totaled $11
million and $4 million, respectively. Environmental expenses were $11 million,
$5 million and $3 million during the years ended December 31, 1999, 1998 and
1997, respectively, and are included in operating expenses. It is not presently
possible to estimate the ultimate amount of all remediation costs that might be
incurred or the penalties that might be imposed.
For a number of years, the Business has made substantial capital expenditures to
maintain compliance with various laws relating to the environment at existing
facilities. The Business anticipates making additional such expenditures in the
future; however, the exact amounts and timing of such expenditures are uncertain
because of the continuing evolution of specific regulatory requirements.
UNOCAL Patent Litigation
ExxonMobil and four other refiners filed a lawsuit against Unocal Corporation
(UNOCAL) in Los Angeles, California, seeking a determination that a UNOCAL
patent on certain gasoline compositions (commonly referred to as the "'393
patent") is invalid and unenforceable. UNOCAL's '393 patent
F-54
<PAGE> 124
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999--(CONTINUED)
potentially 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 found that the refiners had not proven the
'393 patent to be invalid or unforceable and, furthermore, found the reasonable
royalty for infringement to be 5.75 cents per gallon. The case was appealed and,
in March 2000, the Court of Appeals for the Federal Circuit affirmed. In April
2000, ExxonMobil and the other four refiners filed a petition for
reconsideration and for rehearing en banc with the appellate court. The ultimate
outcome of the litigation is uncertain. ExxonMobil has retained, and will
continue to retain, even after transfer of the Business to Valero Refining
Company--California, any and all liability associated with the UNOCAL patent
litigation arising prior to the date of transfer of the assets. For operations
subsequent to the transfer of the Business, Valero Refining Company--California
will be responsible for any UNOCAL patent exposure.
Other Matters
Claims have been made against ExxonMobil relating to the Business in other
pending lawsuits, the outcome of which is not expected to have a materially
adverse effect on the Business' operations, cash flows or financial position.
12. RECENTLY ISSUED STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board released Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities Information."
As amended by Statement No. 137 issued in June 1999, this statement, which must
be adopted no later than January 1, 2001 for calendar-year companies such as the
Business, establishes accounting and reporting standards for derivative
instruments. The statement requires that an entity recognize all derivatives as
either assets or liabilities in the financial statements and measure those
instruments at fair value, and it defines the accounting for changes in the fair
value of the derivatives depending on the intended use of the derivative.
Adoption of this statement is not expected to have a material effect upon the
Business' operations or financial condition.
F-55
<PAGE> 125
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
BALANCE SHEET
MARCH 31, 2000 AND DECEMBER 31, 1999
<TABLE>
<CAPTION>
MARCH 31,
2000 DECEMBER 31,
(UNAUDITED) 1999
------------- --------------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 99 $ 4
Receivables............................................... 44,998 41,039
Inventories............................................... 30,345 41,680
Other current assets...................................... 3,224 3,922
---------- ----------
Total current assets.............................. 78,666 86,645
Property, plant and equipment, net.......................... 475,450 476,687
Prepaids and deferred charges............................... 9,901 8,422
Other noncurrent assets..................................... 8,208 7,360
---------- ----------
Total assets...................................... $ 572,225 $ 579,114
========== ==========
LIABILITIES AND EXXON MOBIL CORPORATION NET INVESTMENT
Current liabilities:
Accounts payable.......................................... $ 37,768 $ 23,949
Payroll and benefits payable.............................. 2,080 2,080
Taxes other than income taxes............................. 14,856 17,481
Deferred income tax....................................... 1,147 1,147
Other current liabilities................................. 6,429 5,932
---------- ----------
Total current liabilities......................... 62,280 50,589
Long-term deferred income taxes............................. 88,560 85,654
Deferred credits and other liabilities...................... 11,503 6,057
---------- ----------
Total liabilities................................. 162,343 142,300
Exxon Mobil Corporation net investment...................... 409,882 436,814
---------- ----------
Total liabilities and Exxon Mobil Corporation net
investment...................................... $ 572,225 $ 579,114
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-56
<PAGE> 126
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
STATEMENT OF INCOME
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
<TABLE>
<CAPTION>
2000 1999
-------- --------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Revenues:-
Sales and other operating revenue, including excise taxes:
Unrelated parties...................................... $619,358 $233,106
Related parties........................................ 3,979 1,497
-------- --------
623,337 234,603
-------- --------
Costs and expenses:
Crude oil and product purchases........................... 397,081 79,006
Operating expenses........................................ 39,158 86,966
Selling, general and administrative expenses.............. 7,501 7,722
Depreciation and amortization............................. 6,723 6,496
Excise taxes.............................................. 128,538 108,337
Taxes other than income taxes............................. 2,758 2,647
Loss on property, plant and equipment sales............... 45 203
-------- --------
Total costs and expenses.......................... 581,804 291,377
-------- --------
Income (loss) before income taxes........................... 41,533 (56,774)
Income taxes................................................ 16,923 (23,133)
-------- --------
Net income (loss)........................................... $ 24,610 $(33,641)
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-57
<PAGE> 127
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
STATEMENT OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2000 AND 1999
<TABLE>
<CAPTION>
2000 1999
-------- --------
(IN THOUSANDS)
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:-
Net income (loss)......................................... $ 24,610 $(33,641)
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 6,723 6,496
Deferred income taxes.................................. 2,906 2,813
Loss on sale of property, plant and equipment.......... 45 203
Increase in accounts receivable........................ (3,959) (24,740)
Decrease (increase) in inventories..................... 11,335 (3,530)
Decrease in other current assets....................... 698 9,656
Increase in prepaids and deferred charges.............. (1,479) (2,348)
Increase in other noncurrent assets.................... (848) (262)
Increase in accounts payable and accrued liabilities... 14,316 6,984
Decrease in taxes other than income.................... (2,625) (9,004)
Increase in deferred credits and other liabilities..... 5,446 4,038
-------- --------
Net cash provided by (used in) operating
activities....................................... 57,168 (43,335)
-------- --------
Cash flows from investing activities:
Additions to property, plant and equipment................ (5,531) (9,498)
-------- --------
Net cash used in investing activities............. (5,531) (9,498)
-------- --------
Cash flows from financing activities:
Net cash advances from (distributions to)
Exxon Mobil Corporation................................ (51,542) 52,787
-------- --------
Net cash provided by (used in) financing
activities....................................... (51,542) 52,787
-------- --------
Net increase (decrease) in cash............................. 95 (46)
Cash at beginning of period................................. 4 246
-------- --------
Cash at end of period....................................... $ 99 $ 200
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-58
<PAGE> 128
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2000
1. BUSINESS DESCRIPTION AND BASIS OF PRESENTATION
Exxon Mobil Corporation (ExxonMobil) operates a refinery and marketing assets in
the state of California which are collectively referred to herein as the Exxon
California Refinery, Terminal and Retail Assets Business (the Business). The
Business is engaged in the manufacturing, purchasing and marketing of petroleum
products in the state of California. Operating assets primarily consist of: (a)
the Benicia Refinery, located in the San Francisco Bay area, including a
deepwater dock, (b) a 20-inch crude pipeline and an adjacent truck terminal for
regional truck rack sales and (c) Exxon-branded retail assets comprised of 80
marketing sites, of which ten are ExxonMobil owned and operated and 70 are owned
by ExxonMobil and leased to dealers. The retail assets owned by ExxonMobil are
primarily located in the San Francisco Bay area. In addition, there are 260
independently owned and operated, Exxon-branded retail assets located throughout
California.
On March 2, 2000, ExxonMobil agreed to sell to Valero Refining
Company -- California (a subsidiary of Valero Energy Corporation) these assets
as a result of Consent Decrees issued by the Federal Trade Commission and the
state of California, which provided that certain assets be divested by
ExxonMobil in connection with the merger of Exxon Corporation and Mobil
Corporation. The closing date for the refinery sale was May 15, 2000 with a
secondary close for the remaining assets scheduled for June 15, 2000. The
accompanying unaudited financial statements do not include any adjustments that
might result from the proposed sale.
The accompanying unaudited financial statements represent a carve-out financial
statement presentation of the Business' operations and reflect ExxonMobil
historical cost basis. The unaudited financial statements include allocations
and estimates of direct and indirect ExxonMobil administrative costs
attributable to the Business' operations. The methods by which such amounts are
attributed or allocated are deemed reasonable by management. However, these
allocations and estimates are not necessarily indicative of the costs and
expenses that would have resulted if the Business had been operated as a
separate entity.
These unaudited financial statements should be read in the context of the
carve-out financial statements and notes thereto included in Valero Energy
Corporation's Form 8-K/A filed with the Securities and Exchange Commission. In
the opinion of management, the information furnished herein reflects all known
accruals and adjustments necessary for a fair statement of the results for the
periods reported herein. All such adjustments are of a normal recurring nature.
2. EXXON MOBIL CORPORATION NET INVESTMENT, ALLOCATIONS AND RELATED-PARTY
TRANSACTIONS
For purposes of these unaudited carve-out financial statements, payables and
receivables related to transactions between the Business and ExxonMobil, as well
as liabilities and refunds related to current income taxes, are included as a
component of the Exxon Mobil Corporation net investment. Such amounts related to
current income taxes are deemed to have been paid in cash to ExxonMobil in the
year in which the income taxes were recorded. ExxonMobil uses a centralized cash
management system under which cash receipts of the Business are remitted to
ExxonMobil and cash disbursements of the Business are funded by ExxonMobil. No
interest has been charged or credited on transactions with ExxonMobil.
F-59
<PAGE> 129
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
Crude oil................................................... $ 7,481 $12,892
Refined products............................................ 10,980 17,416
Materials and supplies...................................... 11,884 11,372
------- -------
Total inventories................................. $30,345 $41,680
======= =======
</TABLE>
4. CONTINGENCIES AND COMMITMENTS
ExxonMobil is the subject of, or party to, a number of pending or threatened
legal actions, contingencies and commitments relating to the Business involving
a variety of matters, including laws and regulations relating to the
environment. The more significant of these matters are discussed below.
Environmental Matters
The Business is subject to federal, state and local environmental laws and
regulations that in the future may require ExxonMobil to take action to correct
or reduce the effects on the environment of prior disposal or release of
chemical or petroleum substances, including MTBE, by ExxonMobil or other
parties. These laws generally provide for control of pollutants released into
the environment and require responsible parties to undertake remediation of
hazardous waste disposal sites. Penalties may be imposed for noncompliance. At
March 31, 2000 and December 31, 1999, accrued liabilities for remediation
totaled $11 million and $11 million, respectively.
For a number of years, the Business has made substantial capital expenditures to
maintain compliance with various laws relating to the environment at existing
facilities. The Business anticipates making additional such expenditures in the
future; however, the exact amounts and timing of such expenditures are uncertain
because of the continuing evolution of specific regulatory requirements.
UNOCAL Patent Litigation
ExxonMobil and four other refiners filed a lawsuit against Unocal Corporation
(UNOCAL) in Los Angeles, California, seeking a determination that a UNOCAL
patent on certain gasoline compositions (commonly referred to as the " '393
patent") is invalid and unenforceable. UNOCAL's '393 patent potentially 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 found that the refiners had not proven the '393 patent to be
invalid or unforceable and, furthermore, found the reasonable royalty for
infringement to be 5.75 cents per gallon. The case was appealed and, in March
2000, the Court of Appeals for the Federal Circuit affirmed. In April 2000,
ExxonMobil and the other four refiners filed a petition for reconsideration and
for rehearing en banc with the appellate court. In May 2000, the federal appeals
court denied this petition. ExxonMobil is currently reviewing its options and
the ultimate outcome of the litigation is uncertain. ExxonMobil has retained,
and will continue to retain, even after transfer of the Business to Valero
Refining Company -- California, any and all liability associated with the UNOCAL
patent litigation arising prior to the date of transfer of the assets. For
operations subsequent to the transfer of the Business, Valero Refining
Company -- California will be responsible for any UNOCAL patent exposure.
F-60
<PAGE> 130
EXXON CALIFORNIA REFINERY, TERMINAL AND RETAIL ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Other Matters
Claims have been made against ExxonMobil relating to the Business in other
pending lawsuits, the outcome of which is not expected to have a materially
adverse effect on the Business' operations, cash flows or financial position.
5. RECENTLY ISSUED STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board released Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities Information."
As amended by Statement No. 137 issued in June 1999, this statement, which must
be adopted no later than January 1, 2001 for calendar-year companies such as the
Business, establishes accounting and reporting standards for derivative
instruments. The statement requires that an entity recognize all derivatives as
either assets or liabilities in the financial statements and measure those
instruments at fair value, and it defines the accounting for changes in the fair
value of the derivatives depending on the intended use of the derivative.
Adoption of this statement is not expected to have a material effect upon the
Business' operations or financial condition.
F-61
<PAGE> 131
PROSPECTUS
$1,300,000,000
[VALERO ENERGY CORPORATION LOGO]
SENIOR DEBT SECURITIES
SUBORDINATED DEBT SECURITIES
COMMON STOCK
PREFERRED STOCK
WARRANTS
Valero Energy Corporation
One Valero Place
San Antonio, Texas 78212
(210) 370-2000
<TABLE>
<S> <C>
THE OFFERING
We may offer from time to time
- Senior debt securities
We will provide the specific - Subordinated debt securities
terms of the securities in one or - Common stock
more supplements to this prospectus. - Preferred stock
You should read this prospectus and - Warrants
the related prospectus supplement We will provide the specific terms of the securities in
carefully before you invest in our supplements to this prospectus. Our common stock is listed
securities. This prospectus may not on the New York Stock Exchange under the symbol "VLO."
be used to offer and sell our
securities unless accompanied by a
prospectus supplement.
</TABLE>
---------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this prospectus is May 30, 2000
<PAGE> 132
TABLE OF CONTENTS
<TABLE>
<S> <C>
About This Prospectus....................................... 3
About Valero Energy Corporation............................. 3
Forward-Looking Information................................. 4
Use of Proceeds............................................. 5
Ratio of Earnings to Fixed Charges.......................... 6
Description of Debt Securities.............................. 6
Description of Capital Stock................................ 14
Description of Warrants..................................... 17
Plan of Distribution........................................ 18
Legal Matters............................................... 19
Experts..................................................... 20
Where You Can Find More Information......................... 20
Information We Incorporate by Reference..................... 20
</TABLE>
---------------------
THIS PROSPECTUS IS PART OF A REGISTRATION STATEMENT WE FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. YOU SHOULD RELY ONLY ON THE INFORMATION WE
HAVE PROVIDED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS OR ANY PROSPECTUS
SUPPLEMENT. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH ADDITIONAL OR
DIFFERENT INFORMATION. WE ARE NOT MAKING AN OFFER OF THESE SECURITIES IN ANY
JURISDICTION WHERE THE OFFER IS NOT PERMITTED. YOU SHOULD ASSUME THAT THE
INFORMATION IN THIS PROSPECTUS OR ANY PROSPECTUS SUPPLEMENT IS ACCURATE ONLY AS
OF THE DATE ON THE FRONT OF THE DOCUMENT AND THAT ANY INFORMATION WE HAVE
INCORPORATED BY REFERENCE IS ACCURATE ONLY AS OF THE DATE OF THE DOCUMENT
INCORPORATED BY REFERENCE.
2
<PAGE> 133
ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we have filed with
the Securities and Exchange Commission using a "shelf" registration process. The
registration statement also includes a prospectus under which VEC Trust I and
VEC Trust II, two of our subsidiaries, may offer from time to time preferred
securities guaranteed by us and we may offer our related senior debt securities
or subordinated debt securities, which securities may be convertible into our
common stock, and our stock purchase contracts or stock purchase units. Under
the shelf process, we may offer any combination of the securities described in
these two prospectuses in one or more offerings with a total initial offering
price of up to $1,300,000,000. This prospectus provides you with a general
description of the senior debt securities, subordinated debt securities, common
stock, preferred stock and warrants we may offer. Each time we use this
prospectus to offer securities, we will provide a prospectus supplement that
will contain specific information about the terms of that offering. The
prospectus supplement may also add, update or change information contained in
this prospectus. Please carefully read this prospectus and the prospectus
supplement together with the additional information described under the heading
"Where You Can Find More Information."
References in this prospectus to the terms "we," "us" or "Valero" or other
similar terms mean Valero Energy Corporation, unless we state otherwise or the
context indicates otherwise.
ABOUT VALERO ENERGY CORPORATION
We are one of the largest and most geographically diverse independent
petroleum refining and marketing companies in the United States. As of March 31,
2000, we owned five refineries in Texas, Louisiana and New Jersey, providing us
with core operations on both the Gulf Coast and the East Coast. These refineries
are located in Corpus Christi, Houston, and Texas City in Texas, Krotz Springs,
Louisiana and Paulsboro, New Jersey. In addition, on March 2, 2000, we entered
into an agreement to purchase Exxon Mobil Corporation's Benicia, California
refinery and Exxon-branded California retail assets, which consist of
approximately 80 service station facilities and branded supplier relationships
with approximately 260 Exxon-branded service stations, for a purchase price of
$895 million plus the value of refinery inventories acquired in the transaction.
We believe the acquisition of these assets will provide us with a significant
presence on the West Coast and extends our geographic reach from coast to coast.
The acquisition of the Benicia refinery and the branded supplier relationships
closed on May 15, 2000, and the acquisition of the service station facilities is
expected to close on or about June 15, 2000. The acquisition of the Benicia
refinery increased our throughput capacity from approximately 790,000 barrels
per day to approximately 950,000 barrels per day.
We produce premium, environmentally clean products such as reformulated
gasoline, low sulfur diesel and oxygenates and are able to produce gasoline
meeting the specifications of the California Air Resources Board, or CARB
gasoline. We also produce a substantial slate of middle distillates, jet fuel
and petrochemicals. We have distinguished our company among independent refiners
by cost effectively upgrading our refineries to not only increase output but
also increase overall refining complexity and flexibility, enhancing our ability
to process lower cost feedstocks into higher value-added premium products. We
process a wide slate of feedstocks including medium sour crude oils, heavy sweet
crudes and residual fuel oils, or resid, which can typically be purchased at a
discount to West Texas Intermediate, a benchmark crude oil. Excluding the
production of the Benicia refinery, over 55% of our total gasoline production is
reformulated gasoline, which sells at a premium over conventional grades of
gasoline. The Benicia refinery produces approximately 110,000 barrels per day of
gasoline, approximately 95% of which is CARB gasoline. Excluding the production
of the Benicia refinery, we also produce over 75% of our distillate slate as
low-sulfur diesel and jet fuel, which sell for a premium over high-sulfur
heating oil. In addition to our feedstock and product advantages, we have
synergies among our Gulf Coast refineries which allow us to transfer
intermediate feedstocks, such as deasphalted oil and atmospheric tower bottoms,
among the Texas City, Houston and Corpus Christi refineries. Our products are
marketed in 35 states as well as to select export markets.
3
<PAGE> 134
We were incorporated in Delaware in 1981 as Valero Refining and Marketing
Company, a wholly owned subsidiary of our predecessor company. On July 31, 1997,
our stock was distributed, or spun off, by our predecessor company to its
shareholders, and we changed our name to Valero Energy Corporation. Our common
stock is listed for trading on the New York Stock Exchange under the symbol
"VLO."
We have our principal executive offices at One Valero Place, San Antonio,
Texas, 78212, and our telephone number is (210) 370-2000.
FORWARD-LOOKING INFORMATION
This prospectus, including the information we incorporate by reference,
contains certain estimates, predictions, projections and other "forward-looking
statements" (as defined in Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934) that involve various risks and
uncertainties. While these forward-looking statements, and any assumptions upon
which they are based, are made in good faith and reflect our current judgment
regarding the direction of our business, actual results will almost always vary,
sometimes materially, from any estimates, predictions, projections, assumptions,
or other future performance suggested herein. These forward-looking statements
can generally be identified by the words "anticipate," "believe," "expect,"
"plan," "intend," "estimate," "project," "budget," "forecast," "will," "could,"
"should," "may" and similar expressions. These forward-looking statements
include, among other things, statements regarding:
- the acquisition of Exxon Mobil Corporation's Benicia, California refinery
and Exxon-branded California retail assets and our results of operations
following the acquisition
- future refining margins, including gasoline and heating oil margins
- the expected cost of feedstocks, including crude oil discounts, and
refining products
- anticipated levels of crude oil and refined product inventories
- our anticipated level of capital investments, including deferred
turnaround and catalyst costs and capital expenditures for regulatory
compliance and other purposes, and the effect of these capital
investments on our results of operations
- refinery utilization rates
- anticipated trends in the supply and demand for crude oil feedstocks and
refined products in the United States and elsewhere
- expectations regarding environmental and other regulatory initiatives,
and
- the effect of general economic and other conditions on refining industry
fundamentals
We have based our forward-looking statements on our beliefs and assumptions
derived from information available to us at the time the statements are made.
Differences between actual results and any future performance suggested in our
forward-looking statements or projections could result from a variety of
factors, including the following:
- the domestic and foreign supplies of refined products such as gasoline,
diesel, heating oil and petrochemicals
- the domestic and foreign supplies of crude oil and other feedstocks
- the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil price and production controls
- the level of consumer demand, including seasonal fluctuations
- refinery overcapacity or undercapacity
4
<PAGE> 135
- the actions taken by competitors, including both pricing and the
expansion and retirement of refining capacity in response to market
conditions
- environmental and other regulations at both the state and federal levels
and in foreign countries
- political conditions in oil producing regions, including the Middle East
- the level of foreign imports
- accidents or other unscheduled shutdowns affecting our plants, machinery,
pipelines or equipment, or those of our suppliers or customers
- changes in the cost or availability of transportation for feedstocks and
refined products
- write-downs of inventories caused by a material decline in petroleum
prices
- the price, availability and acceptance of alternative fuels
- cancellation of or failure to implement planned capital projects and
realize the various assumptions and benefits projected for such projects
- irregular weather, which can unforeseeably affect the price or
availability of feedstocks and refined products
- rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any
reserves and claims of product liability
- the introduction or enactment of federal or state legislation which may
adversely affect our business or operations
- changes in the credit ratings assigned to our debt securities and trade
credit, and
- overall economic conditions
We caution you that any one of these factors, or a combination of these
factors, could materially affect our future results of operations and whether
our forward-looking statements ultimately prove to be accurate. These
forward-looking statements are not guarantees of our future performance, and our
actual results and future performance may differ materially from those suggested
in our forward-looking statements. When considering these forward-looking
statements, you should keep in mind the factors described under the heading
"Risk Factors" and other cautionary statements in this prospectus and the
documents we have incorporated by reference. We do not intend to update these
statements unless the securities laws require us to do so.
All subsequent written and oral forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
the foregoing. We undertake no obligation to publicly release the result of any
revisions to any such forward-looking statements that may be made to reflect
events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events.
USE OF PROCEEDS
Unless we inform you otherwise in the prospectus supplement, we expect to
use the net proceeds from the sale of securities for general corporate purposes.
These purposes may include, but are not limited to:
- equity investments in existing and future projects
- acquisitions
- working capital
- capital expenditures
- repayment or refinancing of debt or other corporate obligations
- repurchases and redemptions of securities
5
<PAGE> 136
Pending any specific application, we may initially invest funds in short-term
marketable securities or apply them to the reduction of short-term indebtedness.
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth the ratio of earnings to fixed charges for
the periods indicated:
<TABLE>
<CAPTION>
THREE
MONTHS
ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
------------ ------------------------------------
2000 1999 1999 1998 1997 1996 1995
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<S> <C> <C> <C> <C> <C> <C> <C>
Ratio of earnings to fixed charges....... 3.42x -- 1.23x -- 4.08x 1.74x 2.61x
</TABLE>
We have computed the ratios of earnings to fixed charges by dividing
earnings by fixed charges. For this purpose, earnings consist of consolidated
income from continuing operations before income taxes and fixed charges
(excluding capitalized interest), with certain other adjustments. Fixed charges
consist of total interest, whether expensed or capitalized, including
amortization of debt expense and premiums or discounts related to outstanding
indebtedness, and one-third (the proportion deemed representative of the
interest factor) of rental expense. For the three months ended March 31, 1999,
our earnings were insufficient to cover fixed charges by $4.4 million. This
deficiency was due primarily to (i) depressed refined product margins resulting
from weak refining industry fundamentals and (ii) the effect of significant
downtime at our Corpus Christi refinery in early 1999 due to a major maintenance
turnaround and expansion of the heavy oil cracker and related units. For the
year ended December 31, 1998, our earnings were insufficient to cover fixed
charges by $80.6 million. This deficiency was due primarily to a $170.9 million
pre-tax charge to earnings to write down the carrying amount of our 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.
Prior to our spin-off from our former parent on July 31, 1997, our parent
had preferred stock outstanding which was issued in connection with the
discontinued natural gas related services business. We had no preferred stock
outstanding with respect to continuing operations for any period presented. As a
result, the ratio of earnings to combined fixed charges and preferred stock
dividends for each of the periods is the same as the ratio of earnings to fixed
charges.
DESCRIPTION OF DEBT SECURITIES
The debt securities covered by this prospectus will be our general
unsecured obligations. We will issue senior debt securities under an indenture
dated as of December 12, 1997 between us and The Bank of New York, a New York
banking corporation, as trustee. We will issue subordinated debt securities
under an indenture to be entered into between us and The Bank of New York, as
indenture trustee. The indenture for the senior debt securities and the
indenture for the subordinated debt securities will be substantially identical,
except for the provisions relating to subordination and restrictive covenants.
We sometimes refer to the senior indenture and the subordinated indenture as the
"indentures."
We have summarized selected provisions of the indentures and the debt
securities below. This summary is not complete. We have filed the senior
indenture and the form of subordinated indenture with the SEC as exhibits to the
registration statement, and you should read the indentures for provisions that
may be important to you before investing in these securities. Please read "Where
You Can Find More Information."
RANKING
The senior debt securities will constitute senior debt and will rank
equally with all of our unsecured and unsubordinated debt. The subordinated debt
securities will be subordinated to, and thus have a junior
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position to, the senior debt securities and all of our other senior debt.
Neither indenture limits the amount of debt securities that can be issued under
that indenture or the amount of additional indebtedness Valero or any of its
subsidiaries may incur. We may issue debt securities under either indenture from
time to time in one or more series, each in an amount we authorize prior to
issuance. The trustee will authenticate and deliver debt securities executed and
delivered to it by us as set forth in the applicable indenture.
Valero is organized as a holding company that owns subsidiary companies.
Its subsidiary companies conduct substantially all of its business. The holding
company structure results in two principal risks:
- Valero's subsidiaries may be restricted by contractual provisions or
applicable laws from providing it the cash that it needs to pay parent
company debt service obligations, including payments on the debt
securities
- In any liquidation, reorganization or insolvency proceeding involving
Valero, your claim as a holder of the debt securities will be effectively
junior to the claims of holders of any indebtedness or preferred stock of
our subsidiaries
TERMS
The prospectus supplement relating to any series of debt securities we are
offering will include specific terms relating to that offering. These terms will
include some or all of the following:
- whether the debt securities are senior or subordinated debt securities
- the title of the debt securities
- any limit on the total principal amount of the debt securities
- the date or dates on which the principal of the debt securities will be
payable
- any interest rate, or the method of determining the interest rate, on the
debt securities, the date from which interest will accrue, interest
payment dates and record dates
- any right to extend or defer the interest payment periods and the
duration of the extension
- if other than as set forth in this prospectus, the place or places where
payments on the debt securities will be payable
- any optional redemption provisions
- any sinking fund or other provisions that would obligate us to redeem or
purchase the debt securities
- any provisions for the remarketing of the debt securities
- any changes or additions to the events of default or covenants
- whether we will issue the debt securities in individual certificates to
each holder in registered or bearer form, or in the form of temporary or
permanent global securities held by a depositary on behalf of holders
- the denominations in which we will issue the debt securities, if other
than denominations of an integral multiple of $1,000
- the terms of any right to convert debt securities into shares of our
common stock or other securities or property
- whether payments on the debt securities will be payable in foreign
currency or currency units (including composite currencies) or another
form
- any provisions that would determine the amount of principal, premium, if
any, or interest, if any, on the debt securities by references to an
index or pursuant to a formula
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- the portion of the principal amount of the debt securities that will be
payable if the maturity is accelerated, if other than the entire
principal amount
- any other terms of the debt securities not inconsistent with the relevant
indentures
We may sell the debt securities at a discount, which may be substantial,
below their stated principal amount. These debt securities may bear no interest
or interest at a rate that at the time of issuance is below market rates. We
will describe in the prospectus supplement any material United States federal
income tax consequences applicable to those securities.
If we sell any of the debt securities for any foreign currency or currency
unit or if payments on the debt securities are payable in any foreign currency
or currency unit, we will describe in the prospectus supplement the
restrictions, elections, tax consequences, specific terms and other information
relating to those debt securities and the foreign currency or currency unit.
CONSOLIDATION, MERGER AND SALE
Valero has agreed in the indentures that we will consolidate with or merge
into any entity or transfer or dispose of all or substantially all of our assets
to any entity only if:
- Valero is the continuing corporation, or
- if Valero is not the continuing corporation, the successor is organized
and existing under the laws of any United States jurisdiction and assumes
all of Valero's obligations under the indenture and the debt securities,
and
- in either case, immediately after giving effect to the transaction, no
default or event of default would occur and be continuing
EVENTS OF DEFAULT
Unless we inform you otherwise in the prospectus supplement, the following
are events of default under the indentures with respect to a series of debt
securities:
- our failure to pay interest on any debt security of that series for 30
days
- our failure to pay principal of or any premium on any debt security of
that series when due
- our failure to make any sinking fund payment for any debt security of
that series when due
- our failure to perform any of our other covenants or breach of any of our
other warranties in that indenture, other than a covenant or warranty
included in the indenture solely for the benefit of another series of
debt securities, and that failure continues for 60 days after written
notice is given or received as provided in the indentures
- certain bankruptcy, insolvency or reorganization events involving Valero
Energy Corporation
- our failure to pay at final maturity, after the expiration of any
applicable grace periods, or upon the declaration of acceleration of
payment of, any of our indebtedness for borrowed money in excess of $25
million, if such indebtedness is not discharged, or such acceleration is
not annulled, within 10 days after written notice is given as provided in
the indentures
- any other event of default we may provide for that series
If an event of default for any series of debt securities occurs and is
continuing, the trustee or the holders of at least 25% in principal amount of
the outstanding debt securities of the series affected by the default may
declare the principal amount of all the debt securities of that series to be due
and payable immediately. The holders of a majority in principal amount of the
outstanding debt securities of that series may in some cases rescind and annul
that acceleration.
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In most cases, the trustee will be under no obligation to exercise any of
its rights or powers under the indentures at the request or direction of any of
the holders, unless the holders have offered to the trustee reasonable
indemnity. Subject to this provision for indemnification, the holders of a
majority in aggregate principal amount of the outstanding debt securities of any
series may direct the time, method and place of:
- conducting any proceeding for any remedy available to the trustee
- exercising any trust or power conferred on the trustee, with respect to
the debt securities of that series
Each indenture requires us to furnish to the trustee annually a statement
as to our performance of certain of our obligations under the indenture and as
to any default in performance.
MODIFICATION AND WAIVER
We may modify or amend each of the indentures without the consent of any
holders of the debt securities in certain circumstances, including to:
- evidence the assumption of our obligations under the indenture and the
debt securities by a successor
- add further covenants for the protection of the holders
- cure any ambiguity or correct any inconsistency in the indenture, so long
as such action will not adversely affect the interests of the holders
- establish the form or terms of debt securities of any series
- evidence the acceptance of appointment by a successor trustee
We may modify or amend each indenture with the consent of the holders of a
majority in principal amount of the outstanding debt securities of each series
issued under the indenture affected by the modification or amendment. Without
the consent of the holder of each outstanding debt security affected, however,
no modification may:
- change the stated maturity of the principal of, or any installment of
interest on, any debt security
- reduce the principal amount of, the interest on, or the premium payable
on, any debt security
- reduce the amount of principal of discounted debt securities payable upon
acceleration of maturity
- change the place of payment or the currency in which any debt security is
payable
- impair the right to institute suit for the enforcement of any payment on
any debt security
- reduce quorum or voting rights
The holders of a majority in aggregate principal amount of the outstanding
debt securities of each series may waive past defaults by us under the
indentures with respect to the debt securities of that series only. Those
holders may not, however, waive any default in any payment on any debt security
of that series or compliance with a provision that cannot be modified or amended
without the consent of each holder affected.
DISCHARGE
We will be discharged from all obligations of any series of debt
securities, except for certain surviving obligations to register the transfer or
exchange of the debt securities and any right by the holders to receive
additional amounts under the indentures if:
- all debt securities of that series previously authenticated and delivered
under the relevant indenture have been delivered to the trustee for
cancellation or
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- all debt securities of that series have become due and payable or will
become due and payable within one year, at maturity or by redemption, and
we deposit with the trustee, in trust, sufficient money to pay the entire
indebtedness of all the debt securities of that series on the dates the
payments are due in accordance with the terms of the debt securities
To exercise the right of deposit described above, we must deliver to the
trustee an opinion of counsel and an officers' certificate stating that all
conditions precedent to the satisfaction and discharge of the relevant indenture
have been complied with.
FORM, EXCHANGE, REGISTRATION AND TRANSFER
Unless we inform you otherwise in the prospectus supplement, we will issue
the debt securities only in fully registered form, without coupons, in
denominations of $1,000 and integral multiples.
Debt securities will be exchangeable for other debt securities of the same
series, the same total principal amount and the same terms in such authorized
denominations as may be requested. Holders may present debt securities for
registration of transfer at the office of the security registrar or any transfer
agent we designate. The security registrar or transfer agent will effect the
transfer or exchange when it is satisfied with the documents of title and
identity of the person making the request. We will not charge a service charge
for any transfer or exchange of the debt securities. We may, however, require
payment of any tax or other governmental charge payable for the registration of
the transfer or exchange.
We will appoint the trustee under each indenture as security registrar for
the debt securities issued under that indenture. We are required to maintain an
office or agency for transfers and exchanges in each place of payment. We may at
any time designate additional transfer agents for any series of debt securities.
We will not be required:
- to issue, register the transfer of or exchange debt securities of a
series during a period beginning 15 business days prior to the day of
mailing of a notice of redemption of debt securities of that series
selected for redemption and ending on the close of business on the day of
mailing of the relevant notice or
- to register the transfer of or exchange any debt security, or portion of
any debt security, called for redemption, except the unredeemed portion
of any debt security we are redeeming in part
PAYMENT AND PAYING AGENTS
Unless we inform you otherwise in the prospectus supplement, principal and
interest will be payable, and the debt securities will be transferable and
exchangeable, at the office or offices of the applicable trustee or any paying
agent we designate. At our option, we will pay interest on the debt securities
by check mailed to the holder's registered address or by wire transfer for
global debt securities. Unless we inform you otherwise in a prospectus
supplement, we will make interest payments to the persons in whose name the debt
securities are registered at the close of business on the record date for each
interest payment date.
In most cases, the trustee and paying agent will repay to us upon written
request any funds held by them for payments on the debt securities that remain
unclaimed for two years after the date upon which that payment has become due.
After payment to us, holders entitled to the money must look to us for payment.
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BOOK-ENTRY AND SETTLEMENT
Valero may issue the debt securities of a series in the form of one or more
global debt securities that would be deposited with a depositary or its nominee
identified in the prospectus supplement. The prospectus supplement will
describe:
- any circumstances under which beneficial owners may exchange their
interests in a global debt security for certificated debt securities of
the same series with the same total principal amount and the same terms
- the manner in which Valero will pay principal of and any premium and
interest on a global debt security
- the terms of any depositary arrangement and the rights and limitations of
owners of beneficial interests in any global debt security
NOTICES
Notices to holders will be given by mail to the addresses of such holders
as they appear in the security register.
GOVERNING LAW
New York law will govern each indenture and the debt securities.
THE TRUSTEE
The Bank of New York is the trustee under the senior indenture. Its address
is 101 Barclay Street, Floor 21 West, New York, New York 10286. Pursuant to the
senior indenture, The Bank of New York serves as trustee with regard to
approximately $450,000,000 aggregate principal amount of our senior unsecured
notes and receives customary fees for its services. The Bank of New York also
will serve as trustee under the subordinated indenture. Please read "About This
Prospectus."
The holders of a majority in principal amount of the outstanding debt
securities of any series issued under each indenture will have the right to
direct the time, method and place of conducting any proceeding for exercising
any remedy available to the trustee, subject to certain exceptions. If an event
of default occurs and is continuing, the trustee will be required in the
exercise of its powers to use the degree of care and skill of a prudent person
in the conduct of his own affairs. The trustee will be obligated to exercise any
of its rights or powers under the relevant indenture at the request of any
holders of debt securities of any series issued under that indenture only after
those holders have offered the trustee indemnity reasonably satisfactory to it.
The trustee may resign at any time or the holders of a majority in principal
amount of the debt securities may remove the trustee. If the trustee resigns, is
removed or becomes incapable of acting as trustee or if a vacancy occurs in the
office of the trustee for any reason, we will appoint a successor trustee in
accordance with the provisions of the applicable indenture.
If the trustee becomes one of our creditors, it will be subject to
limitations in the indenture on its rights to obtain payment of claims or to
realize on certain property received for any claim, as security or otherwise.
The trustee may engage in other transactions with us. If, however, it acquires
any conflicting interest, it must eliminate that conflict or resign as required
under the indenture.
SUBORDINATION UNDER THE SUBORDINATED INDENTURE
Under the subordinated indenture, payment of the principal, interest and
any premium on the subordinated debt securities will generally be subordinated
and junior in right of payment to the prior
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payment in full of all senior debt. Unless we inform you otherwise in the
prospectus supplement, we may not make any payment of principal of, interest on,
or any premium on, the subordinated debt securities if:
- we fail to pay the principal, interest, premium or any other amounts on
any senior debt when due or
- we default in performing any other covenant (a "covenant default") in any
senior debt that we have designated if the covenant default allows the
holders of that senior debt to accelerate the maturity of the senior debt
they hold
Unless we inform you otherwise in the prospectus supplement, a covenant
default will prevent us from paying the subordinated debt securities only for up
to 179 days after holders of the senior debt give the trustee for the
subordinated debt securities notice of the covenant default.
The subordination does not affect our obligation, which is absolute and
unconditional, to pay, when due, the principal of and any premium and interest
on the subordinated debt securities. In addition, the subordination does not
prevent the occurrence of any default under the subordinated indenture.
The subordinated indenture will not limit the amount of senior debt that we
may incur. As a result of the subordination of the subordinated debt securities,
if we became insolvent, holders of subordinated debt securities may receive less
on a proportionate basis than other creditors.
Unless we inform you otherwise in the prospectus supplement, "senior debt"
will mean all indebtedness, including guarantees, of Valero, unless the
indebtedness states that it is not senior to the subordinated debt securities or
our other junior debt.
RESTRICTIVE COVENANTS IN THE SENIOR INDENTURE
We have agreed to two principal restrictions on our activities for the
benefit of holders of the senior debt securities. Unless waived or amended, the
restrictive covenants summarized below will apply to a series of debt securities
issued under the senior indenture as long as any of those debt securities is
outstanding, unless the prospectus supplement for the series states otherwise.
We have used in this summary description terms that we have defined below under
"-- Glossary."
Limitations on Liens
We have agreed that when any senior debt securities are outstanding neither
we nor any of our subsidiaries will create or assume any liens upon any of our
receivables or other assets or any asset, stock or indebtedness of any of our
subsidiaries unless those senior debt securities are secured equally and ratably
with or prior to the debt secured by the lien. This covenant has exceptions that
permit:
- subject to certain limitations, any lien created to secure all or part of
the purchase price of any property or to secure a loan made to finance
the acquisition of the property described in such lien
- subject to certain limitations, any lien existing on any property at the
time of its acquisition or created not later than 12 months thereafter
- subject to certain limitations, any lien created in connection with the
operation or use of any property acquired or constructed by us and
created within 12 months after the acquisition, construction or
commencement of full operations on the property
- any mechanic's or materialmen's lien or any lien related to workmen's
compensation or other insurance
- any lien arising by reason of deposits with or the giving of any form of
security to any governmental agency, including for taxes and other
governmental charges
- liens for taxes or charges which are not delinquent or are being
contested in good faith
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- any judgment lien the execution of which has been stayed or which has
been adequately appealed and secured
- any lien incidental to the conduct of our business which was not incurred
in connection with the borrowing of money or the obtaining of advances or
credit and which does not materially interfere with the conduct of our
business
- any intercompany lien
- liens incurred in connection with the borrowing of funds, if such funds
are used within 120 days to repay indebtedness of at least an equal
amount secured by a lien on our property having a fair market value at
least equal to the fair market value of the property securing the new
lien
- any lien created to secure indebtedness and letter of credit
reimbursement obligations incurred in connection with the extension of
working capital financing
- any lien existing on the date of the indenture
- subject to an aggregate limit of $60 million, any lien on cash, cash
equivalents, options or futures positions and other account holdings
securing derivative obligations or otherwise incurred in connection with
margin accounts with brokerage or commodities firms
- subject to an aggregate limit of 10% of our consolidated net tangible
assets, any liens not otherwise permitted by any of the other exceptions
set forth in the indenture
Limitations on Sale/Leaseback Transactions
We have agreed that neither we nor our subsidiaries would enter into any
sale/leaseback transactions with regard to any principal property, providing for
the leasing back to us or a subsidiary by a third party for a period of more
than three years of any asset which has been or is to be sold or transferred by
us or such subsidiary to such third party or to any other person. This covenant
has exceptions that permit transactions of this nature under the following
circumstances:
- we would be entitled, pursuant to the "Limitations on Liens" covenant
described above, to incur indebtedness secured by a lien on the property
to be leased, without equally and ratably securing the senior debt
securities then outstanding or
- within 120 days of the effective date of such sale/leaseback transaction,
we apply an amount equal to the value of such transaction:
- to the voluntary retirement of funded debt or
- to the purchase of another principal property
In addition, subject to a limit (on an aggregated basis with indebtedness
secured by liens permitted by the limitations on liens covenant described above)
of 10% of our consolidated net tangible assets, we can enter into sale/leaseback
transactions not otherwise permitted by the express provisions of the indenture.
Glossary
We define the following terms in the senior indenture. We use them here
with the same definitions. Generally accepted accounting principles should be
used to determine all items in this section, unless otherwise indicated.
"Consolidated net tangible assets" means the total amount of assets shown
on a consolidated balance sheet of us and our subsidiaries (excluding goodwill
and other intangible assets), less all current liabilities (excluding notes
payable and current maturities of long-term debt).
"Funded debt" means generally any indebtedness for money borrowed, created,
issued, incurred, assumed or guaranteed which would be classified as long-term
debt.
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"Principal Property" means any of our or our subsidiaries' refineries or
refinery-related assets, distribution facilities or other real property which
has a net book value exceeding 2.5% of consolidated net tangible assets, but not
including any property which in our opinion is not material to our and our
subsidiaries' total business conducted as an entirety or any portion of a
particular property that is similarly found not to be material to the use or
operation of such property.
"Subsidiary" means any entity of which at the time of determination we or
one or more of our subsidiaries owns or controls directly or indirectly more
than 50% of the shares of voting stock or the outstanding partnership or similar
interests and any limited partnership of which we or any one of our subsidiaries
are a general partner.
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of:
- 150,000,000 shares of common stock, par value $.01 per share
- 20,000,000 shares of preferred stock, par value $.01 per share, issuable
in series
We have summarized selected aspects of our capital stock below. The summary
is not complete. For a complete description, you should refer to our restated
certificate of incorporation, restated by-laws and the Rights Agreement, dated
as of July 17, 1997 between us and Harris Trust and Savings Bank, as rights
agent, all of which are exhibits to the registration statement of which this
prospectus is part.
COMMON STOCK
Each share of common stock is entitled to participate equally in dividends
as and when declared by our board of directors. The payment of dividends on our
common stock may be limited by obligations we may have to holders of any
preferred stock. For information regarding restrictions on payments of
dividends, see the prospectus supplement applicable to any issuance of common
stock.
Common stockholders are entitled to one vote for each share held on all
matters submitted to them. The common stock does not have cumulative voting
rights, meaning that holders of a majority of the shares of common stock voting
for the election of directors can elect all the directors if they choose to do
so.
If we liquidate or dissolve our business, the holders of common stock will
share ratably in the distribution of assets available for distribution to
stockholders after creditors are paid and preferred stockholders receive their
distributions. The shares of common stock have no preemptive rights and are not
convertible, redeemable or assessable or entitled to the benefits of any sinking
fund.
All issued and outstanding shares of common stock are fully paid and
nonassessable. Any shares of common stock we offer under this prospectus will be
fully paid and nonassessable.
The common stock is listed on the New York Stock Exchange and trades under
the symbol "VLO."
PREFERRED STOCK
Our board of directors can, without action by stockholders, issue one or
more series of preferred stock. The board can determine for each series the
number of shares, designation, relative voting rights, dividend rates,
liquidation and other rights, preferences and limitations. In some cases, the
issuance of preferred stock could delay or discourage a change in control of us.
We have summarized material provisions of the preferred stock in this
section. This summary is not complete. We will file the form of the preferred
stock with the SEC before we issue any of it, and you should read it for
provisions that may be important to you.
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The prospectus supplement relating to any series of preferred stock we are
offering will include specific terms relating to the offering. These terms will
include some or all of the following:
- the title of the preferred stock
- the maximum number of shares of the series
- the dividend rate or the method of calculating the dividend, the date
from which dividends will accrue and whether dividends will be cumulative
- any liquidation preference
- any redemption provisions
- any sinking fund or other provisions that would obligate us to redeem or
purchase the preferred stock
- any terms for the conversion or exchange of the preferred stock for other
securities of us or any other entity
- any voting rights
- any other preferences and relative, participating, optional or other
special rights or any qualifications, limitations or restrictions on the
rights of the shares
Any shares of preferred stock we issue will be fully paid and
nonassessable.
Our board of directors has reserved for issuance pursuant to our
Stockholder Rights Plan described below a total of 1,500,000 shares of Junior
Participating Preferred Stock, Series I. We have not issued any shares of
preferred stock at the date of this prospectus.
ANTI-TAKEOVER PROVISIONS
The provisions of Delaware law and our restated certificate of
incorporation and our restated by-laws summarized below may have an
anti-takeover effect and may delay, defer or prevent a tender offer or takeover
attempt that a stockholder might consider in his or her best interest, including
those attempts that might result in a premium over the market price for the
common stock.
Staggered Board of Directors
Our board of directors is divided into three classes that are elected for
staggered three-year terms. The classification of the board of directors has the
effect of requiring at least two annual stockholder meetings, instead of one, to
effect a change in control of the board of directors. Holders of 60% of the
shares of common stock entitled to vote in the election of directors may remove
a director for cause, but stockholders may not remove any director without
cause.
Fair Price Provision
Our restated certificate of incorporation contains a fair price provision.
Mergers, consolidations and other business combinations involving us and an
"interested stockholder" require the approval of holders of at least 66 2/3% of
our outstanding voting stock not owned by the interested stockholder. Interested
stockholders include the holder of 15% or more of our outstanding voting stock.
The 66 2/3% voting requirement does not apply, however, if the "continuing
directors," as defined in our restated certificate of incorporation, approve the
business combination, or the business combination meets other specified
conditions.
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Liability of Our Directors
As permitted by the Delaware corporations statute, we have included in our
restated certificate of incorporation a provision that limits our directors'
liability for monetary damages for breach of their fiduciary duty of care to us
and our stockholders. The provision does not affect the liability of a director:
- for any breach of his/her duty of loyalty to us or our stockholders
- for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law
- for the declaration or payment of unlawful dividends or unlawful stock
repurchases or redemptions or
- for any transaction from which the director derived an improper personal
benefit
This provision also does not affect a director's responsibilities under any
other laws, such as the federal securities laws or state or federal
environmental laws.
Stockholder Proposals and Director Nominations
Our stockholders can submit stockholder proposals and nominate candidates
for our board of directors if the stockholders follow advance notice procedures
described in our restated by-laws.
Generally, stockholders must submit a written notice between 60 and 90 days
before the first anniversary of the date of our previous year's annual
stockholders' meeting. To nominate directors, the notice must include the name
and address of the stockholder, the class and number of shares owned by the
stockholder, information about the nominee required by the SEC and a description
of any arrangements or understandings with respect to the election of directors
that exist between the stockholder and any other person. To make stockholder
proposals, the notice must include a description of the proposal, the reasons
for bringing the proposal before the meeting, the name and address of the
stockholder, the class and number of shares owned by the stockholder and any
material interest of the stockholder in the proposal.
In each case, if we have changed the date of the annual meeting to more
than 30 days before or 60 days after the anniversary date of our previous year's
annual stockholders' meeting, stockholders must submit the notice between 60 and
90 days prior to such annual meeting or no later than 10 days after the day we
make public the date of the annual meeting.
Director nominations and stockholder proposals that are late or that do not
include all required information may be rejected. This could prevent
stockholders from bringing certain matters before an annual meeting, including
making nominations for directors.
Delaware Anti-takeover Statute
We are a Delaware corporation and are subject to Section 203 of the
Delaware General Corporation Law. In general, Section 203 prevents us from
engaging in a business combination with an "interested stockholder" (generally,
a person owning 15% or more of our outstanding voting stock) for three years
following the time that person becomes a 15% stockholder unless one of the
following is satisfied:
- before that person became a 15% stockholder, our board of directors
approved the transaction in which the stockholder became a 15%
stockholder or approved the business combination
- upon completion of the transaction that resulted in the stockholder's
becoming a 15% stockholder, the stockholder owns at least 85% of our
voting stock outstanding at the time the transaction began (excluding
stock held by directors who are also officers and by employee stock plans
that do not provide employees with the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer) or
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- after the transaction in which that person became a 15% stockholder, the
business combination is approved by our board of directors and authorized
at a stockholders' meeting by at least two-thirds of the outstanding
voting stock not owned by the 15% stockholder
Under Section 203, these restrictions also do not apply to certain business
combinations proposed by a 15% stockholder following the disclosure of an
extraordinary transaction with a person who was not a 15% stockholder during the
previous three years or who became a 15% stockholder with the approval of a
majority of our directors. This exception applies only if the extraordinary
transaction is approved or not opposed by a majority of our directors who were
directors before any person became a 15% stockholder in the previous three
years, or the successors of these directors.
Other Provisions
Our restated certificate of incorporation also provides that:
- stockholders may act only at an annual or special meeting and not by
written consent
- an 80% vote of the outstanding voting stock is required for the
stockholders to amend our restated by-laws and
- an 80% vote of the outstanding voting stock is required to amend our
restated certificate of incorporation with respect to certain matters,
including those described in the first two bullet points above
TRANSFER AGENT AND REGISTRAR
Harris Trust and Savings Bank, Chicago, Illinois, is our transfer agent and
registrar.
STOCKHOLDER RIGHTS PLAN
We have a stockholder rights plan under which one preferred share purchase
right is attached to each outstanding share of our common stock. The rights
become exercisable under specified circumstances, including any person or group
(an "acquiring person") becoming the beneficial owner of 15% or more of our
outstanding common stock, subject to specified exceptions. Each right entitles
the registered holder to purchase from us one one-hundredth of a share of Junior
Participating Preferred Stock, Series I, at an exercise price of $100, subject
to adjustment under specified circumstances. If events specified in the
stockholder rights plan occur, each holder of rights other than the acquiring
person can exercise their rights. When a holder exercises a right, the holder
will be entitled to receive common stock valued at twice the exercise price of
the right. In some cases, the holder will receive cash, property or other
securities instead of common stock. We may redeem the rights for $0.01 per right
at any time prior to the tenth day after a person or group becomes an acquiring
person. The stockholder rights plan and the rights expire in June 2007.
DESCRIPTION OF WARRANTS
We may issue warrants to purchase debt securities, common stock, preferred
stock or other securities. We may issue warrants independently or together with
other securities. Warrants sold with other securities may be attached to or
separate from the other securities. We will issue warrants under one or more
warrant agreements between us and a warrant agent that we will name in the
prospectus supplement.
The prospectus supplement relating to any warrants we are offering will
include specific terms relating to the offering. These terms will include some
or all of the following:
- the title of the warrants
- the aggregate number of warrants offered
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- the designation, number and terms of the debt securities, common stock,
preferred stock or other securities purchasable upon exercise of the
warrants and procedures by which those numbers may be adjusted
- the exercise price of the warrants
- the dates or periods during which the warrants are exercisable
- the designation and terms of any securities with which the warrants are
issued
- if the warrants are issued as a unit with another security, the date on
and after which the warrants and the other security will be separately
transferable
- if the exercise price is not payable in U.S. dollars, the foreign
currency, currency unit or composite currency in which the exercise price
is denominated
- any minimum or maximum amount of warrants that may be exercised at any
one time
- any terms relating to the modification of the warrants
- any terms, procedures and limitations relating to the transferability,
exchange or exercise of the warrants
The description in the prospectus supplement will not necessarily be
complete, and reference will be made to the warrant agreements which will be
filed with the SEC.
PLAN OF DISTRIBUTION
We may sell the offered securities in and outside the United States (a)
through underwriters or dealers, (b) directly to purchasers, including our
affiliates, (c) through agents or (d) through a combination of any of these
methods. The prospectus supplement will include the following information:
- the terms of the offering
- the names of any underwriters or agents
- the name or names of any managing underwriter or underwriters
- the purchase price of the securities from us
- the net proceeds to us from the sale of the securities
- any delayed delivery arrangements
- any underwriting discounts, commissions and other items constituting
underwriters' compensation
- any initial public offering price
- any discounts or concessions allowed or reallowed or paid to dealers
- any commissions paid to agents
SALE THROUGH UNDERWRITERS OR DEALERS
If we use underwriters in the sale, the underwriters will acquire the
securities for their own account. The underwriters may resell the securities
from time to time in one or more transactions, including negotiated
transactions, at a fixed public offering price or at varying prices determined
at the time of sale. Underwriters may offer securities to the public either
through underwriting syndicates represented by one or more managing underwriters
or directly by one or more firms acting as underwriters. Unless we inform you
otherwise in the prospectus supplement, the obligations of the underwriters to
purchase the securities will be subject to certain conditions, and the
underwriters will be obligated to purchase all the offered
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securities if they purchase any of them. The underwriters may change from time
to time any initial public offering price and any discounts or concessions
allowed or reallowed or paid to dealers.
During and after an offering through underwriters, the underwriters may
purchase and sell the securities in the open market. These transactions may
include overallotment and stabilizing transactions and purchases to cover
syndicate short positions created in connection with the offering. The
underwriters may also impose a penalty bid, which means that selling concessions
allowed to syndicate members or other broker-dealers for the offered securities
sold for their account may be reclaimed by the syndicate if the offered
securities are repurchased by the syndicate in stabilizing or covering
transactions. These activities may stabilize, maintain or otherwise affect the
market price of the offered securities, which may be higher than the price that
might otherwise prevail in the open market. If commenced, the underwriters may
discontinue these activities at any time.
If we use dealers in the sale of securities, we will sell the securities to
them as principals. They may then resell those securities to the public at
varying prices determined by the dealers at the time of resale. We will include
in the prospectus supplement the names of the dealers and the terms of the
transaction.
DIRECT SALES AND SALES THROUGH AGENTS
We may sell the securities directly. In this case, no underwriters or
agents would be involved. We may also sell the securities through agents we
designate from time to time. In the prospectus supplement, we will name any
agent involved in the offer or sale of the offered securities, and we will
describe any commissions payable by us to the agent. Unless we inform you
otherwise in the prospectus supplement, any agent will agree to use its
reasonable best efforts to solicit purchases for the period of its appointment.
We may sell the securities directly to institutional investors or others
who may be deemed to be underwriters within the meaning of the Securities Act of
1933 with respect to any sale of those securities. We will describe the terms of
any such sales in the prospectus supplement.
DELAYED DELIVERY CONTRACTS
If we so indicate in the prospectus supplement, we may authorize agents,
underwriters or dealers to solicit offers from certain types of institutions to
purchase securities from us at the public offering price under delayed delivery
contracts. These contracts would provide for payment and delivery on a specified
date in the future. The contracts would be subject only to those conditions
described in the prospectus supplement. The prospectus supplement will describe
the commission payable for solicitation of those contracts.
GENERAL INFORMATION
We may have agreements with the agents, dealers and underwriters to
indemnify them against certain civil liabilities, including liabilities under
the Securities Act of 1933, or to contribute with respect to payments that the
agents, dealers or underwriters may be required to make. Agents, dealers and
underwriters may be customers of, engage in transactions with or perform
services for us in the ordinary course of their businesses.
LEGAL MATTERS
Mr. Jay D. Browning, Esq., Managing Attorney, Corporate Law and Secretary
of Valero, will issue opinions about the legality of the offered securities for
us. Mr. Browning is our employee and at May 1, 2000, beneficially owned 1,419
shares of our common stock (including shares held under employee benefit plans)
and held options under our employee stock option plans to purchase an additional
28,412 shares of our common stock. None of such shares or options were granted
in connection with the offering of the securities. Any underwriters will be
advised about other issues relating to any offering by their own legal counsel.
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EXPERTS
Our audited consolidated financial statements incorporated by reference in
this prospectus from our annual report on Form 10-K for the year ended December
31, 1999 have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report with respect thereto, and are
incorporated in this prospectus by reference in reliance upon the authority of
said firm as experts in accounting and auditing in giving said report.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. You can read and copy any materials we file with the
SEC at the SEC's public reference room at 450 Fifth Street, N.W., Washington,
D.C. 20549. You can obtain information about the operation of the SEC's public
reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a
web site that contains information we file electronically with the SEC, which
you can access over the Internet at http://www.sec.gov. You can obtain
information about us at the offices of the New York Stock Exchange, 20 Broad
Street, New York, New York 10005.
This prospectus is part of a registration statement we have filed with the
SEC relating to the securities we may offer. As permitted by SEC rules, this
prospectus does not contain all of the information we have included in the
registration statement and the accompanying exhibits and schedules we file with
the SEC. You may refer to the registration statement, the exhibits and schedules
for more information about us and our securities. The registration statement,
exhibits and schedules are available at the SEC's public reference room or
through its web site.
INFORMATION WE INCORPORATE BY REFERENCE
We are incorporating by reference information we file with the SEC, which
means that we are disclosing important information to you by referring you to
those documents. The information we incorporate by reference is an important
part of this prospectus, and information that we file later with the SEC
automatically will update and supersede this information. We incorporate by
reference the documents listed below and any future filings we make with the SEC
under Section 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934
until we sell all the securities:
- our annual report on Form 10-K for the year ended December 31, 1999
- our quarterly report on Form 10-Q for the quarterly period ended March
31, 2000
- the description of our common stock contained in our registration
statement on Form 8-A, as may be amended from time to time to update that
description
- the description of the rights associated with our common stock contained
in our registration statement on Form 8-A, as may be amended from time to
time to update that description
- our current report on Form 8-K dated March 17, 2000 and filed with the
SEC on March 20, 2000
You may request a copy of these filings (other than an exhibit to those
filings unless we have specifically incorporated that exhibit by reference into
the filing), at no cost, by writing or telephoning us at the following address:
Valero Energy Corporation
One Valero Place
San Antonio, Texas 78212
Attention: Investor Relations
Telephone: (210) 370-2139
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